the big question :what can we learn from previous stock market panics?

The Big Question: What can we learn from previous stock market panics?

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By Ben Chu and Michael SavageWednesday, 23 January 2008
Why are we asking this now?
Share prices around the world took a mauling yesterday, despite the surprise move by the United States Federal Reserve to cut interest rates by three-quarters of a percentage point. It is still early days, but many analysts are beginning to regard this latest bout of volatility on global equity exchanges as a full-blown stock market crash.
Has anything like this happened before?
Financial panics are nothing new. They date back as far as "Tulipmania" in the 17th century, when Dutch investors pushed up the price of tulip bulbs to ridiculous levels only to see the bottom fall out of the market. There were various financial "bubbles" in the shares of joint-stock companies during the first half of the 18th century in Britain and acute banking crises in 1825 and 1866.
The greatest economic shock of the 20th century was the Wall Street Crash, which resonated around the world. It took a quarter of a century for the Dow Jones industrial average to return to the levels of pre-October 1929.
The next major global crash came in the 1980s. In October 1987, the Dow Jones dropped by 22 per cent. Eighteen other major industrial nations saw their stock markets lose more than a fifth of their value.
The Japanese stock market disintegrated in 1990, with the Nikkei shedding three-quarters of its value in a matter of months. Markets crashed in developing economies across Asia in 1997. And eight years ago, Western stock markets endured the dotcom collapse.
Why do they happen?
No financial panic is identical, but they tend to have features in common. A certain type of investment becomes popular. Those with a vested interest in the shares hype the price still further. People who do not understand what they are buying pile in solely to avoid missing out. A piece of bad news emerges. Investors start to panic and sell off stock, all at the same time.
Often (although not always) these panics coincide with a peak in the business cycle. The process can be summarised as an emotional roller coaster of greed, followed by euphoria, and finally fear. The late economist J K Galbraith in his A Short History of Financial Euphoria describes a kind of mass psychosis taking hold of investors. Large numbers have "a vested interest in error" because they want to see the price of their holdings rise and are willing to "suspend disbelief", even when the evidence tells them that the holdings are overvalued, or when it is clear that a scheme will never pay out on the scale expected.
Why don't investors learn from history?
Bubbles tend to be accompanied by that dread phrase, "It's different this time". Speculative frenzies often feed on a theory of a fundamental economic shift.
In Holland in the 1620s, newly imported tulips from the Ottoman Empire were believed to be so beautiful that the bulbs would eventually be worth more than gold. The South Sea Bubble of the 1710s was supported by a faith in the new profitability of Trans-Atlantic trade. American investors in the "Roaring Twenties" were enthralled by new industries such as broadcasting and car-making.
Their counterparts in the 1980s were seduced by talk of a revolution in supply-side economics. In the early 1990s, the mania was for Japanese land. The dotcom bubble was fuelled by the transforming power of the internet.
Are there any other common features?
Bubbles often also involve dubious financial innovation. In the early 1700s investors were beguiled by a new model for funding government debt. In 1987, the frenzy was partially fuelled by assumptions about junk bonds. This all helps with the suspension of disbelief by investors.
But J K Galbraith points to a more basic psychological explanation for booms and subsequent panics: "There is a possibility, even the close likelihood, of self-approving and extravagantly error-prone behaviour on the part of those closely associated with money."
So is this the story of the latest crash?
This crisis is slightly different. It is not a direct result of a bubble in share prices, but rather a banking crisis combining with the beginnings of a slowdown. Stock markets are responding to those two factors.
But the banking side of the crisis does have very similar features to past panics. For instance, the hunger of bankers for huge returns led to their selling home loans to hundreds of thousands of Americans in recent years who simply could not afford them. Corporate investors and insurers then bought up complex financial securitisation packages such as "collateralised debt obligations" made up of these dodgy loans, without really understanding what they were acquiring.
Are crashes more dangerous nowadays?
Perhaps the major development in recent years is the influence of hedge funds and computers. Hedge funds place huge bets on small market movements with borrowed money. Some argue that this can drastically affect markets in a crisis.
The collapse of the US hedge fund Long Term Capital Management (LTCM) is a good example. When Russia defaulted on government bonds in August 1998, investors fled from other government paper to the safe haven of US Treasury securities. LTCM, which had borrowed a huge amount of money from other companies to invest in international bonds, stood to lose billions. To liquidate its positions, it was forced to sell its Treasury bonds, plunging US credit markets into turmoil and forcing up interest rates.
Computerised trading systems can also have a dramatic effect on panics. In October 1987, a newly introduced computerised trading system exacerbated share falls as sell orders were executed automatically when stock prices reached a certain level. These two new trends came together last summer when hedge funds with complicated computer trading programmes were forced to offload shares automatically, exacerbating market volatility.
How should the authorities respond?
The experience of the 1929 Wall Street Crash shows how financial authorities can make matters far worse in a crisis if they act foolishly. In that case, the Federal Reserve raised interest rates to protect the value of the dollar and preserve the gold standard. But in doing so, it starved the markets of liquidity. The financial system went into meltdown and ensured that the contagion spread into the broader economy. Companies went under. There were massive lay-offs and suffering. At one stage, one third of the American workforce was unemployed. The US economy shrank by 50 per cent.
There was similar absence of foresight from the British authorities in the Overend & Guerney crisis in London in 1866. Overend was a discount bank that provided money for commercial and retail banks in the capital. When it was declared bankrupt, many smaller banks were unable to access funds, even though they were otherwise solvent. The shock transmitted itself at bewildering speed through the financial system.
The good news is that governments seem to have learned from these traumatic experiences. Central banks are more active and primed to deal with liquidity crises in their role as "lender of last resort".
So is cutting interest rates the solution?
There are hazards in this approach. Rate cuts in Britain in the wake of the 1987 crash arguably contributed to a housing bubble that, when it eventually burst in the early 1990s, led to recession. The risks of rate cuts were even more starkly illustrated after the 2000 dotcom bubble. Central banks in Britain and the US went too far in lowering interest rates. Credit was made too cheap and plentiful, sowing the seeds of the present panic.
Then there is the spectre of Japan. The country has still not fully recovered from the 1990 crash. Failing companies were bailed out by ultra-low interest rates. And still Japanese consumers refused to spend. Central bankers will be fervently hoping that this is one piece of recent history they are not going to see repeated.

djibouti in th world bank view

EXECUTIVE SUMMARY1

During the late 1980s and most of the 1990s, domestic and regional military strife ledto deep macroeconomic imbalances and weakened economic activity in Djibouti. A prolongedcivil war disrupted vital economic sectors and imposed a heavy cost on the budget. War inneighboring countries led to a large influx of refugees, putting an extra burden on alreadystretched public services. Fiscal mismanagement and waning donor support compounded theimpact o f these shocks leading to a build-up o f Government arrears o f some 30 percent o f GDPby 2000. The Currency Board Arrangement limited the possibility o f the use o f monetaryinstruments inmacroeconomic management. GDP growth averaged less thanone percent duringthis period, compared with an average population growth rate o f 2.8 percent per annum furtherdeepening poverty...11. During the past four years-the period of the last CAS-good progress was made inaddressing many of theseproblems. Supported by an IDA Fiscal Consolidation Credit (FCC),and an IMF Poverty Reduction and Growth Facility (PRGF), fiscal and structural reformmeasures succeeded inhalting the deteriorating macroeconomic situation and reversing the buildup of domestic arrears. These measures included civil service downsizing, a far-reachingpension reform that placed the system on a much stronger footing, improved management o f theport and airport facilities by entrusting it to a private intemational investor, and strengthening ofpublic expenditure institutions.iii. However, thisimprovedmacroeconomicstability,whilecritical, isnotsufficient todeal with the deep structuralproblems of poverty and income distribution and take the countyout of the trap of low social and economic equilibrium. Despite its high per capita income(US$920 in 2004) that places it in the ranks o f low middle-income countries, Djibouti has anextremely highincidence of poverty (42 percent absolute and 75 percent relative poverty rates),and a very low level o f human development as indicated, among others, by one of the lowestschool enrollment and highest mortality rates inthe world. At the same time, highwage rates inthe formal sector create serious problems o f non-competitiveness and skewed incomedistribution. All these factors have contributed to low growth and employment creation andwould, inthe future, continue to limit the possibility for Djiboutians to benefit from employmentopportunities that would be generated from the envisaged extension o f the port and thedevelopment o f an associated free trade zone.iv. Djibouti's Poverty Reduction Strategy Paper (PRSP),presented to the Board on JuneS, 2004, identifies an ambitious four-pronged strategv. The strategy aims at: (i) strengtheningcompetitiveness for higher and sustainable growth by persevering with overall macroeconomicstability, while accelerating structural reforms to create a better investment climate for privateinvestment; (ii) accelerating human development through improved school enrollment andquality o f education, strengthening the health care system, broadening the social safety net; andimplementing the national gender strategy; (iii) promoting regional and local development toreach out to poor urban neighborhoods, nomads, and isolated rural communities; and (iv)improving governance and public sector management through greater transparency andaccountability.v. Theplanned CASfor the period FY06-OS is broadly aligned with the main pillars ofthe PRSP, building on the achievements of the previous CAS, which has alsofocused on thesame areas. Solid performance has been achieved under the previous CAS, marking a cleardeparture from the past: all programs were, or are expected to be, completed on or ahead o f time; 11portfolio performance improved dramatically meeting all portfolio performance targets; andevery project i s expected to meet its developmental objectives. The planned IDAprogram wouldsupport the pillars o f PRSP through lending and non-lending services. The competitivenesspillar will be supported through: (i)power and water sector project to lower utilities' cost and aextend service delivery to the poor, and (ii) a partial risk guarantee to the concession o f the raillinkto Ethiopia insupport ofthe port to complement the previous roadcorridor project. Supportto the humandevelopment pillar will consist o f (i) a second education project (APL), followingon a first successful project; (ii)a skills development and employment creation project, and (iii)an emergency floods rehabilitation project. Support to the governance pillar focuses on providingassistance through IDFgrants to the implementation o f the action program andrecommendationsof the Country Financial Accountability Assessment (CFAA) and Country ProcurementAssessment Review (CPAR).vi. This CAS arguesfor a more active incomdrent distribution policy (more so than thePRSP) as a critical policy reform area to reducepoverty, because Djibouti's skewed incomedistribution impedes the trickle down of the benefits of growth to thepoor, and because, in thecase of a rent-based economy like Djibouti, it will continue to act as a major constraint togrowth itsew Djibouti i s essentially a rent-based economy, with rents deriving from itsgeographical and geopolitical position contributing a much larger share o f GDP than agricultureand industry. At present, most of the rent (revenues from the port, rent of military bases, andgrants and assistance), essentially channeled through the budget, i s captured by the civil serviceinthe form ofhighpublic wages (the average publicwage is 9-10 times GDPper capita). Thisdeprives the majority o f the population from benefiting from public services, such as educationand health, because the excessive size o f the public wage bill (50 percent o f the budget) leavesno room for improving service delivery beyond its very low level. In addition to crowding outsocial expenditures and investment in human capital, the oversized wage bill crowds outinvestment inphysical infrastructure that fbrther drives up the cost o f doing business. The fixedexchange rate policy emanating from the Currency Board Arrangements, keeps real wages highas it shelters it from any adjustment through general price increase. Taken together, these factorsimpede growth and employment and, inturn, hurtthe poor.vii. With rents associated with theport and the militay bases, andforeign aid expected tocontinue to be the major drivers of Government revenues and GDP, the only policy optionavailable to the Government in the short run to improve poverty and income distribution is tofind ways to reducepublic sector wage expenditures and redistribute these towards social andinfrastructure expenditures. This can be achieved through the combination o f an adjustment inthe exchange rate, an explicit reduction inwages, and a restructuring o f the size and compositionof the civil service. The CAS proposes to intensify the policy dialogue with the authorities todelineate the most appropriate and feasible reform policy venue to address wage levelmisalignment. It reserves financial support to this reform under a high-case scenario whichwould be triggeredby the Government's willingness to undertakethis reform.viii. The planned assistance strategy entails risks. Sustained macroeconomic stabilitydepends heavily on the steady flow o f Government revenues from the port and military basesrental, and more critically, on the implementation o f an adjustment o f the wage bill and exchangerate to address Djibouti's skewed income distribution and competitiveness problems. The first islinked to unpredictable development in the regional security situation, and the second on thepolitical will o f the authorities to move ahead with reforms. While the new foreign directinvestment in the port extension and the renewed rental o f military bases may mitigate the first ... 111risk, the difficult political economy o f implementing an exchange rate and wage bill adjustmentsheds uncertainty around an effective way out o f the low equilibrium situation. Risks related tothe implementation capacity also exist, but experience from the last CAS shows that well-focused projects with simple design and close and proactive supervision from the Sana'a Officewill help minimize significantly this risk.ix. Thefollowing issues are suggestedfor Board consideration:0 Alignment of the CAS program to the PRSP and focus o f the CAS program given the limited IDAenvelope.0 Emphasis on income distribution and appropriateness o f the CAS proposed policy instruments to address it.
I.COUNTRYCONTEXTA. GENERAL CONTEXT1.1

Djibouti is a small and poorly endowed country with a service-based economy. It hasan estimated population of 660,000, two-thirds o f whom live in the capital city Djibouti-Ville.Most o f the remaining population lives in a handhl o f secondary towns. The natural rate o fpopulation growth is estimated at 2.4 percent per annum. Djibouti i s poorly endowed innaturalresources (limited arable land, rainfall and underground water). However, the country benefitsmainly from its strategic military and intemational shipping location on the Red Sea's southernentrance.Intemational since 2001) as well as relatedbusiness, It also relies on the rental o f military Box 1: HistoricalBackgroundbases to France since independence in 1977, and France established the port of Djibouti in 1892 as amost recently to the us and Germany, including coalingstationfor shipstraveling to its possessionsinthe Indian Ocean and Far East. Four years later, Djiboutiservices associated to these bases. External became a French territory. In 1977, after 80 years of by Djibouti'spartners grants colonial rule, Djibouti gained independencefrom France.and other financing facilities is also an At the time of independence, an agreement between France and Djibouti provided for a French militaryimportant source. This i s reflected in the large presence and development assistance, including sizableshare of the service sector in the economy, budgetarysupport.1.3 With a per capita income of US$920, Djibouti is classified as a low middle-incomecountry. Yet, it has a very high level of poverty (42% absolute and 75% relative) and some ofthepoorest social indicators in the world. This paradox is explained essentially by the fact thatwhile a large part o f the economy i s based on rents (derived from the port, military bases rentalanddonors financial support), and channeled mainly throughthe budget, a significant part o fthisrent i s passed on to Government employees through high wages, leaving insufficient resourcesfor social expenditures, social transfers and public investment. Because of the marginalcontribution o f the primary and secondary sectors in the process o f production, Governmentexpenditure policy i s the primaryinstrument available for achieving income re-distribution intheshort- to medium-term. Achieving a better income distribution must be at the heart o f theGovernment's poverty reduction strategy, given the prevailing degree o fpoverty and low level o fhuman capital development in Djibouti. This implies a need for difficult policy actions if theGovernment wishes to pursue a pro-poor agenda. The issue is discussed further inSection

111.B. POLITICALANDINTERNATIONALRELATIONSCONTEXT1.4

A key determinant of Djibouti's domestic political context and developments is thepower balance interplay between its ethnicities. Djibouti's population is composed mainly o ftwo ethnic groups, the Afars and the Issas. The Issas extend into Somalia and the Afars alsoextend into Ethiopia andEritrea. Competition for power amongthese ethnic groups led to a very* Of which only 2.5 percent is manufacturing and the rest is for construction and public works, and water andelectricity. 2damaging civil war in 1991-94. This civil war triggered huge disruptions and macroeconomicinstability from which the country has yet to fully recover. The strong ethnic linkage o f Djiboutito its volatile and conflict-prone neighbors-Somalia, Ethiopia and Eritrea, is a source o fvulnerability and risk, e.g., leadingto refugees flows, deterring foreign investment, and affectingoverall internal political stability. The pressure on the country's leadership and decision-makingprocess not to upset the precarious balance between these interests, under the current volatileregional circumstances, diminishes its ability to take critical economic and social reformdecisions, precisely when they are most needed.1.5 Djibouti's political system remains, however, relatively open, with an electedpresident,a Parliament and ajudiciary. The executive reflects a sharing o fpower between the two majorethnic groups with higher representation o f the Issas in the Government, civil service, and theruling party. This power sharing is subject to sporadic resentments (and challenges) by theAfars. Widely acclaimed reforms toward a more meritocracy-based access to civil service andpublic sector jobs were undertaken by the current President. The next presidential elections arescheduled for April 2005. The opposition has limited influence and representation inParliamentas a result o f the winner-take-all electoral system. The President's dominant coalition party,Unionpour la majorite`pre`sidentielle, i s expected to remain inpower for the foreseeable future.1.6 Djibouti's international relations and partnerships strengthened in the last 3years andare expected to deepen during the CAS period. In addition to Djibouti's strong historicalpartnershipwith France, relations with the United States deepened following the increased U.S.military presence inthe region and the establishment o f a U.S. military base inDjibouti. Bothhave resulted in improved external flows in the form of rent (for bases) and aid. However, thisalso creates the risk of taking the pressure o f f the much-needed reforms, a possibility that theGovernment andthe donors should guard against.1.7 Commercial relations with Ethiopia (currently capturing more than 60 percent of theDjibouti's port traffic) have become easier. This followed the signature in April 2003 o f anagreement with Ethiopia governing the use o f the port and the transit o f goods to and fromEthiopia. This lowers the risk o f Ethiopia traffic going to other ports. 1.8 Djibouti's trade system is fully open with no protective targfs and non-tariff barriers.Capital movement i s free, which has yielded a very high level o f openness. As such, Djiboutihas been a regional center for trade and financial services and could build hrther on this and onits prospective port development to further strengthen its position. 1.9 Djibouti has recently adopted anti-money laundering legislation but it lacksimplementation capacig. Djibouti has not undergone a Financial Sector Assessment Program orAnti-Money Laundering (AML) assessment. Djibouti's fully open trading system and freecapital movement make the development o f an effective AML system a necessity to preventpotential abuse that mightundermine the country's openness.
C. SOCIAL CONTEXT

1.10 Djibouti's social indicators rank 157th among 174 countries on the UNDP's HumanDevelopment Index. Despite recent progress in expanding access, Djibouti's education systemis still not on track to meet the Millennium Development Goals (MDGs). Illiteracy is extremelyhigh, especially for women (85 percent). About 50 percent of children still do not attend 3school, and more than 20 percent of those enrolled do not complete the six years of primaryeducation. There are also large inequalities in access to education services: enrollment varieswidely across income levels, gender, andregions. Moreover, the system is very costly due to thehighunit costs for school construction andteacher salaries. Unfortunately, despite the enormousneeds, the budget does not have much room for additional expenditures since educationexpenditure already accounts for close to 27 percent o f Djibouti's large budget size of 30 percento f GDP. These constraints render the achievements o f the MDGs nearly impossible (see Table1,oncost ofachieving educationgoals).1.11 The health situation is also very difficult. Life expectancy, as an overall healthindicator, is estimated at 49 years, one of the shortest inthe world. Infantmortality i s at 103 per1,000. The immunization rate is only 45 percent, and malnutrition is a serious problem, withindications that 14 percent of children under the age of five suffer from acute malnutrition, and31percent from chronic malnutrition. Diarrheic illnesses and acute respiratory infections are themost common causes o f infant mortality. Maternal mortality rate i s high at about 7 per 1,000live births and for extremely poor women this rate i s as highas 9 percent.1.12 Wide gender gap and Female Genital Mutilation (FGM) are major socialdevelopmental challenges. Women represent a very vulnerable segment o f the population. Thedisadvantaged status of women i s reflected in the gender gap indicators in all social areas asindicated above. High female mortality rates can be attributed to high fertility rates, anemiacaused by malnutrition, which are in turn exacerbated by the widespread practice o f femalecircumcision. Ninety-five percent o f young girls between 6 and 9 years of age have undergoneFGM. Infibulations, the most severe and harmful form o f FGM, are the most widely practiced.They are knownto cause serious lifelong negative physical andpsychological impacts. This alsoincreases their vulnerability to HIV/AIDS infection.1.13 A law prohibiting thepractice of FGM was adopted in 1995, but hasproved difJicult toenforce because of the private nature of the procedure. The National Strategy for theIntegration of Women inDevelopment (SNIFD), adopted by the new Ministry o f Women Affairsin2002, includesthe fight against this practice as one ofitspillars. There have also beenseveralrecently organized workshops and awareness campaigns involving religious leaders, local andintemational NGOs, UNagencies, and Government officials to help stop the practice.1.14 The Qat Problem is not adequately addressed. Considerable time and resources aredevoted to chewing qat, an amphetamine-based stimulant grown mainly inEthiopia and Yemen.Most adult males in Djibouti chew Qat at all-male social gatherings for up to 5-6 hours a day,taking time from work and family life, diverting the limited incomes of poor people from basicneeds spending, and adversely affecting their labor productivity and struggle for improvingtheirwell being. While precise figures are not available, it is estimated that Qat absorbs up to 30percent o f family budgets. Even the poorest families spend a considerable share o f their budgeton Qat. Official import figures show that about 4,000 tons o f Qat, valued at DF3.00 billion ($12million), were imported yearly, making it the highest value o f all import items. Long-term use o fQat has been shown in other countries to be associated with mouth cancer and other healthproblems, including child malnutrition and mortality. While the issue was debated during thePRSP preparation process, it was ultimately not reflected in the actual PRSP. Unfortunately,there seems to be neither the consensus nor the commitment from the leadership to recognize anddeal with this issue.

4 11. POVERTYANDINCOMEDISTRIBUTION-THEPARADOXOFHIGHINCOMEPER CAPITA AND HIGHAND INCREASINGPOVERTY2.1

Recent data' show that poverty in Djibouti is both extremely high and on the rise. In2002, about three-fourths (74.4 percent) o f the population lived under relative poverty line and42.2 percent under extreme poverty, as compared to 64.9 percent and 34.5 percent, respectively,in 1996. Surveys show that the most dramatic poverty incidence is in rural areas, where 83percent lives in extreme poverty. However, Djibouti-Ville shelters the largest number o f poorpeople and contributes by itself-65 percent and 57 percent-to relative and extreme poverty,respectively. The EDAMIS study indicates that the incidence o f relative and extreme poverty isthe strongest among households whose heads are unemployed. Unemployment, which isestimated at 60 percent, contributes about 65 percent to extreme poverty. What explains theapparent paradox o f a relatively highGNI per capita o f about US$920, which places Djibouti atclose to middle income countries, and its high and increasing poverty rate that places it amongthe poorest? The main explanation of such a paradox lies in the sensitivity of poverty to incomedistribution and on Djibouti's budget structure which is biased against thepoor.2.2 One of the strongest results of the two poverty studies is the sensitive linkage betweenpoverty incidence and income distribution. The 20 percent upper income household has anaverage expenditure eight times higher than the lower quintile. For low poverty lines, the studiesnote that poverty is more sensitive to changes in expenditure inequality than to changes in meanexpenditures. If the Gini Index o f expenditure distribution increases by 1 percent, ceterisparibus, the extreme poverty index is estimated to increase between 1 to 4.2 percent3. Thepoorare more affected by changes in expenditure inequality than by changes in mean expenditure.This implies that an economic growth that is accompanied by increased inequality has thepotential to be an "immiserating" growth. This highlights the critical importance of an activeincome redistribution policy that should accompany, if not even precede growth, in order forDjibouti's poverty reduction strategy to be effective. To reduce extreme poverty to the PRSPgoal of 19.3 percent in2015, the PRSP itself underlines the need for "an annual real growth rateof GDP per capita of 2.5 percent in 2005-10 and o f 3.5 percent in 2010-15, [combined with] aregular reduction o f inequalities o f 2 percent per year." Given the uncertain growth prospectsthat are heavily dependent o f external factors, re-distribution must be an important part of short-term agenda o fpoverty reduction.2.3 Labor market distortion, highpublic sector and civil service wages, and the size of theGovernment's wage bill explain agreat deal of thepoverty and income distributionproblem inDjibouti. Poverty i s strongly related to unemployment in Djibouti. Unemployment has reached60 percent up from 44 percent in 1996, and has a high incidence among the poor (66 percent),and the extremely poor (72 percent). Djibouti has a dual labor market with about 70 percent ofthe employed inthe formal sector. Fifty-five percent o f those employed inthe formal sector arecivil servants. While unemployment i s at 60 percent, the average wage in the formal sector inDjibouti remains very high. The persistence o f this paradox i s largely explained by the high The knowledge base onpoverty stems primarily from EDAMIS studies o f 1996 and its 2002. Poverty informationandthe statistical system ingeneral suffer from severe shortcoming, the least o f which is the absence of a recent andreliable population census on to which surveys canbe anchored. One percent as estimated by the 2002 survey and4.2 percent was the estimate of the 1996survey. 5 wage level o f civil service and public enterprises, which averages about $8,000, or 9 times the GNIper capita. 2.4 High Government wages impact negatively on the poor by expanding the size of the public wage bill and crowding out other Government spending on basic services and direct transfers to thepoor. Djibouti has, indeed, one o f the largest wage bills among its comparators, inparticular when consideringthe low service delivery level. It constitutes about 15 percent of GDP, 60 percent oftotal fiscal revenues, and half ofbudget expenditures4. Consideringthe very low base in education and health service coverage and the increasing population, reaching the MDGs will require intensive hiring o f teachers and nurses. There are few options to meet this new hiring-through wage cuts under the same relative size of the wage bill, being direct cuts in nominal wages; or through devaluation of the exchange rate5, or through a combination o f a civil service reform involving reduction inother categories o f civil service employees andwage level reduction. As an example, Table 1illustrates, for the education sector, the adjustment needed in average wages inthe sector to make up for the financing gap implied by a scenario o f full school enrollment required by MDGs. The financing gap corresponds to a reduction of the wage level by about half, which could be an indication of the overall overvaluation of the wage level and prices ingeneral. Quality Measures Efticienc Financing Measures Y Measures Annual Student Non-teacher Average Repetition Government Primary % of Financing Teacher Salary Teacher Rate Budget Education Students Gapc/ Ratio Spendinga/ Salary (in %For Education Recurrent inPrivate (DF million) per capita Spendingb/ Schools GDP unit) a/ As apercentageof total recurrentspendingon primary education.~ b/ As apercentageof totalrecurrent educationspending. c/ Refersto the differencebetweentotal cost of service delivery andthe resourcesdomestically mobilized. Source:Bank Staff calculation. 2.5 The political economy of such a reform is obviously difficult as it runs against the immediate interest of thepublic sector elite itsew But inaction also has a highcost that Djibouti policy makers need to consider seriously. The high level and structure of civil pay has been inherited from the French colonial administration and has little changed since. By virtue o f Djibouti's Currency Board system (the nominal exchange rate has not changed since 1971, inflation is only about 2 percent, which does little to adjust down the real wages as in other developing countries. Since most of the Government revenues are in dollars or indexed to it and, a part from wages, most of other expenditures are essentially imported are in foreign currency, a devaluation would reduce the relative sue of the wage bill in the budget opening space for more hiring of needed education and health specialists and other social spending. 62.6 In addition to crowding out social expenditures, the oversized wage bill crowds outinvestment in infrastructure that could directly and indirectly benefit the poor throughemployment and growth. High public wages and salaries also negatively affect the overallcompetitivenessof the economy and hinder growth. Redistribution inDjiboutineeds to go handinhand,ifnotprecede, growth.2.7 I n the past, the inflexibility of wages and attendant wage bill have led to majorstructuralfiscal imbalances, and the continuous avoidance of addressing theproblem upfronthas only shifted its effects to increase in other prices andfurther accumulation of arrears. Agrowing population andhigher needs for public service have exacerbated the fiscal situation overthe years. Given Djibouti's currency board system, which excludes money creation to financebudget deficit, financing these deficits was generally accommodated through accumulation o farrears, and/or an increase intaxes and surtaxes, reflected inhigher prices, especially on servicesand service inputs, such as electricity, water, and petroleum products (surtaxes have, forexample, reached about 30 percent o f the price o f electricity), further hindering the country'scompetitiveness (see Box 4 on Competitiveness Indicators). 111.


MACROECONOMIC DEVELOPMENTSSTRUCTURALPOLICIES EXECUTIVE SUMMARY1. During the late 1980s and most of the 1990s, domestic and regional military strife ledto deep macroeconomic imbalances and weakened economic activity in Djibouti. A prolongedcivil war disrupted vital economic sectors and imposed a heavy cost on the budget. War inneighboring countries led to a large influx of refugees, putting an extra burden on alreadystretched public services. Fiscal mismanagement and waning donor support compounded theimpact o f these shocks leading to a build-up o f Government arrears o f some 30 percent o f GDPby 2000. The Currency Board Arrangement limited the possibility o f the use o f monetaryinstruments inmacroeconomic management. GDP growth averaged less thanone percent duringthis period, compared with an average population growth rate o f 2.8 percent per annum furtherdeepening poverty...11. During the past four years-the period of the last CAS-good progress was made inaddressing many of theseproblems. Supported by an IDA Fiscal Consolidation Credit (FCC),and an IMF Poverty Reduction and Growth Facility (PRGF), fiscal and structural reformmeasures succeeded inhalting the deteriorating macroeconomic situation and reversing the buildup of domestic arrears. These measures included civil service downsizing, a far-reachingpension reform that placed the system on a much stronger footing, improved management o f theport and airport facilities by entrusting it to a private intemational investor, and strengthening ofpublic expenditure institutions.iii. However, thisimprovedmacroeconomicstability,whilecritical, isnotsufficient todeal with the deep structuralproblems of poverty and income distribution and take the countyout of the trap of low social and economic equilibrium. Despite its high per capita income(US$920 in 2004) that places it in the ranks o f low middle-income countries, Djibouti has anextremely highincidence of poverty (42 percent absolute and 75 percent relative poverty rates),and a very low level o f human development as indicated, among others, by one of the lowestschool enrollment and highest mortality rates inthe world. At the same time, highwage rates inthe formal sector create serious problems o f non-competitiveness and skewed incomedistribution. All these factors have contributed to low growth and employment creation andwould, inthe future, continue to limit the possibility for Djiboutians to benefit from employmentopportunities that would be generated from the envisaged extension o f the port and thedevelopment o f an associated free trade zone.iv. Djibouti's Poverty Reduction Strategy Paper (PRSP),presented to the Board on JuneS, 2004, identifies an ambitious four-pronged strategv. The strategy aims at: (i) strengtheningcompetitiveness for higher and sustainable growth by persevering with overall macroeconomicstability, while accelerating structural reforms to create a better investment climate for privateinvestment; (ii) accelerating human development through improved school enrollment andquality o f education, strengthening the health care system, broadening the social safety net; andimplementing the national gender strategy; (iii) promoting regional and local development toreach out to poor urban neighborhoods, nomads, and isolated rural communities; and (iv)improving governance and public sector management through greater transparency andaccountability.v. Theplanned CASfor the period FY06-OS is broadly aligned with the main pillars ofthe PRSP, building on the achievements of the previous CAS, which has alsofocused on thesame areas. Solid performance has been achieved under the previous CAS, marking a cleardeparture from the past: all programs were, or are expected to be, completed on or ahead o f time; 11portfolio performance improved dramatically meeting all portfolio performance targets; andevery project i s expected to meet its developmental objectives. The planned IDAprogram wouldsupport the pillars o f PRSP through lending and non-lending services. The competitivenesspillar will be supported through: (i)power and water sector project to lower utilities' cost and aextend service delivery to the poor, and (ii) a partial risk guarantee to the concession o f the raillinkto Ethiopia insupport ofthe port to complement the previous roadcorridor project. Supportto the humandevelopment pillar will consist o f (i) a second education project (APL), followingon a first successful project; (ii)a skills development and employment creation project, and (iii)an emergency floods rehabilitation project. Support to the governance pillar focuses on providingassistance through IDFgrants to the implementation o f the action program andrecommendationsof the Country Financial Accountability Assessment (CFAA) and Country ProcurementAssessment Review (CPAR).vi. This CAS arguesfor a more active incomdrent distribution policy (more so than thePRSP) as a critical policy reform area to reducepoverty, because Djibouti's skewed incomedistribution impedes the trickle down of the benefits of growth to thepoor, and because, in thecase of a rent-based economy like Djibouti, it will continue to act as a major constraint togrowth itsew Djibouti i s essentially a rent-based economy, with rents deriving from itsgeographical and geopolitical position contributing a much larger share o f GDP than agricultureand industry. At present, most of the rent (revenues from the port, rent of military bases, andgrants and assistance), essentially channeled through the budget, i s captured by the civil serviceinthe form ofhighpublic wages (the average publicwage is 9-10 times GDPper capita). Thisdeprives the majority o f the population from benefiting from public services, such as educationand health, because the excessive size o f the public wage bill (50 percent o f the budget) leavesno room for improving service delivery beyond its very low level. In addition to crowding outsocial expenditures and investment in human capital, the oversized wage bill crowds outinvestment inphysical infrastructure that fbrther drives up the cost o f doing business. The fixedexchange rate policy emanating from the Currency Board Arrangements, keeps real wages highas it shelters it from any adjustment through general price increase. Taken together, these factorsimpede growth and employment and, inturn, hurtthe poor.vii. With rents associated with theport and the militay bases, andforeign aid expected tocontinue to be the major drivers of Government revenues and GDP, the only policy optionavailable to the Government in the short run to improve poverty and income distribution is tofind ways to reducepublic sector wage expenditures and redistribute these towards social andinfrastructure expenditures. This can be achieved through the combination o f an adjustment inthe exchange rate, an explicit reduction inwages, and a restructuring o f the size and compositionof the civil service. The CAS proposes to intensify the policy dialogue with the authorities todelineate the most appropriate and feasible reform policy venue to address wage levelmisalignment. It reserves financial support to this reform under a high-case scenario whichwould be triggeredby the Government's willingness to undertakethis reform.viii. The planned assistance strategy entails risks. Sustained macroeconomic stabilitydepends heavily on the steady flow o f Government revenues from the port and military basesrental, and more critically, on the implementation o f an adjustment o f the wage bill and exchangerate to address Djibouti's skewed income distribution and competitiveness problems. The first islinked to unpredictable development in the regional security situation, and the second on thepolitical will o f the authorities to move ahead with reforms. While the new foreign directinvestment in the port extension and the renewed rental o f military bases may mitigate the first ... 111risk, the difficult political economy o f implementing an exchange rate and wage bill adjustmentsheds uncertainty around an effective way out o f the low equilibrium situation. Risks related tothe implementation capacity also exist, but experience from the last CAS shows that well-focused projects with simple design and close and proactive supervision from the Sana'a Officewill help minimize significantly this risk.ix. Thefollowing issues are suggestedfor Board consideration:0 Alignment of the CAS program to the PRSP and focus o f the CAS program given the limited IDAenvelope.0 Emphasis on income distribution and appropriateness o f the CAS proposed policy instruments to address it. I.COUNTRYCONTEXTA. GENERAL CONTEXT1.1 Djibouti is a small and poorly endowed country with a service-based economy. It hasan estimated population of 660,000, two-thirds o f whom live in the capital city Djibouti-Ville.Most o f the remaining population lives in a handhl o f secondary towns. The natural rate o fpopulation growth is estimated at 2.4 percent per annum. Djibouti i s poorly endowed innaturalresources (limited arable land, rainfall and underground water). However, the country benefitsmainly from its strategic military and intemational shipping location on the Red Sea's southernentrance.Intemational since 2001) as well as relatedbusiness, It also relies on the rental o f military Box 1: HistoricalBackgroundbases to France since independence in 1977, and France established the port of Djibouti in 1892 as amost recently to the us and Germany, including coalingstationfor shipstraveling to its possessionsinthe Indian Ocean and Far East. Four years later, Djiboutiservices associated to these bases. External became a French territory. In 1977, after 80 years of by Djibouti'spartners grants colonial rule, Djibouti gained independencefrom France.and other financing facilities is also an At the time of independence, an agreement between France and Djibouti provided for a French militaryimportant source. This i s reflected in the large presence and development assistance, including sizableshare of the service sector in the economy, budgetarysupport.1.3 With a per capita income of US$920, Djibouti is classified as a low middle-incomecountry. Yet, it has a very high level of poverty (42% absolute and 75% relative) and some ofthepoorest social indicators in the world. This paradox is explained essentially by the fact thatwhile a large part o f the economy i s based on rents (derived from the port, military bases rentalanddonors financial support), and channeled mainly throughthe budget, a significant part o fthisrent i s passed on to Government employees through high wages, leaving insufficient resourcesfor social expenditures, social transfers and public investment. Because of the marginalcontribution o f the primary and secondary sectors in the process o f production, Governmentexpenditure policy i s the primaryinstrument available for achieving income re-distribution intheshort- to medium-term. Achieving a better income distribution must be at the heart o f theGovernment's poverty reduction strategy, given the prevailing degree o fpoverty and low level o fhuman capital development in Djibouti. This implies a need for difficult policy actions if theGovernment wishes to pursue a pro-poor agenda. The issue is discussed further inSection 111.B. POLITICALANDINTERNATIONALRELATIONSCONTEXT1.4 A key determinant of Djibouti's domestic political context and developments is thepower balance interplay between its ethnicities. Djibouti's population is composed mainly o ftwo ethnic groups, the Afars and the Issas. The Issas extend into Somalia and the Afars alsoextend into Ethiopia andEritrea. Competition for power amongthese ethnic groups led to a very* Of which only 2.5 percent is manufacturing and the rest is for construction and public works, and water andelectricity. 2damaging civil war in 1991-94. This civil war triggered huge disruptions and macroeconomicinstability from which the country has yet to fully recover. The strong ethnic linkage o f Djiboutito its volatile and conflict-prone neighbors-Somalia, Ethiopia and Eritrea, is a source o fvulnerability and risk, e.g., leadingto refugees flows, deterring foreign investment, and affectingoverall internal political stability. The pressure on the country's leadership and decision-makingprocess not to upset the precarious balance between these interests, under the current volatileregional circumstances, diminishes its ability to take critical economic and social reformdecisions, precisely when they are most needed.1.5 Djibouti's political system remains, however, relatively open, with an electedpresident,a Parliament and ajudiciary. The executive reflects a sharing o fpower between the two majorethnic groups with higher representation o f the Issas in the Government, civil service, and theruling party. This power sharing is subject to sporadic resentments (and challenges) by theAfars. Widely acclaimed reforms toward a more meritocracy-based access to civil service andpublic sector jobs were undertaken by the current President. The next presidential elections arescheduled for April 2005. The opposition has limited influence and representation inParliamentas a result o f the winner-take-all electoral system. The President's dominant coalition party,Unionpour la majorite`pre`sidentielle, i s expected to remain inpower for the foreseeable future.1.6 Djibouti's international relations and partnerships strengthened in the last 3years andare expected to deepen during the CAS period. In addition to Djibouti's strong historicalpartnershipwith France, relations with the United States deepened following the increased U.S.military presence inthe region and the establishment o f a U.S. military base inDjibouti. Bothhave resulted in improved external flows in the form of rent (for bases) and aid. However, thisalso creates the risk of taking the pressure o f f the much-needed reforms, a possibility that theGovernment andthe donors should guard against.1.7 Commercial relations with Ethiopia (currently capturing more than 60 percent of theDjibouti's port traffic) have become easier. This followed the signature in April 2003 o f anagreement with Ethiopia governing the use o f the port and the transit o f goods to and fromEthiopia. This lowers the risk o f Ethiopia traffic going to other ports. 1.8 Djibouti's trade system is fully open with no protective targfs and non-tariff barriers.Capital movement i s free, which has yielded a very high level o f openness. As such, Djiboutihas been a regional center for trade and financial services and could build hrther on this and onits prospective port development to further strengthen its position. 1.9 Djibouti has recently adopted anti-money laundering legislation but it lacksimplementation capacig. Djibouti has not undergone a Financial Sector Assessment Program orAnti-Money Laundering (AML) assessment. Djibouti's fully open trading system and freecapital movement make the development o f an effective AML system a necessity to preventpotential abuse that mightundermine the country's openness.C. SOCIAL CONTEXT 1.10 Djibouti's social indicators rank 157th among 174 countries on the UNDP's HumanDevelopment Index. Despite recent progress in expanding access, Djibouti's education systemis still not on track to meet the Millennium Development Goals (MDGs). Illiteracy is extremelyhigh, especially for women (85 percent). About 50 percent of children still do not attend 3school, and more than 20 percent of those enrolled do not complete the six years of primaryeducation. There are also large inequalities in access to education services: enrollment varieswidely across income levels, gender, andregions. Moreover, the system is very costly due to thehighunit costs for school construction andteacher salaries. Unfortunately, despite the enormousneeds, the budget does not have much room for additional expenditures since educationexpenditure already accounts for close to 27 percent o f Djibouti's large budget size of 30 percento f GDP. These constraints render the achievements o f the MDGs nearly impossible (see Table1,oncost ofachieving educationgoals).1.11 The health situation is also very difficult. Life expectancy, as an overall healthindicator, is estimated at 49 years, one of the shortest inthe world. Infantmortality i s at 103 per1,000. The immunization rate is only 45 percent, and malnutrition is a serious problem, withindications that 14 percent of children under the age of five suffer from acute malnutrition, and31percent from chronic malnutrition. Diarrheic illnesses and acute respiratory infections are themost common causes o f infant mortality. Maternal mortality rate i s high at about 7 per 1,000live births and for extremely poor women this rate i s as highas 9 percent.1.12 Wide gender gap and Female Genital Mutilation (FGM) are major socialdevelopmental challenges. Women represent a very vulnerable segment o f the population. Thedisadvantaged status of women i s reflected in the gender gap indicators in all social areas asindicated above. High female mortality rates can be attributed to high fertility rates, anemiacaused by malnutrition, which are in turn exacerbated by the widespread practice o f femalecircumcision. Ninety-five percent o f young girls between 6 and 9 years of age have undergoneFGM. Infibulations, the most severe and harmful form o f FGM, are the most widely practiced.They are knownto cause serious lifelong negative physical andpsychological impacts. This alsoincreases their vulnerability to HIV/AIDS infection.1.13 A law prohibiting thepractice of FGM was adopted in 1995, but hasproved difJicult toenforce because of the private nature of the procedure. The National Strategy for theIntegration of Women inDevelopment (SNIFD), adopted by the new Ministry o f Women Affairsin2002, includesthe fight against this practice as one ofitspillars. There have also beenseveralrecently organized workshops and awareness campaigns involving religious leaders, local andintemational NGOs, UNagencies, and Government officials to help stop the practice.1.14 The Qat Problem is not adequately addressed. Considerable time and resources aredevoted to chewing qat, an amphetamine-based stimulant grown mainly inEthiopia and Yemen.Most adult males in Djibouti chew Qat at all-male social gatherings for up to 5-6 hours a day,taking time from work and family life, diverting the limited incomes of poor people from basicneeds spending, and adversely affecting their labor productivity and struggle for improvingtheirwell being. While precise figures are not available, it is estimated that Qat absorbs up to 30percent o f family budgets. Even the poorest families spend a considerable share o f their budgeton Qat. Official import figures show that about 4,000 tons o f Qat, valued at DF3.00 billion ($12million), were imported yearly, making it the highest value o f all import items. Long-term use o fQat has been shown in other countries to be associated with mouth cancer and other healthproblems, including child malnutrition and mortality. While the issue was debated during thePRSP preparation process, it was ultimately not reflected in the actual PRSP. Unfortunately,there seems to be neither the consensus nor the commitment from the leadership to recognize anddeal with this issue. 4 11. POVERTYANDINCOMEDISTRIBUTION-THEPARADOXOFHIGHINCOMEPER CAPITA AND HIGHAND INCREASINGPOVERTY2.1 Recent data' show that poverty in Djibouti is both extremely high and on the rise. In2002, about three-fourths (74.4 percent) o f the population lived under relative poverty line and42.2 percent under extreme poverty, as compared to 64.9 percent and 34.5 percent, respectively,in 1996. Surveys show that the most dramatic poverty incidence is in rural areas, where 83percent lives in extreme poverty. However, Djibouti-Ville shelters the largest number o f poorpeople and contributes by itself-65 percent and 57 percent-to relative and extreme poverty,respectively. The EDAMIS study indicates that the incidence o f relative and extreme poverty isthe strongest among households whose heads are unemployed. Unemployment, which isestimated at 60 percent, contributes about 65 percent to extreme poverty. What explains theapparent paradox o f a relatively highGNI per capita o f about US$920, which places Djibouti atclose to middle income countries, and its high and increasing poverty rate that places it amongthe poorest? The main explanation of such a paradox lies in the sensitivity of poverty to incomedistribution and on Djibouti's budget structure which is biased against thepoor.2.2 One of the strongest results of the two poverty studies is the sensitive linkage betweenpoverty incidence and income distribution. The 20 percent upper income household has anaverage expenditure eight times higher than the lower quintile. For low poverty lines, the studiesnote that poverty is more sensitive to changes in expenditure inequality than to changes in meanexpenditures. If the Gini Index o f expenditure distribution increases by 1 percent, ceterisparibus, the extreme poverty index is estimated to increase between 1 to 4.2 percent3. Thepoorare more affected by changes in expenditure inequality than by changes in mean expenditure.This implies that an economic growth that is accompanied by increased inequality has thepotential to be an "immiserating" growth. This highlights the critical importance of an activeincome redistribution policy that should accompany, if not even precede growth, in order forDjibouti's poverty reduction strategy to be effective. To reduce extreme poverty to the PRSPgoal of 19.3 percent in2015, the PRSP itself underlines the need for "an annual real growth rateof GDP per capita of 2.5 percent in 2005-10 and o f 3.5 percent in 2010-15, [combined with] aregular reduction o f inequalities o f 2 percent per year." Given the uncertain growth prospectsthat are heavily dependent o f external factors, re-distribution must be an important part of short-term agenda o fpoverty reduction.2.3 Labor market distortion, highpublic sector and civil service wages, and the size of theGovernment's wage bill explain agreat deal of thepoverty and income distributionproblem inDjibouti. Poverty i s strongly related to unemployment in Djibouti. Unemployment has reached60 percent up from 44 percent in 1996, and has a high incidence among the poor (66 percent),and the extremely poor (72 percent). Djibouti has a dual labor market with about 70 percent ofthe employed inthe formal sector. Fifty-five percent o f those employed inthe formal sector arecivil servants. While unemployment i s at 60 percent, the average wage in the formal sector inDjibouti remains very high. The persistence o f this paradox i s largely explained by the high The knowledge base onpoverty stems primarily from EDAMIS studies o f 1996 and its 2002. Poverty informationandthe statistical system ingeneral suffer from severe shortcoming, the least o f which is the absence of a recent andreliable population census on to which surveys canbe anchored. One percent as estimated by the 2002 survey and4.2 percent was the estimate of the 1996survey. 5 wage level o f civil service and public enterprises, which averages about $8,000, or 9 times the GNIper capita. 2.4 High Government wages impact negatively on the poor by expanding the size of the public wage bill and crowding out other Government spending on basic services and direct transfers to thepoor. Djibouti has, indeed, one o f the largest wage bills among its comparators, inparticular when consideringthe low service delivery level. It constitutes about 15 percent of GDP, 60 percent oftotal fiscal revenues, and half ofbudget expenditures4. Consideringthe very low base in education and health service coverage and the increasing population, reaching the MDGs will require intensive hiring o f teachers and nurses. There are few options to meet this new hiring-through wage cuts under the same relative size of the wage bill, being direct cuts in nominal wages; or through devaluation of the exchange rate5, or through a combination o f a civil service reform involving reduction inother categories o f civil service employees andwage level reduction. As an example, Table 1illustrates, for the education sector, the adjustment needed in average wages inthe sector to make up for the financing gap implied by a scenario o f full school enrollment required by MDGs. The financing gap corresponds to a reduction of the wage level by about half, which could be an indication of the overall overvaluation of the wage level and prices ingeneral. Quality Measures Efticienc Financing Measures Y Measures Annual Student Non-teacher Average Repetition Government Primary % of Financing Teacher Salary Teacher Rate Budget Education Students Gapc/ Ratio Spendinga/ Salary (in %For Education Recurrent inPrivate (DF million) per capita Spendingb/ Schools GDP unit) a/ As apercentageof total recurrentspendingon primary education.~ b/ As apercentageof totalrecurrent educationspending. c/ Refersto the differencebetweentotal cost of service delivery andthe resourcesdomestically mobilized. Source:Bank Staff calculation. 2.5 The political economy of such a reform is obviously difficult as it runs against the immediate interest of thepublic sector elite itsew But inaction also has a highcost that Djibouti policy makers need to consider seriously. The high level and structure of civil pay has been inherited from the French colonial administration and has little changed since. By virtue o f Djibouti's Currency Board system (the nominal exchange rate has not changed since 1971, inflation is only about 2 percent, which does little to adjust down the real wages as in other developing countries. Since most of the Government revenues are in dollars or indexed to it and, a part from wages, most of other expenditures are essentially imported are in foreign currency, a devaluation would reduce the relative sue of the wage bill in the budget opening space for more hiring of needed education and health specialists and other social spending. 62.6 In addition to crowding out social expenditures, the oversized wage bill crowds outinvestment in infrastructure that could directly and indirectly benefit the poor throughemployment and growth. High public wages and salaries also negatively affect the overallcompetitivenessof the economy and hinder growth. Redistribution inDjiboutineeds to go handinhand,ifnotprecede, growth.2.7 I n the past, the inflexibility of wages and attendant wage bill have led to majorstructuralfiscal imbalances, and the continuous avoidance of addressing theproblem upfronthas only shifted its effects to increase in other prices andfurther accumulation of arrears. Agrowing population andhigher needs for public service have exacerbated the fiscal situation overthe years. Given Djibouti's currency board system, which excludes money creation to financebudget deficit, financing these deficits was generally accommodated through accumulation o farrears, and/or an increase intaxes and surtaxes, reflected inhigher prices, especially on servicesand service inputs, such as electricity, water, and petroleum products (surtaxes have, forexample, reached about 30 percent o f the price o f electricity), further hindering the country'scompetitiveness (see Box 4 on Competitiveness Indicators). 111. MACROECONOMIC DEVELOPMENTSSTRUCTURALPOLICIES AND3.1 Djibouti's economy is slowly recovering from a deep recession and persistent macroinstability that characterized the late 1980s and most of the 1990s, a long period marred byshocks, mismanagement of public Rgurel: Djibouti:RealCDP Growth,1981-2004,inpercent idonor community. These shocksincluded a civil war involvinglargerecruitment into the regular army, 2 -whose size jumped from 4,000 to o., , ,16,000 in 1992 alone; large inflowof refugees from Somalia and -2other, neighboring countries in -4 -conflict estimated at 120,000 in -6-population at the time) increasing ' 881 1982883 sa 8%88s 887 888 889 890891 892 893 8%895 896 a97 8%899200020012002200320043.2 Since Djibouti gained independence in 1977, it maintained a large Government sectorfinanced by the rentsfrom theport,the rent for France's military baseand donors' assistance. Civilservants continued to be paid highreal wages, because the highnominalwages inherited from the Frenchadministration were protected frominflation by Djibouti's CurrencyBoard Arrangement (CBA). Therewas good economic growth period -140 ` I 7between 1978 and 1984 (with an average 4.2 percent growth per annum). This was boosted bylarge public investments financed by generous external grants. But it was not sustainable forlong and the economy subsequently entered into a long recession with less than one percentannual GDP growth inthe face o f an average population growth o f 2.8 percent per annum. Thefiscal situation deteriorated markedly during the civil war, and the ensuing large recruitment o fmilitarypersonnelwhich further increased the size o fthe wage billbysome 6 percent o f GDP toreach 24 percent o f GDP by 1993. As a result, the overall fiscal deficit increased to 8.1 percento f GDP in 1994. This increased number o f civil servants under highpublic wages i s the mostchallenging developmental problem that Djibouti has to solve before progress can materialize.3.3 Because of the currency Board limitations on financing the large deficits throughmonetary creation,fiscal deficits were ultimately `ffinanced" by the accumulation of domesticarrears on payments of wages, pension funds contribution, and to private sector and publicentities. This, inturn, ledto a loss of credibility o f the state and an escalation inthe use of ad hocprocedures, such as uncontrolled advanced payments, that often circumvented the normalaccounting and control system. Moreover, such procedures reduced transparency andaccountability, contributing to further overruns and distrust from Djibouti's developmentpartners with decrease ingrants andexternal financing.3.4 To address the destabilized and deteriorating economic situation, the Governmentstarted an adjustment program in 1996, supported, first, by an IMF Stand-By Arrangement(SBA) during 1996-1998. A temporary restoration o f fiscal balances was achievedthrough largecuts in public expenditures and a first wave of military demobilization. But this was notsustained as the budget position deteriorated again in 1999, and domestic arrears increased againto reach more than 27 percent o f GDP. Growth rate was also slow at 1.5 percent in spite o f thediversion o f all Ethiopiantransit trade from Eritrea ports to the port o fDjibouti.3.5 To enhance the stabilization effort, only partially successful under the SBA, theGovernment initiated a medium-term structural adjustmentprogram (1999-2002) supported byan IMF Poverty Reduction and Growth Facility (PRGF). The Government requested IDA'Ssupport to its adjustmentprogram. This was provided through the Fiscal Consolidation Credit in2001 with satisfactory results.3.6 The Fiscal Consolidation Credit focused on a core of interrelated fiscal consolidationactions to restore financial and budgetary discipline; contain and reduce the wage bill;improve expenditure management systems; and strengthen financial management of the keypublic enterprises, and initiate a process leading to the liberalization and privatization ofselected infrastructure sectors. Notwithstanding limitations o fthis fiscal consolidationprogram,inparticular the deliberate delay insequencing the core issue of highwage level andwage bill,tangible progress was achieved. This included:0 Halting the build-up o f domestic payment arrears, and beginning an orderly process for clearing them. An audit was carried out that enabled the Government to validate an overall stock o f domestic arrears payments o f DF29 billion or 27 percent o f GDP. A ten-year prioritized settlement plan was defined and adopted by the Government and i s being implemented on an accelerated basis for wages and on a timely basis for the rest. 8 On pension system reform, implementing a strong parametric Box 2: Djibouti's PensionSystemReform reform to improve the viability o f Under the FCC and with technical assistance from the World Bank, the the existing pay-as-you-go Govemmentundertook acomprehensivereform ofthe pensionsystem. The (PAYG) pension system bringing reform included a range of corrective measures covering the parametric, financial and institutional aspects of the pension system. The parametric it much closer to sustainability reform comprised (i)unifying and extending the vesting period to 25 (Box. 2). years to be eligible for a full retirement pension; (ii)extending the minimum age of retirement from 50 to 55 years; (iii)changing the On civil service, close to 800 civil calculationmode of kture pensionto using an average of salaries earned service employees eligible for over the last 10 years of work, compounded by a percentage of all contributions; (iv) changing the rules for cumulative pensions (civil retirement were removed from the servants, Parliamentarians,and cabinet Ministers); (v) introducingatax on payroll and Government pensions of 15 percent; and (vi) ensuring a minimal yearly pensionof DF contributions to the pension fbnds 170,000 to guarantee a social safety net to pensioners. Part of the outstandingstock ofGovernmentarrears to the pensionfunds were covered have been paid on a regular basis. by the FCC and since then, the Government resumed its regular In preparation for addressing the contributionandeffectivepaymentsto pensionfunds. The institutional part wage bill and better managing the of the reform included the merging into one single institution of the different pension funds, but due to design problems it didn't progress as civil service, the authorities expected. Completing the merger of the pension funds and expanding implemented an action plan to coverageare remindingchallengesfor the Government. merge the civil service and payroll databases on the basis o f a census o f employees, ministrybyministry. On the reform o f the public enterprises, management o f the Port and Airport was entrusted through a long-term management contract to an intemational investor (Dubai Port Intemational). Independent financial andorganizational audits were completed in2003 for all public companies. On the basis o f these financial and organizational audits, the Government has undertaken the restructuring of Djibouti. Telecom and a national strategy and actionplan for the regulation and liberalization o f the information and communication sectors were adopted bythe Parliament. There has also been progress inimplementing other institutional reforms to strengthen public finance institutions and reduce the scope for mismanagement. The recently completed Country Financial Accountability Assessment (CFAA) and Country Procurement Assessment Review (CPAR) highlighted the improvement in the legal framework and the achievement o f satisfactory level o f extemal control by the newly created Chamber o f Accounts. There has been improvement in the debt management system, supported by an Institutional Development Fund (IDF) grant. Achievements in institutional management o f public finances build on good progress under the IMF PRGF which included: (i) strengthening budget execution procedures; (ii)updating budgetary and treasury nomenclatures; (ii) reorganizing the Ministry o f Finance to provide an improved institutional framework for effective budget preparation and execution; (iv) reforming the legal framework governing public spending; and (v) rigorous implementation of a treasury cash management plan which enforced discipline and brought Government spending in line with available resources.3.7 Over the past 4 years there has been progress in stabilizing the budget, partly inresponse to thefiscal consolidation efforts and higher port activities, and partly owing to thewindfall from the regional security situation and the establishment of new foreign militarybases. Such progress in stabilization centers on a low equilibrium with an unacceptably highpoverty level. Movingto a new higher equilibrium with lower poverty rates hinges on sustainingthe ongoing macroeconomic reforms, as well as addressing the more challenging central 9structural problem o f the oversized wage bill and highwage levels. This would open the way tomore poor people sharing the public resources, rents, anddonors' grants and support. IV. DJIBOUTIPOVERTY REDUCTION STRATEGY (PRSP)A. VISION, OBJECTIVES AND STRATEGY4.1 The Country Vision. As stated inits recent PRSP, Djibouti's povertyreduction strategyaims to foster economic growth by improvingthe country's overall competitiveness andbuildinghuman capital to achieve a substantial reduction in income poverty and unemployment, andimprove living conditions for all citizens. The PRSP is structured around a long-term vision thatbuildsonthe country's strengths: its geographic location, and its port. The targetedreduction inpoverty i s predicated on enhancing the conditions for stronger, more equitable and sustainablegrowth.4.2 The Objectives. The PRSP objectives are as follows: (i) reduce the incidence of toextreme poverty from 42.2 percent in 2002 to 36.1 percent in2006, to 27.9 percent in2010, andto 19.2 percent in2015; (ii) to increasethe average real GDP growth to 4.6 percent in 2004-06,to 5.5 percent in 2006-10, and to 6.5 percent in 2010-15, while simultaneously reducing theinequalities in income distribution by an average 2 percent per annum during 2003-15; (iii) toincreasegross primary school enrollment from 42.7 percent in2001/02 to 73 percent in2005/06,and to achieve universal enrollment by 2015; (iv) to reduce the infant mortality rate from 103.1per thousand in2002, to 75 per thousand in2006, and to 50 per thousand in2015; (v) to reducethe infant-juvenile mortality rate from 124.5 per thousand in 2002, to 85 per thousand in 2006,andto 70 per thousand in2015; (vi) to reducethe matemal mortality rate from 690 per 100,000live births in 2002, to 570 in 2006, and to 400 in 2015; and (vii) to stabilize the rate ofprevalenceofHIV at approximately 3 percentby 2015.4.3 The Strategy. The PRSP rests on four main pillars. Thefirstpillar seeks to strengthenthe country's competitiveness and to create conditions conducive to a strong and sustainableeconomic growth through (i) the pursuit of fiscal prudence and overall macroeconomic stability;(ii) implementationofstructuralreformstoattractprivateinvestment,includingtherevision theof the legal andjudicial framework (aninvestment climate assessment i s plannedfor FY08); (iii)the promotion of Djibouti as a competitive economic and financial hub; and (iv) the reduction inthe costs of production factors through improved efficiency o f investments inthe infrastructuresectors (water, power, transport). The secondpillar aims to acceleratethe development o fhumanresources through the implementation of social programs aimed at reducing poverty and genderdisparities. Inparticular, the aim is to: (i)improve the coverage and quality o f health care andeducation; (ii) reduce unemployment through the development of labor-intensive activities,micro-finance provision, andjob training, (iii) set up social safety nets for the most vulnerablesegments o f the population; and (iv) implement the national gender strategy. The thirdpillarfocuses on regional and local development through investments in water and basic services inpoor neighborhoods located in rural and urban areas o f the country. Thefourth pillar seeks toimprove govemance and public sector management. The priority will be to strengthen thetransparency and accountability of public expenditure management to improve its distributionalandefficiency impact on the poor. 10B. MEDIUM-TERMMACROECONOMIC PROSPECTSUNDERTHE CAS PERIOD(2005-08)4.4 I n the base case medium-term scenario, Djibouti would witness a relatively improvedgrowth rate owing to the higher investment in the port and the pursuit of reforms aiming toimprove the efficiency of investments. A surge inprivate investment due to the construction o fthe new modem port in Doraleh and a higher public investment in support o f the Government'sPRSP are expected to boost growth during the period 2005-08 to an average rate o f 4 percent ayear, at a higher pace than in the past, but less than the 4.6 percent per annum on averageanticipated in the PRSP. Inflation i s expected to remain at its current average o f 2 percent aslong as the currency board is maintained.4.5 Fiscal consolidation would bepursued to offset pressures onpublicfinances stemmingfrom the PRSP implementation. The pursuit o f the budgetary consolidation effort (barring anexpected slippage during the first half o f 2005 which corresponds to the Presidential electoralperiod) should result in achieving a surplus inthe primarybudget close to 4 percent o f GDP onaverage per annum. Such a surplus i s also needed to ensure a continued implementation o f theGovernment plan for clearing domestic arrears. Fiscal consolidation will be achieved throughefforts on both expenditure and revenue sides. On the revenue side, additional extemaldisbursements o f military bases rental linked to new military agreements with the United Statesand France (representing about 3 percentage points o f GDP on average per annum), willmaterialize over the projected period, and tax revenues are projected to remain stable before thenew VAT i s introduced and implemented. On the expenditure side, total expenditures level willremain overall stable. A shift in the structure o f expenditures toward higher capital spendinglinked to PRSP implementationwill be partially balanced by lower current expenditures throughthe pursuit o f retirement programs and military demobilization and the rationalization o f othernon-wage current expenditures.4.6 Current account pressures would intensifjl financing needs, but the external debt-to- GDPratio will remain stable over theperiod 2005-2008. Total financing needs are expected toincrease from US$135 million in 2003 to US$164 million by 2006, and decline thereafter toreach US$ 129million by 2008. Higher current account deficits duringthe PRSP implementationperiod (2004-06) will be financed through additional extemal assistance, mostly in the form o fofficial grants. Additional new lending i s expected to be negotiated on concessional terms.Fiscal consolidation efforts and prudent borrowing should help maintain Government debt-to-GDP to sustainable levels (with external debt averaging 68 percent o f GDP duringthe projectedperiod). The base case scenario also envisages a steady inflow o f foreign direct investment, although the pace will critically depend upon maintaining the investors' confidence in the Government commitment to enhance competitiveness, rule o f law and economic and social stability. 11 Djibouti Selected Indicators Table - Table 2 (InpercentofGDP, unless otherwiseindicated)Base-case (most likely) projectionPart A Main Macro Aggregates GDP (millions of USS) 536.1 552.9 573.6 592.0 625.0 663.0 708.1 759.2 807.7 858.4 GDP (millions of DF) 95,272.7 38,266.6 101,932.3 105,210.2 111,070.4 117,834.2 125,852.8 134,924.0 143,540.3 152,560.3Real GrowthRates (%)GDP (mp) per capita -0.5 -1.5 -0.2 0.6 1.8 1.6 3.2 3.9 3.3 3.2Total consumptionper capita 10.9 -0.3 -2.5 -0.7 2.0 -0.2 10.1 -2.4 4.6 4.7GDP at market prices 2.2 0.7 1.9 2.6 3.5 3.2 4.2 4.9 4.3 4.2 Total consumption 13.8 1.9 -0.4 1.2 3.8 1.3 11.1 -1.5 5.6 5.7 Private consumption 11.0 -2.6 -9.9 6.3 3.5 3.0 13.1 -2.8 6.3 6.0Gross domestic investment (GDI) -13.0 40.0 -31.2 35.5 47.4 21.9 25.0 48.9 -1.8 -5.6Exports (GNFS) -0.7 -5.2 4.6 0.9 2.9 0.8 5.4 5.1 5.4 5.4 of which Goods 2.7 13.3 7.2 6.3 6.5 -1.6 1.7 5.8 6.6 6.8Imports (GNFS) -3.2 3.9 -6.8 3.6 11.9 3.0 21.4 8.4 4.3 3.2 o f which Goods 5.0 8.9 -3.7 7.9 0.0 3.1 22.6 7.9 1.5 -0.2Savings-investmentbalances,as %of GDPGross Domestic inveshnent 8.8 12.2 8.3 10.9 15.5 19.0 21.8 30.2 28.0 25.0 of which Government inveshnent 3.1 2.7 2.5 4.5 6.7 6.1 10.0 11.0 10.0 9.0 Gross domestic savings -5.7 -7.4 -5.2 -4.5 -5.6 -5.4 -11.3 -3.8 -4.6 -5.7 Gross national savings 8.4 5.1 2.7 4.2 8.0 10.2 5.4 11.8 11.3 13.1Other GDP inflation (% growth rate) 2.0 2.4 1.8 0.6 2.0 2.8 2.5 2.2 2.0 2.0 Annual average exchange rate (LCU/US$) 177.72 177.72 177.72 177.72 177.72 177.72 177.72 177.72 177.72 177.72 Money (% growth rate) 5.2 1.1 7.5 15.7 17.8 6.1 6.8 7.2 6.4 6.3Part B: Government FinanceIndicatorsPercentageof GDP (%) Total revenues & grants, of which 30.9 31.0 28.2 29.4 34.2 34.6 34.7 33.9 34.3 33.4 Tax revenues 21.6 21.5 20.5 21.1 22.7 21.9 21.4 21.3 21.3 20.9 Total expenditures, of which 33.1 32.8 29.6 32.9 36.4 35.7 38.1 38.1 36.4 35.3 Consumption 26.1 25.8 23.4 24.7 21.9 20.4 20.0 19.8 19.4 19.3 Overall Balance - commihnent basis, incl. grants -2.2 -1.8 -1.4 -3.5 -2.3 -1.1 -3.5 -4.2 -2.1 -1.9 Domestic Fiscal Balance, excl. grants -2.6 -1.6 -0.3 -0.2 0.8 0.8 3.5 3.7 6.4 6.4Part C:Debt & Liquidity IndicatorsTotal DOD and TDS DOD (US$ millions) 274.6 262.2 262.7 335.3 396 408 464 519 563 572 DOD / GDPmp ratio (%) 51.2 47.4 45.8 56.6 63.4 61.5 65.5 68.3 69.7 66.6 TDS (US millions) 10 14 11 12 16 24 28 30 32 35 TDS /exports (XGS) ratio (%) 4.0 5.5 4.0 4.4 4.6 6.6 7.0 7.4 7.4 7.3 Total gross reserves (months' imports GNFS) 2.6 2.3 2.5 2.5 2.2 2.2 2.2 2.2 2.2 2.1Part D: ExternalFinancingPlan(US$,millions) Private inveshnent (net) 4.2 3.3 2.2 5.0 21.4 51.7 75.4 90.1 94.8 96.5 Net Long term borrowingexcl IMF -5.5 27.4 7.9 29.9 19.9 25.1 52.4 51.3 42.0 9.7 Adjustments to scheduled debt service 7.9 0.0 16.3 -3.2 0.0 0.0 0.0 0.0 0.0 0.0 All other capital flows 11.0 -12.3 53.2 58.2 83.8 -11.7 0.0 0.0 0.0 0.0 Financing Requirements(incl IMF) 7.9 -21.3 31.4 53.0 135.6 84.4 149.2 164.1 159.5 129.9 of which current account deficit (including grants) 1.9 39.7 31.9 40.0 47.4 58.5 115.8 139.6 134.9 102.1 12 v. THELAST ACHIEVEMENTSANDLESSONS CAS5.1 The strategicfocus of the last CAS (2001-2004) was to support the Government effortto reducepoverty in two main ways:0 Interventions to enhance human capital development, giving priority to reversing one o f the worst rates o f school enrollment in the world, addressing the deteriorated health situation, in particular inthe critical area o f HIV/AIDS, and promoting a more direct support program to the poor through an active public works and community service program.0 Restoring growth by: (i)consolidating fiscal stability and improving economic competitiveness necessary to jumpstart growth; and (ii) rehabilitation o f infrastructure and services related to the port as the main source o f growth inDjibouti.A. OUTCOMES HUMAN IN RESOURCE DEVELOPMENT5.2 There was impressive progress made in human resource development, with verytangible accomplishments in education. Early results from the School Access andImprovement Program, still under implementation, show an impressive 12.5 percent increase inthe rate o f enrollment over the first three years of the project implementation. This first projecto f a three-phase Education APL focused essentially on filling the huge gap in the supply side:building and rehabilitation and management o f schools, providing textbooks and supplies,training teachers and developing curriculum. The effectiveness and satisfactory implementationof the project triggered interest from other donors and discussions are underway for a donor wideeducation-for-all initiative.5.3 I n the other sectors, the two health projects, HIV/AIDS Malaria and TB Control, andHealth Sector Development project have had a good implementation start. The SocialDevelopment and Public Works project helped extend economic and social infrastructure topoor communities, including road, drainage and water supply network improvement,rehabilitation of health and social services, marketplaces, andpreparation and implementation o fparticipatory community development plans. The project also helped promote small constructionand service contractors' capacitybuilding, which prepares local SMEs to take advantage of otherbusiness and work opportunities offered by militarybases and new developments. The expectedemployment creation impact was, however, more modest thanexpected.B. OUTCOMES IN THE AREAS OF FISCAL CONSOLIDATION, COMPETITIVENESS AND GROWTH RESUMPTION5.4 I n the second area of strategic focus of the CAS i.e., restoring economic growththrough improvement of the port-linked infrastructure and structural adjustment and fiscalconsolidation, macro stability was re-established and GDP per capita re-commenced itsgrowth, but the impact on poverty reduction was rather disappointing. The IDA-financedEmergency Road Corridor Rehabilitation project and a supplemental credit to this project, wereinstrumental to the timely removal of a binding constraint to port activities. The projectresponded to the reorientation o f Ethiopia's foreign trade route to the port o f Djibouti followingthe Ethiopian-Eritrea war in 1998. Total port traffic rose to 6.0 million tons in2003, comparedto solely 1.7 million in 1997. 135.5 I n the area of structural reforms, IDA-Jinanced Fiscal Consolidated Credit supportedthe most critical policy reforms over the past four years, in particular in the area o f pensionsystem reform, arrears management and clearing, and public enterprises reform (section 111).Djibouti's fiscal situation has been brought closer to stability, with improved-though still farfrom satisfactory-public finance management. Since 2002, Djibouti's GDP per capita growthhas reverted to a positive trajectory after a long period of decline. However, the impact onpoverty has been disappointing with the dramatic worsening o f poverty indicators between 1996and 2002 (section 11). With no indication that this tendency has been reversed during the CASperiod, the pressing need to confront upfront and actively the income distribution problem inDjibouti i s underscored.C. PORTFOLIOMANAGEMENT5.6 Portfolio management over the past CASperiod improved dramatically. The projectportfolio showed a dramatic turn around with all portfolio indicators turning from highlyunsatisfactory to satisfactory or highly satisfactory. Ratings for development objective andimplementation progress of all projects in the portfolio are currently satisfactory. Thedisbursementratio has progressively increasedto reach 28 percent inFY04, comparedto only 6percent in FYOO and to the target of 18 percent set in the CAS. Disbursementlags have beenreduced significantly, and project implementation time and efficiency have also improved. Inparticular, the Education project will be closing a year ahead o f schedule leading the way to anearlier than expected start of the second phase o f the Education APL. The implementation o fboth the International Corridor project and the Social Development and Public Works projectprogressedmuchbetter and much faster thenplanned; and the Boardapproved two supplementalcredits on June 5,2003 andJune 26,2003 respectively for these projects. Table3: PortfolioStatusand Performanceunderthe lastCAS Actual Performance ProjectedTargets (FYOl Indicators (Base Line) CAS) Actual Annual Performance FYOO FYOl FY02 FY03 FYOl FY02 FY03 FY04 DisbursementRatio PA) 6.0 10.0 15.0 18.0 15 21 42 28 DisbursementLag:Org. ('A) 48.0 51 39 19 -3 ProjectsAt Risk (%) 75.0 50.0 20.0 20.0 40 33 29 0 ProblemProjects(%) 50.0 20.0 10.0 10.0 40 0 14 0 ProactivityIndex 100.0 85.0 85.0 85.0 100 100 100 100 145.7 Factors that have contributed to the improvement in the quality and speed ofimplementation include: (i)focused, and simpler design o f the projects adapted to localimplementation capacity; (ii)a more intensive supervision o f the portfolio with a problem-solving approach, supported by closer involvement o f the Country Management Unit and anexcellent dialogue with the Government; and (iii) more proactive and professional External aFinancingCoordination Unitwithin the Ministry o fthat helped quickly address the problems asthey arose. VI. BANKGROUP ASSISTANCE STRATEGYA. CHOICEOFFOCUSOFTHENEW CAS6.1 During the consultation process, the Bank team and the authorities discussed twooptions as to how tofocus the CASprogram to bring about higher effectiveness given the largedemand for IDA support and the limitedavailable IDA allocation.6.2 Thefirst option was to target the CASprogram to one of thefour pillars of the PRSPthat the Government and IDA considered the most important (e.g. social development), to bringabout a critical difference inthis particular area.6.3 The second option was to cover more areas of the PRSP, at the cost of spreadingresources more thinly, using small but strategic interventions of mixed lending and ESW ineach of the important areas. The objective would be to bring Bank good practices andknowledge to bear in more than one area o f the PRSP, and to unlock higher mobilization ofdonor partner resources and assistancein these sectors. Several donors have experienced slowimplementation o f their programs due to difficulties in dialogue on critical sectoral policy andinstitutional reform areas. Some donors have expressed interest in IDA's involvement in theirarea o f involvement/support because of: (i) IDA's comparatively good quality sector work (oneducation, water and sewerage, energy, transport and the port, public enterprise reform, thepension system, CFAA and CPAR); (ii)IDA's relatively good dialogue on critical structuralissues advanced under the FCC process; and (iii)the good momentum and excellentcollaborative spirit andtrust prevailing between the Government andthe Bank.6.4 The second option is favored. It will allow the Bank to build on the previous CASprogram, which was essentially in line with the PRSP priorities, thereby allowing, to a certainlimit, for the needed critical mass to attain the developmental objectives o f the program andcreate the desired changes and improvements.B. ALIGNMENTTO THEPRSPPILLAROFIMPROVINGCOMPETITIVENESS, GROWTH INCOME AND DISTRIBUTION6.5 The envisaged CAS program in support of the PRSP pillar of growth andcompetitiveness involves several interconnected actions, building on the investment andstructural adjtlstmentprograms started under theprevious CAS. Specifically, it involves: (i)moving a step W h e r inaddressing fiscal consolidation, improving competitiveness, and incomedistribution--this would be carried out through a combination of further wage bill adjustments tocreate more fiscal room to expand priority public services and transfers to the poor, and throughthe restructuring of utility sectors (power and water) to reduce the costs o f doing business and 15improve access of the poor to these essential public services; (ii) sustaining development andimproved management o f the Ethiopia Djibouti transport infrastructure in support o f portactivities, the economic backbone for growth and employment; and (iii) vocational training toenable local work force take advantage o f spillover activities related to the expansion ofthe port.6.6 B.1 Assistance in support of wage bill reduction and expenditure restructuringreform: As highlighted above (Section 11),the relative size o fthe public wage bill inthe budgeti s too high, mostly driven by an average high wage o f about 9 times the GDP per capita. Thislimits severely the fiscal room to hire more teachers and health professionals and to providetransfers and assistance to the poorest to meet the PRSP and Millennium Development Goals.There are really no other options than to tradeoff high wages to higher recruitment. This i spossible through the combination o f restructuring (less o f administrative and security personneland more ofpublic service professionals) lower real wage levels through any politically feasiblecombination of direct nominal wage cuts, and adjustment o f the exchange rate. Inaddition to thedirect effects o f this reform, these actions could also reduce business costs, enhancing growththrough improving competitiveness, and provide fiscal space also for raising investment andmaintenance expenditures inthe physical infrastructure base, thereby reaching andbenefiting thepoor bothdirectly andindirectly.6.7 Planned IDA assistance. On the analytical and technical side, IDA assistance wouldconsist of economic and sector work and technical support covering the critical aspects o f thewage bill restructuring reform. This includes a C E M based on a series o f focused analyticalpolicy notes covering the different components o f the reform and assessing their economic andsocial impact, their phasing, and the alleviation o f their impact on the poor; and finalizing thePublic Expenditure Review with emphasis on restructuring expenditure in key sectors. On thelending side, IDA assistance would consist, under a high case scenario, of a second fiscalconsolidation credit, supporting the second phase o f reforms undertaken under the FCC,focusing on wage billand public expenditure restructuring.6.8 B2. Restructuringthe utilities sector as a means of enhancing competitivenessandimproving access to services to the poor: The utility sectors, mainly power and water, hawbeen identified inthe PRSP as key bottlenecks Box 3: Renewable water resources (2000) Ito improving the overall economiccompetitiveness. The issue i s the very highcost of utilities, which also constitutes anaccess barrier to the poor. Tariffs for Cubicelectricity and water services are the highest in meter'the MENA region, at an average o fUS$0.20/kWh for electricity, and US$l.l Om3 yearfor water (as compared to MENA average o fUS$0.07 for electricity and US$0.28 forwater). The reasons for the high prices areseveral, but notably: the higher cost o f MENA Egypt Moroc- PalestineJordan Yemen Djiboutielectricity production due to a reliance on mimported diesel fuel for power generation; large inefficiencies in the form o f network losses;highadministrativeoverhead costs due to overstaffing; inordinatelyhighwages (seeBox 4); andhighlevels oftaxation (33 percent taxes on all petroleum products and about 20 percent more of 16surtaxes6). IDA has played a leading role in assisting the Government inassessingthe financialperformance o f the power andwater companiesthrough the FCC. The two sector strategy noteson power and water and PRSP work have identified an action plan for both sectors focusing onthe following key objectives: (i) improving the efficiency and financial performance o f theutilities through restructuring and promotion of private sector participation; (ii) addressing keyservice-delivery constraints through rehabilitation of networks and protection o f resources; and(iii) exploring new resources for water supply (e.g., desalination) and power generation (e.g.,renewable energy and interconnectionpossibilities). Box 4: CompetitivenessIndicatorsInDjibouti High wages and high wagebilL An IMF survey was conductedto comparewage and price levels inDjibouti, Addis Ababa (Ethiopia) and Sana'a (Yemen). The survey revealed that Djibouti's wages are much higher than those of neighboringcountries. At 1999exchange rates, wages inDjibouti were 3 to 6 % times the level of those in Ethiopia andYemen. The differentialswere generally higherfor skilled and semi-skilledemployees (public servants, and hotel andrestaurantstaff) than for unskilledworkers (manual laborers anddomestic servants). The apparent insensitivity of wage rates to the high level of unemploymentmay reflect the benchmark establishedby the dominant public sector, which accounts for approximatelyhalf of the total reportedwage earner population(or almost three-quarters when public enterprises are included in the public sector). In 1998, the average wage rate in Djibouti's civil service was indeedabout45 percentabove the averagewage rateof workers inthe privatesector andpublic enterprises.Estimated average salaries for public sector employeeswere more than five times the level inEthiopia and about four times the level of comparableemployees inYemen. High utilitiesprices. Djibouti faces high productioncosts associatedwith utility prices. Inparticular, the price of the kW/hour for industries was about 26 cents in 2000, and the cost of telephone calls abroad ranged from more than US$1 per minute to neighboring countries to almost US$3 per minute to Europe, and US$ 4 to the United States. Utilities are expensive primarily because of high wages, a large tax burden, and poor managementpractices. When looking at public enterprise accounts, it appears thatwages and salaries ofpublic enterprisesrangefrom 31percentof value added for Djibouti-Telecom, to 77 percent for the airport. The wage bill of the electricity company was 51 percent in 2000. Poor collectionrates and fraud are other problems faced by some public enterprises, including the electricity andwater company. High serviceprices. Higherpricesof transport contributeto the fact that roadtraffic betweenDjibouti and Ethiopia is mostly handledby Ethiopiancompanies, which pay lower wages to their drivers than those paid to Djibouti drivers. Other prices of services (recreational, tailoring, shoe repairing, apartmentrents) are muchmore expensive inDjibouti. As a result, the ratio of non-tradable prices to tradable prices is higher in Djibouti than in its two neighboring countries. High Real exchange rate (REER). Following the depreciationof the US dollar in effective terms, Djibouti's real effective exchange rate depreciatedbetween2002 and 2004 by about 30 percent. Despitethis depreciationthe REER remained overvaluedcomparedto the early 1990s (over 20 percent). Such an overvaluedexchange rate continuesto undermine the country's overallcompetitiveness.6.9 Planned IDA assistance would consist of a dual power and water project. The IDAcontributiontowards this project is expectedto be about US$7 million. Inaddition, a GEF granttowards renewable and energy efficiency improvement i s being pursued and would be in therange ofUS$2.5 to US$3.5 million. The power sector-related components would include a smallinvestment inthe distribution network inDjibouti-Ville to rehabilitate and extend the network toun-served residential consumers, as well as to the commercial district; and the construction o f asmall wind farm to serve an interior town. The water sector component will focus on initiatingprotective measures of the aquifer that serves 70 percent o f Djibouti's population. However,although the Bank's contribution to the critical needs o f the water sector are limiteddue to theconstraints of the IDA envelope, the Bank will work closely with the EU who is preparing alargewater sector investment project (US$20 million) andhas requestedthat its project be linked The abnormally highlevelo ftaxes and surtaxes were inheritedfromthe stabilization period. Theyneedto berevised within a potential new fiscal consolidation follow up operation. 17to the Bank's activities in terms of overall development objectives (see below under theinstitutionalcomponent). Another component will focus on the institutionalrestructuring of thepower and water utilities and the associated regulatory frameworks. IDA involvement in thesectors' institutionalrestructuring builds on the work undertakenunder the FCC. Inaddition, theEU, the largest donor inthe water sector, has requested Bank leadership insectoral reform, andi s conditioning the releaseo f its investment fbnds on the implementation o freforms inthe sector. Box 5: Utilities' Unit Performance Compared to MNA's Good Practice The price for electricity and water inDjibouti i s muchhigher than inother countriesinthe region, and also when comparedto goodgeneralindustrypracticemore generally. Average electricity tariffs inthe region range from US#9ikWh to industry and US#6kWh to households in Yemen; US#6kWh to industry and households in Jordan and USf6.9kWh to industry and US#9.5kWh to households in Morocco. In Djibouti, the average selling price is US#20kWh, but commercial customers including small enterprises pay as much as US#32/kWhand the Office National des Eaux de Djibouti (ONED) pays US.4lkWh. The same applies to the water sector, where the lowest tariff to households reaches US#35/m3, comparedto US#25/m3inYemen; US#22/m3inJordan, and US#20/m3inMorocco. Good practice in electricity is an average tariff of between US#10-15kWh. It is more difficult to have a benchmarkfor water since it variesgreatlywith the source andamount ofwater resources. The sectors also suffer from overstaffing, which i s of serious concem, given the high cost of labor in Djibouti. Measuredinrelationshipto number of connections, the Djibouti Electricity Authority (EDD) has 31 connectionsper employees whereas good practiceis 70-100. Measuredslightly differently for the water sector, ONED has 21 employees per active 1,000 connections, while good practice is in the rangeof4 to 6.6.10 B3. Developmentandrehabilitationofthe transport infrastructureinsupport ofthePort of Djiboutias the engine of economic growth and employment: Djibouti has put thedevelopment o f the port and the transport sectors at the heart of its poverty reduction strategy.The potential of the port as an engine o f growth looks clearer today than inthe mid-1990s whenthe port was losingmost o f its transshipmenttraffic to other competing ports inthe region. Thesituation i s much improved today because o f the sharp increase in port traffic following theEthiopian-Eritrea war in 1998, combined with the rehabilitation o f the road link to Ethiopia,which was supported by IDA'S emergency Road Corridor Rehabilitation Project and asupplemental credit, as well as the Government's decision to transfer the port management to aprivate operator. This stimulated considerably port activity (traffic increased by 165 percentbetween 1997 and 2002), andmore than compensatedfor the drop intransshipment.6.11 The first challenge for Djibouti is to preserve the Ethiopian transit traffic by improvingthe attractiveness and competitiveness of the port, as well as its transportation logistical linkswith its hinterland. The second challenge i s to maximize the port's significant growth andemployment potential by regaining and expanding its share in transshipment and diversifyingrelatedbusiness, including a potential free trade zone (FTZ).6.12 Improvement in both physical infrastructure and the institutional setting are needed forthe port of Djibouti to play its role as the gateway to and from its hinterland, especially vis-a-visEthiopia. Regarding the port, a new oil terminal is being built at the Dorale site with privatefinancing to alleviate the operational constraints posedby the old oil facilities inthe current portsite.6.13 A long-term plan to develop the Djibouti-Addis Ababa Corridor started with the IDA-supported rehabilitation o f the Djibouti-Galafi road, encompassing also the development o f therail link between Djibouti and Addis. The European Union is also financing a hture improved 18road linkbetween Djibouti and Addis Ababa, inaddition to its financing of emergency repairs tothe rail linkto bringit up to an acceptablelevel for efficient and safe operations.6.14 Onthe institutional side, Djibouti's decision to have a partnership with the private sectorinport and airport managementhas been successfulthus far, andlays the ground for more suchpartnerships. Preparation is underway for a concessionscheme for the rail linkbetweenDjiboutiand Addis Ababa through the privatization of "Chemin de Fer Djibouto-Ethiopien ", a joint-national company operating the 800-kilometer rail link between Djibouti and Addis.Governments inboth countries now sponsor this scheme. Box 6: Developmentof the Port of DjiboutiDjiboutihas put the development of the port and the transport sector at the heart of its povertyreductionstrategy. The potentialof the port as an engine of growth looks clearer today than inthe mid 1990swhen the port was losing most of its transshipmenttraffic to other competing ports in the region. The sharp increase in port traffic following the Ethiopian-Eritreawar in 1998,combined with the rehabilitation of the road link to Ethiopia, which was supported by IDA's emergency Road CorridorRehabilitation Project and a supplemental credit, as well as the Government's decision to transfer the port management to aprivate operator stimulated considerably port activity. Total port traffic rose to 5.97 million tons in 2003, compared to 4.55million tons in 2002 and solely 1.7 million in 1997, which more than compensatedfor the drop intransshipment. The challengefor Djibouti is to first preserve Ethiopiantransit trafic by improving the attractivenessandthe competitivenessofthe port and itslogisticslinkswith its hinterland,andthen to seek to diversify the port's business.Strengtheningthe competitivenessof theport of Djibouti and logistics links with its hinterland. Improvementofbothphysicalinfrastructureand institutional settings is neededfor the port of Djibouti to play its role as the gate to and from its hinterland, andmainly Ethiopia. On the port side, anew oil terminalis beingbuilt at Dorale site with private financing to alleviatethe currentoperationalconstraintsposed by the old oil facilities in the current port site. A long-term plan to develop the Djibouti-AddisCorridor started with the IDA's supported rehabilitationof the Djibouti-Galafi roadand it also encompasses development of therail linkbetweenDjibouti and Addis. The EuropeanUnion is financing a future improvedroadlinkbetweenDjibouti andAddisAbaba along the same route as the existing rail link via Ali-Sabieh in Djibouti and Dire-Dawa in Ethiopia. The EU is alsofinancing emergency repairs to the rail link to bring it up to an acceptable level for efficient and safe operations. On theinstitutionalside, Djibouti's decisionto have apartnershipwith theprivatesector inport managementwas so far successfuland itlays the ground for more such partnerships. Preparation is underway of a concessionscheme for the rail link between Djiboutiand Addis through the privatization of "Chemin de Fer Djibouto-Ethiopien (CFDE)", a joint-national company operating the800-kilometer rail link between Djibouti and Addis. This scheme is now sponsored by Governments in both countries. Anational road strategy aimed at improving the institutional arrangements of the road sector including road management andfinancing of roadmaintenanceis beingcarriedout under the emergencyroadcorridor rehabilitationproject. This CAS proposessupport in this area through a Partial Risk Guarantee in support of the concession to the privatization of the CFDE, and atransport strategy study.Diversifying the port's business and related activities. The Government and the private operator of the port have set as astrategic goal to increase Djibouti's share inthe very competitive regional transshipment traffic. The constructionwith privateparticipationof anew deepwater container terminal at Dorale site along with an industrial and commercialfree zone is on theiragenda. While the activities of this proposedport are rather capital than labor intensive, a successful free zone should be asignificantsource of employment. Ifthis ambitiousprojectdid materialize, for it to benefitthe economic and socialdevelopmentof the country, special attentionshouldbe focused to train aqualified labor force on one hand, and to reducethe extremelyhighcost of labor inDjibouti onthe other hand. This CAS supports address the first areathroughthe proposedPartial Risk Guarantee.6.15 Planned IDA assistancewould consist of an IDA partial risk guarantee, which could bematched by the same amount from Ethiopia with which coordination is under way, to theconcession being considered to mitigate the risks associated with such a complex bi-nationalproject. IDA is also carrying out a Transport Sector Review aimed at improving the institutionalarrangements of the road sector, including road management and financing of road maintenance.IDA will support the Government in adopting and implementing the recommendations o f thisReview. 19c. ALIGNMENTTO THE PRSP PILLAR OF HUMAN RESOURCE DEVELOPMENT POVERTY AND ALLEVIATION6.16 The focus of the previous CAS on human development was also aligned with whatsubsequently became the second pillar of the PRSP. This CAS continues IDA support in thesame area covered in the previous CAS with additional lending except in health, where twooperations (Health Sector Development; and HIV/AIDS) have just started and theirimplementation should cover the requiredIDA support inthis sector over the next four years.6.17 C1. Continuing support for an acceleratedschool access and improvement agenda:The first phase of Djibouti's School Access and Improvement Adaptable Program Lending(APL),the first IDA project in education, is beingcompleted one year ahead of schedule withsignificant and encouraging results inseveral areas: (i) increasedenrollment with a primarygrossenrollment ratio (GER) of 52 percent comparedto 39.5 percent at the start o fthe project in2000;(ii)decreased grade repeater rates from 10 percent to 7 percent; (iii) increased availability o ftextbook at a ratio of 1:l; (iv) increased teacher training; (v) revised curriculum; and (vi)achievement o f all the triggers agreeduponto move the secondPhaseo fthe APL.6.18 Planned IDA assistance would consist of a second accelerated school access andimprovement project for the secondphase of the education APL. The objectives o f this projectare to expand coverage of quality basic education through targetedactivities which contribute toincreased access and retention rates of the system, and to further reduce repetition and drop-outrates. The specific objective o f this phase is to increase the enrollment to 70 percent by 2008,with special emphasis on girls education, in line with the PRSP targets. IDA will work closelywith other donors to mobilize additional financial resources for reaching this target. AnEducation Sector Strategy Assessment will beprepared inFY07.6.19 C2. Continuingsupport for employment generationand direct support to the poor:With respect to employment generation and social development, the last CAS programconsistedof the consolidation and expansion o f a Social Development and Public Works Program. Theprogram contributed to poverty reduction through: (i) construction and rehabilitation o f socialand economic infrastructure in the poorest neighborhoods with a direct impact on the livingconditions o f the poor (such as street works, drainage, water and sanitation systems, localmarkets, schools, and health care facilities), while at the same time, offering employmentopportunities; (ii)supporting community developmentthrough social mobilization programs andinvestment grants for the creation o f community facilities; and (iii)institutional capacity buildingby developing the capability of small local private contractors to enable them to benefit fromopportunities offered by the port development, the military bases and other activities; and alsoimproving the institutional capacity o f the Government, communities and NGOs to design andimplementpoverty reduction interventions.6.20 One of the main factors characterizing the unemployment situation inDjibouti i s the lackof basic skilled labor and the lack o f training to address this problem. Addressing thisimpediment to employment would enable labor force to better take advantage of existing andpotential service activities developments, in particular that of construction and other servicesrelated to the military bases, and transport related to the port, as well as to the potential demandfrom its ongoing expansion andpossible free zone development. 206.21 Planned IDA assistance would consist of a credit focused on employment creation withtwo components: (i) rehabilitation o f basic services (inparticular water and sewerage system) inone o f the poorest districts (the Cartier Dariba); and (ii) financing of a small focused VocationalTraining project to enable unemployedyoungpeople to take advantage o f expected employmentopportunities linked to the development o f the port. IDA support will continue in the area o fpension system reform (under the Planned second Fiscal Consolidation Credit) and anemployment strategy note (CEM).6.22 C3. Providing support to poor victims of the flood: The PRSP highlights thevulnerability o f Djibouti to various natural disaster dangers and emphasizes need for developingprevention and management capacity. An Emergency Floods Rehabilitation project for $6.4million was approved in September 2004 to assist the Government o f Djibouti inhelpingpeoplehurtbythe floods that devastatedthe regioninApril 2004, that impactedabout 15percent ofthepopulation, or about 100,000 people. Most of the affected population lives inthe poorest areas.Support will be given to rehabilitate social and economic infrastructure (e.g., housing, schools,medical centers) that was damaged. The project also includes technical assistance to supportshort andlong-termdisaster preventionmanagementplans.6.23 C4. Providing support in other key problematic social areas: As identified above(paras. 1.10-1-14), women in Djibouti bear additional disadvantages and burden that the PRSPrecognize as keyhurdles inthe way o f upliftingthe well beingo f the whole society. The PRSP,however, does not deal adequately with the Qat issue, because there i s less internal consensusabout the problem. IDA assistance under the CAS program will, nevertheless, address bothissues.6.24 Planned IDA assistance tofurthering the gender agenda: The UNDP and UNFPA areprovidingassistanceto the Ministry of Gender, mainly incapacity building. The IDA-financedSocial Development and Public Works project provided credit to micro-enterprises, many o fwhich are run by women. The Planned new Social Development and Public Works I1creditwould follow step. The first School Access and Improvement project under the previous CAShas met its explicit targets for reducing the gender gap in schooling. The second School Accessproject, under this CAS will further aid in this effort with still greater emphasis on girlsschooling. The Health project, currently under implementation, also aims at reducingthe highrates of infant and matemal mortality. A coordinated effort will be made with donors to supportNGOs in the on-going public awareness and education campaign for the elimination of FGMpractice.6.25 Planned I D A assistance to address the Qatproblem: IDA efforts will aim at buildingconsensus in the country on the importance o f this issue in terms o f its serious social andeconomic consequences. An assessment of the social and economic implications of Qat importand consumption at the household and macro levels will be made within the framework o f theprogrammed work on poverty assessment. IDA will raise the issue more prominently in itspolicy dialogue with the authorities. IDA willjoin other donors inthe effort o fraising awarenessabout the harmful effects of Qat consumption and provide support to national initiatives toaddress this problem. 21D. ALIGNMENTTO THEPRSPPILLAROFPROMOTINGGOODGOVERNANCE6.26 The PRSP emphasizes governance improvement as one o f the main pillars ofdevelopment and poverty reduction. Inthis agenda, governance improvement is defined broadlyas furthering the promotion of good political, local, economic and financial governance,strengthening the capacity for planning and administrative management and modernizing it.Priority in this agenda is given to ensuring transparent and efficient management o f publicexpenditure, and to improving equity and effectiveness inorder to transform governance into "atrue instrument for combating poverty."6.27 Two key IDAfiduciary activities, a CFAA and a CPAR, have beenfinalized in addition toa Public Expenditure Review. These constitute a strong basis for identifylng improvement areasand a concrete program of actions that the authorities are willing to undertake to move forwardon their governance agenda6.28 Inthe area of public financial management, the CFAA noted a relatively good quality ofthe legal framework, a satisfactory level of the external control carried on by the newly createdChamber o f Accounts, and a relative improvement inthe system o fpayments and accounting. Onthe other hand, it pointed to major weaknesses undermining the management and transparency o fpublic spending. The three areas o f weaknesses identified and examined by the CFAA concernbudget formulation, execution, andinternal control.6.29 The CPAR collaborative exercise also pointed to several weaknesses in publicprocurement which diminish the absorptive capacity, and deprive the country from fullybenefiting from available donor financing. Absorptive capacity remains hampered by severalprocurement weaknesses at different levels, including an incomplete and complex procurementcode; an unclear legislative and regulatory framework; lengthy and inefficient procurementprocedures; loss o f private sector confidence due to large Government arrears leading toexaggerated risk premiums; and weaknesses inthe customs' institutions at both the institutionalandhumanresource levels.6.30 Theplanned IDA assistance would consist o f support inimplementing the detailed andphased program of actions in the areas of financial management and public procurement, whichhave been identified and discussed collaboratively with the authorities, the private sector, and thedonor community during a workshop organized by the Government. IDA would support thisPRSP Governance improvement pillar with two IDFs(to implement the CPAR and CFAA policyrecommendations), which would also be complemented by technical assistance from otherdonors. 22 Table 4: PlannedWorldBankGroupProgramFY 05-08 (Base Case: US$30 mil.) Operations (US$ m) Operations (US%m) Operations (US$ m) Operati (US%m) ons EmergencyFloods 6.4' School 10 Djibouti-Ethiopia 3 Social 5 Rehabilitation Access and Rail RoadPartial Dev./ Improvement RiskGuarantee Public (Phase 11) Works I1 I I I I I I I I~~~ Power and Water 7 Project Total 13.4 10 3 5 rmframework for Impact Analysis ImprovedEconomic * This policy note is part ofthe CEM. E. LENDING SCENARIOS AND TRIGGERS 6.31 The base-case lending program of about US$31 million will fully utilize Djibouti's IDA indicative allocation for the next four years*. The base case is predicated on continued satisfactory macroeconomic management and good portfolio performance. The CAS does not envisage a low case scenariobecause of: i)negligibleprobability o f base case triggers not being met; (ii) small size of IDA allocation in the base case; and (iii) remaining lending the the program beyond FY05 i s essentially in education and poverty alleviation. The alternative lendingcase scenariois thus limitedto ahighcase scenario. 6.32 The highcase lendingscenariowould providefor US$9 millionabove the base case It would consist of a poverty reduction credit in support of scaling up the fiscal consolidation agenda started during the last CAS with a Fiscal Consolidation Credit (FCC). The second FCC will focus on public expenditure restructuring with emphasis on the wage bill (structure of civil service and wage level adjustment) with the objectives, as highlighted above of: (i) creating needed fiscal room for higher public service spending, (ii) improving income distribution and direct transfers to the poor; and (iii) enhancing overall competitiveness o f the economy. The triggers for the highcase scenario would consist of: satisfactory IDA portfolio performance with no more than two problem projects in the portfolio; satisfactory progress in implementationof 'Outof theprojectcostofUSS6.4 million, $3.2 million is inthe formof agrant, and anequal amount is inthe form of an IDA credit. This envelope will be finalized subsequently along IDA14 rules andIDA14 funds availability. 23the economic governance and transparency agenda; and Government's readiness to undertake acredible and sustainable reform program o f wage bill restructuring and enhancingcompetitiveness. Table 5: LendingScenarios and Triggers e bill reduction andF. IDALENDING TERMSAND DJIBOUTI'S INFLATED GNIPER CAPITA6.33 Djibouti GNIper capita of US$920 has became higher than the operational cutoff foreligibilityfor 40-year IDAfunding of US$S95over thepast threeyears. This highlevel o f GNIper capita indollar terms i s to a large extent artificially inflated by the overvalued exchange rate.It does not reflect the extent o f prevailing poverty in Djibouti as highlighted above. Unless theGovernment addresses the underlining factors of its inflated GNI per capita, it will depriveDjibouti from the needed IDA softer terms. This is inaddition to the beneficial implication thatsuch policy reform could have in correcting the income distribution bias against the poor asdiscussed insection 11.G. COORDINATIONWITHDEVELOPMENT PARTNERS6.34 Quite in contrast with the improvement in IDA portfolio performance and dialoguewith the Government, many partners expressfrustration about dijjficult policy dialogue andslow project implementation. Several large and critical projects have been inthe pipeline for along time without materializing. Portfolio performance is also un-even across partners. Thisunderscores the need to assess donors' collective experience with Djibouti and share lessons o fwhat has worked well and what did not as the donors community prepares to pledge its futureassistance to Djibouti's PRSP during the Consultative Group (CG) meetings to be organized thissummer.6.35 The PRSP preparation and consultation process, in which donors were associated,offered a good opportunity for a shared understanding of the Government strategy andpriorities. Through its PRSP, Djibouti has its first comprehensive and consistent vision andstrategy o f development and poverty reduction since independence. The PRSP processes leddonors to start refocusing their assistance on a more informed basis along the Governmentpriorities. The process has also forced the start o f a more active coordination among the donorcommunity which should intensify at the Consultative Group meeting that would be chaired bythe World Bank. IDA would work with donor agencies to ensure that: (i) or institutional policy 24advise i s mutually consistent; (ii) investmentprograms addressing the priorities of the PRSP areconsistent and do not overlap; (iii) share sectoral and economic analysis and information; donorsand (iv) IDA and donors operational procedures (e.g., for procurement, accounting, and audit)are as standardized as possible to ease project implementation.6.36 This CAS,prepared in close collaboration with the donor community, is designed tocomplement and support other donors' effort. (see section VI-A). It specifically arranged someo f the lending and non-lending operations to address problems that constrain other donorssupport (as i s the case with the water and power project for example) and use any comparativeadvantage IDA might have to help inthis regard. As shown in the CAS results matrix (AnnexB9) there are already many synergies between IDA assistance and other donors' proposedinterventions. These will be further clarified as donors' consultation on defining respectiveassistanceto the PRSP investmentprogramprogress.6.37 More specifically, the World Bank will continue its strong collaboration with the IMFand will ensure that a consistent message is conveyed on the macroeconomic, public financemanagement and other structural reforms. The planned second Fiscal Consolidation Credit(FCC) would reinforce and complement the IMF's potential PRGF program as it was the casewith the first FCC. On other areas, such as in the water, power, and transport sectors, IDA'Sassistanceboth inlendingand inanalytical (AAA) work i s beingprepared inclose collaborationwith the EU and complements its investment and assistance in sector reforms as well as theAfDB's intervention in the energy sector. The Bank is also supporting in-country aidcoordination led by other donors through sector-level technical assistance (e.g., Djiboutieducation local donor group ledby France). There i s also close collaboration with the UN, theCuisse Fruncaise de Developpement andother donors inimproving Govemance. VII. MANAGINGRISKSTHE7.1 The realization of Djibouti's poverv reduction strategy, and the effectiveness of thisCAS which is aligned to it, are subject to several external and internal risks. The PRSPrecognizedupfront most ofthese risks.7.2 Djibouti's exposure to external risk is high because its economy depends mainly on theport and its development; the rental of militaly bases; and grants and soft financing fromdonors-all of which are subject to high geo-political uncertainties. Regarding the port, thesurge in growth since the mid-1990s o f port activities with Ethiopia was attributable to theEthiopifiritrea war, and subsequent reliance o f Ethiopia on the Djibouti port for most of itsimports and exports. To limit the risk o f the reversibility o f the increase in its share in Ethiopiatrade traffic, Djibouti needs to improve the overall competitiveness o f the port by reducing costs,and improving infrastructure links (road and railways) to Ethiopia. Inthis respect, the on-goingeffort to expand transport infrastructure with direct financial participation o f the Ethiopian sideraises the stakes of the latter in maintaining continuous business and limits this risk. As for theprospective development and expansion o f port as a transshipment hub, it i s still awaiting theconclusion of a deal with a foreign private investor. The rental of the newest militarybases (theU S and Germany bases) which constitutes an important additional source o f revenue to theGovernment and influences the development o f many service activities, i s also subject tounpredictability, even though more inthe longer term thaninthe near term, giventhe continuingregional instabilityinthe MiddleEast. 257.3 The financing of the PRSP investment program hinges on important contributionsfrom donors in theform of grants, which, if notforthcoming in the amounts envisaged, couldjeopardize fiscal sustainability and/or the PRSP investmentprogram. This risk and its effectswill be hopefully adequately addressed by Djibouti's partners during the planned ConsultativeGroup Meeting in support o f the PRSP. Djibouti would mitigate this risk significantly byaddressing its structural adjustment reform to boost confidence o f its partners inthe effectivenesso f their support and foreign investors on the competitiveness and long term economic, social andpolitical stability of the country.7.4 CAS implementation is also subject to two major internal risks. First, there is the riskthat the Government may move too slowly or not at all with respect to the next phase offiscalconsolidation and restructuring. Failing to take these decisions and implementing such reformswould shed more uncertainty on the attainment o f the PRSP objectives in terms o f basic servicedelivery and better income and rent distribution. It would also delay the necessary adjustmentsneeded to improve competitiveness and thus deter potential FDI, and diminish donor support.The envisaged high-case scenario lending (FCC 11) would provide, along with expected larger support from Djibouti's other partners, both technical and financial assistance to help wither down the social costs o fthis reform, and enhance its social andpolitical feasibility. 7.5 The other source of internal risk is related to the capacity to implement and monitorDjibouti's poverty reduction strategy, which implies a large increase in thepublic investmentprogram in a situation of relatively low skill levels and limited administrative and management capacity. The risk i s not significant with regard to the implementation o f the CAS program (section V). However, the institutional capacity constraints can potentially limit the Government's ability to utilize fully and effectively increased support from other donors. IDA will keep this broader issue under review. 26 Djibouti at a glance CAS Annex A2 M. East Lower.P O M R Nand SOCIAL 8 North mlddie- Dllbouti Africa income Developmentdiamond.2003Population,mid-year (millionsj 0.71 312 2,655 Life expectancyGNi per capita (Atlasmethod, US$J 910 2,210 1.480GNI (Atiasmethod, US$ billions) 0.64 689 3,934 TAveraQeannual growth, 1997-03Population(%) 2.2 1 9 0 9Labor force (%) 2 9 1.2 GNi Gross per p r "Most recent estimate (latest yaar available, 1997-031 capita enrollmentPoverty(% ofpopulation belownationalpoverty iineiUrbanpopulation (% of totaipopulatlon~ 84 56 50Life expectancyat birth (years) 44 69 69Infant mortality (per 1,000 live births) 100 44 32Child malnutrltion (% of childrenunder 5J 11 Accessto improvedwater sourceAccess to an improvedwater source (% ofpopulation) 100 88 61illiteracy(% ofpopulation age 15+1 31 10Gross pnmaryenrollment (% of school-agepopulationJ 40 96 112 -Djibouti Male 46 100 113 -Lower-middle-incomearoup Female 35 92 111 1KEY ECONOMICRATIOSand LONG-TERMTRENDS 1983 1993 2002 2003 Economic ratios*GDP (US%billionsi 0.47 0 59 0.62Gross domestic investmenWGDPExports ofgoods and seMcesIGDP TradeGross domestic sawngslGDP -Gross nationaisavingslGDPCurrentaccount balanceiGDPInterestpaymentslGDP 0.4 0 4 0.5Total debffGDP 56.1 56 6 63.4Total debt servicdewortsPresentvalue of debffGDP 37 2Presentvalue of debtiexports I Indebtedness 1983-93 1993-03 2002 2003 200347(average annualgrowth)GDP -0.9 0.2 2.6 3 6 -DjiboutiGDP per capita -6.5 -2.4 0.6 1 8 __ Lower-middle-incomegroup&ports of goods and servicesSTRUCTUREof the ECONOMY 1983 1993 2002 2003 ~Growth of investment and GDP (%)(%of GDPJ IAgriculture 3 1 Industry 20 5 Manufacturing 5 3 "SeMces 76 4 :: / O 98 F $9 00 01 02 d3 Privateconsumption Generalgovernment COnSUmPtiOn II Importsof goodsand SemCeS -GDI -GDP 1983-93 199343 2002 2003 (average annualgrowth) Agriculture 2.2 Industry .... -5.7 Manufactunng -9.9 Services .... 0.3 Privateconsumption Generalgovernmentconsumption Grossdomestic investment imports of goodsand services Note:2003 data are preliminaryestimates This tablewas producedfrom the Development Economicscentraldatabase. *The diamondsshow four keyindicatorsinthe country (in bold) comparedwith its income-groupaverage. If data are missing. the diamond will be incomplete. 27 DjiboutiPRICESand GOVERNMENT FINANCE 1983 1993 2002 2003Domestic prices I inflation("A) 1(% change) IConsumer pricesImplicit GDP deflator 4.4 0.6 2.0Government finance(% OFGDP, includes currentgranfsj ICurrent revenue 37.2 31.6 31.O 98 99 00 01 02 03Current budget balance -4.6 3.3 3.7 -GDP deflator +CPIOverall surplus/deficit -13.0 -0.7 -0.5TRADE 1983 1993 2002 2003(US$ milhonsJ Exporland import levels (US$ mill.)Total exports (fob) 71 86 94 400- Foodand live animals 7 8 Coffeeand derivatives 7 7 Manufactures 55 60Total imports (cif) 295 303 Food 85 87 Fuel and energy 13 13 Capital goods 103 106 IExport price index (1995=100j 97 98 99 00 01 02 IImport price index f1995=100j I O3 BEqpolts BlmpoltsTerms of trade (1995=100J IIBALANCEof PAYMENTS 1983 1993 2002 2003(US$ miLonsJ ' Currentaccount balanceto GDP (70) 1~xportsof goods and sewcesImports of goods and serwcesResourcebalanceNet incomeNet currenttransfersCurrentaccount baianceFinancingitems (net)Changes in net reservesMemo:Reserves including gold (US$ mi//ionsjConversion rate IDEC, /oca//US$J 177.7 177.7 177.7 177.7EXTERNALDEBTand RESOURCEFLOWS 1983 1993 2002 2003(US$millionsj 1Composition of 2003 debt (US$mill.)Total debt outstandingand disbursed 46 264 335 396 I IBRD 0 0 0 0 IDA 1 40 79 112 6 8Totai debt seruce 5 11 12 16 IBRD 0 0 0 0 IDA 0 0 1 2Compositionof net resourceflows Official grants 24 53 26 Official creditors 13 19 24 20 Prime creditors 0 0 0 0 Foreigndirect investment 0 1 4 Portfolioequity 0 0 0 1World Bank program Commitments 15 11 E Bilaierai ~ Disbursements 16 26 D .Other multilateral F Pnvate Principalrepayments 1 1 G Short-tenn -- I Netflows 17 25 Interestpayments 0 1 Nettransfers 17 24 Note: This tabiewas produced from the Development Economicscentral database. 9/15/04 28 CASAnnex B2 CAS Annex B2 Djibouti - Selected Indicators* of Bank Portfolio Performanceand Management As of February8,2005Indicator 2002 2003 2004 2005PortfolioAssessmentNumber of Projects Under Implementationa 6 7 5 5Average ImplementationPeriod (years) 2.1 2.7 3.2 2.9Percentof Problem Projects by Number a,c 0.0 14.3 0.0 0.0Percentof Problem Projects by Amount a, 0.0 10.6 0.0 0.0Percent of Projects at Risk by Number 33.3 28.6 0.0 60.0**Percent of Projectsat Risk by Amount a, 41.8 32.9 0.0 60.5**Disbursement Ratio (%) e 27.0 41.7 28.3 19.9Portfolio ManagementCPPR duringthe year (yedno)Supervision Resources (total US$) 201 297 551 570Average Supervision(US$/project) 29 42 79 80** Djibouti's portfoliohas no unsatisfactoryproject and no problemprojects.Thepercentageof project at risk is driven by only one project-specificriskflag fortwo of the projectsin the portfolio. This one risk flag triggersthe qualifierproblem projectas it adds to the two automaticcountry risk flags (CountryEnvironmentand Country RecordsRisk Flags). The problemsare beingactively dealtwith and shall be resolved on time. Last FiveMemorandumItem Since FY 80 FYsProject Evaluated by OED by Number 11 3Project Evaluated by OED by Amt (US$ millions) 64.2 18.5% of OED Projects Rated U or HU by Number 54.5 66.7% of OED Projects Rated U or HU by Amt 44.4 43.0a. As shown in the Annual Reporton PortfolioPerformance(exceptfor current FY).b. Average age of projectsin the Bank's country portfolio.c. Percentof projectsrated U or HU on development objectives (DO) and/or implementationprogress (IP).d. As definedunderthe PortfolioImprovementProgram.e. Ratio of disbursements during the year to the undisbursedbalanceof the Bank's portfolio at the beginning of the year: Investmentprojectsonly. 29 CASAnnex B3 CAS Annex B3 IDA ProgramSummary-Djibouti - As o fFebruary 8,2005PlannedIDA Base-Case LendingProgramaFiscal Strategic Year Project ID us$(M) Rewards bImplementation Rish ('/M/L) (H/M/L) 2005 Flood Emergency Rehabilitation 6.4 H L Power and Water 7.0 H M Result 13.4 2006 Second School Access andImprovement 10.0 H L Result 10.0 2007 Ethiopia Rail RoadPartial Risk Guarantee 3.0 H M FiscalConsolidation Credit 9.0 H M Result 12.0 2008 Second Social Developmenthblic Works I1 5.0 H M Result 5.0 OverallResult 40.4 a. This table presents the planned program for the next three fiscal years. b. For eachproject, indicate whether the strategic rewards and implementationrisks are expectedto be high (H), moderate (M) or low (L) 30 CASAnnex B4 CAS Annex B4 Summary of Nonlending Services Djibouti - - As of February 8,2005 CostProduct CompletionFY (US$OOO) Audience" ObjectivebRecentcompletionsEnvironmentalMainstreaminginto PRSP 2004 16.0 GovtlDonor KnowledgeGenerationWater SectorNote 2004 136.0 Govemment KnowledgeGenerationCountryProcurementAssessment Review 2004 86.0 Govemment KnowledgeGenerationCountryFinancialAccountability Assessment 2004 126.0 KnowledgeGenerationPublic ExpenditureReview 2005 133.0 Chemment KnowledgeGenerationUnderwayDjibouti CAS 2005 55.0 Go-ank KnowledgeGenerationTransportReview 2005 60.0 KnowledgeGenerationEconomic/PRSPMonitoring 2005 50.0 KnowledgeGenerationEnergyPoverty& Social Impact Analysis 2005 80.0 Govam-" KnowledgeGenerationEconomicand Social ImpactofPublic WageBillReforms 2005 100.0 Govemment ProblemSolvingPlannedIDF CPAWGovemance 2006 70.0 Govemment ProblemSolvingIDF CFANGovemance 2006 70.0 Govemment ProblemSolvingEconomicPRSP Monitoring 2006 50.0 Govemment KnowledgeGenerationCPPR 2006 50.0 Govemment KnowledgeGenerationCountryEconomicMemorandum 2006 170.0 Govemment KnowledgeGenerationPovertyAssessment 2006 100.0 Govemment KnowledgeGenerationCGMeetings 2006 40.0 Govt/Donors ProblemSolvingPRSPAssessment 2007 100.0 Govemment KnowledgeGenerationEconomidPRSPMonitoring 2007 50.0 Govemment KnowledgeGenerationCPPR 2007 50.0 Govemment KnowledgeGenerationPublic ExpenditureReviewUpdate 2008 85.0 Govemment KnowledgeGenerationEconomic/PRSPMonitoring 2008 50.0 Govemment KnowledgeGenerationCPPR 2008 50.0 Government KnowledgeGenerationa. Govemment, donor, Bank, public dissemination.b. Knowledgegeneration, public debate, problem-solving. 31 CASAnnex B 5 Djibouti Social Indicators Latest siwle year Same regionlincome group M.East& North Lower-middle- 1970-75 1980-85 1997-03 Africa incomePOPULATIONTotal population, mid-year (millions) 0.2 0.4 0.7 311.6 2,655.2 Growth rate (% annual averageforperiod) 6.1 3.3 2.2 1.9 0.9Urbanpopulation (% ofpopulation) 61.6 71.1 83.6 58.0 49.7Total fertility rate (births per woman) 6.7 6.4 5.2 3.1 2.1POVERTY(% ofpopulation)Nationalheadcount index Urban headcount index RuralheadcountindexINCOMEGNIper capita (US$) 910 2,210 1,480Consumerprice index (1995=100) 54 117Foodprice index (1995=100)INCOME/CONSUMPTION DISTRIBUTIONGini indexLowest quintile (`?Aof income or consumption)Highest quintile (% of income or consumption)SOCIAL INDICATORSPublicexpenditure Health (% of GDP) 4.1 2.8 2.6 Education (%of GNJ 4.3 4.0 Social security and welfare (% of GDP)Net primary schoolenrollment rate(% of agegroup) Total 31 34 83 91 Male 37 38 86 92 Female 26 30 83 91Accessto an improvedwater source(% ofpopulation) Total 100 88 81 Urban 100 96 94 Rural 100 78 70Immunization rate (% of children ages 12-23 months) Measles 27 62 92 78 DPT 22 62 92 84Child malnutrition(% under 5years) 11Lifeexpectancy at birth bears) Total 42 46 44 69 69 Male 41 45 44 67 67 Female 44 48 44 70 71 Mortality Infant (per 1,000 live births) 160 137 100 44 32 Under 5 (per 1,000) 241 199 143 54 40 Adult (15-59) Male (per 1,000population) 586 527 590 193 214 Female(per 1,OOOpopulation) 470 428 541 143 135 Matemal (per 100,000live births) 730 Birthsattendedby skilled health staff (%) 73 CAS AMeX B5. This table was produced from the CMU LDB system 09-Feb-OS Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break inseries between 1997and 1998 due to change from ISCED76 to ISCED97. Immunization: refers to children ages 12-23 months who received vaccinations before one year o f age. 663 708 759 808 8 337 357 380 52 75 90 94 95 -21.1 -24.4 -33.1 -34.0 -32..8 4.3 6.7 -1.6 1.7 5.8 6.6 6.83 -2.9 3.4 34 CASAnnex B8 CASAnnex B8-Djibouti StatusofBankOperationsPortfolio As ofFebruary 8,2005ClosedProjects 11 Difference Between Active Proiects Last PSR Expectedand Actual SupervisionRating OriginalAmount inUS$ millions Disbursementspl Project 2:' ID Project Name DO IP IDA Grant Cancel Undisb. Orig. FrmRev'dPO89968 Flood EmergencyRehabilitation S S 2005 6.46 6.77 0.48 HIVIAIDS, Malaria & TBPO73603 Control S S 2003 12.00 9.57 -1.50PO71062 HealthSector Development S S 2002 15.00 13.81 3.46PO44584 Social Dev. andPublic Works S S 1999 19.80 6.83 1.07 2.06PO44585 SchoolAccess andImprovement S s 2001 10.00 0.20 -0.45Total 63.26 0.0 0.0 37.19 3.06 2.06 -* IDA Total Disbursed(Active) 49.74 of which hasbeenrepaid 0.00 Total Disbursed(Closed) 64.16 ofwhich hasbeenrepaid 5.22 Total Disbursed(Active +Closed) 113.90 of which has been repaid 5.22 Total Undisbursed(Active) 39.50 Total Undisbursed(Closed) 0.00 Total Undisbursed(Active + Closed) 39.50* Disbursementdata are updatedat the first week of the monthai IntendedDisbursementsto date minus actualdisbursementsto date as projectedat appraisal v1h l- 3.1 Djibouti's economy is slowly recovering from a deep recession and persistent macroinstability that characterized the late 1980s and most of the 1990s, a long period marred byshocks, mismanagement of public Rgurel: Djibouti:RealCDP Growth,1981-2004,inpercent idonor community. These shocksincluded a civil war involvinglargerecruitment into the regular army, 2 -whose size jumped from 4,000 to o., , ,16,000 in 1992 alone; large inflowof refugees from Somalia and -2other, neighboring countries in -4 -conflict estimated at 120,000 in -6-population at the time) increasing ' 881 1982883 sa 8%88s 887 888 889 890891 892 893 8%895 896 a97 8%899200020012002200320043.2 Since Djibouti gained independence in 1977, it maintained a large Government sectorfinanced by the rentsfrom theport,the rent for France's military baseand donors' assistance. Civilservants continued to be paid highreal wages, because the highnominalwages inherited from the Frenchadministration were protected frominflation by Djibouti's CurrencyBoard Arrangement (CBA). Therewas good economic growth period -140 ` I 7between 1978 and 1984 (with an average 4.2 percent growth per annum). This was boosted bylarge public investments financed by generous external grants. But it was not sustainable forlong and the economy subsequently entered into a long recession with less than one percentannual GDP growth inthe face o f an average population growth o f 2.8 percent per annum. Thefiscal situation deteriorated markedly during the civil war, and the ensuing large recruitment o fmilitarypersonnelwhich further increased the size o fthe wage billbysome 6 percent o f GDP toreach 24 percent o f GDP by 1993. As a result, the overall fiscal deficit increased to 8.1 percento f GDP in 1994. This increased number o f civil servants under highpublic wages i s the mostchallenging developmental problem that Djibouti has to solve before progress can materialize.3.3 Because of the currency Board limitations on financing the large deficits throughmonetary creation,fiscal deficits were ultimately `ffinanced" by the accumulation of domesticarrears on payments of wages, pension funds contribution, and to private sector and publicentities. This, inturn, ledto a loss of credibility o f the state and an escalation inthe use of ad hocprocedures, such as uncontrolled advanced payments, that often circumvented the normalaccounting and control system. Moreover, such procedures reduced transparency andaccountability, contributing to further overruns and distrust from Djibouti's developmentpartners with decrease ingrants andexternal financing.3.4 To address the destabilized and deteriorating economic situation, the Governmentstarted an adjustment program in 1996, supported, first, by an IMF Stand-By Arrangement(SBA) during 1996-1998. A temporary restoration o f fiscal balances was achievedthrough largecuts in public expenditures and a first wave of military demobilization. But this was notsustained as the budget position deteriorated again in 1999, and domestic arrears increased againto reach more than 27 percent o f GDP. Growth rate was also slow at 1.5 percent in spite o f thediversion o f all Ethiopiantransit trade from Eritrea ports to the port o fDjibouti.3.5 To enhance the stabilization effort, only partially successful under the SBA, theGovernment initiated a medium-term structural adjustmentprogram (1999-2002) supported byan IMF Poverty Reduction and Growth Facility (PRGF). The Government requested IDA'Ssupport to its adjustmentprogram. This was provided through the Fiscal Consolidation Credit in2001 with satisfactory results.3.6 The Fiscal Consolidation Credit focused on a core of interrelated fiscal consolidationactions to restore financial and budgetary discipline; contain and reduce the wage bill;improve expenditure management systems; and strengthen financial management of the keypublic enterprises, and initiate a process leading to the liberalization and privatization ofselected infrastructure sectors. Notwithstanding limitations o fthis fiscal consolidationprogram,inparticular the deliberate delay insequencing the core issue of highwage level andwage bill,tangible progress was achieved. This included:0 Halting the build-up o f domestic payment arrears, and beginning an orderly process for clearing them. An audit was carried out that enabled the Government to validate an overall stock o f domestic arrears payments o f DF29 billion or 27 percent o f GDP. A ten-year prioritized settlement plan was defined and adopted by the Government and i s being implemented on an accelerated basis for wages and on a timely basis for the rest. 8 On pension system reform, implementing a strong parametric Box 2: Djibouti's PensionSystemReform reform to improve the viability o f Under the FCC and with technical assistance from the World Bank, the the existing pay-as-you-go Govemmentundertook acomprehensivereform ofthe pensionsystem. The (PAYG) pension system bringing reform included a range of corrective measures covering the parametric, financial and institutional aspects of the pension system. The parametric it much closer to sustainability reform comprised (i)unifying and extending the vesting period to 25 (Box. 2). years to be eligible for a full retirement pension; (ii)extending the minimum age of retirement from 50 to 55 years; (iii)changing the On civil service, close to 800 civil calculationmode of kture pensionto using an average of salaries earned service employees eligible for over the last 10 years of work, compounded by a percentage of all contributions; (iv) changing the rules for cumulative pensions (civil retirement were removed from the servants, Parliamentarians,and cabinet Ministers); (v) introducingatax on payroll and Government pensions of 15 percent; and (vi) ensuring a minimal yearly pensionof DF contributions to the pension fbnds 170,000 to guarantee a social safety net to pensioners. Part of the outstandingstock ofGovernmentarrears to the pensionfunds were covered have been paid on a regular basis. by the FCC and since then, the Government resumed its regular In preparation for addressing the contributionandeffectivepaymentsto pensionfunds. The institutional part wage bill and better managing the of the reform included the merging into one single institution of the different pension funds, but due to design problems it didn't progress as civil service, the authorities expected. Completing the merger of the pension funds and expanding implemented an action plan to coverageare remindingchallengesfor the Government. merge the civil service and payroll databases on the basis o f a census o f employees, ministrybyministry. On the reform o f the public enterprises, management o f the Port and Airport was entrusted through a long-term management contract to an intemational investor (Dubai Port Intemational). Independent financial andorganizational audits were completed in2003 for all public companies. On the basis o f these financial and organizational audits, the Government has undertaken the restructuring of Djibouti. Telecom and a national strategy and actionplan for the regulation and liberalization o f the information and communication sectors were adopted bythe Parliament. There has also been progress inimplementing other institutional reforms to strengthen public finance institutions and reduce the scope for mismanagement. The recently completed Country Financial Accountability Assessment (CFAA) and Country Procurement Assessment Review (CPAR) highlighted the improvement in the legal framework and the achievement o f satisfactory level o f extemal control by the newly created Chamber o f Accounts. There has been improvement in the debt management system, supported by an Institutional Development Fund (IDF) grant. Achievements in institutional management o f public finances build on good progress under the IMF PRGF which included: (i) strengthening budget execution procedures; (ii)updating budgetary and treasury nomenclatures; (ii) reorganizing the Ministry o f Finance to provide an improved institutional framework for effective budget preparation and execution; (iv) reforming the legal framework governing public spending; and (v) rigorous implementation of a treasury cash management plan which enforced discipline and brought Government spending in line with available resources.3.7 Over the past 4 years there has been progress in stabilizing the budget, partly inresponse to thefiscal consolidation efforts and higher port activities, and partly owing to thewindfall from the regional security situation and the establishment of new foreign militarybases. Such progress in stabilization centers on a low equilibrium with an unacceptably highpoverty level. Movingto a new higher equilibrium with lower poverty rates hinges on sustainingthe ongoing macroeconomic reforms, as well as addressing the more challenging central 9structural problem o f the oversized wage bill and highwage levels. This would open the way tomore poor people sharing the public resources, rents, anddonors' grants and support. IV. DJIBOUTIPOVERTY REDUCTION STRATEGY (PRSP)A. VISION, OBJECTIVES AND STRATEGY4.1 The Country Vision. As stated inits recent PRSP, Djibouti's povertyreduction strategyaims to foster economic growth by improvingthe country's overall competitiveness andbuildinghuman capital to achieve a substantial reduction in income poverty and unemployment, andimprove living conditions for all citizens. The PRSP is structured around a long-term vision thatbuildsonthe country's strengths: its geographic location, and its port. The targetedreduction inpoverty i s predicated on enhancing the conditions for stronger, more equitable and sustainablegrowth.4.2 The Objectives. The PRSP objectives are as follows: (i) reduce the incidence of toextreme poverty from 42.2 percent in 2002 to 36.1 percent in2006, to 27.9 percent in2010, andto 19.2 percent in2015; (ii) to increasethe average real GDP growth to 4.6 percent in 2004-06,to 5.5 percent in 2006-10, and to 6.5 percent in 2010-15, while simultaneously reducing theinequalities in income distribution by an average 2 percent per annum during 2003-15; (iii) toincreasegross primary school enrollment from 42.7 percent in2001/02 to 73 percent in2005/06,and to achieve universal enrollment by 2015; (iv) to reduce the infant mortality rate from 103.1per thousand in2002, to 75 per thousand in2006, and to 50 per thousand in2015; (v) to reducethe infant-juvenile mortality rate from 124.5 per thousand in 2002, to 85 per thousand in 2006,andto 70 per thousand in2015; (vi) to reducethe matemal mortality rate from 690 per 100,000live births in 2002, to 570 in 2006, and to 400 in 2015; and (vii) to stabilize the rate ofprevalenceofHIV at approximately 3 percentby 2015.4.3 The Strategy. The PRSP rests on four main pillars. Thefirstpillar seeks to strengthenthe country's competitiveness and to create conditions conducive to a strong and sustainableeconomic growth through (i) the pursuit of fiscal prudence and overall macroeconomic stability;(ii) implementationofstructuralreformstoattractprivateinvestment,includingtherevision theof the legal andjudicial framework (aninvestment climate assessment i s plannedfor FY08); (iii)the promotion of Djibouti as a competitive economic and financial hub; and (iv) the reduction inthe costs of production factors through improved efficiency o f investments inthe infrastructuresectors (water, power, transport). The secondpillar aims to acceleratethe development o fhumanresources through the implementation of social programs aimed at reducing poverty and genderdisparities. Inparticular, the aim is to: (i)improve the coverage and quality o f health care andeducation; (ii) reduce unemployment through the development of labor-intensive activities,micro-finance provision, andjob training, (iii) set up social safety nets for the most vulnerablesegments o f the population; and (iv) implement the national gender strategy. The thirdpillarfocuses on regional and local development through investments in water and basic services inpoor neighborhoods located in rural and urban areas o f the country. Thefourth pillar seeks toimprove govemance and public sector management. The priority will be to strengthen thetransparency and accountability of public expenditure management to improve its distributionalandefficiency impact on the poor. 10B. MEDIUM-TERMMACROECONOMIC PROSPECTSUNDERTHE CAS PERIOD(2005-08)4.4 I n the base case medium-term scenario, Djibouti would witness a relatively improvedgrowth rate owing to the higher investment in the port and the pursuit of reforms aiming toimprove the efficiency of investments. A surge inprivate investment due to the construction o fthe new modem port in Doraleh and a higher public investment in support o f the Government'sPRSP are expected to boost growth during the period 2005-08 to an average rate o f 4 percent ayear, at a higher pace than in the past, but less than the 4.6 percent per annum on averageanticipated in the PRSP. Inflation i s expected to remain at its current average o f 2 percent aslong as the currency board is maintained.4.5 Fiscal consolidation would bepursued to offset pressures onpublicfinances stemmingfrom the PRSP implementation. The pursuit o f the budgetary consolidation effort (barring anexpected slippage during the first half o f 2005 which corresponds to the Presidential electoralperiod) should result in achieving a surplus inthe primarybudget close to 4 percent o f GDP onaverage per annum. Such a surplus i s also needed to ensure a continued implementation o f theGovernment plan for clearing domestic arrears. Fiscal consolidation will be achieved throughefforts on both expenditure and revenue sides. On the revenue side, additional extemaldisbursements o f military bases rental linked to new military agreements with the United Statesand France (representing about 3 percentage points o f GDP on average per annum), willmaterialize over the projected period, and tax revenues are projected to remain stable before thenew VAT i s introduced and implemented. On the expenditure side, total expenditures level willremain overall stable. A shift in the structure o f expenditures toward higher capital spendinglinked to PRSP implementationwill be partially balanced by lower current expenditures throughthe pursuit o f retirement programs and military demobilization and the rationalization o f othernon-wage current expenditures.4.6 Current account pressures would intensifjl financing needs, but the external debt-to- GDPratio will remain stable over theperiod 2005-2008. Total financing needs are expected toincrease from US$135 million in 2003 to US$164 million by 2006, and decline thereafter toreach US$ 129million by 2008. Higher current account deficits duringthe PRSP implementationperiod (2004-06) will be financed through additional extemal assistance, mostly in the form o fofficial grants. Additional new lending i s expected to be negotiated on concessional terms.Fiscal consolidation efforts and prudent borrowing should help maintain Government debt-to-GDP to sustainable levels (with external debt averaging 68 percent o f GDP duringthe projectedperiod). The base case scenario also envisages a steady inflow o f foreign direct investment, although the pace will critically depend upon maintaining the investors' confidence in the Government commitment to enhance competitiveness, rule o f law and economic and social stability. 11 Djibouti Selected Indicators Table - Table 2 (InpercentofGDP, unless otherwiseindicated)Base-case (most likely) projectionPart A Main Macro Aggregates GDP (millions of USS) 536.1 552.9 573.6 592.0 625.0 663.0 708.1 759.2 807.7 858.4 GDP (millions of DF) 95,272.7 38,266.6 101,932.3 105,210.2 111,070.4 117,834.2 125,852.8 134,924.0 143,540.3 152,560.3Real GrowthRates (%)GDP (mp) per capita -0.5 -1.5 -0.2 0.6 1.8 1.6 3.2 3.9 3.3 3.2Total consumptionper capita 10.9 -0.3 -2.5 -0.7 2.0 -0.2 10.1 -2.4 4.6 4.7GDP at market prices 2.2 0.7 1.9 2.6 3.5 3.2 4.2 4.9 4.3 4.2 Total consumption 13.8 1.9 -0.4 1.2 3.8 1.3 11.1 -1.5 5.6 5.7 Private consumption 11.0 -2.6 -9.9 6.3 3.5 3.0 13.1 -2.8 6.3 6.0Gross domestic investment (GDI) -13.0 40.0 -31.2 35.5 47.4 21.9 25.0 48.9 -1.8 -5.6Exports (GNFS) -0.7 -5.2 4.6 0.9 2.9 0.8 5.4 5.1 5.4 5.4 of which Goods 2.7 13.3 7.2 6.3 6.5 -1.6 1.7 5.8 6.6 6.8Imports (GNFS) -3.2 3.9 -6.8 3.6 11.9 3.0 21.4 8.4 4.3 3.2 o f which Goods 5.0 8.9 -3.7 7.9 0.0 3.1 22.6 7.9 1.5 -0.2Savings-investmentbalances,as %of GDPGross Domestic inveshnent 8.8 12.2 8.3 10.9 15.5 19.0 21.8 30.2 28.0 25.0 of which Government inveshnent 3.1 2.7 2.5 4.5 6.7 6.1 10.0 11.0 10.0 9.0 Gross domestic savings -5.7 -7.4 -5.2 -4.5 -5.6 -5.4 -11.3 -3.8 -4.6 -5.7 Gross national savings 8.4 5.1 2.7 4.2 8.0 10.2 5.4 11.8 11.3 13.1Other GDP inflation (% growth rate) 2.0 2.4 1.8 0.6 2.0 2.8 2.5 2.2 2.0 2.0 Annual average exchange rate (LCU/US$) 177.72 177.72 177.72 177.72 177.72 177.72 177.72 177.72 177.72 177.72 Money (% growth rate) 5.2 1.1 7.5 15.7 17.8 6.1 6.8 7.2 6.4 6.3Part B: Government FinanceIndicatorsPercentageof GDP (%) Total revenues & grants, of which 30.9 31.0 28.2 29.4 34.2 34.6 34.7 33.9 34.3 33.4 Tax revenues 21.6 21.5 20.5 21.1 22.7 21.9 21.4 21.3 21.3 20.9 Total expenditures, of which 33.1 32.8 29.6 32.9 36.4 35.7 38.1 38.1 36.4 35.3 Consumption 26.1 25.8 23.4 24.7 21.9 20.4 20.0 19.8 19.4 19.3 Overall Balance - commihnent basis, incl. grants -2.2 -1.8 -1.4 -3.5 -2.3 -1.1 -3.5 -4.2 -2.1 -1.9 Domestic Fiscal Balance, excl. grants -2.6 -1.6 -0.3 -0.2 0.8 0.8 3.5 3.7 6.4 6.4Part C:Debt & Liquidity IndicatorsTotal DOD and TDS DOD (US$ millions) 274.6 262.2 262.7 335.3 396 408 464 519 563 572 DOD / GDPmp ratio (%) 51.2 47.4 45.8 56.6 63.4 61.5 65.5 68.3 69.7 66.6 TDS (US millions) 10 14 11 12 16 24 28 30 32 35 TDS /exports (XGS) ratio (%) 4.0 5.5 4.0 4.4 4.6 6.6 7.0 7.4 7.4 7.3 Total gross reserves (months' imports GNFS) 2.6 2.3 2.5 2.5 2.2 2.2 2.2 2.2 2.2 2.1Part D: ExternalFinancingPlan(US$,millions) Private inveshnent (net) 4.2 3.3 2.2 5.0 21.4 51.7 75.4 90.1 94.8 96.5 Net Long term borrowingexcl IMF -5.5 27.4 7.9 29.9 19.9 25.1 52.4 51.3 42.0 9.7 Adjustments to scheduled debt service 7.9 0.0 16.3 -3.2 0.0 0.0 0.0 0.0 0.0 0.0 All other capital flows 11.0 -12.3 53.2 58.2 83.8 -11.7 0.0 0.0 0.0 0.0 Financing Requirements(incl IMF) 7.9 -21.3 31.4 53.0 135.6 84.4 149.2 164.1 159.5 129.9 of which current account deficit (including grants) 1.9 39.7 31.9 40.0 47.4 58.5 115.8 139.6 134.9 102.1 12 v. THELAST ACHIEVEMENTSANDLESSONS CAS5.1 The strategicfocus of the last CAS (2001-2004) was to support the Government effortto reducepoverty in two main ways:0 Interventions to enhance human capital development, giving priority to reversing one o f the worst rates o f school enrollment in the world, addressing the deteriorated health situation, in particular inthe critical area o f HIV/AIDS, and promoting a more direct support program to the poor through an active public works and community service program.0 Restoring growth by: (i)consolidating fiscal stability and improving economic competitiveness necessary to jumpstart growth; and (ii) rehabilitation o f infrastructure and services related to the port as the main source o f growth inDjibouti.A. OUTCOMES HUMAN IN RESOURCE DEVELOPMENT5.2 There was impressive progress made in human resource development, with verytangible accomplishments in education. Early results from the School Access andImprovement Program, still under implementation, show an impressive 12.5 percent increase inthe rate o f enrollment over the first three years of the project implementation. This first projecto f a three-phase Education APL focused essentially on filling the huge gap in the supply side:building and rehabilitation and management o f schools, providing textbooks and supplies,training teachers and developing curriculum. The effectiveness and satisfactory implementationof the project triggered interest from other donors and discussions are underway for a donor wideeducation-for-all initiative.5.3 I n the other sectors, the two health projects, HIV/AIDS Malaria and TB Control, andHealth Sector Development project have had a good implementation start. The SocialDevelopment and Public Works project helped extend economic and social infrastructure topoor communities, including road, drainage and water supply network improvement,rehabilitation of health and social services, marketplaces, andpreparation and implementation o fparticipatory community development plans. The project also helped promote small constructionand service contractors' capacitybuilding, which prepares local SMEs to take advantage of otherbusiness and work opportunities offered by militarybases and new developments. The expectedemployment creation impact was, however, more modest thanexpected.B. OUTCOMES IN THE AREAS OF FISCAL CONSOLIDATION, COMPETITIVENESS AND GROWTH RESUMPTION5.4 I n the second area of strategic focus of the CAS i.e., restoring economic growththrough improvement of the port-linked infrastructure and structural adjustment and fiscalconsolidation, macro stability was re-established and GDP per capita re-commenced itsgrowth, but the impact on poverty reduction was rather disappointing. The IDA-financedEmergency Road Corridor Rehabilitation project and a supplemental credit to this project, wereinstrumental to the timely removal of a binding constraint to port activities. The projectresponded to the reorientation o f Ethiopia's foreign trade route to the port o f Djibouti followingthe Ethiopian-Eritrea war in 1998. Total port traffic rose to 6.0 million tons in2003, comparedto solely 1.7 million in 1997. 135.5 I n the area of structural reforms, IDA-Jinanced Fiscal Consolidated Credit supportedthe most critical policy reforms over the past four years, in particular in the area o f pensionsystem reform, arrears management and clearing, and public enterprises reform (section 111).Djibouti's fiscal situation has been brought closer to stability, with improved-though still farfrom satisfactory-public finance management. Since 2002, Djibouti's GDP per capita growthhas reverted to a positive trajectory after a long period of decline. However, the impact onpoverty has been disappointing with the dramatic worsening o f poverty indicators between 1996and 2002 (section 11). With no indication that this tendency has been reversed during the CASperiod, the pressing need to confront upfront and actively the income distribution problem inDjibouti i s underscored.C. PORTFOLIOMANAGEMENT5.6 Portfolio management over the past CASperiod improved dramatically. The projectportfolio showed a dramatic turn around with all portfolio indicators turning from highlyunsatisfactory to satisfactory or highly satisfactory. Ratings for development objective andimplementation progress of all projects in the portfolio are currently satisfactory. Thedisbursementratio has progressively increasedto reach 28 percent inFY04, comparedto only 6percent in FYOO and to the target of 18 percent set in the CAS. Disbursementlags have beenreduced significantly, and project implementation time and efficiency have also improved. Inparticular, the Education project will be closing a year ahead o f schedule leading the way to anearlier than expected start of the second phase o f the Education APL. The implementation o fboth the International Corridor project and the Social Development and Public Works projectprogressedmuchbetter and much faster thenplanned; and the Boardapproved two supplementalcredits on June 5,2003 andJune 26,2003 respectively for these projects. Table3: PortfolioStatusand Performanceunderthe lastCAS Actual Performance ProjectedTargets (FYOl Indicators (Base Line) CAS) Actual Annual Performance FYOO FYOl FY02 FY03 FYOl FY02 FY03 FY04 DisbursementRatio PA) 6.0 10.0 15.0 18.0 15 21 42 28 DisbursementLag:Org. ('A) 48.0 51 39 19 -3 ProjectsAt Risk (%) 75.0 50.0 20.0 20.0 40 33 29 0 ProblemProjects(%) 50.0 20.0 10.0 10.0 40 0 14 0 ProactivityIndex 100.0 85.0 85.0 85.0 100 100 100 100 145.7 Factors that have contributed to the improvement in the quality and speed ofimplementation include: (i)focused, and simpler design o f the projects adapted to localimplementation capacity; (ii)a more intensive supervision o f the portfolio with a problem-solving approach, supported by closer involvement o f the Country Management Unit and anexcellent dialogue with the Government; and (iii) more proactive and professional External aFinancingCoordination Unitwithin the Ministry o fthat helped quickly address the problems asthey arose. VI. BANKGROUP ASSISTANCE STRATEGYA. CHOICEOFFOCUSOFTHENEW CAS6.1 During the consultation process, the Bank team and the authorities discussed twooptions as to how tofocus the CASprogram to bring about higher effectiveness given the largedemand for IDA support and the limitedavailable IDA allocation.6.2 Thefirst option was to target the CASprogram to one of thefour pillars of the PRSPthat the Government and IDA considered the most important (e.g. social development), to bringabout a critical difference inthis particular area.6.3 The second option was to cover more areas of the PRSP, at the cost of spreadingresources more thinly, using small but strategic interventions of mixed lending and ESW ineach of the important areas. The objective would be to bring Bank good practices andknowledge to bear in more than one area o f the PRSP, and to unlock higher mobilization ofdonor partner resources and assistancein these sectors. Several donors have experienced slowimplementation o f their programs due to difficulties in dialogue on critical sectoral policy andinstitutional reform areas. Some donors have expressed interest in IDA's involvement in theirarea o f involvement/support because of: (i) IDA's comparatively good quality sector work (oneducation, water and sewerage, energy, transport and the port, public enterprise reform, thepension system, CFAA and CPAR); (ii)IDA's relatively good dialogue on critical structuralissues advanced under the FCC process; and (iii)the good momentum and excellentcollaborative spirit andtrust prevailing between the Government andthe Bank.6.4 The second option is favored. It will allow the Bank to build on the previous CASprogram, which was essentially in line with the PRSP priorities, thereby allowing, to a certainlimit, for the needed critical mass to attain the developmental objectives o f the program andcreate the desired changes and improvements.B. ALIGNMENTTO THEPRSPPILLAROFIMPROVINGCOMPETITIVENESS, GROWTH INCOME AND DISTRIBUTION6.5 The envisaged CAS program in support of the PRSP pillar of growth andcompetitiveness involves several interconnected actions, building on the investment andstructural adjtlstmentprograms started under theprevious CAS. Specifically, it involves: (i)moving a step W h e r inaddressing fiscal consolidation, improving competitiveness, and incomedistribution--this would be carried out through a combination of further wage bill adjustments tocreate more fiscal room to expand priority public services and transfers to the poor, and throughthe restructuring of utility sectors (power and water) to reduce the costs o f doing business and 15improve access of the poor to these essential public services; (ii) sustaining development andimproved management o f the Ethiopia Djibouti transport infrastructure in support o f portactivities, the economic backbone for growth and employment; and (iii) vocational training toenable local work force take advantage o f spillover activities related to the expansion ofthe port.6.6 B.1 Assistance in support of wage bill reduction and expenditure restructuringreform: As highlighted above (Section 11),the relative size o fthe public wage bill inthe budgeti s too high, mostly driven by an average high wage o f about 9 times the GDP per capita. Thislimits severely the fiscal room to hire more teachers and health professionals and to providetransfers and assistance to the poorest to meet the PRSP and Millennium Development Goals.There are really no other options than to tradeoff high wages to higher recruitment. This i spossible through the combination o f restructuring (less o f administrative and security personneland more ofpublic service professionals) lower real wage levels through any politically feasiblecombination of direct nominal wage cuts, and adjustment o f the exchange rate. Inaddition to thedirect effects o f this reform, these actions could also reduce business costs, enhancing growththrough improving competitiveness, and provide fiscal space also for raising investment andmaintenance expenditures inthe physical infrastructure base, thereby reaching andbenefiting thepoor bothdirectly andindirectly.6.7 Planned IDA assistance. On the analytical and technical side, IDA assistance wouldconsist of economic and sector work and technical support covering the critical aspects o f thewage bill restructuring reform. This includes a C E M based on a series o f focused analyticalpolicy notes covering the different components o f the reform and assessing their economic andsocial impact, their phasing, and the alleviation o f their impact on the poor; and finalizing thePublic Expenditure Review with emphasis on restructuring expenditure in key sectors. On thelending side, IDA assistance would consist, under a high case scenario, of a second fiscalconsolidation credit, supporting the second phase o f reforms undertaken under the FCC,focusing on wage billand public expenditure restructuring.6.8 B2. Restructuringthe utilities sector as a means of enhancing competitivenessandimproving access to services to the poor: The utility sectors, mainly power and water, hawbeen identified inthe PRSP as key bottlenecks Box 3: Renewable water resources (2000) Ito improving the overall economiccompetitiveness. The issue i s the very highcost of utilities, which also constitutes anaccess barrier to the poor. Tariffs for Cubicelectricity and water services are the highest in meter'the MENA region, at an average o fUS$0.20/kWh for electricity, and US$l.l Om3 yearfor water (as compared to MENA average o fUS$0.07 for electricity and US$0.28 forwater). The reasons for the high prices areseveral, but notably: the higher cost o f MENA Egypt Moroc- PalestineJordan Yemen Djiboutielectricity production due to a reliance on mimported diesel fuel for power generation; large inefficiencies in the form o f network losses;highadministrativeoverhead costs due to overstaffing; inordinatelyhighwages (seeBox 4); andhighlevels oftaxation (33 percent taxes on all petroleum products and about 20 percent more of 16surtaxes6). IDA has played a leading role in assisting the Government inassessingthe financialperformance o f the power andwater companiesthrough the FCC. The two sector strategy noteson power and water and PRSP work have identified an action plan for both sectors focusing onthe following key objectives: (i) improving the efficiency and financial performance o f theutilities through restructuring and promotion of private sector participation; (ii) addressing keyservice-delivery constraints through rehabilitation of networks and protection o f resources; and(iii) exploring new resources for water supply (e.g., desalination) and power generation (e.g.,renewable energy and interconnectionpossibilities). Box 4: CompetitivenessIndicatorsInDjibouti High wages and high wagebilL An IMF survey was conductedto comparewage and price levels inDjibouti, Addis Ababa (Ethiopia) and Sana'a (Yemen). The survey revealed that Djibouti's wages are much higher than those of neighboringcountries. At 1999exchange rates, wages inDjibouti were 3 to 6 % times the level of those in Ethiopia andYemen. The differentialswere generally higherfor skilled and semi-skilledemployees (public servants, and hotel andrestaurantstaff) than for unskilledworkers (manual laborers anddomestic servants). The apparent insensitivity of wage rates to the high level of unemploymentmay reflect the benchmark establishedby the dominant public sector, which accounts for approximatelyhalf of the total reportedwage earner population(or almost three-quarters when public enterprises are included in the public sector). In 1998, the average wage rate in Djibouti's civil service was indeedabout45 percentabove the averagewage rateof workers inthe privatesector andpublic enterprises.Estimated average salaries for public sector employeeswere more than five times the level inEthiopia and about four times the level of comparableemployees inYemen. High utilitiesprices. Djibouti faces high productioncosts associatedwith utility prices. Inparticular, the price of the kW/hour for industries was about 26 cents in 2000, and the cost of telephone calls abroad ranged from more than US$1 per minute to neighboring countries to almost US$3 per minute to Europe, and US$ 4 to the United States. Utilities are expensive primarily because of high wages, a large tax burden, and poor managementpractices. When looking at public enterprise accounts, it appears thatwages and salaries ofpublic enterprisesrangefrom 31percentof value added for Djibouti-Telecom, to 77 percent for the airport. The wage bill of the electricity company was 51 percent in 2000. Poor collectionrates and fraud are other problems faced by some public enterprises, including the electricity andwater company. High serviceprices. Higherpricesof transport contributeto the fact that roadtraffic betweenDjibouti and Ethiopia is mostly handledby Ethiopiancompanies, which pay lower wages to their drivers than those paid to Djibouti drivers. Other prices of services (recreational, tailoring, shoe repairing, apartmentrents) are muchmore expensive inDjibouti. As a result, the ratio of non-tradable prices to tradable prices is higher in Djibouti than in its two neighboring countries. High Real exchange rate (REER). Following the depreciationof the US dollar in effective terms, Djibouti's real effective exchange rate depreciatedbetween2002 and 2004 by about 30 percent. Despitethis depreciationthe REER remained overvaluedcomparedto the early 1990s (over 20 percent). Such an overvaluedexchange rate continuesto undermine the country's overallcompetitiveness.6.9 Planned IDA assistance would consist of a dual power and water project. The IDAcontributiontowards this project is expectedto be about US$7 million. Inaddition, a GEF granttowards renewable and energy efficiency improvement i s being pursued and would be in therange ofUS$2.5 to US$3.5 million. The power sector-related components would include a smallinvestment inthe distribution network inDjibouti-Ville to rehabilitate and extend the network toun-served residential consumers, as well as to the commercial district; and the construction o f asmall wind farm to serve an interior town. The water sector component will focus on initiatingprotective measures of the aquifer that serves 70 percent o f Djibouti's population. However,although the Bank's contribution to the critical needs o f the water sector are limiteddue to theconstraints of the IDA envelope, the Bank will work closely with the EU who is preparing alargewater sector investment project (US$20 million) andhas requestedthat its project be linked The abnormally highlevelo ftaxes and surtaxes were inheritedfromthe stabilization period. Theyneedto berevised within a potential new fiscal consolidation follow up operation. 17to the Bank's activities in terms of overall development objectives (see below under theinstitutionalcomponent). Another component will focus on the institutionalrestructuring of thepower and water utilities and the associated regulatory frameworks. IDA involvement in thesectors' institutionalrestructuring builds on the work undertakenunder the FCC. Inaddition, theEU, the largest donor inthe water sector, has requested Bank leadership insectoral reform, andi s conditioning the releaseo f its investment fbnds on the implementation o freforms inthe sector. Box 5: Utilities' Unit Performance Compared to MNA's Good Practice The price for electricity and water inDjibouti i s muchhigher than inother countriesinthe region, and also when comparedto goodgeneralindustrypracticemore generally. Average electricity tariffs inthe region range from US#9ikWh to industry and US#6kWh to households in Yemen; US#6kWh to industry and households in Jordan and USf6.9kWh to industry and US#9.5kWh to households in Morocco. In Djibouti, the average selling price is US#20kWh, but commercial customers including small enterprises pay as much as US#32/kWhand the Office National des Eaux de Djibouti (ONED) pays US.4lkWh. The same applies to the water sector, where the lowest tariff to households reaches US#35/m3, comparedto US#25/m3inYemen; US#22/m3inJordan, and US#20/m3inMorocco. Good practice in electricity is an average tariff of between US#10-15kWh. It is more difficult to have a benchmarkfor water since it variesgreatlywith the source andamount ofwater resources. The sectors also suffer from overstaffing, which i s of serious concem, given the high cost of labor in Djibouti. Measuredinrelationshipto number of connections, the Djibouti Electricity Authority (EDD) has 31 connectionsper employees whereas good practiceis 70-100. Measuredslightly differently for the water sector, ONED has 21 employees per active 1,000 connections, while good practice is in the rangeof4 to 6.6.10 B3. Developmentandrehabilitationofthe transport infrastructureinsupport ofthePort of Djiboutias the engine of economic growth and employment: Djibouti has put thedevelopment o f the port and the transport sectors at the heart of its poverty reduction strategy.The potential of the port as an engine o f growth looks clearer today than inthe mid-1990s whenthe port was losingmost o f its transshipmenttraffic to other competing ports inthe region. Thesituation i s much improved today because o f the sharp increase in port traffic following theEthiopian-Eritrea war in 1998, combined with the rehabilitation o f the road link to Ethiopia,which was supported by IDA'S emergency Road Corridor Rehabilitation Project and asupplemental credit, as well as the Government's decision to transfer the port management to aprivate operator. This stimulated considerably port activity (traffic increased by 165 percentbetween 1997 and 2002), andmore than compensatedfor the drop intransshipment.6.11 The first challenge for Djibouti is to preserve the Ethiopian transit traffic by improvingthe attractiveness and competitiveness of the port, as well as its transportation logistical linkswith its hinterland. The second challenge i s to maximize the port's significant growth andemployment potential by regaining and expanding its share in transshipment and diversifyingrelatedbusiness, including a potential free trade zone (FTZ).6.12 Improvement in both physical infrastructure and the institutional setting are needed forthe port of Djibouti to play its role as the gateway to and from its hinterland, especially vis-a-visEthiopia. Regarding the port, a new oil terminal is being built at the Dorale site with privatefinancing to alleviate the operational constraints posedby the old oil facilities inthe current portsite.6.13 A long-term plan to develop the Djibouti-Addis Ababa Corridor started with the IDA-supported rehabilitation o f the Djibouti-Galafi road, encompassing also the development o f therail link between Djibouti and Addis. The European Union is also financing a hture improved 18road linkbetween Djibouti and Addis Ababa, inaddition to its financing of emergency repairs tothe rail linkto bringit up to an acceptablelevel for efficient and safe operations.6.14 Onthe institutional side, Djibouti's decision to have a partnership with the private sectorinport and airport managementhas been successfulthus far, andlays the ground for more suchpartnerships. Preparation is underway for a concessionscheme for the rail linkbetweenDjiboutiand Addis Ababa through the privatization of "Chemin de Fer Djibouto-Ethiopien ", a joint-national company operating the 800-kilometer rail link between Djibouti and Addis.Governments inboth countries now sponsor this scheme. Box 6: Developmentof the Port of DjiboutiDjiboutihas put the development of the port and the transport sector at the heart of its povertyreductionstrategy. The potentialof the port as an engine of growth looks clearer today than inthe mid 1990swhen the port was losing most of its transshipmenttraffic to other competing ports in the region. The sharp increase in port traffic following the Ethiopian-Eritreawar in 1998,combined with the rehabilitation of the road link to Ethiopia, which was supported by IDA's emergency Road CorridorRehabilitation Project and a supplemental credit, as well as the Government's decision to transfer the port management to aprivate operator stimulated considerably port activity. Total port traffic rose to 5.97 million tons in 2003, compared to 4.55million tons in 2002 and solely 1.7 million in 1997, which more than compensatedfor the drop intransshipment. The challengefor Djibouti is to first preserve Ethiopiantransit trafic by improving the attractivenessandthe competitivenessofthe port and itslogisticslinkswith its hinterland,andthen to seek to diversify the port's business.Strengtheningthe competitivenessof theport of Djibouti and logistics links with its hinterland. Improvementofbothphysicalinfrastructureand institutional settings is neededfor the port of Djibouti to play its role as the gate to and from its hinterland, andmainly Ethiopia. On the port side, anew oil terminalis beingbuilt at Dorale site with private financing to alleviatethe currentoperationalconstraintsposed by the old oil facilities in the current port site. A long-term plan to develop the Djibouti-AddisCorridor started with the IDA's supported rehabilitationof the Djibouti-Galafi roadand it also encompasses development of therail linkbetweenDjibouti and Addis. The EuropeanUnion is financing a future improvedroadlinkbetweenDjibouti andAddisAbaba along the same route as the existing rail link via Ali-Sabieh in Djibouti and Dire-Dawa in Ethiopia. The EU is alsofinancing emergency repairs to the rail link to bring it up to an acceptable level for efficient and safe operations. On theinstitutionalside, Djibouti's decisionto have apartnershipwith theprivatesector inport managementwas so far successfuland itlays the ground for more such partnerships. Preparation is underway of a concessionscheme for the rail link between Djiboutiand Addis through the privatization of "Chemin de Fer Djibouto-Ethiopien (CFDE)", a joint-national company operating the800-kilometer rail link between Djibouti and Addis. This scheme is now sponsored by Governments in both countries. Anational road strategy aimed at improving the institutional arrangements of the road sector including road management andfinancing of roadmaintenanceis beingcarriedout under the emergencyroadcorridor rehabilitationproject. This CAS proposessupport in this area through a Partial Risk Guarantee in support of the concession to the privatization of the CFDE, and atransport strategy study.Diversifying the port's business and related activities. The Government and the private operator of the port have set as astrategic goal to increase Djibouti's share inthe very competitive regional transshipment traffic. The constructionwith privateparticipationof anew deepwater container terminal at Dorale site along with an industrial and commercialfree zone is on theiragenda. While the activities of this proposedport are rather capital than labor intensive, a successful free zone should be asignificantsource of employment. Ifthis ambitiousprojectdid materialize, for it to benefitthe economic and socialdevelopmentof the country, special attentionshouldbe focused to train aqualified labor force on one hand, and to reducethe extremelyhighcost of labor inDjibouti onthe other hand. This CAS supports address the first areathroughthe proposedPartial Risk Guarantee.6.15 Planned IDA assistancewould consist of an IDA partial risk guarantee, which could bematched by the same amount from Ethiopia with which coordination is under way, to theconcession being considered to mitigate the risks associated with such a complex bi-nationalproject. IDA is also carrying out a Transport Sector Review aimed at improving the institutionalarrangements of the road sector, including road management and financing of road maintenance.IDA will support the Government in adopting and implementing the recommendations o f thisReview. 19c. ALIGNMENTTO THE PRSP PILLAR OF HUMAN RESOURCE DEVELOPMENT POVERTY AND ALLEVIATION6.16 The focus of the previous CAS on human development was also aligned with whatsubsequently became the second pillar of the PRSP. This CAS continues IDA support in thesame area covered in the previous CAS with additional lending except in health, where twooperations (Health Sector Development; and HIV/AIDS) have just started and theirimplementation should cover the requiredIDA support inthis sector over the next four years.6.17 C1. Continuing support for an acceleratedschool access and improvement agenda:The first phase of Djibouti's School Access and Improvement Adaptable Program Lending(APL),the first IDA project in education, is beingcompleted one year ahead of schedule withsignificant and encouraging results inseveral areas: (i) increasedenrollment with a primarygrossenrollment ratio (GER) of 52 percent comparedto 39.5 percent at the start o fthe project in2000;(ii)decreased grade repeater rates from 10 percent to 7 percent; (iii) increased availability o ftextbook at a ratio of 1:l; (iv) increased teacher training; (v) revised curriculum; and (vi)achievement o f all the triggers agreeduponto move the secondPhaseo fthe APL.6.18 Planned IDA assistance would consist of a second accelerated school access andimprovement project for the secondphase of the education APL. The objectives o f this projectare to expand coverage of quality basic education through targetedactivities which contribute toincreased access and retention rates of the system, and to further reduce repetition and drop-outrates. The specific objective o f this phase is to increase the enrollment to 70 percent by 2008,with special emphasis on girls education, in line with the PRSP targets. IDA will work closelywith other donors to mobilize additional financial resources for reaching this target. AnEducation Sector Strategy Assessment will beprepared inFY07.6.19 C2. Continuingsupport for employment generationand direct support to the poor:With respect to employment generation and social development, the last CAS programconsistedof the consolidation and expansion o f a Social Development and Public Works Program. Theprogram contributed to poverty reduction through: (i) construction and rehabilitation o f socialand economic infrastructure in the poorest neighborhoods with a direct impact on the livingconditions o f the poor (such as street works, drainage, water and sanitation systems, localmarkets, schools, and health care facilities), while at the same time, offering employmentopportunities; (ii)supporting community developmentthrough social mobilization programs andinvestment grants for the creation o f community facilities; and (iii)institutional capacity buildingby developing the capability of small local private contractors to enable them to benefit fromopportunities offered by the port development, the military bases and other activities; and alsoimproving the institutional capacity o f the Government, communities and NGOs to design andimplementpoverty reduction interventions.6.20 One of the main factors characterizing the unemployment situation inDjibouti i s the lackof basic skilled labor and the lack o f training to address this problem. Addressing thisimpediment to employment would enable labor force to better take advantage of existing andpotential service activities developments, in particular that of construction and other servicesrelated to the military bases, and transport related to the port, as well as to the potential demandfrom its ongoing expansion andpossible free zone development. 206.21 Planned IDA assistance would consist of a credit focused on employment creation withtwo components: (i) rehabilitation o f basic services (inparticular water and sewerage system) inone o f the poorest districts (the Cartier Dariba); and (ii) financing of a small focused VocationalTraining project to enable unemployedyoungpeople to take advantage o f expected employmentopportunities linked to the development o f the port. IDA support will continue in the area o fpension system reform (under the Planned second Fiscal Consolidation Credit) and anemployment strategy note (CEM).6.22 C3. Providing support to poor victims of the flood: The PRSP highlights thevulnerability o f Djibouti to various natural disaster dangers and emphasizes need for developingprevention and management capacity. An Emergency Floods Rehabilitation project for $6.4million was approved in September 2004 to assist the Government o f Djibouti inhelpingpeoplehurtbythe floods that devastatedthe regioninApril 2004, that impactedabout 15percent ofthepopulation, or about 100,000 people. Most of the affected population lives inthe poorest areas.Support will be given to rehabilitate social and economic infrastructure (e.g., housing, schools,medical centers) that was damaged. The project also includes technical assistance to supportshort andlong-termdisaster preventionmanagementplans.6.23 C4. Providing support in other key problematic social areas: As identified above(paras. 1.10-1-14), women in Djibouti bear additional disadvantages and burden that the PRSPrecognize as keyhurdles inthe way o f upliftingthe well beingo f the whole society. The PRSP,however, does not deal adequately with the Qat issue, because there i s less internal consensusabout the problem. IDA assistance under the CAS program will, nevertheless, address bothissues.6.24 Planned IDA assistance tofurthering the gender agenda: The UNDP and UNFPA areprovidingassistanceto the Ministry of Gender, mainly incapacity building. The IDA-financedSocial Development and Public Works project provided credit to micro-enterprises, many o fwhich are run by women. The Planned new Social Development and Public Works I1creditwould follow step. The first School Access and Improvement project under the previous CAShas met its explicit targets for reducing the gender gap in schooling. The second School Accessproject, under this CAS will further aid in this effort with still greater emphasis on girlsschooling. The Health project, currently under implementation, also aims at reducingthe highrates of infant and matemal mortality. A coordinated effort will be made with donors to supportNGOs in the on-going public awareness and education campaign for the elimination of FGMpractice.6.25 Planned I D A assistance to address the Qatproblem: IDA efforts will aim at buildingconsensus in the country on the importance o f this issue in terms o f its serious social andeconomic consequences. An assessment of the social and economic implications of Qat importand consumption at the household and macro levels will be made within the framework o f theprogrammed work on poverty assessment. IDA will raise the issue more prominently in itspolicy dialogue with the authorities. IDA willjoin other donors inthe effort o fraising awarenessabout the harmful effects of Qat consumption and provide support to national initiatives toaddress this problem. 21D. ALIGNMENTTO THEPRSPPILLAROFPROMOTINGGOODGOVERNANCE6.26 The PRSP emphasizes governance improvement as one o f the main pillars ofdevelopment and poverty reduction. Inthis agenda, governance improvement is defined broadlyas furthering the promotion of good political, local, economic and financial governance,strengthening the capacity for planning and administrative management and modernizing it.Priority in this agenda is given to ensuring transparent and efficient management o f publicexpenditure, and to improving equity and effectiveness inorder to transform governance into "atrue instrument for combating poverty."6.27 Two key IDAfiduciary activities, a CFAA and a CPAR, have beenfinalized in addition toa Public Expenditure Review. These constitute a strong basis for identifylng improvement areasand a concrete program of actions that the authorities are willing to undertake to move forwardon their governance agenda6.28 Inthe area of public financial management, the CFAA noted a relatively good quality ofthe legal framework, a satisfactory level of the external control carried on by the newly createdChamber o f Accounts, and a relative improvement inthe system o fpayments and accounting. Onthe other hand, it pointed to major weaknesses undermining the management and transparency o fpublic spending. The three areas o f weaknesses identified and examined by the CFAA concernbudget formulation, execution, andinternal control.6.29 The CPAR collaborative exercise also pointed to several weaknesses in publicprocurement which diminish the absorptive capacity, and deprive the country from fullybenefiting from available donor financing. Absorptive capacity remains hampered by severalprocurement weaknesses at different levels, including an incomplete and complex procurementcode; an unclear legislative and regulatory framework; lengthy and inefficient procurementprocedures; loss o f private sector confidence due to large Government arrears leading toexaggerated risk premiums; and weaknesses inthe customs' institutions at both the institutionalandhumanresource levels.6.30 Theplanned IDA assistance would consist o f support inimplementing the detailed andphased program of actions in the areas of financial management and public procurement, whichhave been identified and discussed collaboratively with the authorities, the private sector, and thedonor community during a workshop organized by the Government. IDA would support thisPRSP Governance improvement pillar with two IDFs(to implement the CPAR and CFAA policyrecommendations), which would also be complemented by technical assistance from otherdonors. 22 Table 4: PlannedWorldBankGroupProgramFY 05-08 (Base Case: US$30 mil.) Operations (US$ m) Operations (US%m) Operations (US$ m) Operati (US%m) ons EmergencyFloods 6.4' School 10 Djibouti-Ethiopia 3 Social 5 Rehabilitation Access and Rail RoadPartial Dev./ Improvement RiskGuarantee Public (Phase 11) Works I1 I I I I I I I I~~~ Power and Water 7 Project Total 13.4 10 3 5 rmframework for Impact Analysis ImprovedEconomic * This policy note is part ofthe CEM. E. LENDING SCENARIOS AND TRIGGERS 6.31 The base-case lending program of about US$31 million will fully utilize Djibouti's IDA indicative allocation for the next four years*. The base case is predicated on continued satisfactory macroeconomic management and good portfolio performance. The CAS does not envisage a low case scenariobecause of: i)negligibleprobability o f base case triggers not being met; (ii) small size of IDA allocation in the base case; and (iii) remaining lending the the program beyond FY05 i s essentially in education and poverty alleviation. The alternative lendingcase scenariois thus limitedto ahighcase scenario. 6.32 The highcase lendingscenariowould providefor US$9 millionabove the base case It would consist of a poverty reduction credit in support of scaling up the fiscal consolidation agenda started during the last CAS with a Fiscal Consolidation Credit (FCC). The second FCC will focus on public expenditure restructuring with emphasis on the wage bill (structure of civil service and wage level adjustment) with the objectives, as highlighted above of: (i) creating needed fiscal room for higher public service spending, (ii) improving income distribution and direct transfers to the poor; and (iii) enhancing overall competitiveness o f the economy. The triggers for the highcase scenario would consist of: satisfactory IDA portfolio performance with no more than two problem projects in the portfolio; satisfactory progress in implementationof 'Outof theprojectcostofUSS6.4 million, $3.2 million is inthe formof agrant, and anequal amount is inthe form of an IDA credit. This envelope will be finalized subsequently along IDA14 rules andIDA14 funds availability. 23the economic governance and transparency agenda; and Government's readiness to undertake acredible and sustainable reform program o f wage bill restructuring and enhancingcompetitiveness. Table 5: LendingScenarios and Triggers e bill reduction andF. IDALENDING TERMSAND DJIBOUTI'S INFLATED GNIPER CAPITA6.33 Djibouti GNIper capita of US$920 has became higher than the operational cutoff foreligibilityfor 40-year IDAfunding of US$S95over thepast threeyears. This highlevel o f GNIper capita indollar terms i s to a large extent artificially inflated by the overvalued exchange rate.It does not reflect the extent o f prevailing poverty in Djibouti as highlighted above. Unless theGovernment addresses the underlining factors of its inflated GNI per capita, it will depriveDjibouti from the needed IDA softer terms. This is inaddition to the beneficial implication thatsuch policy reform could have in correcting the income distribution bias against the poor asdiscussed insection 11.G. COORDINATIONWITHDEVELOPMENT PARTNERS6.34 Quite in contrast with the improvement in IDA portfolio performance and dialoguewith the Government, many partners expressfrustration about dijjficult policy dialogue andslow project implementation. Several large and critical projects have been inthe pipeline for along time without materializing. Portfolio performance is also un-even across partners. Thisunderscores the need to assess donors' collective experience with Djibouti and share lessons o fwhat has worked well and what did not as the donors community prepares to pledge its futureassistance to Djibouti's PRSP during the Consultative Group (CG) meetings to be organized thissummer.6.35 The PRSP preparation and consultation process, in which donors were associated,offered a good opportunity for a shared understanding of the Government strategy andpriorities. Through its PRSP, Djibouti has its first comprehensive and consistent vision andstrategy o f development and poverty reduction since independence. The PRSP processes leddonors to start refocusing their assistance on a more informed basis along the Governmentpriorities. The process has also forced the start o f a more active coordination among the donorcommunity which should intensify at the Consultative Group meeting that would be chaired bythe World Bank. IDA would work with donor agencies to ensure that: (i) or institutional policy 24advise i s mutually consistent; (ii) investmentprograms addressing the priorities of the PRSP areconsistent and do not overlap; (iii) share sectoral and economic analysis and information; donorsand (iv) IDA and donors operational procedures (e.g., for procurement, accounting, and audit)are as standardized as possible to ease project implementation.6.36 This CAS,prepared in close collaboration with the donor community, is designed tocomplement and support other donors' effort. (see section VI-A). It specifically arranged someo f the lending and non-lending operations to address problems that constrain other donorssupport (as i s the case with the water and power project for example) and use any comparativeadvantage IDA might have to help inthis regard. As shown in the CAS results matrix (AnnexB9) there are already many synergies between IDA assistance and other donors' proposedinterventions. These will be further clarified as donors' consultation on defining respectiveassistanceto the PRSP investmentprogramprogress.6.37 More specifically, the World Bank will continue its strong collaboration with the IMFand will ensure that a consistent message is conveyed on the macroeconomic, public financemanagement and other structural reforms. The planned second Fiscal Consolidation Credit(FCC) would reinforce and complement the IMF's potential PRGF program as it was the casewith the first FCC. On other areas, such as in the water, power, and transport sectors, IDA'Sassistanceboth inlendingand inanalytical (AAA) work i s beingprepared inclose collaborationwith the EU and complements its investment and assistance in sector reforms as well as theAfDB's intervention in the energy sector. The Bank is also supporting in-country aidcoordination led by other donors through sector-level technical assistance (e.g., Djiboutieducation local donor group ledby France). There i s also close collaboration with the UN, theCuisse Fruncaise de Developpement andother donors inimproving Govemance. VII. MANAGINGRISKSTHE7.1 The realization of Djibouti's poverv reduction strategy, and the effectiveness of thisCAS which is aligned to it, are subject to several external and internal risks. The PRSPrecognizedupfront most ofthese risks.7.2 Djibouti's exposure to external risk is high because its economy depends mainly on theport and its development; the rental of militaly bases; and grants and soft financing fromdonors-all of which are subject to high geo-political uncertainties. Regarding the port, thesurge in growth since the mid-1990s o f port activities with Ethiopia was attributable to theEthiopifiritrea war, and subsequent reliance o f Ethiopia on the Djibouti port for most of itsimports and exports. To limit the risk o f the reversibility o f the increase in its share in Ethiopiatrade traffic, Djibouti needs to improve the overall competitiveness o f the port by reducing costs,and improving infrastructure links (road and railways) to Ethiopia. Inthis respect, the on-goingeffort to expand transport infrastructure with direct financial participation o f the Ethiopian sideraises the stakes of the latter in maintaining continuous business and limits this risk. As for theprospective development and expansion o f port as a transshipment hub, it i s still awaiting theconclusion of a deal with a foreign private investor. The rental of the newest militarybases (theU S and Germany bases) which constitutes an important additional source o f revenue to theGovernment and influences the development o f many service activities, i s also subject tounpredictability, even though more inthe longer term thaninthe near term, giventhe continuingregional instabilityinthe MiddleEast. 257.3 The financing of the PRSP investment program hinges on important contributionsfrom donors in theform of grants, which, if notforthcoming in the amounts envisaged, couldjeopardize fiscal sustainability and/or the PRSP investmentprogram. This risk and its effectswill be hopefully adequately addressed by Djibouti's partners during the planned ConsultativeGroup Meeting in support o f the PRSP. Djibouti would mitigate this risk significantly byaddressing its structural adjustment reform to boost confidence o f its partners inthe effectivenesso f their support and foreign investors on the competitiveness and long term economic, social andpolitical stability of the country.7.4 CAS implementation is also subject to two major internal risks. First, there is the riskthat the Government may move too slowly or not at all with respect to the next phase offiscalconsolidation and restructuring. Failing to take these decisions and implementing such reformswould shed more uncertainty on the attainment o f the PRSP objectives in terms o f basic servicedelivery and better income and rent distribution. It would also delay the necessary adjustmentsneeded to improve competitiveness and thus deter potential FDI, and diminish donor support.The envisaged high-case scenario lending (FCC 11) would provide, along with expected larger support from Djibouti's other partners, both technical and financial assistance to help wither down the social costs o fthis reform, and enhance its social andpolitical feasibility. 7.5 The other source of internal risk is related to the capacity to implement and monitorDjibouti's poverty reduction strategy, which implies a large increase in thepublic investmentprogram in a situation of relatively low skill levels and limited administrative and management capacity. The risk i s not significant with regard to the implementation o f the CAS program (section V). However, the institutional capacity constraints can potentially limit the Government's ability to utilize fully and effectively increased support from other donors. IDA will keep this broader issue under review. 26 Djibouti at a glance CAS Annex A2 M. East Lower.P O M R Nand SOCIAL 8 North mlddie- Dllbouti Africa income Developmentdiamond.2003Population,mid-year (millionsj 0.71 312 2,655 Life expectancyGNi per capita (Atlasmethod, US$J 910 2,210 1.480GNI (Atiasmethod, US$ billions) 0.64 689 3,934 TAveraQeannual growth, 1997-03Population(%) 2.2 1 9 0 9Labor force (%) 2 9 1.2 GNi Gross per p r "Most recent estimate (latest yaar available, 1997-031 capita enrollmentPoverty(% ofpopulation belownationalpoverty iineiUrbanpopulation (% of totaipopulatlon~ 84 56 50Life expectancyat birth (years) 44 69 69Infant mortality (per 1,000 live births) 100 44 32Child malnutrltion (% of childrenunder 5J 11 Accessto improvedwater sourceAccess to an improvedwater source (% ofpopulation) 100 88 61illiteracy(% ofpopulation age 15+1 31 10Gross pnmaryenrollment (% of school-agepopulationJ 40 96 112 -Djibouti Male 46 100 113 -Lower-middle-incomearoup Female 35 92 111 1KEY ECONOMICRATIOSand LONG-TERMTRENDS 1983 1993 2002 2003 Economic ratios*GDP (US%billionsi 0.47 0 59 0.62Gross domestic investmenWGDPExports ofgoods and seMcesIGDP TradeGross domestic sawngslGDP -Gross nationaisavingslGDPCurrentaccount balanceiGDPInterestpaymentslGDP 0.4 0 4 0.5Total debffGDP 56.1 56 6 63.4Total debt servicdewortsPresentvalue of debffGDP 37 2Presentvalue of debtiexports I Indebtedness 1983-93 1993-03 2002 2003 200347(average annualgrowth)GDP -0.9 0.2 2.6 3 6 -DjiboutiGDP per capita -6.5 -2.4 0.6 1 8 __ Lower-middle-incomegroup&ports of goods and servicesSTRUCTUREof the ECONOMY 1983 1993 2002 2003 ~Growth of investment and GDP (%)(%of GDPJ IAgriculture 3 1 Industry 20 5 Manufacturing 5 3 "SeMces 76 4 :: / O 98 F $9 00 01 02 d3 Privateconsumption Generalgovernment COnSUmPtiOn II Importsof goodsand SemCeS -GDI -GDP 1983-93 199343 2002 2003 (average annualgrowth) Agriculture 2.2 Industry .... -5.7 Manufactunng -9.9 Services .... 0.3 Privateconsumption Generalgovernmentconsumption Grossdomestic investment imports of goodsand services Note:2003 data are preliminaryestimates This tablewas producedfrom the Development Economicscentraldatabase. *The diamondsshow four keyindicatorsinthe country (in bold) comparedwith its income-groupaverage. If data are missing. the diamond will be incomplete. 27 DjiboutiPRICESand GOVERNMENT FINANCE 1983 1993 2002 2003Domestic prices I inflation("A) 1(% change) IConsumer pricesImplicit GDP deflator 4.4 0.6 2.0Government finance(% OFGDP, includes currentgranfsj ICurrent revenue 37.2 31.6 31.O 98 99 00 01 02 03Current budget balance -4.6 3.3 3.7 -GDP deflator +CPIOverall surplus/deficit -13.0 -0.7 -0.5TRADE 1983 1993 2002 2003(US$ milhonsJ Exporland import levels (US$ mill.)Total exports (fob) 71 86 94 400- Foodand live animals 7 8 Coffeeand derivatives 7 7 Manufactures 55 60Total imports (cif) 295 303 Food 85 87 Fuel and energy 13 13 Capital goods 103 106 IExport price index (1995=100j 97 98 99 00 01 02 IImport price index f1995=100j I O3 BEqpolts BlmpoltsTerms of trade (1995=100J IIBALANCEof PAYMENTS 1983 1993 2002 2003(US$ miLonsJ ' Currentaccount balanceto GDP (70) 1~xportsof goods and sewcesImports of goods and serwcesResourcebalanceNet incomeNet currenttransfersCurrentaccount baianceFinancingitems (net)Changes in net reservesMemo:Reserves including gold (US$ mi//ionsjConversion rate IDEC, /oca//US$J 177.7 177.7 177.7 177.7EXTERNALDEBTand RESOURCEFLOWS 1983 1993 2002 2003(US$millionsj 1Composition of 2003 debt (US$mill.)Total debt outstandingand disbursed 46 264 335 396 I IBRD 0 0 0 0 IDA 1 40 79 112 6 8Totai debt seruce 5 11 12 16 IBRD 0 0 0 0 IDA 0 0 1 2Compositionof net resourceflows Official grants 24 53 26 Official creditors 13 19 24 20 Prime creditors 0 0 0 0 Foreigndirect investment 0 1 4 Portfolioequity 0 0 0 1World Bank program Commitments 15 11 E Bilaierai ~ Disbursements 16 26 D .Other multilateral F Pnvate Principalrepayments 1 1 G Short-tenn -- I Netflows 17 25 Interestpayments 0 1 Nettransfers 17 24 Note: This tabiewas produced from the Development Economicscentral database. 9/15/04 28 CASAnnex B2 CAS Annex B2 Djibouti - Selected Indicators* of Bank Portfolio Performanceand Management As of February8,2005Indicator 2002 2003 2004 2005PortfolioAssessmentNumber of Projects Under Implementationa 6 7 5 5Average ImplementationPeriod (years) 2.1 2.7 3.2 2.9Percentof Problem Projects by Number a,c 0.0 14.3 0.0 0.0Percentof Problem Projects by Amount a, 0.0 10.6 0.0 0.0Percent of Projects at Risk by Number 33.3 28.6 0.0 60.0**Percent of Projectsat Risk by Amount a, 41.8 32.9 0.0 60.5**Disbursement Ratio (%) e 27.0 41.7 28.3 19.9Portfolio ManagementCPPR duringthe year (yedno)Supervision Resources (total US$) 201 297 551 570Average Supervision(US$/project) 29 42 79 80** Djibouti's portfoliohas no unsatisfactoryproject and no problemprojects.Thepercentageof project at risk is driven by only one project-specificriskflag fortwo of the projectsin the portfolio. This one risk flag triggersthe qualifierproblem projectas it adds to the two automaticcountry risk flags (CountryEnvironmentand Country RecordsRisk Flags). The problemsare beingactively dealtwith and shall be resolved on time. Last FiveMemorandumItem Since FY 80 FYsProject Evaluated by OED by Number 11 3Project Evaluated by OED by Amt (US$ millions) 64.2 18.5% of OED Projects Rated U or HU by Number 54.5 66.7% of OED Projects Rated U or HU by Amt 44.4 43.0a. As shown in the Annual Reporton PortfolioPerformance(exceptfor current FY).b. Average age of projectsin the Bank's country portfolio.c. Percentof projectsrated U or HU on development objectives (DO) and/or implementationprogress (IP).d. As definedunderthe PortfolioImprovementProgram.e. Ratio of disbursements during the year to the undisbursedbalanceof the Bank's portfolio at the beginning of the year: Investmentprojectsonly. 29 CASAnnex B3 CAS Annex B3 IDA ProgramSummary-Djibouti - As o fFebruary 8,2005PlannedIDA Base-Case LendingProgramaFiscal Strategic Year Project ID us$(M) Rewards bImplementation Rish ('/M/L) (H/M/L) 2005 Flood Emergency Rehabilitation 6.4 H L Power and Water 7.0 H M Result 13.4 2006 Second School Access andImprovement 10.0 H L Result 10.0 2007 Ethiopia Rail RoadPartial Risk Guarantee 3.0 H M FiscalConsolidation Credit 9.0 H M Result 12.0 2008 Second Social Developmenthblic Works I1 5.0 H M Result 5.0 OverallResult 40.4 a. This table presents the planned program for the next three fiscal years. b. For eachproject, indicate whether the strategic rewards and implementationrisks are expectedto be high (H), moderate (M) or low (L) 30 CASAnnex B4 CAS Annex B4 Summary of Nonlending Services Djibouti - - As of February 8,2005 CostProduct CompletionFY (US$OOO) Audience" ObjectivebRecentcompletionsEnvironmentalMainstreaminginto PRSP 2004 16.0 GovtlDonor KnowledgeGenerationWater SectorNote 2004 136.0 Govemment KnowledgeGenerationCountryProcurementAssessment Review 2004 86.0 Govemment KnowledgeGenerationCountryFinancialAccountability Assessment 2004 126.0 KnowledgeGenerationPublic ExpenditureReview 2005 133.0 Chemment KnowledgeGenerationUnderwayDjibouti CAS 2005 55.0 Go-ank KnowledgeGenerationTransportReview 2005 60.0 KnowledgeGenerationEconomic/PRSPMonitoring 2005 50.0 KnowledgeGenerationEnergyPoverty& Social Impact Analysis 2005 80.0 Govam-" KnowledgeGenerationEconomicand Social ImpactofPublic WageBillReforms 2005 100.0 Govemment ProblemSolvingPlannedIDF CPAWGovemance 2006 70.0 Govemment ProblemSolvingIDF CFANGovemance 2006 70.0 Govemment ProblemSolvingEconomicPRSP Monitoring 2006 50.0 Govemment KnowledgeGenerationCPPR 2006 50.0 Govemment KnowledgeGenerationCountryEconomicMemorandum 2006 170.0 Govemment KnowledgeGenerationPovertyAssessment 2006 100.0 Govemment KnowledgeGenerationCGMeetings 2006 40.0 Govt/Donors ProblemSolvingPRSPAssessment 2007 100.0 Govemment KnowledgeGenerationEconomidPRSPMonitoring 2007 50.0 Govemment KnowledgeGenerationCPPR 2007 50.0 Govemment KnowledgeGenerationPublic ExpenditureReviewUpdate 2008 85.0 Govemment KnowledgeGenerationEconomic/PRSPMonitoring 2008 50.0 Govemment KnowledgeGenerationCPPR 2008 50.0 Government KnowledgeGenerationa. Govemment, donor, Bank, public dissemination.b. Knowledgegeneration, public debate, problem-solving. 31 CASAnnex B 5 Djibouti Social Indicators Latest siwle year Same regionlincome group M.East& North Lower-middle- 1970-75 1980-85 1997-03 Africa incomePOPULATIONTotal population, mid-year (millions) 0.2 0.4 0.7 311.6 2,655.2 Growth rate (% annual averageforperiod) 6.1 3.3 2.2 1.9 0.9Urbanpopulation (% ofpopulation) 61.6 71.1 83.6 58.0 49.7Total fertility rate (births per woman) 6.7 6.4 5.2 3.1 2.1POVERTY(% ofpopulation)Nationalheadcount index Urban headcount index RuralheadcountindexINCOMEGNIper capita (US$) 910 2,210 1,480Consumerprice index (1995=100) 54 117Foodprice index (1995=100)INCOME/CONSUMPTION DISTRIBUTIONGini indexLowest quintile (`?Aof income or consumption)Highest quintile (% of income or consumption)SOCIAL INDICATORSPublicexpenditure Health (% of GDP) 4.1 2.8 2.6 Education (%of GNJ 4.3 4.0 Social security and welfare (% of GDP)Net primary schoolenrollment rate(% of agegroup) Total 31 34 83 91 Male 37 38 86 92 Female 26 30 83 91Accessto an improvedwater source(% ofpopulation) Total 100 88 81 Urban 100 96 94 Rural 100 78 70Immunization rate (% of children ages 12-23 months) Measles 27 62 92 78 DPT 22 62 92 84Child malnutrition(% under 5years) 11Lifeexpectancy at birth bears) Total 42 46 44 69 69 Male 41 45 44 67 67 Female 44 48 44 70 71 Mortality Infant (per 1,000 live births) 160 137 100 44 32 Under 5 (per 1,000) 241 199 143 54 40 Adult (15-59) Male (per 1,000population) 586 527 590 193 214 Female(per 1,OOOpopulation) 470 428 541 143 135 Matemal (per 100,000live births) 730 Birthsattendedby skilled health staff (%) 73 CAS AMeX B5. This table was produced from the CMU LDB system 09-Feb-OS Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break inseries between 1997and 1998 due to change from ISCED76 to ISCED97. Immunization: refers to children ages 12-23 months who received vaccinations before one year o f age. 663 708 759 808 8 337 357 380 52 75 90 94 95 -21.1 -24.4 -33.1 -34.0 -32..8 4.3 6.7 -1.6 1.7 5.8 6.6 6.83 -2.9 3.4 34 CASAnnex B8 CASAnnex B8-Djibouti StatusofBankOperationsPortfolio As ofFebruary 8,2005ClosedProjects 11 Difference Between Active Proiects Last PSR Expectedand Actual SupervisionRating OriginalAmount inUS$ millions Disbursementspl Project 2:' ID Project Name DO IP IDA Grant Cancel Undisb. Orig. FrmRev'dPO89968 Flood EmergencyRehabilitation S S 2005 6.46 6.77 0.48 HIVIAIDS, Malaria & TBPO73603 Control S S 2003 12.00 9.57 -1.50PO71062 HealthSector Development S S 2002 15.00 13.81 3.46PO44584 Social Dev. andPublic Works S S 1999 19.80 6.83 1.07 2.06PO44585 SchoolAccess andImprovement S s 2001 10.00 0.20 -0.45Total 63.26 0.0 0.0 37.19 3.06 2.06 -* IDA Total Disbursed(Active) 49.74 of which hasbeenrepaid 0.00 Total Disbursed(Closed) 64.16 ofwhich hasbeenrepaid 5.22 Total Disbursed(Active +Closed) 113.90 of which has been repaid 5.22 Total Undisbursed(Active) 39.50 Total Undisbursed(Closed) 0.00 Total Undisbursed(Active + Closed) 39.50* Disbursementdata are updatedat the first week of the monthai IntendedDisbursementsto date minus actualdisbursementsto date as projectedat appraisal v1h l-