Documuat of

The World Bank

FOR OMCIAL USE ONLY

Report N0o 12544

PROJECT COMPLETION REPORT

MI-ACASCAR

AGRICULTURAL SECTOR ADJUSThENT CREDIT(IDA CREIDIT 1691-MAG AND SFA CREDIT A-16-NAG)

NOVEMBER 24, 1993

MIICRORAPHICS

Report No: 12544Type: PCR

Agriculture Operations DivisionSouth-Central and Indian Ocean DepartmentAfrica Regional Office

This document has a restricted distribution and may be asd by recipients only in the performance oftheir o:icdal dties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit: Malagasy franc (FMG)

1985 US$1 = FMG 6621986 US$1 = FMG 6761987 US$1 = FMG 10691988 US$1 = FMG 14071989 US$1 = FMG 16031990 US$1 = FMG 14941991 US$1 = FMG 1835

ABBREVIATIONS

AflB African Development BankASAC Agricultural Sector Adjustment CreditBFV Commercial Bank (Banky Fampandrosoana ny Varotra)BNI Industrial Development Bank (Bankin' ny Indostria)BTM Nationat Rural Development Bank (Bankin' ny Tantsaha Mpamokatra)COROI State t.ading company (Comptoir de Commerce et de Representation de

l'Ocean Indien)EIB European Investment BankEMSAP Economic Management and Social Action ProjectFMG Malagasy franc (franc malgache)FNUP National Consolidated Equalization Fund (Fonds, National Unique de

PNrdquation)GDP Gross Domestic ProductIDA International Development AssociationIMF International Monetary FundISAC Industrial Sector Adjustment CreditITPAC Industry and Trade Policy Adjustment CreditMPAEF Ministry of Livestock and Forestry (Ministere de la Production Animale et

des Eaux et Forets)MPARA Ministry of Agricultural Production (Ministere de la Production Agricole et

de la Reforme Agraire)O:L Open General LicensePCR Project Completion ReportPIP Public Investment ProgramPSAC Public Sector Adjustment CreditSDR Special Drawing RightSFA Africa Facility CreditUNDP United Nations Development ProgramUNIDO United Nations Industrial Development OrganizationUSAID United States Agency for International DevelopmentWFP World Food Program

FOR OFCIAL USE ONLYTHE WORLD BANK

WashiMntO D.C 20433U.SA

OPeIffm Evdudon

November 24, 1993

MEMORANDUM TO THE ECT DRECrORS AMT PRESNT

SUBJECD Project Completion Report on MadagascarAgricultural Sector Adjustment Credit aDA Cr. 1691-MAG and SA Cr. A-16EMAG)

Attached is the Project Completion Report on Madagascar Agricultural Sector AdjustmentCredit (IDA Cr. 1691-MAG and SFA Cr. A-16.MAG) prepared by the Africa Regional Office. PartH was requested from the Borrwer but was not received.

The adjustment operation was consistent with both Government policies and Bank supportstrategy. The rice liberalization component, the core of the reform program, was successfullyimplemented, even though the proces proved bumpier than anticipated. The intended reforms wore,in the event, fully implemented, and the anticipated benefits are being reached.

In contrast, compliance with other policy changes was poor, and the rationale and justifcationfor teleasing the Credit's second tranche are questionable. Eventualy, however, these other policychanges were either effected under, or rendered irelevant by, the two subsequent adjustment creds(Industry and Trade Policy, and Pubhc Sector).

The outcome of the operation is thus rated as satisfactory, and its achievements as likely tobe sustainable. The Credit included no institutional development objectives.

The PCR is complete and informative. An audit is in process.

Attachment

-Tisdoumnthas a reSWWte distbuaon OM may be used by ecw o* nb th a& we ome ofthel ofL duds ft contrds may not ostw be dscosed wfthot wadd Bank auIbd

FOR OMCIL USE ONLY

PROJECT COMPLETION REPORT

MADAGASCAR

AGRICULTURAL SECTOR ADJUSTMENT CREDIT(IDA Credit 1691-MAG and SFA Credit A-16-MAG)

TABLE OF CONTENTS

PREFACE .............................................

EVALUATION SUMMARY ......................................... iii

PART I: PROJECT REVIEW FROM BANK'S PERSPECTIVE .................... 1Project Identity ............................................. IBackground ............................................... ICredit Origin and Genesis ...... 4............... 4Credit Objectives and Description ............................ 6Credit Implementation ........................... 8Implementation of Individual Components ........................... 9Credit Inpact and Sustainability ............................ 8Istitutional Perfomance ........................... 20

PART II: PROJECT REVIEW FROM BORROWER'S PERSPECTIVE .... ......... 24

PART III: STATISTICAL INFORMATION ............ .. ................ 25Table 1: Related Bank Loans/Credits ............................. 25Table 2: Credit Data ......... 26Table 3: Credit rTmetable: Original and Actual Dates ................... 26Table 4: Cumulative Credit Disbursement .......................... 27Table 5: Use of Bank Resources ................................ 28

MAP IBRD 20035R

This document has a restrcted distribudon and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

PROJECT COMPLETION REPORT

MADAGASCAR

AGRICULTURAL SECTOR ADJUSTMENT CREDIT(IDA Credit 1691-MAG and SFA Credit A-16-MAG)

PREFACE

This is the Project Completion Report (PCR) for the Agricultural Sector Adjustment Credit(ASAC) to Madagascar. Tle Credit was approved by the Board on May 8, 1986 and comprised of:IDA Credit 1691-MAG in the amount of SDR 19 million, Africa Facility Credit A-16-MAG in theamount of SDR 31 million and grants from the Govc-nment of Japan in the amount of Y600 millionand from the Government of Germany in the amount of DM10 million. The original closing dateof June 30, 1988 was extended three times to June 30, 1990. The final disbursement was made inOctober 1990; Credit 1691-MAG and SFA Credit A-16-MAG were fully disbursed.

This PCR was prepared by the Agriculture Operations Division, Country Department III ofthe Africa Region (Preface, Evaluation Summary, Parts I and IlH). It is based on the Project briefs,the President's Report and Credit Agreements, preparation and supervision reports, correspondencebetween the Bank and the Borrower, consultant and internal Bank studies, memoranda and interviewsof Bank staff, Government officials and private operators.

The Government was sent Parts I and Im of the PCR on March 26, 1992. No commentswere received, despite the follow-up from the Resident Mission.

iii

PROJECT COMPlEIJON REPORT

MAIDAGASCAR

AGRICULTURAL SECTOR ADJUSTMENT CREDIT(IDA Credit 1691-MAG and SFA Credit A-16-MAG)

EVALUATION SUMMARY

Background

1. The Agricultural Sector Adjustment Credit (ASAC), approved in May 1986, was the secondin a series of four adjustment operations extended by IDA to Madagascar since 19&i. Initially. theGovernment and the Bank adopted a cautious strategy and agreed to begin addressing the manystructural distortions affecting the economy sector by sector, first in industy and then in agriculture.After ASAC, the adjustment process gained momentum and Government moved to a broader agendaof policy reforms supported by the Industry and Trade Policy Adjustment Credit ITPAC) in 1987and the Public Sector Adjustment Credit (PSAC) in 1988.

2. When ASAC was prepared in 1984-85, the agricultural sector was heavily taxed both directlyand indirectly through price controls and currency overvaluation, and Government interventiondominated the internal and external marketing of major agricultural products and inputs. A largeshare of public investment in the agricultural sector went into large-scale and capital intensiveoperations managed by the state. As a result of Madagascar's balance of payments difficulties,agricultural inputs as well as consumer goods were extremely scarce In rural areas. Government hadstarted to partially lit mralize the domestic marketing of rice in 1983, but poor management of the riceimports had resulted in periodic rice shortages on urban markets and extremely high seasonal pricefluctuations.

Credit Objectives and Design

3. ASAC's objectives were: (i) to improve the returns on scarce resources in agriculture byfinancing from public sources only selected high priority investmer.ts; (ii) to put into place a coherentrice strategy to restore market confidence, improve productivity and reduce pressure on the balanceof payments; (Iii) to provide better incentives to farmers and improve marketing networks; and (iv) tohelp formulate consistent strategies for the next phase of adjustment. The package of policy reformssupported by ASAC concerned mainly the management of rice imports after full liberalization ofdomestic rice trade, the removal of input subsidies and transfer of input distribution to commercialoperators, improvements in the public investment program for agriculture, improved pricing of edibleoils and export crops, and various studies and action plans to prepare a follow-up sector adjustmentcredit.

4. At the identification stage, a more ambitious program was envisaged, covering four keysubsectors (rice, export crops, edible oils, beef). It was later decided that ASAC should concentrateon the completion of reforms in the rice subsector as a main priority, while gradually moving intoother subsectors, such as edible oils and export crops, and improving overall resource allocation in

iv

agriculture.

S. During project preparation, the politically sensitive qLestion of rice marketing had given riseto intense debate between Government and the Bank. Government wanted to maintain its monopolyand price controls on the purchase of rice in the two surplus areas (Lac Alaotra and Marovoay), whilethe Bank considered the opening of these areas to private trade, as had already been done in the restof the country, an essential condition. Shortly before negotiations, following a meeting between thePresident of Madagascar and the Regional Vice-President of the Bank, it was agreed that the Bank,with the assistance of other donors, would help Government set up a buffer stock of imported rice,provided Government would open up all areas to private trade and adopt appropriate practices for thecounter-seasonal release of imported rice on the domestic market. Detailed operational arrangementsfor the management of the buffer stock of imported rice, which became the major component ofASAC, were worked out during negotiations.

6. The total funding for ASAC of about US$60 million equivalent (including grant financing)was to be disbursed in two tranches, the first upon effectiveness and the second upon satisfactoryprogress in implementing the agreed package of sectoral reforms. Financing was provided for US$42million equivalent for agricultural inputs and, if needed, rice imports to complement the contributionsof other donors, US$3 million for veterinary products, US$5 million for incentive goods (i.e.consumer durables to improve production incentives in ural areas) and US$10 million for tractor andtransport equipment.

Credit Implementation

7. ASAC was approved on May 8, 1986, after a last minute confirmation by the President ofMadagascar of the opening up of all rice producing areas to private trade. Mainly due toadministrative delays, the Credit did not become effective until November 18, 1986 (a delay of fourmonths). First tranche disbursements toek thirty-two months instead of the twelve to sixteen monthsoriginally anticipated, in part due to sluggish demand for commercial imports of fertilizers and otheragricultural inputs, particularly after the mid-1987 devaluation. Moreover, the two subsequent Banksupported adjustment operations, nTAC and PSAC, made foreign exchange available to banks andimporters under adminL rative procedures which were less restrictive and time-consuming than thoseof ASAC.

8. The release of the second tranche, originally expected in 1987, took place on May 1, 1989.Besides slow disbursement of the first tranche, several factors contributed to this delay, including thelarge devaluation of mid-1987. This devaluation deepened and strengthened the agricultural marketreform process, but also affected the pace and direction of the liberalization program and requiredsome adjustments in the specific reforms agreed under ASAC. Despite an agreement to disburseASAC's second tranche funds on the same terms as those applying to ffPAC and PSAC, fulldisbursement of the second tranche was not completed until October 1990. ASAC was closed onJune 30, 1990, after three extensions of the original closing date of June 30, 1988.

9. Rice management program. The essential element of the rice management program agreedunder ASAC was, in addition to the full internal trade liberalization, an automatic mechanism forputting imported rice on the domestic market whenever the market price exceeded a trigger price,set during ASAC negotiations at a level providing adequate incentives for private sector purchase andstorage of domestic production. It had been further agreed that the official distribution of rice (i.e.

v

the Government operated ration scheme that provided rice at sub-market prices to urban residents),also based on imported rice, would be gradually phased out from 80,000 tons in 1986 to 20,000 tonsIn 1989, and that sales under official distribution would cover the full cost of imported rice at theprevailing exchange rate, including transportation, storage and distribution costs. An annual riceimport program was to be submitted by Government to the Bank for approval.

10. In general terms, the rice management program was implemented as agreed under ASACduring the first 1986-87 season. The buffer stock went into operation in November 1986 at thebeginning of the pre-harvest season, by selling imported rice at a fixed price- in wholesale lots. Thisintervention was very successful; with a relatively modest volume of sales, it held rice pricesthroughout the pre-harvest season at a level only slightly higher than the sales price of the bufferstock. After the painful price fluctuations of the previous year, the stable prices brought about bythe buffer stock were highly appreciated in Madagascar. The full liberalization of domestic rice tradein April 1986 had also resulted in intense competition for paddy purchases, which had pushedfarmgate prices up and induced farmers to increase their paddy production for the following year.As a result of this, combined with favorable weather conditions, prospects for the 1987 harvest werequite good.

11. Starting in late 1987 and until 1989, however, rice imports were used to supportGovernment's political interests. The rules agreed under ASAC were largely circumvented, andGovernment went ahead with imports that were in excess of actual needs for buffer stockreplenishment. A semi-private agency (PROCOPS) imported rice commercially that was soldthroughout the year to urban consumers at sub-market prices. This policy, which continuedthroughout 1988 and 1989, disrupted domestic rice trading activities and caused operating losses totraders who passed them on to farmers in the form of lower farmngate prices, thus contributing to aslow down of the growth of rice production in subsequent years. As the Credit Agreement onlyimposed limits on public sector imports, the Bank protested but could not take any legal action.

12. Government intervention in the domestic rice market was significantly reduced in 1990, whenthe private sector accounted for the first time for a large share of rice imports and the bufferstock wasabolished in 1991. Government's stated policy is now to rely mainly on the private sector for riceimports needed to complement the official grants that it may receive from external donors and, exceptfor special emergencies or disaster areas, to allocate external rice donations to commercial operatorsat a price reflecting their full commercial value. Rice remains nonetheless a highly politicalcommodity, which entails significant uncertainty for commercial operators.

13. Export crops. Under ASAC, the producer price of coffee was raised significantly in 1986and 1987, and the special rebate which discriminated in favor of parastatal enterprises in thecollection, processing and storage of coffee was eliminated. These measures did not translate intoany increase in coffee production and/or exports, because producer prices in real terms and relativeto rice remained unattractive, and because of the dilapidated state of the road network and the absenceof significant measures to improve traders' incentives. The latter were subsequently introduced underrTPAC and PSAC, with the abolition in 1988 of the state monopoly on exports of majors crops otherthan vanilla (i.e. coffee, clove and pepper). However, these measures came too late, as internationalcoffee prices collapsed following the suspension of the International Coffee Agreement in 1989.

14. Edible oils. Government had agreed in late 1985 to an increase in the ex-factory price ofgroundnut and other edible oils, but not to the full liberalization of edible oils prices which the Bank

vi

thought iecessary. Instead, it had been agreed under ASAC that Government would prepare andagree with the Bank on an action ptogram for the edible oils subsector and, prior to second trancherelease, take appropriate steps for its implementation. The Bank iwtially insisted on this actionprogrm, the prepartion of which was made difficult by the unclear allocation of responsibility andinsufficient collaboration between the various ministries involved (agriculture, industry, commerce).After mid-1988, the Bank decided that it was best to rely instead on the general trade liberalization,export promotion and parastatal restructuring measures supported under MTPAC and PSAC. Theedible oils subsector presently remains heavily dependent on donations of unrefined oil and/orimports, and the groundnut production, which had undergone a substantial decline throughout the late1970s and early 1980s, Is still stagnant.

15. Inputs pricing and distribution. Under ASAC, the Ministry of Agriculture (MPARA)continued to disengage itself from the direct distribution of fertilizer and other chemical inputs, andleased most of its input stores to commercial operators, including parastatals. It had been agreed thatinput subsidies would be reduced to a maximum of 7% of c.i.f. by the time of ASAC effectiveness,and fully eliminated by second tranche release. However, the devaluation of mid-1987 translated intoa sharp increase in the border price of imported inputs, at a time when abundant supplies of fertilizerwere availabe on the domestic market, as a result of increased aid donations (representing about 50%of total supplies). At the insistence of the MPARA, the Bank shifted its position in 1988 from apolicy of full import parity pricing of donated fertilizer to a policy which would instead allow thedisposal of fertilizer through an auction system that would still promote the development ofcommercial channels. In 1988, MPARA finally opted for an administrative allocation system ofdonated fertilizer to established operators, at a price 20% to 30% below import parity. This policyis still in effect.

16. Public investment program for agriculture. Seven projects of doubtful economic valueincluded in the agricultural Public Investment Program (PIP) had been questioned by the Bank duringASAC post-appraisal, and it had been agreed that they would be reexamined. Three were ruraldevelopment and/or irigation projects which were either dropped from the PIP or reshaped inconsultation with the Bank. The most contentious projects were agro-industrial investments in oilcrops (oil palm, soya and copra) and cashew which were both of doubtful economic viability andinconsistent with Government's stated policy of disengagement from direct production and marketingactivities. Two of them (oil palm and cashew) were new projects with an ensured source of externalfinance., which were executed as originally planned in the PIP, despite Bank suggestions to thecontrary

17. In 1987, several new externally-financed irrigation projects were introduced in the PIP which,as pointed out by ASAC supervision missions, were inconsistent with the strategy agreed betweenGovernment and the Bank. An agreement was reached to drop some of these projects, and reassessthe others. From 1988 onwards, dialogue between Government and the Bank on the PIP has beenpursued in the broader context of ITPAC and PSAC.

Credit Impact

18. Most of the impact came from the policy reforms introduced under ASAC, in particular fromthe rice management program which was the core of this operation. During the 1986-90 period,domestic paddy production increased at an average rate of close to 3.5% per year. Although thisgrowth was aided by favorable weather and has slowed down since then, with a resulting average

vii

growth rate of only around 2.5% per year for the whole period 1986-92, it nonetheless representsa significant improvement over the stagnation which had prevailed throughout the 1970s and early1980s. Rice imports, which exceeded 200,000 tons per year on average during 1980-83, havestabilized at an average level of around 70,000 tons per year over the 1987-90 period.

19. Although rice consumerprices became significantlyhigher in real terms with the liberalizationof domestic markets, most urban consumers have benefited from the liberalization of internal ricetrade and, at least during the 1986&87 pre-harvest season, from the sr'ccessful operation of the bufferstock. Official rice prices were hardly enforced before their elimination, and Government's attemptsto control the domestic market together with poor timing of the release of imports had translated untilmid-1986 into wild fluctuations of consumer prices and periodic rice shortages which badly hurtconsumers. Thereafter, rice became available in adequate quantity throughout the year, and inter-seasonal ptice fluctuations have remained in a reasonable range throughout the second half of the1980s and early 1990s; these gains have, however, been pardy set back from mid-1991 onwards, withthe onset of political turmoil and recurring foreign exchange shortages. A significant proportion ofthe population, both in urban and in rural areas, nonetheless continues to live below poverty level,thus facing serious difficulties in securing adequate food supplies. Specific measures are needed tohelp these vulnerable groups, and the Bank has started in late 1988 to support Government's effortsto address this problem under the Economic Management and Social Action Project (EMSAP). Also,a Food Security and Nutrition Project was approved in 1993.

20. The direct and immediate impact of ASAC on agricultural production other than rice wasmarginal. Increases in the producer price of coffee supported by ASAC in 1986 and 1987, althoughsubstantial, did not translate into increased production and/or exports, mainly due to the dilapidatedstate of the transport network in coffee producing areas, the absence of significant measures toimprove traders incentives and the collapse in international coffee prices. The edible oils subsectorremains heavily dependent on oil donations or imports.

21. On the whole, the performance of the agricultural sector in Madagascar has shown someprogress but remains nonetheless disappointing. During the 1984-PO period, the agricultural sectorgrew at an average rate of 2.6% annually, which compares favorably with the performance of the late1970s and early 1980s but still remains modest and masks a wide disparity in performance amongsubsectors. Most of that growth originates from the fisheries and to a lesser extent the livestocksectors, which together grew on average 4.9% annually between 1984 and 1989. By contrast, theperformance of the crop sub-sector has been much more modest, with an average growth of only1.5% per year during the 1984-89 period, which is well below the 3% population growth rate.Within the crop subsector, most of the growth has come from rice and to a lesser extent from otherfoodcrops. Traditional exports crops (coffee, vanilla, cloves), faced with increased internationalcompetition, have stagnated or regressed, and this has not been compensated for by the emergenceof alternative export crops.

22. In order to sustain and expand agricultural growth, iuprovements will be neededsimultaneously on several of these fronts. Appropriate and consistently followed macro-economicpolicies (exchange rate management, tariff and trade policies, fiscal regime, etc.) will also be essentialfor preserving and building upon the gains which have been made under ASAC and other adjustmentoperations. Political stability and consensus is an obvious pre-requisite for achieving this, togetherwith well conceived and coherent support from external aid agencies.

viii

Conclusions and Main Loessons

23. Ihe main lessons learnt from the experience gained under ASAC can be summarized asfollows:

(a) the adoption of a phased and gradual approach to sectoral adjustment, as has been thecase under ASAC., has its merits but nonetheless results in substantial foregonebenefits; in Madagascar, the external liberalization of major export crops other thanvanilla (i.e. coffee, clove, pepper) occurred only at a late stage in the adjustmentprocess, at a time when world coffee prices had already collapsed to a level thatconsiderably reduced private sector incentives to engage in this sector;

(b) the Bank should be fimer in reacting to serious lapses in program implementation.Government's renewed intervention in the rice market in the 198749 perod and itsgoing ahead with investments outside the agreed upon PIP are cases in point;

(c) the trends in paddy production since 1986, point out the benefits which can be drawnfrom a sustained policy of minimal market intervention;

(d) special programs of targeted food subsidies should have been put in placesimultaneously with the establishment of the buffer stock; this would have helpedease the transition for the poorest segments of the urban population, particularly afterthe mid-1987 devaluation;

(e) greater coherence between the strategies followed by Government and the variousexternal donors or lending agencies is needed in order to improve the PIP process;and

(t) in the case of commodities for which grants in kind represent a major share ofdomestic supplies, as was the case under ASAC for fertilizers and edible oils,pricing policies need to be worked out carefully, taking into account the potentiallydistortional effects of this type of aid on prices and the absorptive capacity of themarket.

PROJECT COMPLETON REPORT

MADAGASCAR

AGRICULTURAL SECTOR ADJUSTMENT CREDIT(IDA Credit 1691-MAG and SFA Credit A-16-MAG)

PART I: PROJECT REVIEW FlROM BANK'S PERSPECTIVE

1. Project Identity

Project Name: Agricultural Sector Adjustment Credit (ASAC)Credit NumberMDA Credit: 1691-MAGSFA Credit: A-16-MAGRegion: AfricaCountry: MadagascarSector: Sectoral Adjustment Credit

2. Background

2.1 In the decade following independence in 1960, Madagascar's economy grew at an averageannual rate of about three percent. Agriculture was responsible for much of this growth, with apositive per capita increase in rice production and a substantial growth of agricultural exports. Thisgrowth process was, however, highly dependent on external funding and continued reliance forexpertise on the former colonial power.

2.2 Starting in 1972, the Malagasy authorities introduced sweeping changes in the political andeconomic management of the country. Inward-looking policies aimed at self-sufficiency in industryand agriculture, most of the largest private companies were nationalized, interventionist practicescharacterized by price controls and administrative regulations were adopted, and direct or indirectstate control over major agricultural marketing activities was established. Real GDP rose at an annualrate of less than one percent between 1970 and 1978 as agricultural output stagnated and Madagascar,which had been self-sufficient in food production and a net exporter of rice, became increasinglydependent on food imports (especially for rice). Between 1978 and 1980, in an attempt to stimulatethe expansion of Madagascar's stagnating economy, the Government embarked on a public investmentpolicy which included several large aned economically non-viable projects. This policy was financedby a substantial increase in external borrowing. Combined with declining terms of trade, this led toa large public sector deficit and rising inflation, together with a heavy external Jebt burden. By1982, real per capita GDP had fallen by an estimated 28 percent from its 1973 level.

2.3 Faced with an unsustainable resource gap, the Government began implementing financialstabiization measures in 1981, with International Monetary Fund (IMF) assistance. Policyadjustment from 1981 to 1985 focused mainly on containing aggregate demand. During this period,the Government deficit was substantially reduced through cutbacks in public expenditure; theremaining deficit was financed increasingly by foreign loans on concessionary terms. On the external

2

side, the current account deficit was significantly reduced. With stagnating export receipts andincreasing external interest payrnents, the brunt of adjustment fell on imports, which dropped by morethan half in real terms between 1980 and 1985. The stabilization program succeeded in arresting thedecline in real GDP, but economic per capita growth remained negative.

2.4 In the second half of the 1980s, the focus of economic management moved from the urgentneed of financial stabilization with IMF assistance towards supply-oriented adjustment measuressupported by the Bank and the IMF. The main policy instruments used during the 1983-88 periodincluded increases in producer prices of major commodities followed by a gradual decontrol of most-prices and other internal and external trade liberalization measures, together with significantdevaluations in real terms. In 1982, the Malagasy franc (FMG) w:.s pegged to a trade-weightedbasket of currencies 1/ and a series of devaluations followed. By mid-1989, the real effectiveexchange rate had fallen to 45% of its level at the beginning of the decade. Non-tariff barriers toimports were gradually eliminated, and a step-by-step freeing up of foreign exchange allocationculminated in July 1988 with the introduction of a non-discretionary Open General License (OGL)system of foreign excnange allocation for merchandise imports. In the next phase of adjustment,from 1988, an increased emphasis was put on budgetary reform aiud public enterprise privatization.

Agricultural Sector Policies and Performance Prior to 1986

2.5 Starting in 1974, the marketing of paddy and rice throughout the country had been a statemonopoly impleminted through state companies and/or parastatals with Government majorityparticipation. Decentralized local govermnent authorities were also heavily involved in the primarymarketing of paddy and the official distribution of rice. A single price for paddy purchase and forretail rice sales was set by the central Governmenw, at a level that was insufficient to provide producerincentives and significantly below import parity, but that provided substantial consumer subsidies.The problems of managing the official marketing circuits and enforcing the marketing monopolybecame increasingly acute, and the share of domestic production officially marketed declined fromabout 241,000 toris of rice in 1975/76 (representing an estimated 12% of total production) to 93,000tons or 5% of domestic production in 1982/83. V Faced with stagnating paddy production,declining official purchases and increasing consumer demand due to population growth and lowconsumer prices, the Govermment had to rely increasingly on rice imports in order to supply theurban markets through the subsidized official channels. Rice imports, which had been negligiblethroughout the 1960s and early 1970s when Madagascar was a net exporter of rice, increased steadilyto reach a high of 287,000 tons in 1982. Consumer subsidy for rice also increased regularly between1972 and 1981 to reach an aggregate amount of 19 million FMG or 2.5 percent of GDP, exceedingthe total budget (operating and investment) of the Ministry of Agricultural Production. In theory,subsidies were financed through a special equalization fund, the "Fonds National Unique deP&requation" (FNUP), whose resources were derived from surpluses of export crop stabilizationfunds. However, clear arrangements for computing and paying for the subsidy were never workedout, and the parastatal agencies involved in the marketing of rice suffered substantial losses andexperienced serious fmancial problems.

1/ Although Madagascar left the franc zone in 1973, the Malagasy franc remained fixed at 50FMG per French fri.nc until 1982.

2/ Eighty percent of rice production is for auto-consumption.

3

2.6 In 1982, as part of the financial -stabilization efforts undertaken with IMF support, the officialretail price of rice was increased by 82%, eliminating explicit consumer subsidies at the prevailingexchange rate. Further measures were taken in subsequent years to promote domestic paddyproduction and improve urban supply. Private sector marketing of paddy and rice was legalized in1983, with the exception of the two "reserved areas" of Alaotra and Marovoay, representing about25% of marketed production, where the Government monopoly and price controls were maintainedin order to help supply the official distribution channels. The producer price of paddy was graduallyincreased from a fixed price of FMG 47 per kg in 1982 to a floor price of FMG 85 in 1985, and theceiling price of rice to the consumer was eliminated in 1985. In the 1983-85 period, quantityrestrictions were imposed on rice imports as part of the IMF Standby agreements. Several problemsdid arise during this initial phase of reform of the domestic rice market. First, farmers in themonopoly reserved areas were excluded from the incentives of market competition. Second, theauthorities disposed of imported and domestically-procured rice stocks in the post-harvest market forpolitical celebrations, in 1985, which not only depleted Government stocks but also depressed pricesand encouraged speculation among traders. For these reasons, the supply response was delayed. Byend 1985, rice prices on the domestic market had risen sharply, which brought ad hoc trade controlsand gave rise to widespread skepticism about the benefits of economic liberalization.

2.7 Stabilization funds for export crops were established shortly before independence, and thecorresponding pricing mechanism remained basically unchanged until the second half of the 1980s.A detailed price structure was issued at the beginning of each marketing season, setting the pricesand margins at every level in the marketing chain from producer to exporter. The initial purpose ofthis system was to protect domesth; operators from excessive fluctuations in international prices, andprovide a mechanism for financing crop development from export profits. Government's directintervention in the marketing of export crops was considerably reinforced after 1973, when all tradein agricultural commodities was officially brought under public control. The largest privatecompanies involved in the processing and export of coffee and cloves were nationalized in 1975. Inthe following two years, state trading companies were given a monopoly for handling exports ofcoffee, cloves and pepper on behalf of Government, and the role of the private sector becameconfined to the purchase, processing and storage of these commodities. Although free competitionprevailed in primary marketing and processing of these crops, the state trading companies had acompetitive edge over private firms as they received a special commission amounting to 10% ofexport crop revenues. The Government also exerted a broad range of administrative and financialcontrols over trade in vanilla and other agricultural export commodities.

2.8 Export crops became a major source of Government revenues and the corresponding increasesin taxes and levies resulted in a steady decline in real producer prices. This contributed to astagnating export crop production. Incentives to diversify exports started in 1984, with theelimination of all taxes on non-traditional agricultural exports (i.e. commodities other than coffee,cloves, vanilla and pepper). Producer price increases for coffee in 1984 and 1985 amounted to a totalreal increase of about 15 percent, but they still remained significantly below the levels received inthe early 1970s, and remained unattractive relative to the price of rice.

2.9 Most industrial crops (in particular cotton, sugarcane and oilseeds) were purchased from theproducers by parastatals involved in the processing of these crops, at a price that was fixed byGovernment. With a view to protect consumers, producer and/or ex-factory prices were onlyinfrequently revised with little regard for actual trends in production costs, which discouraged newinvestments in the production and processing of these crops. Cotton production stagnated at a low

4

level in the 1970s, and the edible oils industry faced increasing difficulties in securing adequatesupplies mainly as a result of steadily declining groundnut production from the mid-1970s onwards.The ex-factory price of groundnut oil, which had been previously maintained at a low level givingrise to a high cost parallel market, was also increased in late 1985 from FMG 750 per kg to FMG1150. Ambitious plans to develop soybean, coconut oil and oil palm production were developed inthe late 1970s and early 1980s with the help of external donors; the economic viabilitv of some ofthese investments was questioned by the Bank and gave rise to controversy during ASAC'spreparation and implementation.

2.10 The provision of inputs and services to rural producers also fell largely to the public sector,and underwent a steady deterioration throughout the late 1970s and early 1980s. During this period,commercial fertilizer imports were severely curtailed as a result of foreign exchange restrictions andbecame mainly confined to a few parastatals dealing with sugar and cotton production. Limitedquantities were granted by external donors under aid programs, and sold to farmers at subsidizedprices through a network of retail outlets managed directly by the Ministry of Agricultural Production(MPARA); in 1982, MPARA started to transfer its fertilizer distribution activities to a state tradingcompany (Comptoir de Commerce et de Representation de l'Ocean indien, COROI). The availabilityof all other types of agricultural inputs (pesticides, veterinary products, etc.) and equipment was alsolimited because of insufficient foreign exchange allocations, and farmers' access to improved seedsand planting materials was further constrained by extremely restrictive quarantine regulations onimports.

2.11 More generally, all services in rural areas (including the management of large and mediumsize irrigation schemes, rural credit, research, extension and veterinary services, etc.), which weretypically under the responsibility of public agencies or enterprises, quickly deteriorated in the late1970s and early 1980s. This, together with increasing transportation problems due to the dilapidatedstate of the road network, declining real producer prices for most agricultural products, a-Iincreasing shortages of consumer goods in rural areas, led to a withdrawal of farmers into asubsistence economy and a sharp decline in marketed output.

3. Credit Origin and Genesis

3.1 An Initial Project Brief for ASAC was issued in May 1984. Policy reforms to be supportedby the credit, as envisaged at that stage, were both of a general nature (i.e. integration of counterpartfunds of external assistance and of FNUP resources into regular budget mechanisms; improvementsin public sector procurement; and streamdining of inter-sectoral management responsibility betweenagriculture, industry, commerce and transport) and commodity specific, with an emphasis onmarketing and pricing policies for rice and other agricultural products, transfer of agricultural inputsdistribution to commercial channels, improved resource allocation and management in agriculture,and parastatals reform. Action programs for key subsectors (rice, beef, export crops, edible oils)were to be agreed with Government, and a Bank credit of US$35 million was proposed in order tofinance the foreign exchange costs of implementing these programs over a three-year period. Bankfinancing was to cover the importation of agricultural inputs, credit for the rehabilitation anddevelopment of processing plants and other farming or agro-industrial ventures, inputs and equipmentfor relaunching seed production, purchases of vehicles for transport in rural areas, and a rural roadspilot program. A second Agricultural Institutions Technical Assistance Project (Cr. 1709-MAG), alsounder preparation at that time, was expected to provide the required support for additional policy

5

analysis and strategy formuiation during implementation.

3.2 During further preparation, the scope of the proposed credit was gradually scaled down andits time span reduced to a two-year period, and financing focused on quick-disbursing balance ofpayments support. The rural roads pilot program was dropped as it was to be handled through on-going and future infrastructure projects, and the seed production component was reduced to a reformof the quarantine regime to facilitate the introduction of new crop varieties in Madagascar. Theproposed policy package became explicitly focused on the completion of reforms already initiated byGovernment in the marketing and pricing of rice, with measures of more limited scope for otheragricultural commodities and for parastatals reform which were mainly designed to prepare the nextphase of sectoral adjustment. It was decided that part of the credit would be allocated to theimportation of consumer durables for rural areas. The total credit amount was then estimated atUS$25 million, and procurement and disbursement were to be done through the allocation of foreignexchange to conunercial importers.

3.3 At a later stage, it was decided that the credit line for sectoral investments should be detachedfrom ASAC and handled separately. This led to the Second Agricultural Credit Project (Cr. 1804-MAG).

3.4 The politically sensitive question of rice marketing gave rise to intense debate during and afterthe appraisal mission of May 1985. A commitment to open up the reserved areas to free marketcompetition was viewed by the Bank as an essential pre-requisite for restoring producers and tradersincentives and promoting increased domestic production. The Government of Madagascar was,however, reluctant to commit itself on this matter until a rice security strategy could be put in place.Access to the large rice surplus of the reserved areas was considered by Government as its bestinsurance against urban rice shortages and possible political unrest, and the importance of retainingthis monopoly had in fact increased following the sharp curtailment of rice imports in 1984 and 1985under the IMF Standby agreements. During appraisal and post-appraisal missions, Governmentpolicy towards edible oils also emerged as another contentious issue. Government was hesitant toallow full liberalization of edible oil prices, arguing that other constraints (ack of seed) were themain limiting factors to domestic groundnut production. For export crops, it was agreed that the10% special commission benefiting parastatals would be gradually eliminated and that Governmentwould increase the producer price of coffee. Management of the export crops stabilization funds andof FNUP resources were to be improved, and studies would be carried out in order to examineoptions for simplifying the pricing and taxation system for export crops and promoting thediversification of agricultural exports. Detailed terms of reference for studies on the management ofcounterpart funding and on the finances of decentralized local authorities including their involvementin the taxation of agricultural products were prepared.

3.5 In December 1985, conditions for negotiations (i.e. announcement by Government ofacceptable prices for paddy in the reserved areas, and for ex-factory edible oil) were met. Duringa visit to Madagascar in early November, the Regional Vice President had agreed with the Presidentof Madagascar that the Bank would encourage other donors to finance the establishment of a ricebuffer stock and participate itself on a last resort basis, as a Quid pro quo for the opening of reserveda:eas to private traders and the adoption of appropriate practices for counter-seasonal release ofimported rice on the domestic market. Definition and mechanics of the buffer stock were workedout during negotiations.

6

3.6 At the Loan Committee meeting of December 1985, several committee members questionedthe proposal for a rice buffer stock to be fmanced by the Bank. It was clarified that the proposal wasfor the Bank to define with Government a program to manage rice-imports and their sale. The Bankwould encourage the donor community to finance Government rice inports on concessional terms,.and would provide financing for these imports only as a last resort. As post-appraisal missions hadidentified several projects of doubtful economic value in the draft 1986488 agricultural publicinvestment program, the Chairman of the Loan Committee meeting also stated that the Credit shouldbe presented to the Board only when the Bank would be satisfied with the agricultural PIP. The LoanCommittee agreed on negotiations for a US$60 million package (including grant financing), of whichUS$45 million would be allocated for agricultural inputs including the possibility of rice buffer stockfinancing, US$5 million for incentive goods and US$10 million for transportatio-1 equipment andspare parts.

4. Credit Objectives and Desceiption

4.1 The objectives of ASAC, as described in the President's Report, were: (i) to improve thereturns on scarce resources in agriculture by financing from public sources only selective investmentsof high priority; (ii) to put into place a coherent rice strategy to restore market confidence, improveproductivity and reduce pressure on the balance of payments; (iii) to provide better incentives tofarmers and improve marketing networks; and (iv) to help formulate consistent strategies for the nextphase of adjustment.

4.2 ASAC was designed to support a deepening of the sector policy reforms initiated byGovernment in the first half of the 1980s and put them into a coherent framework, thus allowingexpected benefits to materialize. To help restore credibility to the reform program, which had so farlargely fallen short of its goals, the Bank felt that the Government should tackle the rice problemfirst, which was one of the main causes for resistance to liberalization among political forces, whilecontinuing to move gradually with other areas such as edible oils and export crops and improvingoverall resource allocation in agriculture. Progress under ASAC was expected to set the stage fora follow-up sector adjustment credit that would expand into edible oils and export crops, and the useand management of export crops receipts. 3I

Credit Conditlonafity

4.3 The full liberalization of domestic rice trade was a condition of Board presentation. It wasagreed that Government would manage its rice imports in accordance with principles agreed with theBank during negotiations. The rice management program was summarized in an annex to the letterof development policy, and the corresponding technical parameters (i.e. trigger price for sales ofimported rice on the domestic market, quantities of rice to be distributed each year to low-incomeconsumers through official channels, rules for the replenishment of Government's buffer stock ofimported rice) had also been agreed upon during negotiations. Before October 31 of each year,Government was to submit to the Bank for approval its rice import program for the following yearand the corresponding financing plan. Government was also to fiunish to the Bank quarterly reportson rice inports and stock management. The implementation of a rice management program

3I President's Report, paras 35 and 39.

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acceptable to the Bank was a condition for second tranche release.

4.4 Under ASAC, Government was to submit to the Bank by end October 1986 a program forthe promotion of private sector participation in the marketing of agricultural products, and to takeappropriate action for its implementation in particular through improvement in credit access andstreandining of administrativeprocedures. A study and action plan on local government finances wasalso required prior to second tranche release, with a view to finding alternative sources of localrevenues to the taxation of agricultural products and promoting their free circulation within thecountry.

4.5 The ex-factory price of groundnut oil had been increased by Government in late 1985 to alevel that was judged acceptable by the Bank, pending the completion of an edible oils strategy studythat was being launched by Government with the help of UNDPIUNIDO, under terms of referenceagreed with the Bank during negotiations. Based on the results of this study, Government was toagree with the Bank on an action program for the edible oils subsector and take appropriate actionfor its implementation as a condition for ASAC second tranche release. For export cs.Government had already reduced the special commission for parastatals to 7% prior to Boardpresentation, and it was to be further reduced to a maximum of 4% by April 1987 and eliminated byApril 1988. The setting of producer prices for coffee in accordance witha methodology acceptableto the Bank was a condition of Credit effectiveness. Studies were to be carried out, andcorresponding action plans presented to the Bank prior to second tranche release, on: (i) thedisposition of the surplus generated by export crops, including the future of the export cropstabilization funds; A/ and (ii) Madagascar's potential and comparative advantage in coffeeproduction, and the administration of export crops. 51 The implementation of improved pricingsystems for major export crops was a condition for second tranche release.

4.6 ASAC also supported the elimination of subsidies on agr.cultural inpMt, and the transfer ofcorresponding distribution activities to commercial (rather than Ministry-operated) channels. Averagesubsidies on agricultural inputs, which amounted to an estimated 30% for fertilizer and even morefur pesticides, were to be reduced to a maximum of 7% of c.i.f. cost by the time of Crediteffectiveness, and to be fully eliminated thereafter as a condition for second tranche release (exceptfor a naximum of 5% on pesticides and for pesticides used for demonstration purposes by theextension service). As a condition for second tranche release, Government was to implement aprogram acceptable to the Bank for the promotion of the role of commercial enterprises in theimportation and marketing of agricultural inputs and veterinary products. ASAC credit proceeds wereto be used for the importation of inputs and other goods by local commercial firms, thus alsocontributing to the development of commercial channels for input distribution. In order to facilitatefarmers' access to improved seed varieties developed abroad, new quarantine regulations were to beenacted as a condition of Credit effectiveness.

A/ It had been agreed during negotiations that this study would be financed with remaining fundsunder Credit 881-MAG (Mangoky Agricultural Development Project).

These studies were to be carried out jointly with the Bank as part of its sector work. Inaddition, funds were to be provided under the forthcoming second Agricultural InstitutionsTechnical Assistance Project (Cr. 1709-MAG) for the elaboration of an export cropdevelopment and diversification program.

8

4.7 Following the questions raised during post-appraisal on the public investent program (PIP)for agriculture, Government had agreed to undertake new feasibility studies and/or furnish additionalinformation to the Bank before proceeding with the contentious projects (which included two agro-industrial projects respectively for oil palm and cashew nut, a copra project, three rural developmentor irrigation projects, and a soybean production project to be dropped). Under ASAC, Governmentwas to consult with the Bank on any change on the agricultural PIP for the years 1986-1988 and1987-1989, and to seek the Bank's agreement prior to proceeding with any new investment costingthe equivalent of US$5 million or more. The adoption of a 1987-89 PIP for agriculture acceptableto the Bank was a condition for second tranche release.

Disbursement and Procurement Mechanisms

4.8 The total credit proceeds of about US$60 million equivalent (including an IDA credit ofSDR 19 million and a SFA credit of SDR 31 million, together with a grant from Japan of Yen 600million and a credit from Germany of DM 10 million) were to be disbursed in two tranches, the firstone (US$32.5 million equivalent) released upon loan effectiveness and the second one (US$27.5million equivalent) contingent upon satisfactory progress in carrying out the sectoral adjustmentprogram. Financing was provided for US$42 million equivalent for agricultural inputs and, ifneeded, rice, US$3 million for veterinary products, US$5 million for incentive goods and US$10million for tractor and transport equipment.

4.9 Agricultural inputs, incentive goods and equipment financed under the Credits were to bepurchased abroad by local commercial firms, with the exception of some veterinary products thatmaight be purchased by Government and rice imports that would be allowed only as a last resort afterconsultation between Government and the Bank. For fertilizers, pesticides, veterinary products,tractors and tires for transport equipment, it had been agreed during negotiations that Governmentwould invite bids from importers and allocate the required foreign exchange to the lowest bidders.A limit of US$3 million equivalent per importer had been set in order to avoid collusion among a fewimporters. As a general rule, importers using foreign exchange from ASAC proceeds were requiredto provide evidence that they had followed the procurement procedures agreed with the Bank. Inorder to manage the financing of imports under ASAC, Government was to enter into subsidiaryagreements with the three national banks (BTM, BFV and BNI) who would act as intermediaries withimporters, and provide the required support for implementing the agreed procurement and foreignexchange allocation mechanisms.

5. Credit Implementation

5.1 Effectiveness. ASAC became effective on November 18, 1986, about four months behindoriginal schedule. Late effectiveness was mainly due to administrative delays in drawing up themanual on import procurement procedures and finalizing the corresponding subsidiary agreementswith intermediary banks. After effectiveness was declared by the Bank, public announcement of theavailability of ASAC funds was made by Government only in early January, thus contributing tofurther delays in initial disbursements.

5.2 Second tranche release. The release of the second tranche, originally expected in May 1987,took place in May 1989 only. Besides slow disbursement of the first tranche, several factorscontributed to this delay, including initial disagreements on several projects included in tl:e public

9

investment program for agriculture, and difficulties in defining the contents of the edible oils actionprogram and the corresponding steps to be taken by Government prior to tranche release. The Bank'sposition on the elimination of fertflizer subsidies was significantly softened before second trancherelease, on the grounds that available supplies from donations largely exceeded potential domesticdemand at fl import-parity prices. After Initial successes that translated into a significantimprovement of producer and trader incentives, performance under the rice management progrun hadquicldy deteriorated with the onset of the 1988-89 election campaign and the resumption of ricedistribution to urban consumers at sub-market prices. By the time of second tranche release,however, it was felt that significant results had been obtained under this difficult and politically-sensitive component of ASAC, and that Government had carried out the rice management programin conformity with the Development Credit Agreement.

5.3 Disbursements. First tranche disbursement took thirty-two months, instead of the twelve tosixteen months originally anticipated. Tbis was pardy due to sluggish demand for commercialimports of fertilizers and other agricultural inputs after the mid-1987 devaluation. A contributingfactor was also the progressive introduction of the market-based OGL system of foreign exchangeallocation, which the Bank supported under its subsequent adjustment operations. The Industry andTrade Policy Adjustment (ITPAC) and the Public Sector Adjustment (PSAC) Credits made foreignexchange available to banks and importers under administrative procedures that were less restrictiveand time-consuming than those required under ASAC. This difficulty was solved upon ASAC secondtranche release, as it had been agreed in advance during negotiations of n`PAC that coherence wouldbe ensured by disbursing ASAC funds, after second tranche release, under the OGL import regime.

5.4 ASAC's second tranche was nonetheless fully disbursed only in October 1990, mainly dueto administrative delays on Government side. In December 1989, the Bank agreed on an exceptionalbasis to finance petroleum products from ASAC proceeds.

6. Implementation of Individual Components

Rice management program

6.1 The rice agreement worked out during ASAC negotiations was primarily a program tomanage rice imports and their sale, in a way that would restore producers and traders incentives andallow Madagascar to regain self-sufficiency. Underlying the agreement was acceptance ofGovermment's monopoly on importing rice until 1990, when self-sufficiency would be attained andrice imports would no longer be needed. The essential element of the rice management program wasthe sale of imported rice on the domestic market when the market price exceeded a trigger price, setduring negotiations at an initial level of FMG 480 per kilogram. .6I While providing adequateincentives to producers and traders, this mechanism also aimed at containing excessive seasonal pricefluctuations which had been disrupting the market and badly hurting consumers in previous years.It was also agreed that the official distribution of rice (i.e. the Government operated ration schemethat provided rice at sub-market prices to urban residents), based on imported rice, would be

§I This trigger price of FMG 480 had been calculated at 40% above the average market priceof the post-harvest period, so as to provide adequate incentives for private sector purchaseand storage of local production.

to

gradually reduced from 80,000 tons in 1986 to 20.000 tons in 1989. Tese sales, aimed at potectinglow-income consumers, were to be done during the pre-harvest period (i.e. from November to endof April) when rice is usually in short supply and expensive, at a price that was set duringnegotiations at FMG 265 per kilogram for 1986. 7/ Part of Government stock of imported ricecould also be used, if needed, to help victims of natural catastrophes.

6.2 Given Government's monopoly, all imports of rice including donations as well as commercialshipmens were expected to pass through the 'buffer stock' of imported rice, which was to berepenished automatically whenever it fell below the agreed level of 14,000 tons. Although an annualtarget for rice imports was to be agreed between Government and the Bank, no absolute limit wasimposed on rice imports, since it was essential for Government to be in a position to effectivelyintervene whenever the market price exceeded the trigger price.

6.3 Before ASAC effectiveness, the liberalization of domestic rice trade in the reserved areas atharvest time In April 1986, resulted in intense competition between commercial operators, bothprivate and parastatal. This pushed paddy prices far beyond their controlled level of the previousyear which, together with the stock-building behavior of farmers and commercial operators, resultedin higher rice prices on urban markets than originally expected in the post-harvest period.Govemment reacted by increasing its official distribution of rice which reached about 89,000 tonsby end-July 1986, thereby exceeding the limit originally set for the full year. ZI The Julysupervision mission found that no arrangement had been made by Government to curtail the volumeof its official distribution. It was agreed, however, that responsibility for rice management wouldbe assigned to MPARA, and that official distribution would be limited to 35,000 tons fur theremainder of the year; the import target for 1986, originally set at 105,000 tons during ASACnegotiations, was revised accordingly to 134,000 tons. From August to the end of the year, officialdistribution was effectively curtailed to 34,000 tons. The revised import target was, however, largelyexceeded with the arrival in the last quarter of the year of a shipment of 38,000 tons of rice financedby a USSR credit, which brought total 1986 imports to about 162,000 tons. The Bank had not beenpreviously informed of this shipment, which was part of a larger agreement negotiated by thePresident during a visit to USSR in January 1986. This, together with continuing uncertainties onGovermment's commitment to respect the agreed ceiling on official distribution, gave rise to seriousconcerns within the Bank as to whether or not ASAC should be made effective. 2/

I/ Although lower than expected market prices, this price was not subsidized since it had beencalculated so as to cover the full cost of rice imports, including transport, storage and sellingcosts.

J/ It had been agreed during ASAC negotiations that Government would continue officialdistribution after the 1986 harvest in case market prices in Antananarivo by end April wouldstill be higher than FMG 420/kg, which turned out to be the case.

2/ The supervision mission of October 1986 was informed that the President wished to use theUSSR rice to increase official distribution. In its supervision report dated November 3,1986, the mission recommended that ASAC should be suspended in this case, since theASAC agreement was, by its very nature, not legally enforceable in detail, which mademutual confidence between Government and the Bank essential to the success of thisoperation.

6.4 Government began to intervene in the market according to the trigger price in November1986, when ASAC was declared effective. During the 1986-87 pre-harvest season, theseinterventions were carried out in accordance with the principles agreed during negotiations, and theystopped, as planned, at harvest time by end April 1987. During that period, over 34,000 tons of ricewere received in the buffer stock as a grant from USAID and the World Food Program (WFP).About 14,300 tons of imported rice were sold from the buffer stock, mostly in Antananarivo at theagreed price of FMG 4501kg. These interventions, although relatively modest in volume, were verysuccessful in stabilizing the pre-harvest consumer prices, in sharp contrast with the skyrocketingprices that had prevailed a year before. Prospects for the 1987 harvest were also very good, in partdue to the high producer prices that had prevailed in 1986.

6.5 In January and February 1987, official distribution was again increased temporarily to a leveltat could not be sustained without breaching the overall agreement of a maximum of 60,000 tonsfor 1987. Government's commitment to this ceiling for official distribution was reaffirmed in March1987, at which time it was also agreed with the Bank that official distribution would provide nofinancial subsidy to the consumer (i.e. the selling price would be adjusted as needed to reflect the fullcost of rice imports and distribution), LO/ and an import target of 90,000 tons for 1987 wasaccepted. Following the April 1987 harvest, however, the domestic market was glutted with rice.A gcod harvest combined with the sale of rice from the previous season, which dealers hadaccumulated in expectation of a substantial price rise during the pre-harvest period that had notmaterialized as a result of the successful operation of the buffer stock. T-.e Bank advised that riceshipments fnanced by the USSR, due to arrive during the post-harvest period, should be postponedeven though they were not in excess of the previously agreed import target. These shipmentsnonetheless arrived, and by October 1987 there were some 40,000 tons of imported rice in the bufferstock, part of which was approaching the end of its shelf-life and starting to deteriorate, with afurther 25,000 tons of rice financed by USSR expected to arrive between November and January.There was no immediate use for these stocks under the agreed ASAC rules, since domestic marketprices were lower than both the trigger price, maintained at FMG 480/kg, and the import-parity pricefor official distribution, which had increased to over FMG 400/kg following the substantialdevaluation of mid-1987. Options presented by the Bank supervision missions in order to disposeof excessive stocks included possible exports to neighboring countries (which was considered by theBank as the best alternative), the exchange of newly harvested paddy for deteriorating rice, and/orsales of deteriorating rice in the provinces up to a volume of 10,000 to 20,000 tons. The latter wasthe option followed by Government, and over 14,000 tons of rice were auctioned or sold at a discountprice between end-1987 and mid-1988. In October 1987, Govermment also announced that traderswere free to import and export rice.

6.6 By the end of 1987, it became clear that Government was moving from its primary concernwith price stability to the use of imported rice to meet political, and to a lesser extent social,objectives. As noted in the aide-memoire of the October 1987 supervision mission, the 1988 electioncampaign was expected to lead to substantial gifts of imported rice to political parties from theirsupporters abroad, and Government had stated that these gifts were to be eonsidered as "politicalimports" rather than official imports. This clearly meant that they would be exempt from the rulesfor import management agreed under ASAC, and would thus be used as a substitute for official

IQ/ This commitment was also part of an IMF Standby agreement requiring that officialdistribution should be priced so as to avoid any fiscal subsidy.

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distribution. The February 1988 supervision mission reported that the rice program was no longerfunctioning as intended. PROCOOPS, a cooperative wholesale supplier owned by the President'sAREMA political party, had started to play a large part in the urban market for rice during theclosing months of 1987, supported by a direct political gift of 10,000 tons of rice from the Presidentof North Korea to the President of Madagascar. This had the effect of holding market prices at orjust below FMG 400/kg, effectively undercutting the possible operation of the official buffer stock.Although this clearly contravened the spirit of the ASAC agreement, Government was not legallyviolating the letter of this agreement since PROCOOPS was a private operator and its sales werebased on non-official rice donations.

6.7 The Bank attempted to reverse this situation through a Memorandum of Understanding signedin March 1988 by the Minister of Agriculture and the Bank's Department Director, which set animport target of 60,000 tons for 1988 including official imports as well as private donations andreaffirmed that Government would not release its existing stocks and any other official imports priorto the next pre-harvest season, when it would auction rice with a reserve price of at leastFMG 400/kg. It further stated that in the meantime Government would encourage the sale ofprivately donated rice in remote areas and ensure that these donations did not affect the market.These measures were to be announced publicly, to give private traders the assurance they needed tomake adequate farmgate purchases of paddy, and thus support the producer price. Rice sales at lowprices nonetheless continued throughout 1988, even during the post-harvest season. All imported ricemoved through the new circuit that had replaced official distribution, inchiding existing rice stocksas well as new imports financed by USSR (23,000 tons) and Japanese (about 8,100 tons) grants.-1J PROCOOPS was the largest distributor. It did not operate on a commercial basis; it soldbelow market and then used the proceeds to purchase local rice for further rounds of resale belowboth costs and market values. According to the data from MPARA, the buffer stock set under ASACdid not operate throughout 1988. Due to the large stocks accumulated from previous years, total riceimports for 1988 came to about 31,000 tons, which was the lowest volume since 1971.

6.8 In November 1988, market prices began climbing rapidly. The 1988 harvest had been lowerthan in 1987, as a result of poor climatic conditions together with a reluctance by farmers to increaserice production. In late December, Government communicated to the Bank its concern that furtherprice increases were likely since its stocks were low and no imports on order, and made a strong pleafor an authorization to import 30,000 tons of rice using ASAC financing. The Bank replied that itwould accept to act as a lender of last resort, as agreed under ASAC, provided Government wouldsell its remaining stocks at a price of at least FMG 500/kg and thereafter dispose of new shipmentsat a minimum price of FMG 480/kg through the auction system previously agreed in March. 12/

1_1 Madagascar Agricultural Sector Adjustment Credit: Evaluation of the Buffer Stock, March1991, AF3AG.

121 Earlier auctions or sales done since the March agreement had not respected the reserve pricecondition. The rationale for a price of at least FMG 500/kg for immediate sales was that themarket price had already reached FMG 650/kg in December and was still climbing, so thatintervention at a price around FMG450/kg or lower would have been a waste of effort andwould have only contributed to promoting further speculation. The Bank reconmmended in factthat initial releases should be made at an even higher price, possibly as high as FMG 600/kg,with a gradual lowering thereafter to a levei that should not go below FMG 500/kg.

13

Further discussions led to a lowering of the price for immediate sales to FMG 450/kg, and to theactual importation by Government of 27,000 tons of rice which the Bank had agreed to refinanceunder ASAC, after second tranche release. This rice order was received in two shipments in Januaryand February 1989, followed in March by a further 15,000 tons as a grant from WFP and otherdonors.

6.9 In the meantime, internal Bank discussions had led to a decision that the short-run tactics ofintervention in the rice market should from now on be left at Government's discretion. Accordingly,the final Memorandunm of Understanding signed with the Minister of Agriculture in January 1989stated that, during the period from January to April 1989, Government would continue to take whatsteps it could to promote the aims and intentions of the ASAC agreement, so as to ensure that duringthis period the final retail price of locally produced rice would never fall below FMG 515/kg and riceimports from all sources would not exceed 40,000 tons. This agreement marked the end of activeBank intervention in the management of Government rice imports. During 1989, Governmentcontinued to intervene on the rice market both in the pre-harvest and in the post-harves. season, andtotal rice imports amounted to 89,000 tons.

6.10 The buffer stock was closed in 1990, with a final theoretical stock calculated by MPARA at1,956 tons. Govemment's stated policy is now to rely mainly on the private sector for rice importsneeded to complement the official grants that it may receive from external donors. The rice importtariff, which had been 5%-10% since the 1987 liberalization of rice external trade, was increased to30% in January 1991 in order to protect domestic production. In 1990, Government received only2,800 tons of grant rice from Japan, and a further 73,000 tons were imported by commercialoperators (parastatals and private). Reportedly due to foreign exchange and credit shortages as wellas strikes in the transport sector as a result of political unrest, total imports in 1991 decreased to39,400 tons of which close to 28,800 tons were grant rice. According to MPARA estimates, only6,200 tons of grant rice were planned for 1992, against a total import requirement of close to 98,000tons for bridging the gap with the next harvest in March 1993.

Other crop pricing and marketing aspects

6.11 The program for the promotion of private sector participation in the marketing of agriculturalproducts was never prepared in detail by Government. After initial reminders, the Bank decided inOctober 1987 to drop this requirement under ASAC, since it was felt that this complex questionwould be better handled in the broader context of other on-going (ffPAC) and forthcoming (PSAC)structural adjustment operations.

6.12 The study on local government finances was initiated as planned at the time of ASACeffectiveness, and was finally completed in February 1989 through collaboration between an inter-ministerial committee chaired by the Ministry of Finance and a local consulting firm. ._/ By thetime of second tranche release, the corresponding action plan had not yet been developed as originallyrequired under the ASAC agreement. However, since the issues involved raised the question ofpolitical and administrative decentralization of government and were therefore politically sensitive,the Bank felt that it was better to defer the preparation of this action plan until the on-going national

13J. Some limited funding to help carry out this study was provided under the second AgriculturalInstitutions Technical Assistance Project (Cr. 1709-MAG).

14

elections were over.

6.13 Although the completion of this study took more time than originally anticipated, and Itremained mainly descriptive and d;d not lead to any concrete decision or action plan, it was a usefultool for fostering initial discussion among the various ministries concerned with the issue ofdecentralization. The main rationale for including this study under ASAC was that taxes onmarketing transactions were (and still are) a main source of revenue for decentralized localgovernment authorities. A number of crucial issues emerged from the study, which are stili pendingtoday (need to better define the responsibilities devolved to the various levels of local government,and the degree to which they should be given independent access to the tax base). Alternative sourcesof local revenues to the taxation of agricultural products, such as a land tax, also need to be furtherexplored.

6.14 Export crops. Before ASAC effectiveness, Government raised the producer price of coffeefrom FMG 3951kg to FMG 600/kg for the 1986 harvest. In early 1987, the Bank discussed withGoverunent authorities its draft study on Madagascar's potential and comparative advantage in coffeeproduction, 4JA and the producer price was subsequendy increased to FMG 800/kg for the 1987harvest. The Bank study underlined the importance of the coffee subsector for foreign exchangeearnings, and strongly advocated further increases in real producer price at the expense ofGovernment's fiscal revenue, in order to boost coffee exports and foster increased private investmentin the subsector. It was, however, overtaken by events, as international coffee prices collapsed in1987 and the International Coffee Agreement was suspended in 1989. Starting with the liberalizationof coffee exports in 1988, the producer price announced by Government became an indicative priceand was raised to PMG 950/kg.

6.15 A study on administrative constraints to agricultural exports was completed by the Bank asplanned in January 1987, j1/ and further dialogue on this matter was pursued under ITPAC andPSAC rather than ASAC. Although arrangements were made before ASAC effectiveness for therecruitment of consultants to carry out the study on export crop stabilization funds, the signature ofthe contract was delayed and the final report was issued only in May 1988. The main purpose of thisstudy was to examine the existing export crop stabilization system and make recommendations forits improvement. By the time it came out, however, this study was largely obsolete sinceGovermnent made a decision in 1988 to abolish the state monopoly on exports of coffee, cloves andpepper. As a result of this decision and other export promotion measures supported by the Bankunder IMAC and PSAC, Government had largely fulfilled and even exceeded the modestconditionality of ASAC concerning export crops. Stabilization fund levies were replaced by explicitexport taxes as a source of Government revenue, and dialogue between Government and the Bankon the level of these taxes, and on the restructuring and/or privatization of parastatals, has beenpursued in the context of lTPAC and PSAC. However, important recommendations made in thestudy of the vanilla subsector went unheeded, despite a slide in Madagascar's world market share.

JA/ Madagascar Coffee Subsector: Economic Analysis and Recommendations, Report No. 6548-MAG, February 27, 1987.

_S/ Madagascar: Administrative Constraints to Agricultural Exports, Report No. 6595-MAG,January 16, 1987.

6.16 Edible oils study and action program. The draft study on edible oils done by a consultingfirm under UND"IIUNIDO financing which had been initiated in mid-1986, was reviewed andcommented on by the Bank in early 1987 and the final report was issued in June 1987. The purposeof this study was to examine options for reviving the edible oils production and processing industry,based on an assessment of past policies, an analysis of comparative advantage for the various oilcrops, and an examination of the scope for rehabilitating existing processing facilities. The maincriticisms of the Bank on the draft study related to the absence of comparative advantage analysis fordomestic production, and the need to further analyze the impact of import liberalization and thepricing and taxation policy for commercial imports and oil donations. Some of these issues obviouslyhad a bearing on the future of the Antalaha oil-palm project, which was then the subject of intensedebate. Government's exchange rate and trade policies were also rapidly evolving in early 1987, withlarge devaluations and ongoing negotiations for trade liberalization measures under 1TPAC. Thestudy of the consulting firm was therefore partly obsolete by the time it was issued, and it also failedto address the questiot of respective public and private sectors roles in the rchabilitation anddevelopment of the oil industry. It was then agreed that updating and complementary analysis wouldbe done as part of the action program which was to be presented by Government prior to ASACsecond tranche release.

6.17 A document on the edible oils sector was finalized by MPARA in August 1988, whichaddressed the technical aspects of primary production and artisanal transformation, with an emphasison groundnut and coconut, and also made general recommendations on the pricing of imported oildonations in order to protect domestic consumers and preducers. 16f However, a comprehensiveaction plan covering industrial and trade aspects as well as primary production, with a clear indicationof policy measures and other steps to be taken by Gc,/ernment for the rehabilitation and developmentof the edible oils sector, was never actually prepared. Although the Bank had previously 3tronglyinsisted on the need for such an action program, it decided after mid-1988 that this approach was toorigid and that it was best to rely on the general trade liberalization, export promotion and parastatalrestructuring measures supported under ITPAC and PSAC. It was felt that these measures, togetherwith other ongoing efforts to improve the delivery of research, extension and other producersservices, would provide a sound and strong enough basis to promote efficient use of existingindustrial assets, and bring about a revival of the edible oils productiou and processing industry inline with Madagascar's comparative advantage. The control of ex-factory prices of edible oils hadalready been eliminated in late 1987 as a condition of effectiveness for ITAC, and the publicenterprise restructuring and/or liquidation program to be supported under PSAC applied to parastatalsinvolved in the oil processing industry. Government had also taken steps, with the support ofUSAID, for auctioning donated oil in bulk at the port. In early 1989, Government confirmed in aletter to the Bank the main features of its policy in the edible oils subsector, including its intentionto support the expansion of artisanal oilseed processing and the rationalization of its refining industry.This letter was considered by the Bank as satisfactory for meeting the condition for ASAC secondtranche release.

W§I Donations of unrefined soybean oil from USAID provided most of the raw materials for thedomestic refining industry, and had become a major source of edible oil for urbanconsumption following the decline of domestic groundnut oil production i- I the 1970s andearly 1980s.

16

Inputs pricing and distribution

6.18 New quarantine regulations were enacted prior to ASAC effectiveness, which greatly reducedthe time needed for the importation of most seeds and other planting materials. MPARA also pursuedits disengagement from direct distribution of fertilizer and other chemical inputs. The number ofinput stores managed by MPARA went down from over 500 in 1985 to only about 10-20 in 1988,with the balance either closed or, in most cases, leased to commercial operators including privateoperators as well as the parastatal COROI. Fertilizer grants from external donors, which werepreviously handled on behalf of MPARA exclusively by COROI, were allocated from 1986 onwardsto the operator offering the- lowest charge for customs clearance and port handling. Prior to theintroduction of the OGL system for foreign exchange allocation, the mechanisms agreed for theallocation of ASAC proceeds also played a key role in promoting increased private sector involvementand competition in the commercial importation and subsequent distribution of agricultural inputs andveterinary products. About ten commercial operators, most of them private, were regularly involvedin fertilizer distribution from 1987 onwards, and the previous state monopoly on the importation anddistribution of veterinary products was progressively dismantled. Tle newly introduced competitionamong importers and distributors led to a substantial decrease in marketing margins both forcommercial imports and for fertilizer donations.

6.19 However, only mixed progress was achieved in the removal of fertilizer subsidies, which,together with market distortions resulting from fertilizer donations and low domestic demand, limitthe scope for development of a commercial network. In 1986 and early 1987, the limit of 7% ofc.i.f. cost for fertilizer subsidy agreed under ASAC was basically respected. The large devaluationof June 1987 did, however, translate into a sharp increase in the border price equivalent of importedinputs, which in turn reduced farmers demand at a time when abundant supplies of fertilizer wereavailable on the domestic market, as a result both of imports made under ASAC and increasedexternal aid donations. MPARA reacted in August 1987 by pricing a recently arrived donation atthe pre-devaluation exchange rate. The underlying rationale was that available supplies, which weremosdy donations, largely exceeded the potential domestic demand at world price levels; it was alsoargued thai selling donated fertilizer below world market prices would not entail any fiscal subsidyfrom Government, and thus be consistent with the ASAC agreement.

6.20 The Bank made several unsuccessful attempts during 1988 to convince MPARA to auctiondonated fertilizer in small lots, so as to attract competitive participation from small as well as largeoperators and dispose of all available fertilizer donations in a non-discriminatory fashion. In fact,in 1988 and 1989 donated fertilizer was sold to commercial operators by MPARA at a fixed price,which tvas about 20% to 30% below its border price value, but still too high to allow immediatedisposal of all available supplies. The main argument of MPARA was that the price should not betoo low, so as to avoid further destabilization of commercial operators and prepare the ground forthe re-establishment of ordinary commercial imports from 1990 onwards; for similar reasons,MPARA also argued that it was desirable to be selective in the choice of recipients of donatedfertilizer, so as to eliminate the merely occasional operators.

6.21 In subsequent years, fertilizer donations continued at a level which has been variable butusually lower than in 1987-88, and commercial operators have also adjusted their commercial importsdownwards compared to the first years of ASAC implementation. The present policy is to allocatedonated fertilizer to established coperators, but at a price which in principle reflects the full value ofthese donations. Despite this improvement, administrative allocation of donated fertilizer to

17

commercial operators still results in 4 significant degree of uncertainty for these operators, and isprone to lead to discrimination and/or undue practices. Efforts have been made by MPARA toinform operators of planned shipments of donated fertilizer. Pricing also remains an issue, sincedonations are usually made in large shipments at a lower c.i.f. price than smaller scale conmmercialimports, and are not subject to the same transaction and financial costs as commercial imports.

Public investment program

6.22 Among the seven projects in the agricultural Public Investment Program (PIP) which the Bankhad questioned during post-appraisal, thr;e were rural development or irrigation projects. As agreedduring ASAC negotiations, consultants were hired by Government in mid-1986 in order to carry outa feasibility study of the proposed middle-west development project, which was set aside from thePIP in its original form because of its high costs and low returns. Government also furnishedadditional information on the Androy development project in the southern part of the country, -whichwas discussed in detail with the Bank in early 1987. After further study, it was agreed in late 1987that the third project (Ankaizina irrigation) would be incorporated into the Irrigation RehabilitationProject supported by the Bank and other donors. In 1987, several new externally-financed irrigationprojects were introduced in the PIP, which was inconsistent with the strategy agreed betweenGovernment and the Bank to concentrate available resources on the rehabilitation of existingperimeters. An agreement was reached to drop some of these projects, and to reassess others.

6.23 The most contentious projects identified during ASAC post-appraisal were agro-industrialinvestments for oil crops (soya, oil palm and copra) and for cashew nut production. The mainreservations of the Bank concerned the size and the economic and financial viability of theseinvestments, as well as the proposed ownership and management options which were inconsistent withGovernment's stated policy of disengagement from direct production and marketing activities. Priorto ASAC effectiveness, the July 1986 supervision mission found that, irrespective of the agreementreached during negotiations, the Ministry of Livestock and Forestry (MPAEF) had already taken stepsto award contracts for investment in the cashew plant. This project was executed by MPAEF asoriginally planned, with the creation of a parastatal enjoying monopoly rights on cashew exports.171 The soya production project included in the agricultural PIP aimed at providing raw materialsto the Mamisoa plant, which had been built in the late seventies as part of an ambitious plan toproduce soybean oil and cake. This project was dropped from the agricultural PIP as requested bythe Bank, but actual steps to liquidate the plant, which operated uwider the aegis of the Ministry ofIndustry, were initiated only in 1988. The copra project to be managed by the parastatalSOAVOANIO was reexamined as agreed during ASAC negotiations.

6.24 Following ASAC approval in May 1986, the Antalaha oil palm project gave rise to intensedebate which lasted unt.l 1988. 181 A consulting firm was recruited by Government in mid-1986as agreed under ASAC, in order to carry out a new feasibility study for the project. The terms ofreference also reqtired the consultant to consider possible alternative projects, although the Bank hadrequested to drop this provision since the identification of new projects should have awaited the

17/ This monopoly was, however, not actually enforced.

ill As originally proposed, this investment consisted of the creation of 1350 ha of stateplantations, together with a processing plant.

18

conclusions of the edible oils study which was being initiated at the same time. The new feasibilitystudy, 19l completed in October 1986, confirmed the very low economic viability of the originalAntalaha project design, and proposed an alternative investment in a nearby area which was largerand more costly but had a significantly higher rate of return. 20/ In late 1987, the consulting firmdeveloped a proposal for a phased project, starting in the original location with a possible extensionthereafter to the alternative location, together with some cost saving measures which improved theeconomic and financial viability. The Antalaha oil palm project was implemented on this basis from1988 onwards.

6.25 At the time of ASAC second tranche release in May 1989, the Bank considered that theagricultural PIP had been signiftcantly improved and fulfilled the requirement for tranche release.From 1988 onwards, dialogue between Government and the Bank on the national public investmentprogran, including agriculture as well as other sectors, has been pursued in the broader context offfPAC and PSAC.

7. Credit Impact and Sustainability

7.1 In the short run, the funds made available under ASAC helped alleviate the serious foreignexchange crisis that Madagascar was facing in the mid-1980s. The support provided by the Bank forthe establishment of a rice buffer stock, together with the introduction of improved procedures forthe management of Government rice imports, were instrumental in attracting additional rice grantsfrom USAID and WFP during the 1986-87 pre-harvest season, contrasting with the shortages of theprevious year. Agreement by the Bank to finance rice imports in early 1989, at a time whenGovernment rice stocks were reportedly low, also helped Government and consumers weather theelection campaign with sufficient rice supplies. ASAC furthermore contributed to supplying thetransportation and primary processing sectors with spare parts and materials, thus facilitating themarketing of agricultural products. The funds provided under ASAC for the importation ofagricultural inputs and incentive goods had a positive impact on agricultural production, given thegenerally low level of imported inputs used in agricultural production in Madagascar.

7.2 Most of the impact came from the policy reforms introduced under ASAC, in particular fromthe rice management program which was the core of this operation. During the 1986-90 period,domestic paddy production increased at an average rate of close to 3.5% per year. Although thisgrowth was aided by favorable weather and has slowed down since then, with a resulting averagegrowth rate of only around 2.5% per year for the whole period 1986-92, it nonetheless representsa significant improvement over the stagnation which had prevailed throughout the 1970s and early1980s. Rice imports, which exceeded 200,000 tons per year on average during 1980-83, havestabilized at an average level of around 70,000 tons per year over the 1987-90 period.

12/ This study was financed by the Bank with remaining funds under Credit 881-MAG (MangokyAgricultural Development Project).

2Q/ The alternative design allowed savings in road and other transport infrastructure due to itsmore favorable location, and consisted of 1800 ha of state plantation together with 1200 haof smallholder plantations.

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7.3 Following the liberalization of domestic marketing of paddy initiated in 1983 and completedin 1986, the number of private traders, transporters and rice millers in the main paddy producingareas grew substantially. Increased competition for paddy purchases translated into a significantincrease in producer prices from 1983 onwards. Part of these initial gains to the producers have,however, been temporary since real producer prices fell in 1987 and 1988 due to abundant supplieson the domestic market, together with the resumption of rice distribution to urban consumers at sub-market prices. This policy, which continued in 1989, disrupted domestic rice trading activities andcaused operating losses for traders who passed them on to farmers in the form of lower farmgateprices, thus contributing to slowing down the growth of rice production in subsequent years.Government intervention in the domestic rice market was significantly reduced in 1990, when theprivate sector accounted for the first time for a large share of rice imports. Since 1991, theGovernment-operated buffer stock established under ASAC has been closed and Government's statedpolicy, except for special emergencies or disaster areas, is to allocate external rice donations tocommercial operators at a price reflecting their full commercial value. Rice remains nonetheless avery political commodity, which entails significant uncertainty for commercial operators.

7.4 Although rice consumer prices became significantly higher in real terms with the liberalizationof domestic markets, most urban consumers have benefited from the liberalization of internal ricetrade and, at least during the 1986-87 pre-harvest season, from the successful operation of the bufferstock. Official rice prices were hardly enforced before their elimination, and Government's attemptsto control the domestic market together with poor timing of the release of imports had translated untilmid-1986 into wild fluctuations of consumer prices and periodic rice shortages which badly hurtconsumers. Thereafter, rice became available in adequate quantity throughout the year, and inter-seasonal price fluctuations have remained in a reasonable range throughout the second half of the1980s and early 1990s; these gains have, however, been partly set back from mid-1991 onwards, withthe onset of political turmoil and recurring foreign exchange shortages. A significant proportion ofthe population, both in urban and in rural areas, nonetheless continues to live below poverty level,thus facing serious difficulties in securing adequate food supplies. Specific measures are needed tohelp these vulnerable groups, and the Bank has started in late 1988 to support Government's effortsto address this problem under the Economic Management and Social Action Project (EMSAP). Also,a Food Security and Nutrition Project was approved in 1993.

7.5 The direct and immediate impact of ASAC on agricultural production other than rice wasmarginal. Increases in the producer price of coffee supported by ASAC in 1986 and 1987, althoughsubstantial, did not translate into increased production and/or exports, mainly due to the dilapidatedstate of the transport network in coffee producing areas, the absence of significant measures toimprove traders incentives and the collapse in international coffee prices. The edible oils subsectorremains heavily dependent on oil donations or imports.

7.6 On the whole, the overall performance of the agricultural sector in Madagascar has shownsome progress but remains nonetheless disappointing. During the 1984-90 period, the agriculturalsector grew at an average rate of 2.6% annually, wh.^h compares favorably with the performanceof the late 1970s and early 1980s but still remains modest and masks a wide disparity in performanceamong subsectors. Most of that growth originates from the fisheries aad to a lesser extent thelivestock sectors, which together grew on average at 4.9% annually between 1984 and 1989. Bycontrast, the performance of the crop sub-sector has been much more modest, with an average growthof only 1.5% per year during the 1984-89 period, which is well below the 3% population growthrate. Within the crop subsector, most of the growth has come from rice and to a lesser extent other

20

foodcrops. Traditional exports crops (coffee, vanilla, cloves), facing difficult conditions and poorprospects on the international market, have stagnated or regressed, and this has not been compensatedfor by alternative export crops.

7.7 This poor performance, although partly explained by the deterioration of Madagascar's termsof trade, is largely due to the remaining price and market distortions as well as structural constraintswhich have only been partially addressed so far. External trade liberalization for traditional exportcrops other than vanilla occurred only at a late stage in the adjustment process, at a time when worldcoffee and clove prices had already collapsed to a level that considerably reduced private sectorincentives to engage in this sector. The prices and market for vanilla, which is a major export crop,still remain strictly controlled and decisions have yet to be made on the new strategy to adopt in orderto maintain Madagascar's position on this increasingly competitive market. Government's controland/or direct involvement in the importation and exportation of several crops (e.g. rice, coffee,cloves) and in the production and processing of industrial crops (e.g. sugar, cotton, edible oils) haveonly been belatedly and partially reduced and often remain distortional, and the pricing andmanagement of food aid (e.g. rice, edible oils) also tends to be detrimental to domestic productionand creates considerableuncertainty for commercial operators. Other structural non-price constraints,which are equally important and have probably not received adequate attention so far, relate mainlyto deficiencies in the credit system, transportation and conununications bottlenecks and, moregenerally, the low quality of most agricultural services currently provided by the public sector(irrigation management, research, seed production and distribution, extension).

7.8 In order to sustain and expand agricultural growth, improvements will be neededsimultaneously on several of these fronts. Appropriate and consistently followed macro-economicpolicies (exchange rate management, tariff and trade policies, fiscal regime, etc.) will also be essentialfor preserving and building upon the gains which have been made under ASAC and other adjustmentoperations. Political stability and consensus is an obvious pre-requisite for achieving this, togetherwith well conceived and coherent support from external aid agencies.

8. Institutional Performance

Borrower Performance

8.1 On the whole, Government showed a commitment to sector policy reform and economicadjustment which was mitigated by the following factors: (i) the difficulties inherent to a transitionfrom a highly controlled economy, dominated by state enterprises and direct Government control ofall aspects of economic activity, to a totally different type of market-based economy; (ii) a legitimateconcern for the social costs of this transition in a country where a large fraction of the populationlives at or below poverty level, which has translated into a gradual and cautious, even at timeshesitant, approach to economic adjustment; and (iii) the persistence of deeply entrenched and closelyintertwined political and economic interests, which has influenced the phasing of the adjustmentprocess and has contributed to the postponement and/or partial implementation of some majorreforms.

8.2 Government's commitment to ASAC's rice management rogram has been uneven,to theextent that it fully supported the objective of reducing seasonal price fluctuations on urban marketsthrough the operation of the rice buffer stock, but was much less convinced of the need to maintain

21

domestic prices at a high enough level and manage the buffer stock in a consistent and predictableway, so as to provide adequate price incentives to producers and traders in order to stimulatedomestic production. After one year of successful operation of the buffer stock, which generatedimportant benefits both to consumers and producers, Government largely reverted back to its earlierpractice of selling large quantities of rice throughout the year to urban consumers at sub-marketprices. Ihis was prompted in part by legitimate social concerns and the need to facilitate, at leastfor the poorest fraction of the population, the difficult transition which urban consumers had to facefollowing the large devaluation of mid-1987. It also points out a basic deficiency of ASAC and otherBank-supported adjustment operations, which until late 1988 did not consider the short term socialimplications of introducing drastic economic reforms in a country like Madagascar, which has a fairlylarge urban population with a significant proportion of very poor people. However, the distributionof rice at subsidized prices which was undertaken by Government from end-1987 onwards was largelypolitical in nature, and no real attempt was made to organize it in a way that would benefit directlyand mainly the poor, while minimizing market disruption. Beginning in late 1987, the Bank madeunder ASAC several offers to help Government develop a system of targeted food subsidies, usingpart of the rice accumulated in the buffer stock, but Government did not support this initiative at thattime.

8.3 Improvement in the public investment program (PIP) for agriculture has been slow, bothunder ASAC and thereafter, which reflects the still limited canacity of agricultural ministries(MPARA and MPAEF) to adapt to their new role and mandate in the context of a liberal economicenvironment. Under ASAC, MPARA and MPAEF have similarly been slow in relinquishing controlover the allocation of credit proceeds to commercial operators for the importation of agricultural andveterinary inputs. There is also a tendency for some investment decisions to be overly influencedby donor willingness to provide finance. The Bank's approach to improving the agricultural PIPcould, however, have been more forceful.

8.4 Weak inter-ministerial coordination, and at times unclear allocation of responsibilitiesbetweenMPARA and other technical ministries involved in the agricultural sector (Ministry of Comnmerce,Ministry of Industry, MPAEF), have affected in particular the outcome of the edible oils study, whichwas clearly a case where primary production, industrial and trade aspects all needed to be tackledtogether, and incorporated into a comprehensive strategy and action program. Unclear allocation oresponsibilities between central Government and decentralized local authorities also resulted in mixedsignals to farmers and local traders as to the extent of Government's willingness to liberalize domesticmarkets and trade. Particularly in the early years of ASAC implementation, some local authoritiesdid introduce new controls on rice prices and limited the transfer of paddy to other regions. Thisproblem, which has only been touched on under ASAC, still constrains the development of othermarket-oriented agricultural production activities.

Bank Performance

8.5 Rice management program. The support provided by the Bank for the establishment of aGovernment operated buffer stock was mainly motivated by the need to provide a guarantee andreassurance to Government during the transition period towards full liberalization of domestic ricetrade. In this respect, the Bank has been flexible and has shown a capacity to adopt a pragmatic andrealistic solution to help Madagascar move gradually towards a more liberal system of economicmanagement. The implementation of the rice management program was, at least in its early years,closely followed by the Bank supervision missions, who were able to provide timely and generally

22

adequate practical advice for managing rice imports under the new system. The increase in domesticpaddy production which ensued from the liberalization of internal rice trade, and the successfuloperation of the rice buffer stock during the 1986-87 pre-harvest season, demonstrated both thebenefits of increased reliance on market forces and the scope for controlling excessive seasonal pricefluctuations through modest but timely market interventions, rather than the full-fledged control whichGovernment had unsuccessfully attempted to implement in the past. This success was instrumentalin convincing a large fraction of the population, as well as many of the political groups inMadagascar, of the benefits of economic liberalization, thus preparing the ground for a subsequentdeepening of the adjustment process.

8.6 The Bank has, however, consistently underestimated the Government's dedication to low riceprices for urban consumers, and the importance of the parallel system of distribution which emergedat the end of 1987 and continued throughout 1988 and 1989. The elimination of the officialdistribution system after the mid-1987 devaluation was well received in the Bank, as it allowed tomove more quickly towards the elimination of remaining economic distortions, but the fact that it alsocreated an obvious and perhaps legitimate incentive for Government to establish an alternative, andhence parallel, distribution circuit was overlooked; this might have happened even in the absence ofan election campaign, the advent of which only made things worse. Given its awareness of theimportance of poverty in Madagascar, and its general concern with food security, the Bank shouldhave addressed the question of food distribution and targeted subsidies thoroughly and in a timelymanner, at a much earlier stage. This would have provided an incentive for increased Governmentcommitment to the rice management program, and would also have given the Bank a better case foropposing the subsequent diversion of food imports to meet purely political objectives.

8.7 To the extent that the Bank had recognized from the beginning that quantified targets andperformance indicators could not be locked in the Development Credit Agreement, its only recoursewas the provision that, as a condition for second tranche release, the rice management programshould have been carried out in a manner acceptable to the Bank. In practice, the Bank wasextremely reluctant to apply this provision, although it was clear both to Bank staff and toGovernment that the spirit, if not the letter, of the Agreement had been circumvented from end-1987onwards.

8.8 Other ASAC components. The rationale for focusing ASAC on the liberalization of internalrice trade and the management of rice imports was largely dictated by Government's own priorities,as well as the urgency of restoring credibility in the reform process which had only been partiallycompleted in this sub-sector and had given rise to widespread skepticism. In retrospect, substantialforegone benefits could have been derived from an early emphasis on reforming the management ofexport crops, at a time when international market conditions were still relatively favorable. Attemptsto achieve quicker progress on this issue during ASAC preparation were, however, rejected byGoverrnent.

8.9 The role of imported chemical inputs in Madagascar's agriculture was overestimated underASAC. Although it was and still remains a legitimate objective in itself, the time spent and prioritygiven to improving the pricing and distribution system for fertilizer was out of proportion with itsreal importance for most farmers. More benefits could be expected from an improvement inMadagascar's seeds multiplication and distribution system, a subject which was only touched on underASAC. The excessive importance given to fertilizer and other chemical inputs, which washighlighted by the mid-1987 devaluation but could have been anticipated at the time of ASAC

23

preparation and appraisal, has also contributed to the slow disbursement of ASAC funds.

8.10 llte Bank's position on fertilizer subsidies and on the need for an action plan for edible oilshas been shifting over time, in a manner that was not always coherent and consistent. The -staff incharge of ASAC supervision changed over time, and some of the staff involved at the same time hada different perspective on these issues which, in the absence of a consensus and a clear decisionmaking process within the Bank, resulted in mixed signals to Government and also some loss of Bankcredibility, both towards Government and other donors who had started applying full import-paritypricing of fertilizer under their own projects on the basis of the Bank's initial position under ASAC.

8.11 Several important topics on which studies were commissioned under ASAC have not yet beenaddressed, despite their relevance to sector and economic reform. This applies in particular to thestudy on local government finances, and the edible oils action plan. In principle, these aspects wereto be covered under subsequent adjustment operations. The delicate and complex question of localgovenment finances, whose implications go beyond the agricultural sector, has not been tackled yet.No significant development has taken place either in the edible oils sub-sector, desp.-e the policyreforms implemented under ITPAC and PSAC.

8.12 The Bank should also have recognized more clearly the limits and constraints imposed by theconflicting demands of various donors and external lending agencies and, to the extent that it waspossible, perhaps played a more active role in helping Government coordinate external interventionsin the agricultural sector. The problems faced under ASAC in this regard concerned both externally-financed investments included in the PIP, which were inconsistent with the new economic policy ofGovernment, and issues arising from the disposal on the domestic market of food aid (rice, edibleoils) and fertilizer donations. In the case of commodities for which grants in kind represent a majorshare of domestic supplies, as was the case for fertilizer and edible oils, pricing policies need to beworked out carefully taking into account the potentially distortional effects of this type of externalaid.

8.13 Credit documentation. Detailed working papers together with terms of reference for studiesto be conducted under ASAC had been prepared by the preparation and appraisal missions. TheBank's project and correspondence files are, however, increasingly incomplete towards the end ofASAC's implementation period, as indicated by cross-references to memorandums or letters and/orrelevant documentation handed over by Bank staff which are not available in the project files. Filesheld by the resident mission are even more incomplete and scattered. The filing of some studiessupported by ASAC under the specific, and sometimes remote, projects which have contributed totheir financing also complicates the collection of sector specific information and studies.

24

PROJECT COMPLETION REPORT

MADAGASCAR

AGRICULTURAL SECTOR ADJUSTMENT CREDIT(IDA Credit 1691-MAG and SFA Credit A-16-MAG)

PART 1I: PROJECT REVIEW FROM BORROWER'S PERSPECTIVE

No comments were received.

25

PROJECT COMPLETION REPORT

MADAGASCAR

AGRICULTURAL SECTOR ADJUSIMENT CREDIT(IDA Credit 1691-MAG and SFA Credit A16-MAG)

PART III: STATISTICAL INFORMATION

Table I: Related Bank LoanslCredits

Loan/Credit Title Purpose month/Year of Status____________________________ _____________________________________________ ________ Approval ____pp o a

Agricultural Institutions To assist Government in identifying action programs for February 1982 ClosedTechrnical Assistance Project achieving specific sector objectives (particularly June 30, t987(Cr. 1249-NAG) concerning the rice sub-sector), and to initiate a

process of long-term agricultural reform throughinstitution buitding and a redefinition of sectorinvestment programs and policies. II/

Second Agricultural To strengthen management of sector policy and June 1986 ClosedInstitutions Project institutions, to reinforce financial resource December 31,(Cr. 1709-MAG) management, to improve sector planning, to improve 1992

poiicy and economic anatysis, and to strengthen marketdevelopment and export performance. ?1/

Second Agricultural Credit To support institutional strengthening of the National may 1987 OngoingProject Rural Development Bank (tB). and to meet foreign(Cr. 1804-HAG) exchange costs of new investments and expansion or

improvement of existing ventures in agriculture(production and primary processing/ marketing). P_/

211 Prior to the ASAC, the Agricultural Institutions Technical Assistance Project (Cr. 1249-MAG) had been the major vehicle for sector dialogue between Government and the WorldBank, and it has also provided finance for the preparation of many elements of ASAC.

221 The policy analysis and institutional strengthening measures of this project were specificallydesigned to support the Government's Agricultural Sector Adjustment Program, thuscomplementing the ASAC.

D1 This project was designed as a complement to the ASAC, in order to provide investnentfunds needed to help entrepreneurs respond to Govermment's policy and to create economicopportunities in the agriculture sector.

26

Table 2: Credit DataAmounts (million)

(as of December 31, 1990)

____________________ _ ~gOrijinat Disbursed Cancel led Reoaid Outstandin

IDA 1691-NlAG (SOR) 19.0 19.0 0.0 0.0 19.0

SFA A-16-NAG (SDR) 31.0 31.0 0.0 0.0 31.0

Sub-total (SOR) 50.0 50.0 0.0 0.0 50.0

Japanese grant (Yen) 600.0 n.a. n.a. n.a. n.a.

German contribution (ON) 10t.0 n.a. n.a. n.a. n.a.

Table 3: Credit Timetable: Original and Actual Dates

! _______________|__________ Ornfgnal/Plannad Credit Dates Revised/Actual Dates

Initial Project Brief may 17, 1984

Final Project Brief May 14, 1985

Negotiations December 23, 1985 - March 7, 1986

Letter of Development Poticy March 24, 1986

Board Approval Nay 8, 1986

Signing of Credit Agreements May 20, 1986(IDA, IFA)

Effectiveness June 30, 1986 November 18, 1986

Second tranche release March 31, 1987 May 1, 1989

Closing Date June 30, 1988 June 30, 1990

27

Table 4: Cumulative Credit DisbursementAmount (million)

FY 87 FY 88 FY 89 FY 90 FY 91

IOA 1691-MAG (SMR) Ptanned 10.24 19.00 19.00 19.00 19.00

Actual 3.29 9.32 10.40 16.71 19.00

SfA A-16-NAG (SMR) Planned 16.74 31.00 31.00 31.00 31.00

Actual 5.80 12.98 1S.18 24.21 31.00

Totat (SMR) Planned 27.00 50.00 50.00 50.00 50.00

Actual 9.09 22.30 25.58 40.92 50.00

Actual as X of 34 45 51 82 100

Pl.n.ed

Japanese grant (Yen) n.a. n.a. n.a. n.a. n.a.

Genman contribution (OM) n.a. n.a. n.s. n.a. n.a.

Tabte 5: Use of Bank Resources

A. Bank Staff Inputs

Fiscal Year

82 83 s 85 86 87 88 89 90 91 92 93 Total

Project Preparation and Pre- 3.3 47.6 29.9 48.8 129.6appraisal

Appraisal' 32.3 12.6 47.7 92.6

Negotiations 17.1 17.1

Supervision 2.3 40.3 34.6 15.5 0.2 92.9

Project Completion Report 5.0 10.0 15.0 B

'Total 3.3 47.6 62.2 61.4 67.1 40.3 34.6 15.5 0.2 0.0 5.0 10.0 347.2

29

B. Mission Data

Project Stase month/Year so. weeks No. Persons Man-weeks Date of re wort Ratire

tdentificattin April 1984 2.5 3 8

Pr-a'ppraial June 1984 2.5 4 8 July 16. 1984

Preparation September 1984 1 1 1 October 5, 1984

October 1984 1.5 5 8 December S. 1984

February 1985 1.5 2 April 3, 1985

Appraisat May/June 1985 3.5 4 14 June 26, 1985(Issues paper)

Past-Appraisal Septerber 1985 2.5 3 8 October 16 1985

September 1985 2 2 4 n.a.

Supervmisin July 1986 2 2 4 Juty 22, 1986

October 1986 1 1 1 November 3, 1986

January 1987 2 3 6 March 12. 1987

Nay 1987 3 1 2 June 22 1987

July 1987 3 3 6 August 11t 1987

October 1987 1.5 2 3 November 30, 1987

February 1988 3 2 3 June 20. 1988

July 1988 2 2 3 August 12 1988

Hovweber 1988 3 1 1 n.a.

Canpietlon November 1992 2 1 2 December 1989

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