COMMISSION OF THE EUROPEAN COMMUNITIES COMMISSION DECISION

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2 COMMISSION OF THE EUROPEAN COMMUNITIES Draft Brussels, xxx C(2008) yyy final COMMISSION DECISION of on the Annual Action Programme 2008 in favour of Zambia to be financed from the 10th European Development Fund THE COMMISSION OF THE EUROPEAN COMMUNITIES, Having regard to the Treaty establishing the European Community, Having regard to the ACP-EC Partnership Agreement signed in Cotonou on 23 June , revised by the Agreement of 25 June 2005 signed in Luxemburg 2, and in particular Article 34 of Annex IV thereof, Having regard to the Internal Agreement of 17 July 2006 between the Representatives of the Governments of the Member States, meeting within the Council, on the financing of Community aid under multiannual financial framework for the period 2008 to 2013 in accordance with the ACP-EC Partnership Agreement and on the allocation of financial assistance for the Overseas Countries and Territories to which Part Four of the EC Treaty applies and in particular Article 11.1 thereof 3, Having regard to the Council Regulation (EC) No 617/2007 of 14 May 2007 on the implementation of the 10 th European Development Fund under the ACP-EC Partnership Agreement, and in particular Article 7 thereof 4. Having regard to the Financial Regulation applicable to the 10 th European Development Fund 5 and in particular Articles 21 to 24 and 29 thereof, Whereas: (1) The Commission has adopted the Country Strategy Paper for Zambia and the Multiannual Indicative Programme for the period , which provide for the following priorities: 1) eradication of poverty in the context of sustainable development, peace and security, in line with the international agenda, and with particular reference to the Millennium Development Goals; 2) human rights and OJ L 317, , p. 3. OJ L 287, , p. 5 OJ L 247, , p. 32 OJ L 152, , p.1 OJ L 78, C(2007)6057 of 12/12/2007. CSP/NIP was signed on 9 December

3 democratic governance; and 3) regional integration and gradual integration of Zambia into the world economy. (2) The MDG contract is a long-term, predictable form of non targeted general budget support designed for strong performing countries in response to international commitments to make aid more predictable. (3) The objectives pursued by the Annual Action Programme are: 1) to support the national efforts to attain the Millennium Development Goals in Zambia, with enhanced efficiency and effectiveness of poverty focused programmes implemented through the public budget and in the context of macroeconomic stability; 2) to contribute to the implementation of the Zambia's Fifth National Development Plan (FNDP) in relation to transport infrastructure, improving accessibility, mobility and connectivity at district, provincial, national and regional level; 3) to contribute to the implementation of the Zambia's Fifth National Development Plan (FNDP) in the health sector, developing public health service delivery in urban and rural areas of the country; and 4) to support reforms and progress in critical governance and human rights areas in Zambia (electoral system, fight against child trafficking and labour). (4) The measures covered by this Decision are in conformity with the objectives of development finance co-operation as defined in Article 55 of the ACP-EC Partnership Agreement. (5) This decision constitutes a financing decision within the meaning of Article 16 of Annex IV to the ACP-EC Partnership Agreement and Article 67 of the Financial Regulation applicable to the 10 th European Development Fund (6) It is appropriate to define the term "substantial change" within the meaning of Article 7 of Regulation (EC) N 617/2007 to ensure that any substantial change in this decision shall follow the same procedure as the initial decision. (7) The measures provided for in this Decision are in accordance with the opinion of the European Development Fund Committee set up by Article 8 of the Internal Agreement of 17 July HAS DECIDED AS FOLLOWS: Article 1 The Annual Action Programme2008 in favour of Zambia constituted by the actions "General Budget Support. MDG Contract", "Road Sector Policy Support Programme. SPSP II", "Health Sector Policy Support Programme", "Supporting the electoral system in Zambia" and "Supporting actions against child traffic and child labour in Zambia", the texts of which are set out in the attached Annexes, is approved. Article 2 The maximum contribution of the Community to the Annual Action Programme is set at EUR 346 million, to be financed from the 10 th European Development Fund. 2

4 Article 3 Within the global indicative budget of all except the first action mentioned under Article 1, cumulated changes not exceeding 20% of the maximum contribution of the Community and not representing more than EUR 10 million shall not be considered substantial provided that they do not significantly affect the nature and objectives of the Annual Action Programme. The authorising officer may introduce non-substantial changes in the Annual Action Programme in accordance with the principles of sound financial management. Done at Brussels, For the Commission Member of the Commission 3

5 "ANNEXES Annual Action Programme ZAMBIA: Annex 1: action fiche MDG-Contract (MDG-C) Annex 2: action fiche Second Sector Policy Support Programme (SPSP Road Transport II) in support of Zambia's Road Sector Investment Programme ROADSIP II Annex 3: action fiche Supporting public health service delivery in Zambia"

6 Annex 1 1. IDTIFICATION Title Number MDG-Contract (MDG-C); CRIS reference n. FED/2008/19976 Total cost EUR Aid method / Management mode General budget support centralised management DAC-code Sector: General Budget Support 2. RATIONALE AND COUNTRY CONTEXT With macroeconomic stability firmly established over the period 2003 to 2006, the key development challenge now in Zambia is to accelerate progress in poverty reduction through the scaling up of pro-poor programmes and improving service delivery. Budget support provides an important contribution to the discretionary resources necessary to deliver the ambitious poverty reduction objectives of the Fifth National Development Programme (FNDP), covering 2006 to At the same time, dialogue on Public Financial Management (PFM) and the wider structural reform agenda is welcomed by the Government of Zambia (GRZ) as an important feature of partnership towards achieving the MDGs Country Context and National Policy and Strategy Economic and social situation and poverty analysis The Zambian economy, a large landlocked country with around 11 million people, has consistently recovered since the economic stagnation of the 1990s. Real GDP growth stood at above 5% over the period , driven by the expansion in mining (copper price boom), construction and services, as well as by eased investment conditions thanks to extensive debt cancellation (HIPC and MDRI). However, the benefits of this accelerated (urban) growth have not been shared broadly, since around 60% of the working population is employed in agriculture, a sector that has stagnated, due to a combination of inadequate policies, high dependence on rainfalls and low investments. The latest figures on the poverty rates highlight this urban-rural divide: while overall poverty in 2006 reduced to 64% (from 68% in 2004), rural poverty actually increased to 80% (up from 78% in 2004), against a sharp reduction in urban poverty to 34% (down from 53% in 2004). National Development/ Cooperation Policy and Strategy Main policy and strategic priorities and orientations: (1) National policy and strategy: The FNDP proposes a multi-sectoral strategy for increasing Zambia s annual growth rate to 7%, sustaining it at that level, and making growth more inclusive. It emphasises macroeconomic stability, whilst for its focal public expenditures it correctly identifies agriculture as the priority pro-poor growth sector, together with quality service delivery in education, health, social protection and a well-maintained infrastructure. All these sectoral policies will be accompanied by support to economic diversification and institutional and governance reforms, so as to achieve the strategy s objectives. In 2008 GRZ will carry out a Mid-Term Review of the FNDP, to assess progress, revise the financing gap, and start

7 thinking about the successor plan. GRZ also adopted in 2007 the 'Vision 2030', which sets the path for Zambia to become a middle-income country by The FNDP recognises that in addition to strong growth, progress in poverty reduction will require greater diversification of the economy and a more inclusive pattern of growth. Zambia s continued dependence on copper exports renders it highly vulnerable to international market conditions and is unlikely to generate the jobs and income levels needed to reduce poverty. Improved productivity of agriculture, coupled with diversification towards higher value crops, increased commercialisation among smallholders, and expansion of agroprocessing and continued focus on rural roads will be necessary to reduce rural poverty. While Cooperating Partners (CPs) acknowledge that the FNDP provides a credible and comprehensive basis for poverty reduction (see also the IMF World Bank Joint Staff Advisory Note), its implementation needs to focus more on the appropriate policy mix to promote rural expansion and poverty reduction. The financing gap of the FNDP baseline scenario (about 1.1% of GDP per year) highlighted the challenge in meeting the MDGs and the need for continued fiscal discipline and enhanced prioritisation of expenditures. The baseline scenario assumptions have been overtaken by the 2008 changes in the mining sector fiscal regime, which is projected to yield an average of 3.9% of GDP mining taxes per year over 2008 to The new MTEF will provide updated figures on the fiscal framework, and incorporate new challenges and investment needs (e.g. in the energy sector), in order to derive the revised financing gap. (2) National Budget and medium term financial perspectives: The Zambian budget follows and activity based budgeting approach with multiyear perspectives expressed in a 3-year Medium Term Expenditure Framework (MTEF). For 2008, GRZ proposed a budget of around 2.7 billion euro at current exchange rates, or 26.7% of GDP. Domestic resources will finance 71% of the budget, while 24% will be financed by external grants and loans. Domestic borrowing would cover the rest, amounting to 1.2% of GDP. In percentage terms, reliance on external financing is diminishing (28% in 2007). The MTEF seeks to translate the FNDP within the existing resource envelope into concrete policy choices and strategies. The key public spending priorities include infrastructure and agricultural development, as well as health and education and law enforcement services, in line with the FNDP. Concretely, expenditure on economic infrastructure (agriculture, transport, tourism etc.) increases over the MTEF to 23.3% of the total budget by 2010, from 18.6% in The allocation to health is projected to increase from 11.5% in 2008 to 11.9% by 2010, while for education it is projected to rise to 15.3% by 2010 from 14.6% in For the medium-term, both the MTEF and the latest IMF Staff paper provide an indication of Government intentions. Expenditures would remain sustained at 26%-27% of GDP, backed by stronger domestic revenues (up to between 21-22%, from the 17-19% of past years), mostly from the revised mining regime 7. External grants are expected to remain stable at just above 21% of total domestic expenditure (or 5.3% of GDP) over the period 2008 to Within this, general budget support grants are expected to remain broadly stable at about 1.2% of GDP, of which the EC would represent around 25% on average. Taking GBS and 7 The changes introduced by GRZ on the fiscal regime of the mining sector (2008 budget) include: (i) increase of the corporate income tax to 30% from 25%; (ii) increase of mineral royalties to 3% from 0.6% for base metals; (iii) introduction of an additional variable profit tax of 15% for profits above 8% of gross income; (iv) introduction of a Windfall profit tax, depending on copper prices (will not operate simultaneously with the profit variable tax). These measures are expected to bring in additional annual revenues of around $400 million in 2008, to be set aside in a separate fund, until a clear and transparent mechanism for their utilisation is established.

8 SBS together, the EC share is expected to amount to about 43%. Capital expenditure would rise notably in the coming two to three years (reaching 6.8% of GDP in 2010), while at the same time reallocating recurrent expenditures towards wages and salaries, and away from consumption of goods and services, in line with the human resource strategy for social sectors. Interest payments, meanwhile, have fallen from 2.7% of GDP in 2005 to a projected average of 1.3% of GDP, following the various debt relief initiatives (HIPC, MDRI). A key issue is the allocation to the agriculture sector. Releases to a number of FNDP Investment Programmes in agriculture were below projection in 2007, while allocations to the Food Reserve Agency and the Fertilizer Support Programme were doubled. These releases run counter to the priorities set in the MTEF. This issue is the subject of continuing dialogue between GRZ and CPs, and a process of reviewing the impact of these distortive policies has started. (3) Performance Measurement: The newly created monitoring and evaluation unit in the Department of Planning is at the heart of the institutional arrangements for performance monitoring. The basis for performance monitoring for the joint Poverty Reduction Budget Support arrangement is the three-year rolling Performance Assessment Framework (PAF). The PAF , to be approved in the second half of 2008, is the starting point for the current programme. The quality of data and the elaboration of a National Statistical Development Strategy are addressed in the context of regular sectoral dialogue and through capacity development efforts Eligibility for budget support in the form of an MDG-Contract National Development or Cooperation Policy and Strategy As outlined above, the FNDP provides a comprehensive framework for addressing poverty in Zambia. The focus on macroeconomic stability, economic diversification and improved service delivery are entirely relevant to the key development challenges identified above. In light of the latest Annual Progress Reports for 2006 and 2007, attention now focuses on better linking policy to planning and budget allocations, addressing the challenge of rural poverty, and strengthening absorption capacity both for the public and private sectors. The credibility of the FNDP therefore confirms Zambia eligibility under this criterion. The programme is fully consistent with the 10 th EDF Zambia Country Strategy Paper signed during the Africa-EU Summit in Lisbon (December 2007) Macroeconomic situation The performance of the Zambian economy has improved markedly over the past years, reflecting strengthened macroeconomic policies, extensive debt relief (HIPC and MDRI), and a favourable external environment (driven primarily by the revival of mining, in light of the boom in copper prices). Fiscal discipline, especially since 2004, and a prudent monetary policy, coupled with an appreciating exchange rate, lowered inflation to single digits in 2006 for the first time in three decades. Between 2003 and 2007, the deficit was cut from 6.6% of GDP to 0.2% of GDP, despite a decline in external grants. With rapidly increasing mining taxes, the deficit is expected to turn into a modest surplus in 2009, while expenditure increases significantly. International reserves now cover about 3 months of imports. The 2007 DSA for Zambia has concluded that Zambia s risk of external debt distress is low, and total public debt is sustainable through Looking ahead, short run growth will continue to be dominated by expansion in mining and mining-related sectors, while diversification of the economy will be needed to accelerate growth and poverty reduction over the medium to long term. Increasing productivity of

9 agriculture, coupled with renewed emphasis on improving the business environment and physical infrastructure (including on energy), will be key if rural poverty is to be tackled decisively. A three-year IMF PRGF programme was approved in June Domestic revenues are projected to rise from 18.7% of GDP in 2007 to 21.5% by 2010 (driven by mining taxes, which increase from 1.4% of GDP in 2007 to an average of 3.9% over the period ). Beyond 2010, mining taxes are projected to fall, based upon World Development Report projections of strong declines in international copper prices. This injects a note of prudence in the fiscal framework, which may not be accurate if copper prices remain strong. Against this background, the key macroeconomic issue facing Zambia is how to manage the resources arising from the sustained copper boom over time (taking into account potential volatility of copper prices), and how to avoid undermining the fragile competitiveness of the non-traditional sectors, with a stronger Kwacha. At the same time, the increased fiscal space from the lower interest costs and higher revenues presents a challenge to the system and the absorption capacity of line ministries. Notwithstanding these challenges, it is clear that Zambia has made significant progress in restoring macroeconomic stability and prospects are favourable for its continuation. Zambia can therefore be considered to meet the macroeconomic eligibility criterion under the MDG-C Public Financial Management and domestic accountability of the budgetary process A PEFA assessment of Zambia was undertaken in 2005 and followed up again in Despite continuing weaknesses in budget execution and procurement, the 2008 draft PEFA Report shows that significant progress has been made in all of the broad areas assessed, i.e. budget credibility; comprehensiveness and transparency; predictability and control in execution; accounting and reporting; external scrutiny and audit. GRZ is committed to undertake PEFA assessments every two to three years. PFM reforms in Zambia are mostly driven by the Public Expenditure Management and Financial Accountability (PEMFA) programme, covering the period 2005 to After a slow start, progress has since mid-2006 markedly picked up. Most weaknesses are encountered in budget execution and public procurement, hence these are the areas where GRZ efforts have been concentrated. Budget execution in Zambia is affected by a structural constraint on the budget cycle, with a budget approved in the first quarter of the year, leaving only nine months for full execution. This requires a constitutional amendment, to be addressed during the process of Constitutional Review that should be completed by In the meantime, the plan to create a Singe Treasury Account, combined with the elaboration of a quarterly release calendar, should help improve budget execution and ensure greater discipline of programme implementation by the line ministries. In addition, the progressive roll-out of the IFMIS system should help underpin budgetary discipline and enhance transparency. A new procurement law is being approved, providing a more transparent and efficient system. It is expected that the reforms undertaken under the PEMFA programme will be continued in a follow-up programme beyond 2009, to build on the reforms of the first phase. Against this background, the prospects are favourable for maintaining the good progress made in PFM reform over the past few years. Zambia can therefore be considered to satisfy the PFM eligibility. As far as domestic accountability is concerned, the Auditor General (AG) Report is regularly presented to Parliament, and debates are followed by the press. One of the current Performance Assessment Framework (PAF) indicators looks at the role of Parliament in giving recommendations to the AG report, and how these are followed up by GRZ. More

10 broadly on the role of Parliament, Members of Parliament (notably the Chairs of the Public Accounts Committee and of the Economic Affairs Committee) are represented at the PRBS Review (and its preparation), the Performance Assessment Framework (PAF) Report is disseminated to them, and they also receive various documents that monitor budget execution throughout the year. Finally, a new Parliamentary Reform Programme for has been launched, covering Capacity Building activities on the oversight role of Parliament in the budgetary process. The EC is contributing to the Programme with resources from PRBS Sector Policies (where appropriate). See section on the national development strategy Lessons learnt and track record The PRBS 1 programme ( , EUR ) took account of the evaluations on the previous structural support to Zambia in the 1990s, and was designed accordingly. It supported PRSP implementation, macroeconomic stability and PFM reforms. It included a very large variable component (91% of total), with 60% linked to PFM indicators. This approach was effective in providing an appropriate incentive mechanism, with amounts disbursed increasing for successive tranches. PRBS 1 also fostered dialogue between line ministries (especially Health and Education) and the MoFNP on inter-sectoral allocations, and gave confidence to other donors, who started budget support operations in PRBS 2 ( , 62 million) continued with the same objectives, with an increased focus on outcome-based indicators, improved donor harmonisation, and a reduced variable component (at 50%). The track record on both programmes has improved over time, with an average disbursement rate for the variable tranche of 63% for PRBS 1 and 71% for PRBS 2. One other important lessons learnt is the need to comply with the disbursements schedules agreed with GRZ, with a specific request from Government to release GBS funds no later than the end of the third quarter, to allow a smooth budget execution, avoid large carry-overs of unspent balances from one year to the next, and distress to the Bank of Zambia management of the exchange rate Complementary actions PRBS 2 is on-going until 2008, and a capacity building programme for PFM reforms (PEMFA) is also supported by the EC until 2010 through SBS. The remaining EUR out of the total EUR foreseen in the 10 th EDF NIP for macroeconomic support would be used for complementary Capacity Building (strengthening data quality, building national accountability through Parliament, and involving civil society). These interventions will be included in a separate AF, together with the support for PFM reforms foreseen in the NIP, and presented in the 2009 AAP. The CSP/NIP also foresees SBS for the Roads sector (EUR ) and sector support to Health (EUR , most of which would be channelled as SBS) Donor coordination GBS in Zambia is provided through the PRBS Group, made up of GRZ and (currently) nine CPs: Germany, Finland, Netherlands, Norway, Sweden, UK (DFID), African Development Bank, EC and World Bank. On the CP side, the EC holds the Chair, in principle until next June The PRBS Group is regulated by a Memorandum of Understanding (MoU) signed in April The MoU provides a framework for structured dialogue between GRZ and CPs, with two Joint Annual Reviews per year, and a common Performance Assessment Framework (PAF). It is fully consistent with the principles set out in the Joint Assistance Strategy for Zambia, signed by 16 CPs in April 2007, and with the GRZ Aid Policy adopted in May 2007.

11 3. DESCRIPTION 3.1. Objectives The overall objective of the proposed programme is to support the implementation of the FNDP ( ) and any successor plan. The programme therefore seeks to contribute to the promotion of sustainable and broad-based growth and the reduction of poverty, so as to accelerate progress in attaining the MDGs 8. The specific purposes of the programme are to support macroeconomic stability whilst allowing for the scaling-up and enhanced efficiency and effectiveness of poverty focused public programmes implemented through the budget Expected results and main activities The EC support will contribute to improved public finance management, enhanced service delivery in the social sectors, and the promotion of structural reforms that enable job creation and pro-poor growth. The EC will participate with other budget support CPs in dialogue with GRZ on the macroeconomic reform programme, the implementation of the FNDP (and the elaboration of its successor), and the PFM reform programme. In this context, the EC will also continuously assess eligibility for budget support and monitor progress towards the targets set out in the common Performance Assessment Framework (PAF), to allow smooth disbursements of annual tranches. Assessments and disbursements will be made in line with the partnership arrangements and principles covered in the PRBS MoU (covering predictability, harmonisation, alignment and coordination of budget support) Stakeholders The main direct beneficiary of GBS is GRZ, and in particular, the MoFNP, which benefits from increased resource availability for its poverty-reducing programmes, aligned support, reduced transaction costs and policy dialogue. Line ministries will also benefit from increased resource availability and the focus on results-based policy making. Other stakeholders involved in the PRBS process include Parliament and civil society, who will have a say in the dialogue on improved PFM, transparency of public finances, and focus on results Risks and assumptions The major risks are related to continued adherence to the GBS eligibility conditions. On the macro-economic side, Zambia so far has a strong record, and the new IMF PRGF programme will support continued prudent macro-economic policies. After 2011, Zambia may move to a PSI-type of IMF support, thereby graduating to the mature stabilisers category. The main risks in this area are related to the potential external copper price shocks, and the proper management of additional mining fiscal revenues to protect the diversification agenda. Poverty reduction is the main focus of all GRZ policies, and the risk that there may not be a successor to the FNDP is rather low. Government focus is already shifting to better identifying the determinants of pro-poor growth, so that wealth-creation can be the driving force for lifting people out of poverty. Challenges exist on the implementation of the Private Sector Development reforms, and policy coherence in the key pro-poor growth sector (agriculture). This would be mitigated by appropriate selection of Performance Assessment Framework (PAF) indicators that also includes some of those related to the growth agenda, in addition to more classic MDG ones. On PFM reforms, the Government seems to be on a new 8 According to the MDG Progress Report (June 2008), Zambia is likely to meet four MDGs (Hunger, Primary Education, Gender equality, HIV/AIDS), potentially another five (Extreme poverty, Child mortality, Maternal mortality, Malaria and other diseases, Water and Sanitation), while the one on Environmental sustainability is unlikely to be met.

12 trajectory, with a visible acceleration of the pace of reforms, and real ownership on where the stumbling blocks lie for enhancing budget execution. The Constitutional Review, to be completed in 2009, will also solve one of the most structural bottlenecks in this area, i.e. the shortened budget cycle. GRZ stated commitment to regular PEFA evaluations is welcome Crosscutting issues The FNDP recognises the importance of gender equality and tackles the HIV/AIDS pandemic, protection of natural resources and good governance (each having its own chapter and indicators in the FNDP). Through the PRBS policy dialogue, the MDG-C will indirectly address these issues. 4. IMPLEMTATION ISSUES 4.1. Budget and calendar In line with the MDG-C approach, the full EDF 10 amount of EUR will be committed for a period of 6 years (disbursement period ), hence the Financing Agreement will have an operational period of 72 months. Of the EUR , EUR (on average 75% of total) will constitute a fixed base component, subject only to general eligibility conditions. The variable component will amount to EUR , consisting of an Annual Performance Tranche (APT) of 10%, linked to a specific sub-set of Performance Assessment Framework (PAF) indicators, and an MDG-based tranche (MDGT) of 15%, linked to another specific sub-set of PAF indicators. The decision on the APT will be taken every year (2009 to 2013), after the June Review, and it will be released in the following year (scheme n-1/n/n+1 applies). The decision on the MDGT will be taken in the context of a Mid-Contract Review (MCR) in 2011 and only applies to the second three-year period ( ). Given that for the first disbursement of 2009 and its potential APT it is not possible to agree on a sub-set of Performance Assessment Framework (PAF) indicators assessed in 2008, it is proposed to only have a fixed tranche for On the disbursement profile, it is proposed to use the symmetrical profile, which would also mitigate the impact of only having a fixed tranche in The following table summarises the planned profile of disbursements (maximum performance): Fixed base component APT MDGT Annual max. disbursements Total Average 30,00 30,00 30,00 26,25 26,25 26, % 0,00 5,63 5,63 3,75 3,75 3, % 0,00 0,00 0,00 11,25 11,25 11, % 30,00 35,63 35,63 41,25 41,25 41, Budget support modalities The operating modality will be direct untargeted budget support to the National Treasury. The Zambian currency, the Kwacha, is convertible and freely transferable, and complies with article VIII of the IMF s Articles of Agreement with respect to transactions on the current account. Following a NAO request, EC funds will be transferred to a GRZ bank account with the Bank of Zambia Procurement and grants award procedures Not applicable.

13 4.4. Performance monitoring and criteria for disbursement (1) Description of performance monitoring arrangements Performance is measured through the common Performance Assessment Framework (PAF). It includes a rolling multi-annual matrix (3 years) of milestones, targets and indicators, drawn from the FNDP and its priority areas (service delivery, infrastructure and wealth creation), as well as PFM reforms. Every year in October the Performance Assessment Framework (PAF) is revised, by adding an extra year and updating indicators/targets as required. The Performance Assessment Framework (PAF) , to be approved in the second half of 2008, will be the starting point for performance monitoring under this programme and will be assessed on an annual basis and at the MCR (2011). The joint Reviews of 2009, 2010 and 2011 will therefore determine the potential size of the following three-year disbursements (2012 to 2014) under the MDGT. (2) General conditions for disbursement of all tranches. (i) satisfactory progress in the implementation of the FNDP and its successor plans; (ii) satisfactory progress in the maintenance of a stability-oriented macroeconomic policy; (iii) satisfactory progress in the implementation of Zambia's PFM reform strategy. On the basis of the information supplied, the EC shall formulate a positive assessment before the disbursement of all tranches of budget support. (3) Areas in which specific conditions for disbursement of individual tranches will be defined. While the areas of Performance Assessment Framework (PAF) focus identified below should remain the same until the MCR, the specific set of Performance Assessment Framework (PAF) indicators is indicative, as both targets and indicators could change over time, in line with the three-year rolling nature of the Performance Assessment Framework (PAF). In such circumstances, the NAO may submit a request to the European Commission for changing targets and indicators, following discussion and agreement in the PRBS Group. Annual Performance Tranche An APT is envisaged for years 2 to 6 ( ). It will be based on an assessment of mostly input and process Performance Assessment Framework (PAF) indicators, covering the areas of PFM and domestic accountability. MDG-C Tranche The MDGT is envisaged for years 4 to 6 ( ). It will be assessed at the MCR based on continued compliance with the entry criteria for the MDG contract (i.e. track record, rolling three-year Performance Assessment Framework (PAF), macro perspectives, PFM strategy and domestic accountability for budgetary purposes); as well as an a assessment of output and outcome indicators from the Performance Assessment Framework (PAF) for the years 2008 to 2010, covering indicators on social sectors (Health, Education, HIV/AIDS), as well as on wealth creation (agriculture, private sector development, infrastructure) Evaluation and audit An evaluation of GBS in Zambia is currently under consideration but is awaiting the finalisation of the revised GBS evaluation methodology Communication and visibility Communication and visibility issues are addressed through the joint arrangements for budget support with cooperating partners and GRZ. In particular, press conferences will be organised

14 at the end of each second Joint PRBS Review, when commitments for the subsequent budget year are confirmed. Moreover, complementary actions will also address issues of communication and visibility with the public large, by involving parliament and civil society in the budget support process.

15 Annex 2 IDTIFICATION Title/Number Second Sector Policy Support Programme (SPSP Road Transport II) in support of Zambia's Road Sector Investment Programme ROADSIP II. CRIS Nr.: 2008/ Total cost EUR (16.2% of NIP) Aid method / Method of implementation DAC-code Sector Policy Support Programme: Sector budget support (centralised management); Capacity building component (decentralised management) Sector Roads transport (90% of allocation) Transport Policy and Administrative Management (10% of allocation) RATIONALE AND COUNTRY CONTEXT Country context and rationale for SPSP Economic and social situation and poverty analysis The Zambian economy, a large landlocked country with a population of around 11 million people, has consistently recovered since the economic stagnation of the 1990s. Real GDP growth stood at above 5% over the period , driven by the expansion in the mining (copper price boom), construction and services sectors, as well as by eased investment conditions thanks to extensive debt cancellation (HIPC and MDRI). However, the benefits of this accelerated (urban) growth have not been shared broadly, since most of the working population (around 60%) is employed in agriculture, a sector that has stagnated, due to a combination of inadequate policies, high dependence on rainfalls and low investments in the sector. This discrepancy between the urban and the rural areas is visible from the latest figures on the poverty rates, showing that while overall poverty in 2006 slightly reduced to 64%, rural poverty actually increased to 81% (up from 78% in 2004), against a sharp reduction in urban poverty to 34% (down from 53% in 2004). Accelerating economic growth and ensuring that the majority of its population can benefit from this growth therefore remain Zambia s central development challenges. National development policy The Fifth National Development Plan (FNDP) is the backbone of government policy, and is the successor of the first plan of the PRSP brand. The FNDP is comprehensive in scope and depth; it has a more solid M&E framework, and for the first time it contains for every sector a comprehensive expenditure framework, including both domestic and external resources. The key public spending priorities over the MTEF include infrastructure to accelerate growth in line with the focus of the FNDP. A mid term review (MTR) of the implementation of the plan is scheduled within the second semester Sectoral policies are owned by the relevant sector institutions and reasonably well aligned to the overarching FNDP.

16 Sector context: policies and challenges The FNDP places priority attention to those sectors that maximise growth stimulation such as transport infrastructure. A letter of road sector policy of 2003 is in place as well as the national road transport policy of The policy objectives are translated into the road sector programme ROADSIP II for the period which also provides for the implementation & financial strategy and related action plans. ROADSIP II is under Mid Term Review (MTR), to be completed by end of 2008, and will provide amongst others a revised implementation and financing plan for the remainder of the programme. The transport and road sector policy is subject to a review programmed for 2009, an institutional review study to address the below key sector challenges is programmed for the end of the year 2008/beginning of year Network level analysis of a preliminary nature at the beginning of the ROADSIP II MTR indicates a revised financial need in the magnitude of some 3,9 bn USD for the remainder of the programme to bring the public core road network into a maintainable condition by Against this need, sector funding (internal + external) of some 3 bn USD is anticipated leaving a financial gap of some 900 m USD. Sector funding projections from the rolling MTEF as well as from preliminary findings of the MTR of ROADSIP II are shown in table 1 below: Table 1: sector funding projections Item Year 2009 Year 2010 Year 2011 Year 2012 Internal Funding x1) ZMKb ZMKb ZMKb ZMKb GRZ (Treasury) Fuel levy Road User Charges Total 660 1, External Funding (CPs) incl. SPSP II x2) Grand Total 1,014 1,524 1,600 1,632 X1) 2009 and 2010 are derived from the rolling MTEF of GRZ, year 2011 and 2012 figures are projections from preliminary results of the MTR of ROADSIP II; exchange rate applied: 1 USD = 3,000 ZMK X2) the figures are derived from preliminary findings of the MTR of ROADSIP II Apart from meeting the required sector funding needs, the other key challenges for the sector are: (i) the urgent need to increase the low absorption capacity under which the road asset value has declined over the past. This has been mainly attributed to the lack of performance of the construction industry which continues to be relevant, but needs to be analytically assessed in view of institutional inefficiencies (subject to institutional review study referred to above) since it cannot count alone for the recurring absorption capacity problem plaguing the sector, (ii) the development and maintaining of institutional capacity for the efficient, equitable and financially sustainable management of the public road infrastructure at central and particularly regional level (rural road network managed). Institutional capacity development is needed in all aspects of rural roads management, accounting & procurement and the development of systems and procedures for the newly established but not yet operational local road authorities. At central level, a continuation of capacity building is needed in the fields of highway & road asset management and its systems, procedures development, procurement & internal quality control and sector monitoring/evaluation. Concerning sector performance monitoring, the present central statistical system providing data to monitor the sector is weak. Limited data for road sector monitoring are provided by the three road agencies Road Development Agency (RDA), National Road Fund Agency (NRFA) and the Road Traffic and Safety Agency (RTSA) as well as the National Construction Council. There is no aggregation of transport sector performance data at the Ministry of Transport and Communication (MCT) in response to its mandate. The Mid Term Review of ROADSIP II is to develop a revised M&E framework for the road sector including input, output and outcome indicators. Eligibility for budget support As referred to in section 2.2., a well defined sector policy and strategy is in place and subject to revision in 2008 and 2009.

17 Zambia s prospects for continued eligibility in terms of macro-economic stability remain very strong. Following good adherence to prudent monetary and fiscal policies, and thanks to favourable external conditions and extensive debt relief, real GDP has grown above 6% in recent years. This is expected to continue over the medium term, as well as the prudent fiscal stance, which could even strengthen in light of additional revenues from the mining sector. These could effectively be spent in future years on much needed infrastructure, once greater administrative capacity is built to this effect. The 2008 draft PEFA Report shows that significant progress has been made in all of the broad areas assessed. PFM reforms in Zambia are mostly driven by the Public Expenditure Management and Financial Accountability (PEMFA) programme, covering the period 2005 to It is expected that the reforms being undertaken in the context of the PEMFA programme will be continued in a followup programme, beyond 2009, to build on the reforms of the first phase. Against this background, the prospects are favourable for maintaining the good progress made in PFM reform over the past few years. Zambia can therefore be considered to satisfy the PFM eligibility. At sector level, it will be paramount to see an improvement of internal control standards applied within the procurement process at RDA, but also at Zambia National Tender Board level to address issues raised in the 2007 procurement & technical audit carried out by the EC under SPSP I. The continuation of annual procurement audits is ensured through SPSP II and will be used for the assessment of overall eligibility criteria regarding sector specific PFM issues. Lessons learnt ROADSIP II has been successful in marshalling donor and Government support in terms of a coherent and integrated roads strategy and priority investment plan. The lessons learnt from the MTR are crucial to ensure that the programme becomes again a reliable, realistic and affordable master document for the sector. Lessons learnt from the MTR of SPSP I, EDF9, have been used to formulate the EDF10 SPSP II subject to this fiche. Since 2005, EDF9 provides Sector Budget Support which is recognised as a most valuable financing modality. The major lessons learnt are that sector budget support has led (i) to reduced transaction and administrative costs, increased ownership and predictability of funds from the Government's perspective and (ii) increased impact of aid, comprehensive sector dialogue, no more micromanagement of projects and contracts, ensuring a voice in coherent sector policy and strategy formulation from the EC's perspective. The targeted approach used under SPSP I will be changed to non-targeted support under SPSP II. Continuation of SBS under EDF10 is regarded as very important to the sustained success of ROADSIP II and is fully in line with Government and EC objectives as confirmed by the MTR of SPSP I. Complementary actions The main building blocks for a continuation of the sector reform progress are (i) the 2008 MTR of ROADSIP II, (ii) the 2008/2009 institutional review study and (iii) the transport policy review in 2009 (see 2.2). Cooperating Partners (CPs) programmes are well aligned to the ROADSIP II objectives and capacity building programmes are developed under an integrated approach. EC is supporting the Government both through sector budget support and project funding such as the Zimba-Livingstone (EDF9) and Great East Roads rehabilitation projects (EDF10). Donor coordination The three well established major fora in the sector for the CP/GRZ dialogue are: (i) ROADSIP II steering committee meetings on a quarterly basis, (2) bi-annual Joint Donor Fora at policy level and operational level between CPs and the committee of Permanent Secretaries of the Road Management Initiative (RMI) and (3) Sector Advisory Group (SAG) meetings to monitor the implementation of the FNDP at sector level under the Joint Assistance Strategy for Zambia (JASZ). The main CPs are the Worldbank, Denmark, Germany, Japan, the African Development Bank and the EC (lead donor). DESCRIPTION

18 Objectives In line with ROADSIP II and the FNDP, the overall objective of the programme is to contribute to the promotion of equitable economic growth and poverty reduction and the enhancement of food security. The specific objectives of the programme is to improve accessibility, mobility and connectivity at district, provincial and national level promoting basic access and regional integration for people and goods. Expected results and main activities The main goal of the sector programme ROADSIP II is to have a safe & maintainable core road network by The results expected from SPSP II is (i) to support ROADSIP II in achieving its aforementioned goal and (ii) contribute to an improved institutional capacity of sector agencies and local road authorities (LRA) (iii) as well as promoting the private sector through the provision of training to contractors. The EC will participate with other CPs in the sector and policy dialogue, the monitoring of the implementation of ROADSIP II and the sector performance assessment. In this context, the EC will also continuously assess eligibility for sector budget support and monitor progress towards the targets set out in the performance assessment framework, to allow smooth disbursements of annual tranches. Further activities relate to the implementation of a capacity building programme under an integrated approach aligned between CPs and GRZ, training measures for contractors, procurement and technical audits as well as mid and end term evaluations. Risks and assumptions The main assumption is that Zambia will remain eligible for SBS during the duration of SPSP II. According to the 2008 IMF Article IV mission, the overall macroeconomic situation remains strong. Nevertheless, external shocks to the economy, such as extreme weather conditions (floods, droughts), a fall in export commodity prices and ever-increasing oil prices are credible risks for the programme s viability. Regarding PFM issues, it is also assumed that reform of the PFM system will continue. To ensure timely and full releases of tranches, it is assumed that Government and its agencies submit adequate sector reports and that performance indicators will be achieved. In case of non-fulfilment, the risk would be that tranche releases are delayed or not released in full. To mitigate and steer against such developments before they become critical, the close monitoring of the sector performance & evolvement through the existing steering fora (see 2.6) will be paramount. Moreover, it is assumed that the low sector absorption capacity will improve to mitigate the risk of non-achievement of physical sector performance indicators. The institutional review study, planned assessments of adequate contract sizes for tendering and specific contractors training will provide the necessary tools to mitigate the risk. Eventually, it is assumed that Government further supports developing and maintaining the institutional capacity for the efficient, equitable and financially sustainable management of the road sector which is presently at a standstill and thus provides a risk for the overall sector reform progress. The Government's challenge is now to support the fully established and operational autonomous three road agencies RDA, NRFA and RTSA in order for them to efficiently take on and fulfil their statutory roles and mandates. In that context, the institutional review study and its lessons learnt and recommendations will be paramount for the sector. Stakeholders The main stakeholders and beneficiaries of the programme are the NRFA, RDA, an the RTSA which are governed by a Board, the National Council for Construction, Ministry of Works and Supply, Ministry of Communications & Transport and Ministry of Local Government and Housing and the Local Road Authorities at regional level. The main beneficiaries are the public road users and the private sector (construction industry). Crosscutting Issues In general, cross cutting issues are addressed under the framework of ROADSIP II, more specifically, a strategic environmental assessment study (SEA) is under preparation financed under SPSP I. A

19 scoping assessment in line with the EC handbook on environment to prepare the eventual SEA has already been carried out. With regard to gender equality, compared to other sectors, the gender impact of the road sector is relatively limited. By applying labour based construction methods at rural roads level, employment generation of women will be enforced. Furthermore, with the increase in accessibility in the rural areas, particularly women and children will benefit in exercising their daily tasks and rural service delivery can be improved. The HIV problematic is an integral part of ROADSIP II, has however not strategically been tackled which needs a re-focus. Preventive measures are mainly applied on a project by project basis. IMPLEMTATION ISSUES Method of implementation - Direct centralised management (sector budget support) - Decentralised management (capacity building programme): A capacity building programme will be implemented through technical assistance support working directly in sector institutions at central and regional level in the fields referred to in chapter 2.2. Programme Estimates are used for the implementation of (i) training provided to local contractors in the main domain of procurement, accounting, financial and site management, (ii) LRA and regional RDA officers in the main domain of highway and asset management, visual road condition survey, accounting and procurement. The Commission controls ex ante all the procurement contracts except for procurement contracts under Programme Estimates where the Commission controls ex ante procurement contracts > euro and ex post procurement contracts < euro. All grant contracts, whether being under Programme Estimates or not, are subject to ex ante controls. Through the programme estimates, payments are decentralised for operating costs and contracts up to the ceilings indicated in the table below: The Authorising Officer ensures that, by using the model of financing agreement for decentralised management, the segregation of duties between the authorising officer and the accounting officer or of the equivalent functions within the delegated entity will be effective, so that the decentralization of the payments can be carried out for contracts up to the ceilings specified below. Road Works Supplies Services Grants < EUR < EUR (Budget) EUR (EDF) < EUR EUR infrastructure funded by the European Commission must respect the provisions of the safety regulations established by the EC legislation (directive of the European Parliament and the Council in Oct. 2008). Procurement and grant award procedures All contracts implementing the action must be awarded and implemented in accordance with the procedures and standard documents laid down and published by the Commission for the implementation of external operations, in force at the time of the launch of the procedure in question. Participation in the award of contracts for the present action shall be open to all natural and legal persons covered by EDF10 regulations. All programme estimates must respect the procedures and standard documents laid down by the Commission, in force at the time of the adoption of the programme estimates in question.