Vice President: Callisto Madavo Country Director: Emmanuel Mbi Sector Manager: Cadman Atta Mills Team Leader: Eric Nelson

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized FROM: The President REPUBLIC OF BURUNDI Economic Rehabilitation Credit (Cr BU) Release of the Second Tranche April 25, On August 29, 2002, the Executive Directors approved an Economic Rehabilitation Credit (ERC) of SDR 40.8 million to the Republic of Burundi. The ERC is an integral part of the Bank s Transitional Support Strategy (TSS) discussed by the Board on March 7, 2002, to support the transition process and the implementation of the Government s reform program. The Credit was declared effective on October 23, 2002, and the first tranche, of SDR 15.1 million, was released upon effectiveness. A second tranche, of SDR 15.1 million, was to be made available for disbursement upon liberalization of the Borrower s foreign exchange system and fulfillment of budget-related conditions for that tranche described in this memorandum, and a third and final tranche, of SDR 10.6 million, was to be made available for disbursement upon fulfillment of the conditions for that tranche. 2. This memorandum informs Executive Directors that the Second Tranche, of SDR 15.1 million, has been made available for disbursement. As provided in Section 3.01 of and Schedule 1 to the Development Credit Agreement, staff have reviewed with the Government the progress achieved in implementing the program. This memorandum summarizes these reviews and reports on the actions taken by the Government. It concludes that: (a) the macroeconomic policy framework for growth and poverty reduction is consistent with the objectives of the reform program; (b) satisfactory progress has been achieved in the overall execution of the program; and (c) all specific conditions pertaining to the release of the Second Tranche have been met. Vice President: Callisto Madavo Country Director: Emmanuel Mbi Sector Manager: Cadman Atta Mills Team Leader: Eric Nelson James D. Wolfensohn President By Shengman Zhang

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3 I. BACKGROUND OVERALL PROGRESS OF THE PROGRAM 1. The people of Burundi are making efforts to bring to an end a crisis engendered by recurrent conflicts and rivalry between the two main ethnic groups, the Hutu and Tutsi. The last conflict, which broke out in 1993, resulted in the death of a large number of civilians and left thousands of victims. It is believed that more than 250,000 people were killed in the eight-year civil war, and the number of internally displaced persons and refugees is estimated at 1.2 million. The increasing social and economic costs of this conflict prompted the international community to help Burundi establish a framework for negotiations towards national reconciliation and durable peace. Negotiations in Arusha, Tanzania resulted in a comprehensive peace agreement (Arusha Accord), signed in August A new power-sharing Government, inaugurated on November 1, 2001 in accordance with this Accord, has the responsibility to administer the country during the 36-month transition period leading to general democratic elections. The transition period has two phases, to respect the power-sharing principle. Pierre Buyoya, a Tutsi, has led the first 18-month period, with Domitien Ndayizeye, a Hutu, as Vice President. Beginning May 1, 2003, Mr. Ndayizeye will lead the Government in the second 18-month period with a Tutsi, Alphonse Kadege, confirmed by the Senate and National Assembly on April 25 as the new Vice President. However, the overall situation on the ground remains fragile. 2. Burundi continues to face difficult development challenges. These include fostering inclusiveness, peace and security, promoting national reconciliation and good governance, resettling and reintegrating displaced persons and other victims of conflict, rehabilitating destroyed economic and social infrastructure, revitalizing the economy and strengthening human resource capacities. 3. In this environment, beginning in 1999 the World Bank provided emergency assistance within the framework of an Interim Strategy (Report No BU dated July 30, 1999) to help support the peace process, jump-start the economy, and rekindle the reform program. Building on this, the TSS discussed by the Board on March 7, 2002 made an exceptional IDA allocation to Burundi to consolidate the progress made and to support economic reforms for growth and poverty reduction. Within the TSS, the Economic Rehabilitation Credit (ERC) is designed to support the transition process in Burundi through the rehabilitation and the recovery of the economy by helping to build the foundation for (a) the improvement of public service delivery and basic social services, (b) the Government's efforts to deepen institutional and structural reforms for sustained economic recovery and poverty reduction, and (c) the establishment of a track record for early access to relief under the Enhanced Highly Indebted Poor Country (HPC) Initiative. The ERC also builds on the reforms and analytical work on the public expenditure management system carried out under the TSS. 11. RECENT POLITICAL AND SECURITY DEVELOPMENTS 4. Restoration of peace. The political transition is proceeding with the handover from President Buyoya to Vice-president Ndayizeye on schedule for May 1, While two rebel groups, "Forces Nationales de Liberation" (FNL) and "Forces de Defense de la Democratie'' 2

4 (FDD), did not sign the Peace Accord and were not part of the Transition Government, negotiations that continued under the joint chairmanship of President Mkapa of Tanzania and Deputy President Zuma of South Africa led to signing a cease-fire in The leadership of the two groups joined the transition Government. Leaders of both sides of the ethnic divide appear determined to do whatever they can to keep the peace process on track. However, the peace process is fluid and still unstable. One FNL-PALIPEHUTU faction and a breakaway element of the CNDD-FDD continue violent opposition despite a ceasefire signed with the CNDD-FDD on December 2, Much of the country is safe but insecurity continues in some regions, including the district neighboring Bujumbura, Bujumbura Rurale province. International observers have been in place since March 2003, and an international peace-keeping force, acting under the authority of the African Union and initially be made up of 1,500 troops from South Africa, 900 from Ethiopia and 200 from Mozambique, is being mobilized and will be in place by May. The force's mandate will be to demobilize and disarm all armed groups and to set up an integrated national army and police force. A committee to monitor the cease-fire, comprising representatives from the government, rebel groups and the international peacekeeping force, was established in February The Government has asked the World Bank to lead efforts to help it design a Burundi Ex-Combatants Assistance Program and to provide financial assistance, within the framework of the Multi-country Demobilization and Reintegration Program (MDRP). 5. The peace process in neighboring Democratic Republic of Congo is on track, terminating on April with an agreement for a transition government. Nonetheless, the considerable violence that continues in the Eastern parts of the DRC has a direct implication for Burundi, in terms of its security as well as its markets. In recent bilateral discussions, Burundi agreed to withdraw its forces from the DRC while the Congolese government pledged to discontinue support to the Burundian armed groups. The international community's support for both the Lusaka process (which deals with the conflict in the DRC) and the Arusha process is essential for consolidating peace in the Great Lakes Region. 6. Within the transitional govemment, people are collaborating. This collaboration continues at all levels. There are indications of commitment of most stakeholders to peace and the creation of a viable transition process, characterized by potentially credible institutions, a strong anti-poverty program and the protection of human rights. Burundi has produced in November 2002 an Interim PRSP (I-PRSP), which has been submitted to the Bank and IMF for their joint staff appraisal. An appraisal mission is planned for June The 2003 budget reflects priorities identified in the I-PRSP. 7. As peace progresses and takes hold, Burundi faces an enormous problem of demobilization of combatants, the resettlement of a million persons-nearly 15 percent of the population-who are refugees or internally displaced, and assistance to those have suffered from conflict internally. Social and economic institutions must be rebuilt and social institutions that discourage violence as a method of resolving conflicts need to be buttressed MACROECONOMIC POLICY FRAMEWORK 8. The economy has recovered significantly during 2002 and early 2003, driven by favorable weather for agriculture and by an increase in construction as private confidence has returned and as a result of increased development assistance. Real GDP growth was about 4% percent in 2002, 3

5 more than double the 2001 increase and, more important, a significant reversal from the falling real GDP in 1999 and Nevertheless, and despite a coffee crop in that was more than twice as large as the poor crop of the season, export revenues have fallen. This is due in the first place to price effects (an adverse shift in terms of trade in the sector, and lower quality as coffee plantations were poorly attended due to the continuing conflict), and in the second place to the reduction in recent years in local capability to transport the increased volume of coffee to market. Nevertheless, because of drought conditions in late 2002 and early 2003, it is expected that agricultural output will fall in 2003, and the GDP growth might not exceed one percent. 9. Donor Response. Following the Arusha Accord in August 2000, an international donors meeting called by President Mandela was held in December 2000 and raised over US$400 million. Donors met again in December 2001, and in April 2002 the I-PRSP was presented and endorsed by the donor community at a thematic meeting. At a round-table held in November 2002, donors pledged US$981 million for Problems remain concerning the service and eventual reduction of Burundi s external debt, whose current net value amounts to 1,061 per cent of 2001 exports and most of which (US$149 million) is in arrears. A multi-donor debt service trust find has been established but to date, the contributions are insufficient to cover debt service in the medium term even to permit one multilateral lender, the African Development Bank, to resume lending activity. 11. Fiscal developments. Overall fiscal performance was in line with the objectives of the revised budget law approved in August 2002 with assistance from the IMF. Government revenue collection was less than projected, mainly due to lack of customs revenue from a declining level of imports (next section), but this was more than offset by a decline in government expenditure. The primary budget balance (excluding foreign-financed projects) was more than 2 percent of GDP. In discussions with the IMF under the post-conflict assistance program, the government expects in 2003 to maintain a primary budget surplus of 1% percent of GDP, while with an increase in investment spending the overall deficit excluding grants will increase from 5 percent of GDP to 10 percent. 12. Fiscal revenues are expected to be lower in 2003, with lower excise duties on beer, likely lower domestic transaction tax revenues, and a decrease in selected import duties in preparation for the adoption of the COMESA common external tariff. The system of granting exemptions from the turnover tax has been streamlined, but remaining exemptions continue to distort rates of effective protection while contributing to loss of potential revenue. 13. The 2003 budget is designed in accordance with the guidance provided by the I-PRSP. It has increased the share of health and education spending from 21 percent of the budget in 2002 to more than 25 percent in Military spending has been maintained constant in nominal terms, implying a reduction of 0.2 percent of GDP from 2002 to 2003, although demobilization expenditures in 2003 may lead to a revision upwards in this budget item. 14. On the external side, the current account deficit narrowed from 7 percent of GDP in 2001 to 6 percent in 2002, despite 3 percent deterioration in Burundi s terms of trade. This improvement was driven by slightly higher coffee exports from the greatly increased harvest as described above, and to a decline in imports due to low project aid disbursements and a scarcity 4

6 of foreign exchange throughout much of External debt payments arrears rose to US$149 million, nearly 25 percent of GDP by the end of Despite the stagnation of export revenues, the government continued its program of economic liberalization. The first tranche of IDA S ERC for US$20 million, released in November 2002 followed by an EU program grant of 8 million in December, permitted the amount of foreign exchange sold to the private sector through the Central Bank auction to increase to a scale where the weekly auctions could be regularized and the amount sold standardized. The positive list of imports eligible for foreign exchange was abolished in August The foreign exchange auction mechanism was changed from a first-price auction to a modified dutch auction producing a single, weighted transaction rate; in response the bids became more dispersed. Beginning in January 2003 banks were permitted to retain a portion of the foreign exchange from exports (30 percent of coffee, tea and cotton sales; 100 percent of other exports), which increased greatly their ability to provide foreign exchange to their customers outside the auction process and improved the interbank market, while retaining a close link by the market to rates set at the auction. Competitiveness was maintained by a devaluation of the Burundian franc by 20 percent in August 2002, with the devaluation enforced by the imposition of limit prices on the foreign exchange auction. IV. PROGRESS UNDER THE ERC 16. The ERC is an integral part of the Bank s Transitional Support Strategy to support the transition process and the implementation of the transitional government s reform program. The government s program seeks to support poverty reduction efforts, increases the efficiency of resource allocation and utilization, and establish transitional institutions. A series of measures already taken moved the government budget from deficit to surplus, reduced inflation, and reduced indebtedness to the banking system. The strategy outlined in the I-PRSP emphasizes: (i) diversification of sources of growth and rural income, (ii) macroeconomic stability and economic growth, (iii) private sector development, (iv) peace, security and good governance, (v) rehabilitation and reintegration of victims and internally displaced persons, and (vi) strengthening human resources and combating HIV/AIDS. 17. In the period supported by this ERC the Government seeks to lay the basis for sustainable growth and poverty reduction by establishing an environment favorable to private sector development, within a stable macroeconomic framework. The objective is to achieve a real GDP growth rate of 5 percent on average over the period , and at least 7 percent for the period In the area of human resources, key reforms include the reduction of ethnic, regional and gender disparities and promotion of inclusion and the local and community levels, and in all the different branches of the administration, and rehabilitation of social infrastructure coupled with improved access to social services. The Government intends to pursue a privatization strategy that will improve management, modernize production facilities and revive output, and to revive the coffee and tea subsectors. Within the administration, the ERC supports strengthening and making transparent the public procurement administration; an Auditor General (Cow des Comptes) position has already been created. 5

7 1 8. The ERC supports broad reforms in national reconciliation, economic stabilization, growth and poverty reduction in a program supported by a number of donors. Implementation is generally satisfactory. As described above, the government has successfully maintained a macroeconomic policy framework for growth and poverty reduction that is consistent with the I- PRSP and the objectives of the reform program, one of the requirements for the tranche release. The remainder of the present memorandum concentrates on specific steps and the associated requirements for tranche release. v. CONDITIONS FOR RELEASE OF THE SECOND TRANCHE 19. The Development Credit Agreement states that two general conditions must be met at the moment of each of the ERC tranche releases: that (i) the implementation of the overall reform program as outlined in the Letter of Development Policy (LDP) (and summarized in paragraph 17 above) is on track, and (ii) the overall macroeconomic environment is conducive to sustainable growth and poverty reduction, as measured on the basis of indicators agreed between the Government with the Bank. In addition, for release of the second tranche, the following specific actions should have been undertaken: 0 Adoption, through the Council of Ministers, of a strategic privatization plan, acceptable to IDA, as described in the LDP, including the establishment of a unit to implement the privatization, identification of enterprises to be privatized, and the adoption of a strategy and plan for privatization of each. 0 Furnishing to IDA of a report and an action plan, both acceptable to IDA, for the assessment and improvement of public finance management using HIPC tracking benchmarks, as described in the LDP; 0 Furnishing to IDA of a report, acceptable to IDA, on the Borrower's 2003 budget allocations to priority programs identified in the Interim PRSP and on the system for monitoring budget releases to said priority programs, as described in the LDP; and 0 Furnishing to IDA of a report including an action plan, acceptable to IDA, for the complete audit of the Treasury and improvement of Treasury operations, as described in the LDP. Overall execution of the ERC Program 20. The macroeconomic policy framework is satisfactory and program execution is satisfactory, in spite of delays in external aid disbursements, as evidenced by the report of IMF staff to its Board on the staff report and recommendation to approve the request for a drawing under the post-conflict emergency assistance policy. Overall progress in implementation of the ERC financed program is satisfactory and timely. Government's commitment remains firm. Burundi - Staff Report and Letter of Intent for Post-Conflict Emergency Assistance Request. (draft) IMF, March 27,

8 Specific conditions pertaining to the second tranche 21. Condition 1 - Strategic Privatization Plan: Adoption by the Council of Ministers of a strategic privatization plan acceptable to IDA, including the establishment of a unit to implement the privatization, identification of enterprises to be privatized, and the adoption of a strategy and plan for privatization of each. 22. Background: The State continues to be extensively involved in economic activity through State-owned enterprises; the State has shares in 48 enterprises covering 10 areas of activity. In general, these enterprises are inefficient and heavily indebted. The majority of enterprises involved in supplying services have benefited from a de jure monopoly; a large number of other branches and sectors of activity have a dominant position de facto. A privatization program was initiated in 1991, but the progress made so far has been limited, to a large extent due to the conflict in Burundi; 0.5 per cent of the State s holdings have been privatized. The Government has drawn up a program for the period up to 2005 for the full or partial privatization or restructuring of 19 state enterprises, including those operating in certain key areas such as telecommunications and electricity. 23. Action taken: A Ministry of Good Governance and Privatization has been created. A service charged with public enterprises (SCEP) has been established within the Ministry. The SCEP has submitted a detailed program for privatisation2 to the Council of Ministers, which approved it on March 25, This program addresses the REGIDESO (potable water and electricity), ONAPHA (pharmaceutical manufacture), ONATEL (telecomm), COTEBU (textiles), OTB (tea marketing), SOSUMO (sugar), ALCOVIT (livestock feed), INABU (Government printers), OCIBU (coffee marketing), SOGESTAL MUMIRWA (coffee washing station), BRARUDI (brewing), and BCB (banking). It proposes specific strategic actions for each enterprise, along with a calendar, issues to be addressed for the strategy to be successful, and an estimated cost of the privatisation process recommended. The staff finds that this condition has been satisfactorily met. 24. Condition 2 - Public finance management: Issuance of a report and an action plan satisfactory to IDA to assess and improve public finance management issues in light of the diagnostic assessment using the HIPC tracking benchmarks. 25. Background: In the context of the preparation of the ERC, the Government initiated a diagnostic assessment of public finance management issues using the 15 HIPC tracking benchmarks to improve the budget processes (formulation, execution and control) and increase poverty reduction impact of resources from the HIPC relief, in preparation for Burundi s qualification for the enhanced HIPC initiative. Ministkre de la Bonne Gouvernance et de la Privatisation, Service Charge des Entreprises Publiques, Programme indicatif de privatisation des sociktes a participation publique , Bujumbura January 17,2003. Athanase Gahungu, Minister of Finance, Letter 540/0389/2003 dated March 27,2003 addressed to Emmanuel Mbi. 7

9 26. Action taken: A report4 has been completed in March It covers the priorities of the government expressed in the I-PRSP, the Arusha Accords, the World Bank s TSS and the Letter of Intent given to the IMF. It specifically covers the HIPC tracking benchmarks. A new budget presentation5 has been developed to reflect these strategies. The staff, having reviewed these, finds that this condition has been satisfactorily met. 27. Condition 3 - Budget allocation: Agreement with IDA on the 2003 budget allocations to the priority programs identified in the Interim PRSP and on the system for monitoring budget releases to the priority programs. 28. Background: The Government s goal, given in its Letter of Development Policy, is Public spending will be stabilized at around 18.5 percent of GDP during the period , while budget allocations to priority sectors such as health, education, water and sanitation will be increased. 29. Action taken: The budget recommendations developed under the I-PRSP6 propose allocations by sector for the 2002 and 2003 budget, together with a detailed breakdown of the pro-poor expenditures budgeted. The Bank staff has reviewed this. Also, the IMF staff report on the post-conflict emergency assistance request (op. cit., para 22.) concludes, the 2003 budget provides for significant increases in allocations for the social sectors, while raising civil services wages substantially. The share of health and education spending in current expenditure has been raised from 21 percent in 2002 to more than 25 percent in An additional 1,700 teachers have been hired, mostly for primary education. Military spending has been kept broadly unchanged in nominal terms, which implies a reduction by 0.2 percentage point of GDP compared with The strong increase in public investment in 2003 is expected to help rebuild and develop infrastructures, as well as support the economic recovery and poverty reduction through labor-intensive projects. The staff finds that this condition has been satisfactorily met. 30. Condition 4 - Treasury Action Plan: Furnishing of an action plan satisfactory to IDA for audit of Treasury and improvements in Treasury operations. 31. Background: An audit of the Treasury was conducted. On the basis of this audit an action plan was developed which showed the need for extensive capacity enhancement and restructuring of financial management systems. The plan identified extensive scope for improvement in Treasury operations. 32. Action taken: A project-burundi Economic Management Support Project-is currently under development with IDA for a capacity enhancement project that will address the shortcomings. It is the staffs finding that this condition has been satisfactorily met. (( Le programme de rehabilitation et de modernisation de la gestion des finances publiques et du personnel de 1 Etat. )) March 10, (( Budget 2003 : Nouvelle presentation budgetaire )) Cadre Stratkgique de Lutte contre la pauvrete, Budget de programme

10 33. All conditions for the release of the Second Tranche of the Economic Rehabilitation Credit have been met. Overall execution of the program is satisfactory. The macroeconomic framework is consistent with the objectives of the program and execution is satisfactory. The Government of the Republic of Burundi has therefore been advised that the Second Tranche, in an amount of SDR 15.1 million, is now available for disbursement. Washington, DC April 25,2003 9