Document of The World Bank FOR OFFICIAL USE ONLY Report No.12712 KM STAFF APPRAISAL REPORT ISLAMIC FEDERAL REPUBLIC OF THE COMOROS SMALL ENTERPRISE DEVELOPMENT PROJECT JUNE 1, 1994 Industry and Energy Operations Division Country Department III Africa Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EOUIVALENT Currency Unit = Comorian PFrnc (CF) 1988 to 1993 US$1 = 280 CF (I Frech Franc = 50 CF) 1994 USS1 = 430 CF (I Fmrnch Fnc = 7S CF) ABBREVIATIONS AND ACRONYMS BCC Central Bank of the the Cororw (Banque Centale des Corrore.) BDC Development Bank of the Comoros (Banque de D6veloppement des Comors) BIC Bank for Industry an Commeree (Banque pour l'Industric at le Conuncme) CASP Center for Assitance to the Private Sector (Centre d'Appui au Secteur Prive) CFD French Cooperation (Caine Franwaise de D6veloppearnent) CNE National Savings Bank (Caise Nationale d'Epargne) COMOTEL Hotel EDF Enterpriwe Developmeat Fund EEDC Electricity Company EIB European Investment Bank EU European Union PASP Private Sector Asistance Funds (Ponda d'Assitance au Secteur Prive) GDP Gasm Domestic Product IBRD Iterational Bank for Reconstruction nd Development ICB Intemational Competitive Bidding IDA InternLtional Development Association IMF International Monetary Fund LDD Legislative Drafting Division LIC Legal Information Center MERCAP Macroeconomic Reform and Capacity Building Project MIGA Multilateral Investment Guantee Agency NEAP National Environmental Action Plan ONICOR Rice Importing Company PCR Project Completion Report PE Public Enterprise PPI Participating Financial Intermediaries PFP Policy Frunework Paper PIP Public Investment Program PPF Project Preparation Facility SAF Structural Adjustment Facility SAR Staff Appraisal Report SARL Limited Responsibility Company (Societe I Responsabilitd Limitde) SCH Oil Importing Company SCN Maritime Company SDR Special Drawing Right SME Small- and Medium-Sized Enterprise SNI Printing Company SNPT Post and Telecommunication Company SOCOMA Port Handling Company SOCOPOTRAM Port Management Company SOCOTEL Hotel SOCOVIA Meet Importing Company SOE Statement of Expenditure SSE Small-Scale Enterprise UNDP United Nations Development Program FISCAL YEAR January I - Deeamber 31 FOR OFFICUIL USE ONLY ISLAMIC FEDERAL REPUBLIC OF THE COMOROS SMALL ENTERPRISE DEVELOPMENT PROJECT STAFF APPRAISAL REPORT I. INTRODUCTION ................................................ 1 A. Background ............................................... 1 B. The Adjustment Program ...................................... 2 C. The Private Sector and its Potential ................................ 3 Agriculture ............................................ 3 Tourism ......... .............................. 4 Manufacturing and Services .................................. 4 D. The Public Enterprise Sector .................................... 5 E. The Financial Sector ......................................... 6 F. Donor Assistance for Entrepreneurship Development ..................... 7 II. THE BUSINESS ENVIRONMENT. CONSTRAINTS AND STRATEGY .... ......... 8 A. The Legal Framework ........................................ 8 Introduction ............................................ 8 Key Features ........................................... 9 The Institutional Framework ................................. 11 B. The Policy Framework ........................................ 12 Exchange Rate and Trade Policy ............................... 14 Incentives ............................................. 14 C. Government's Private Sector Development Strategy ...................... 15 Ill. THE PROJECT ................................................ 16 A. Project Objectives and Rationale .................................. 16 B. Lessons from Previous Bank Experience and Bank Group Strategy ............. 17 C. Project Description .......................................... 18 Supporting Investment: Line of Credit Component ................... 18 Size of the Line of Credit .............................. 18 Institutional Arrangements .............................. 19 Participating Financial Intermediaries ....................... 20 Eligible Beneficiaries and Subprojects ....................... 21 Subloan Processing and Administration ...................... 21 Improving Business Laws and their Application: Legal Reforms and Strengthening the Judiciary. .......................... 22 This report is based on the fuidings of missions whieh took place in July and December 1993 and February 1994. Thel missions were led by Mr. Iradj Alikhani, Industrial Economist (AF31E, Task Manager). The appraisl tean consided of Mesrs. Eric Boucheny (AF31E, line of credit, public enterprise reform and financial setor policies), Raj Soopranmnian (LEGAP, Legal and Judicial reform), and Maurice Klein (AFTPS, entreprenurship development). Mmac./Mr. Elizabeth Adu and Dirk Elsen (LEGAP) and Leila Webster (PSD) were peer reviewers. Messrs. Franeisco Aguirre-Sacasa (AF3DR) and Michael N. Saris (AP31E) are the Department Director and the managing Division Chief, respectively. This document has a restricted distribution nd may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Implementing the Government's Economic Strategy: Institutional Strengthening and Capacity Building ....................... 24 Taxation and Incentives. ................................... 24 Encouraging Entrepreneurship: Enterprise Development Fund ............ 25 IV. THE PROPOSED CREDIT AND MAIN FEATURES ........................ 26 A. Amount and Allocation of Funds ................................. 26 Estimated Project Costs and Financing Plan ........................ 26 B. Terms and Conditions of Financing ................................ 27 Line of Credit .......................................... 27 Legal and Judicial Reform ................................... 28 Institutional Strengthening ................................... 28 Enterprise Development Fund ................................ 28 C. Project Management, Monitoring and Evaluation ........................ 29 Organization and Management ................................ 29 Mid-Term Review ........................................ 31 Monitorable Targets ...................................... 32 Monitoring and Evaluation .................................. 33 D. IDA Supervision ........................................... 33 E. Procurement Arrangements ..................................... 33 Local Procedures ........................................ 33 Credit Component ........................................ 33 Other Components ....................................... 34 F. Disbursements ............................................. 35 Special Accounts ........................................ 36 Auditing and Reporting .................................... 37 V. PROJECT BENEFITS AND RISKS .................................... 37 A. Benefits ................................................. 37 B. Risks and Uncertainty ........................................ 38 C. Environmental Impact ........................................ 38 VI. AGREEMENTS AND UNDERSTANDINGS REACHED ...................... 38 ANNEXES 1. Statement of Sectoral Policy 2. Action plan for the Development of the Private Sector 3. Financial Sector: Structure and Characteristics 4. Legal Reform 5. Development Bank of the Comoros Business Plan 6. Terms of Reference of Project Coordinator 7. Selected Documents in Project File 8. Schedule of Disbursements 9. Bank Supervision of Key Activities ISLAMIC FEDERAL REPUBLIC OF THE COMOROS SMALL ENTERPRISE DEVELOPMENT PROJECT Credit and Project Summary Boffower: Islamic Federal Republic of the Comoros Beneficiaries: The Ministry of Finance and the Ministry of Justice. Government will also pass-on resources to final beneficiaries: Participating Financial Intermediaries (PFIs), private enterprises, and the Center for Assistance to the Private Sector (CASP). Amount: SDR 3.7 million (US$5.1 million equivalent). Terms: Standard IDA terms, with 40 years maturity. Objectives: The development strategy envisaged for the Comoros calls for accelerated private sector-led, export-oriented growth. Beyond recent adjustment efforts the Government has decided to take specific measures to create a business environment conducive to the development of all private sector enterprises, while catering particularly to the needs of small-scale enterprises. The project objective is to help the Government implement this strategy by providing the nascent private sector with the means and incentives to engage in productive investments. Specifically, the project will provide financing and technical support to small-scale entrepreneurs and help implement improvements in commercial and labor laws as well as legal and judicial procedures, while strengthening investment incentives. Project Components and Onlending Terms: The project would consist of four, mutually reinforcing components: (a) a line of credit (US$2.50 million) which will provide the term resources needed to finance medium- and long-term investment; (b) an enterprise development fund (EDF, US$0.85 million) to help entrepreneurs improve the design of their projects and strengthen their managerial capacity; (c) training and institutional support to the Ministry of Justice (US$0.85 million) to strengthen its capabilities to design and implement legal and judiciary reforms aimed at improving the legal system; and (d) training and institutional support to the Ministry of Finance (US$0.40 million) to undertake studies to design reforms aimed at improving the business environment, and to oversee project implementation. The line of credit will be reimbursed by the banks periodically according to a schedule matching the schedules set for subloans (subloan repayment will be over up to 15 years, including a grace period of less than 5 years). The interest rate charged to banks will reflect the cost of funds (6.5 percent p.a. in 1994) and that charged to beneficiaries will be within the maximum ceiling presently set at 12.5 percent p.a. These interest rates will be variable and will be reviewed periodically to ensure they reflect inflation and macroeconomic conditions. The EDF institution will ii receive the funds as a grant, and private beneficiaries will share in the cost of services provided. Benefits and Risks: The proposed operation is a complement to the Comoros's macro- economic adjustment program already launched with Bank and IMF support. The project would help spur private investment and assist the Comoros achieve its growth objectives. Major expected benefits would stem from an enhanced supply response by small-scale private sector investors, which would create the employment opportunities that are critical for the success of adjustment and the reduction of poverty. The Comoros is undergoing a dual process of political and economic liberalization. A possible risk would be renewed political instability, which could shake investor confidence and slow down the process of improving the business environment. This could mean that the private sector investment and the implementation of a well-focused private sector development strategy, could be slower than expected. Estimated Project Cost: Loaw Foreign To (A) Investments 1.65 2.80 4.45 (B) Legal and Judicial Reform 0.20 0.90 1.10 (C) Institutional Strengthening 0.20 0.30 0.50 (D) Enterprise Development Fund 0.12 0.88 1.00 (1) Assistance to promoters (0.10) (0.80) (0.90) (2) Training for banks (0.02) (0.08) (0.10) (E) Audits 0.03 0.22 0.25 (F) Incremented Operational Costs 0.03 0.13 0.16 (G) Unallocated 0.05 0.15 0.20 TOTAL 2.28 5.38 7.66 Flnancine Plan: Amount Percentages Investment Projects 4.45 100 Subborrowers (Private Sector) 1.00 22 Banks 0.95 21 IDA 2.50 57 Legal and Judicial Reform 1.10 100 Government 0.25 23 IDA 0.85 77 Institutional Strengthening 0.50 100 Government 0.10 20 IDA 0.40 80 Enterprise DeveloRment Fund 1.00 100 Private Sector 0.15 15 IDA 0.85 85 Audits 0.25 100 iii Banks 0.05 20 IDA 0.20 80 Incremental Operational Costs 0.16 100 IDA 0.14 90 Government 0.02 10 Unallocated 0.20 100 IDA 0.20 100 TOTAL 7.66 100 Government 0.37 5 Private Sector 1.15 15 Banks 1.00 13 IDA 5.14 67 of which PPF (0.30) (4) Projected Disbursements by IDA Fiscal Year (million US$) Fiscal Year 1995 1996 1997 1998 1999 2000 2001 Annual 0.6 0.8 0.9 0.9 0.7 0.6 0.6 Cumulative 0.6 1.4 2.3 3.2 3.9 4.5 5.1 Economic Rate of Return: N/A Poverty Category: PTI Memorandum of the President: P 6277-KM M-apR: Map IBRD 25699 ISLAMIC FEDERAL REPUBLIC OF THE COMOROS SMALL ENTERPRISE DEVELOPMENT PROJECT I. INTODUCTION A. ackLyround 1.1 The Islamic Federal Republic of the Comoros has a population of about 510,000, increasing at an annual rate of 3.1 percent. In 1992, GNP per capita was estimated at US$510. This income level has been achieved through heavy reliance on external assistance (US$115 per capita annually), equivalent to about 70 percent of imports. The country is predominantly rural: agriculture accounts for 40 percent of GDP and employs 70-80 percent of the work force. The private sector in the Comoros is not well developed in industry, trade or services. All but a handful of firms are small-scale employing at most 50 people and often less than 20. Market concentration tends to be high, even in trade, where 12 firms (including two public enterprises importing rice and petroleum products) account for the bulk of imports. Comorian exports consist of three commodities (vanilla, cloves and perfume essence), and covered about 40 percent of imports between 1988 and 1992. Following independence in 1975, the economy grew at an annual per capita rate of about 3 percent. However, this growth was fueled by uneconomic public investments and could not be sustained. During 1986-92, GDP per capita declined by an annual average of 2 percent, and the overall budget deficit to GDP (excluding grants) and debt service ratios averaged about 22 percent and 24 percent, respectively. In 1993, the overall budget deficit declined to about 12 percent, thanks to cuts in the wage bill. 1.2 Poor economic performance of the late 1980s can be attributed to a mixture of structural and policy problems: (i) high production costs linked to the overvaluation of the Comorian Franc; (ii) declining terms of trade; (iii) human resource (skilled labor) constraints, despite high unskilled labor unemployment; (iv) weak macroeconomic management; and (v) an inadequate private sector framework. In 1991, the Government, supported by an IDA Credit (MERCAP) and an IMF SAF, launched a structural adjustment program, aimed at counteracting the overvaluation problem and reestablishing sustainable internal and external balance through actions designed to improve productivity and decrease costs. Measures under the program include the compression of current public expenditures, civil service reform, privatization and liquidation of some public enterprises, trade and price liberalization, and simplification of regulatory requirements for businesses. On January 12, 1994, the Comorian Franc was devalued from 50 to 75 per French Franc. This action and a continuation of ongoing measures to keep inflationary pressures under check should contribute to the resumption of employment and income growth and lead to sustainable development. 1.3 By following through on the agreed reforms the Government has clearly indicated its commitment to the adjustment program despite a volatile political situation. The adoption of a new constitution and subsequent multi-party elections have been accompanied by political turmoil and frequent cabinet reshuffling, not unusual in a young democracy. The latest multi-party legislative elections, held in December 1993, produced a working majority in the Federal Assembly. The Government has determined that to foster a sustainable supply response sectoral and microeconomic constraints facing the private sector also need to be addressed, and intends to pay particular attention to the development of the small-scale enterprise (SSE) sector, which is expected to be the main source of future employment, investment and growth. 1.4 The development strategy envisaged for the Comoros calls for accelerated export-led growth, and a business environment where the private sector provides the main impetus for investment and growth, creates employment opportunities and helps alleviate poverty. Beyond reestablishing sustainable internal and external balance and providing a boost to competitiveness through broad measures such as the recent devaluation (as reflected in the 1994-96 PFP), the Government is committed to take specific measures to create a business environment conducive to the development of all private sector enterprises, while catering particularly to the needs of small-scale enterprises. The objective of the project described in this report is to help the Government implement this strategy (set-out in the Statement of Sectoral Policy, Annexes 1 and 2) by providing a nascent private sector with the means and incentives to engage in productive investments. Specifically, the project will provide financing and technical support to small-scale entrepreneurs and help implement improvements in commercial and labor laws as well as legal and judicial procedures, while strengthening investment incentives. B. The Adjustment Program 1.5 In 1991, to restore macroeconomic stability and lay the foundation for sustained economic growth, the Government launched an adjustment program, which is described in the first Policy Framework Paper (PFP, 1991-93). The program is supported by an IDA Credit of US$8 million (MERCAP, approved in June 1991, of which $6 million quick disbursing) and an IMF SAF arrangement of SDR 3 million. However, soon after the approval of MERCAP, the adjustment program went off track due to the volatile political environment. 1.6 The program was restored and the pace of implementation accelerated after a new economic management team was appointed in July 1992. To date, the civil service has been downsized by nearly 22 percent, the role of the state has been reduced by privatizing three hotels, liquidating the meat importing monopoly, and trade has been liberalized, including exports of vanilla and imports of meat and higher-grade rice. The Government has simplified administrative procedures for business creation to promote private sector development. It also eliminated low priority projects from the 1994-96 Public Investment Program (PIP). Release of the second tranche of MERCAP is expected by mid-1994, following the adoption of a second Policy Framework Paper (distributed to the Board in March 1994), a satisfactory 1994 budget and 1994-96 Public Investment Program (PIP), an action plan to promote private sector development and satisfactory implementation of civil service reform. The future of the reform process depends to a large extent on the commitment of the new Government which has emerged after the December legislative elections and the quality of its economic management team. 1.7 The Government's medium-term objective is to establish the conditions for export-led growth and significant increases in per-capita incomes. The policy framework consists of medium-term macroeconomic policies and financial reforms to achieve internal adjustment, structural policies to consolidate the public sector, strengthen the administration and support the private sector, and policies for the development of human resources to improve labor productivity in the long term. The devaluation of January 1994 has improved the country's competitiveness, and continued membership of the Comoros in the Franc zone should ensure future stability based on prudent monetary policy. Internal adjustment would also be continued through compression of public expenditure and of the real cost of public services and labor. The program also calls for tax reforms to remove tax-induced distortions and strengthen the Government's revenue base; reform of public enterprises (PE) to decrease their burden on the economy and the budget; opening opportunities for the private sector; and improvements in the business environment to encourage private sector development. These aspects of the program will be deepened and made operational through studies to be financed by the project (paras. 3.23-35). In addition, the key reform measures could be included amongst the policy reforms supported by a possible second adjustment operation in 1995. - 3 - C. The Private Sector and its Potential 1.8 The economy of the Comoros is small and undiversified. It is also fragile and vulnerable to events that in another context might appear trivial, such as a late arrival of a shipment of rice or a breakdown in negotiations with a single buyer of vanilla. Much of the wealth is highly concentrated. While economic power is concentrated, the social structure appears as differentiated as in many larger countries, with strong regional traditions and loyalties between the islands, between villages on the same island, and among social classes. A more detailed description of the main private sector activities is presented in this section. However, the sector does not lend itself to a systematic analysis due to lack of reliable data and almost non-existent statistics. The company register indicates that 900 firms have been created since independence, mostly by individuals incorporating their service activity. There are no records of exit. The tax authorities estimate that business entities engaged in formal activities number less than 200. Agriculture 1.9 The agriculture sector in the Comoros has been analyzed in a recent Bank study ". The sector as a whole, including fisheries, animal husbandry and forestry, accounts for about 40 percent of GDP. Some 70-80 percent of the active population is engaged in the sector. Food production accounts for close to half of value added in agriculture. Fisheries, livestock and forestry account for another 35-40 percent, and exports for 10-15 percent. Despite their low share in GDP, the exports of three agricultural commodities - vanilla, ylang-ylang and cloves - account for 95 percent of the Comoros' merchandise exports. The value of these exports has been sufficient to cover all the country's imports of food, predominantly rice. Rights of use and ownership in land derive from complex, locality-specific mixtures of village and family tradition, muslim law, and claims arising from the colonial past. They are often clouded by uncertainty and have given rise to conflicting claims'. The lack of security of tenure and use rights hampers investment, the adoption of new technologies and the determination of household creditworthiness to finance improvements on the land. 1.10 There are enough resources along the coast to expand small-scale, coastal fishing to meet the prospective demand of the Comorians and tourists, although quality control and conservation would need to be introduced to supply a modem hotel sector. Development of fish for export is a long-term proposition, involving substantial investment and/or fisheries concessions and regional accords. Should the world market continue to be buoyant, the Comoros could prepare to participate in it through the cultivation of closer relations with the industry. Conditions appear conducive to development of poultry production aimed at the tourist market, but animal husbandry will remain a supplement to the multi-crop system of household agriculture in view of the scarcity of pasture land. 1.11 The potential for growth of Comorian agriculture is by no means fully exploited, and its role in the national economy will remain dominant for many years. Agricultural growth would give the country the breathing space needed to develop other activities, the main objective of the present project. The constraints on the development of agriculture are largely the result of policy, particularly the lack of competitiveness, which rather than encouraging a diversification of production has narrowed the range of products the country exports on international markets, depressed rural investment and limited the profitability of selling foods on village markets. The recent devaluation is expected to provide the 1/ See 'Strategie Pour une Croissance Agricole", World Bank, Report No. 11551-COM, July 1993 for full details. 2/ See discussion of the legal framework pams. 2.10-2.11 and Annex 4. sector's competitiveness an important boost, and strengthen the effectiveness of ongoing and future donor- funded programs and Government initiatives. Tourism 1.12 The world tourism industry no longer depends purely on traditional facilities which offer "sand, sea and sun". Tourists increasingly seek destinations that offer nature-related activities including viewing wild life, fishing and hiking excursions. The Comoros is one such destination, which offers tourists not only a number of high-quality beaches, but also interesting natural physical features and rare flora and fauna. The country's nature is diverse and includes rare turtles, an assortment of sea life, and various sites that can be reached after a reasonably short hike, including Grande Comore's volcano, the Kartala. Moreover, because of its location in the Indian Ocean, the Comoros stands to benefit from the name recognition associated with the region, resulting from promotional efforts undertaken by other countries (Mauritius and the Seychelles). 1.13 A recent survey identifies twenty sites, of which the best are located on the island of Moheli, with beaches, mountain scenery and other assets suitable for holiday tourism. Despite its potential, tourism in the Comoros remains largely in its infancy. At present only one hotel, the Galawa, on Grande Comore, has been developed to international standards. Until recently this facility of approximately 200 rooms has experienced an average occupancy rate slightly above 50 percent. Since August, following a significant marketing effort in Europe, occupancy has increased to close to full capacity and, in the light of long-term contracts with new operators, construction for another 100 rooms is underway. During the past few years, this facility has brought about 8,000 additional tourists per year to the Comoros, each staying for about one week, and is expected to attract 16,000 visitors a year from 1994 onwards. Existing Comorian hotels could accommodate 22,000 to 25,000 tourists per year in the near future. 1.14 The modest success achieved to date, however, is built on a fragile base. Investors' profitability has been ensured by a combination of direct and indirect tax exemption, and preferential tariffs for public utilities which can not be justified. A more coherent sectoral framework is needed and should be devised in collaboration with the private sector (paras. 2.35 and 3.33). Manufacturing and Services 1.15 Manufacturing contributes less than 5 percent to the economy and most of the firms operating today were created in the 1980s. The lack of statistics makes it difficult to obtain a detailed picture of the sector. Nevertheless, available information shows that there are less than 50 manufacturing enterprises, almost all of which employ fewer than 50 people. The main sectors of activities include garment, wood working, printing, construction materials and beverages. Total manufacturing employment is estimated at around 1,000 people. Even with the small domestic market of the Comoros, there are opportunities to develop small-scale processing activities to accommodate a greater share of local needs, including those of tourists, provided that it costs less to do so than to import. These small-scale activities will be important for the development of business and management capacities (and vice-versa). 1.16 Private services are not highly developed, with trade dominating the sector. Trade is highly concentrated, and the bulk of private imports is accounted for by about 10 private and two public (rice and petroleum) companies. There is scope for the Comoros with its relatively abundant work-force to develop manufactured exports, provided that conditions of quality, reliability, as well as price can be adapted to the demands of prospective foreign partners and buyers. Initially processing for export could build on the limited but positive experience of adding value to the Comoros' agricultural products. Over - 5 - time, however, there should be opportunities for the Comoros to attract foreign investments in lower-end manufacturing, as other countries' (such as Mauritius) labor costs rise and their industrial sectors "graduate' to more sophisticated products. 1.17 The low level of private sector activity (estimated at around 10 percent of GDP, excluding agriculture) is not explained solely by the state of the Comoros' economic development and its human resource constraints or the inevitable problems facing a small, three-island economy with a segmented domestic market. The political environment during the 1980s was not conducive to private investment, nor was the business environment. Some of these problems are being tackled through political reform and macroeconomic stabilization, while others, such as human resource development will have to be addressed through sustained longer-term efforts. Remaining structural and policy related issues, including inefficient PEs, inappropriate sectoral incentives, an inadequate legal system, difficult access to financing and insufficient managerial know-how, prevent efficient allocation and use of resources. As discussed in the next chapter, the project will support Government efforts to address these issues within the context of a coherent medium-term private sector development strategy. D. The Public EnterDrise Sector 1.18 The public enterprise sector of the Comoros is composed of 15 companies with clear legal status3'. These firms employ about 1,500 people. There are at least five other PEs operating without any legal status (typically for managing donor-financed projects or funds); a survey to better delimit the sector is expected to be completed by end-1994. PE performance to date has been disappointing (Table 1. 1). Under the MERCAP, reforms have been underway since 1992, with some notable success: (i) one PE was closed (meat importing and hotel holding) and its assets have been sold; (ii) two hotels were sold and another was leased; (iii) rice and petroleum products are now procured through international competitive bidding, yielding significant cost savings (around US$1 million for oil alone) and increased tax contributions; (iv) the telecommunications company has undergone financial restructuring, allowing it to become profitable even though at the same time certain tariffs have been reduced; and (v) some PEs (oil company and the airline) have sold assets related to peripheral activities (boat and car hire) to concentrate on their main line of business. 1.19 Achievements to date constitute only a first step. The problems of the electricity company and the port remain serious (before the devaluation electricity cost was over 50 cents US per kWh, one of the highest in the world, and maritime transport suffered from high cost, poor quality of service and inefficiency). These PEs continue to receive unsustainable subsidies (mainly from funds provided by donors), and over-staffing and high costs caused by inadequate management are prevalent. The Government has reaffirmed its intention to continue with PE reform in the 1994-96 PFP and Government's Statement of Sectoral Policy, and has adopted a coherent strategy towards reforming the sector (para. 3.34). The project will support these efforts by financing required studies, while specific actions are expected to be conditions of a future adjustment operation. 3/ These include 5 companies with le than 100 perent State ownership (Air Comorom, BDC, SOCOTEL (Galawa hotel), SOCOMA and SCN (Maritime handling and transport)) and 10 wholly publicly-owned companies (Al Watwan (newspaper), Moroni airport, EEDC (electricity), ONICOR (rice importing), radio Comoror, SOCOPOTRAM (port), SCH (petroleum importing), SNI (printing), SNPT (post and telecommunications) and the chumber of commcrce. - 6 - Table 1.1: Key Indicators for PEs Entprise Paid in Net Medium- Revenue Added Subsidies Prorflt l Capital Worth and long- Value loss term debt AIRPORT 4,185 2,303 284 150 200 -30o AIR COMORES 880r 1-T - TT 3 T -892 16 S21 EEDC 1,268 572 4,281 2,626 1,028 404 439 350 NICOR 521 5 3 S26 - 2S7 H 650 3,611 368 S,858 1,298 464 120 SNI 100 16- 100 63 24 3 SOCOPOTRAM 2,134 2,162 - 238 130 - 39 211 iNPT 480 -957 4,000 2,354 1,976 S6 Sour: Unaudited 1992 balance shees, (1991 for Socopotranu and Air Comores) Note: All units in CF million, except for number of staff E. The Financial Sector v 1.20 The financial sector of the Comoros is small and undiversified. It comprises the central bank (Banque Centrale des Comores - BCC), a private commercial bank (Banque pour l'Industrie et le Commerce - Comores - BIC), a development bank (Banque de Developpement des Comores - BDC), and a savings bank (Caisse Nationale d'Epargne - CNE), attached to the post and telecommunication company (Societe Nationale des Postes et Tlelcommunications - SNPT). In addition, the Fonds d'Assistance au Secteur Prive (FASP, para. 1.27) manages a fund, financed by donors, which guarantees bank loans to SSEs. 1.21 In 1979, the Govermment signed a monetary cooperation agreement with France making the Comoros part of the franc zone. This agreement provided for: (i) the establishment of a system of fixed parity between the French franc and the Comorian Franc (FF 1 = CF 50), which was adjusted on January 12, 1994 (FF 1 = CF 75); and (ii) free convertibility between the two currencies. 1.22 With M2/GDP of 22 percent, the level of financial intermediation is comparable to the average for African countries. However, the Comorian financial sector remains highly specialized: the BIC collects 75 percent of all deposits and makes all short-term loans, while over 95 percent of long-term loans are granted by the BDC. A detailed inspection by staff of the French central bank, attached to the IMF, completed in December 1993, confirms that both banks are healthy, even though they suggest the level of provisions should adjusted upwards. The CNE, however, will have to be restructured in the context of SNPT reform. The restructuring will involve adopting an autonomous status for CNE, with the post office, improving its financial management for increased transparency and becoming a more effective tool for resource mobilization. The impact of this institution on the financial sector is minimal because its lending activities are insignificant (outstanding loans of CF 66 million (US$230,000) in 1992) and 70 percent of the deposits are held in cash. 1.23 Most Comorian private sector firms are SSEs and have limited access to credit. The main reason is that the banks' approach to assessing their investment projects and associated risk is based mainly on the guarantees provided. The project will aim to alter the perception of untenable risks 4/ For a full description soe Annex 3. Financial sector policies ae discussed in chapter H. -7- associated with lending to small borrowers, though the training of bank staff (para. 3.36 (d)), particularly in the context of implementing BDC's business plan (Annex 5), and by encouraging financial institutions to use quantitative analysis to assess risk and adopt a more flexible interest rate policy to cover it. Legal reforms and the strengthening of tribunals, also supported by the project, are expected to have a beneficial impact on the realization of guarantees and lower the banks' general risk associated with investment lending (para. 3.23 (d)). F. Donor Assistance for Entrepreneurship DeveloRment 1.24 Almost all private firms suffer from basic managerial, marketing, technological and other deficiencies. As a result, their efficiency and competitiveness is low, and even simple problems can become unsurmountable, increasing the rates of failure. There is a clear need for supportive actions aimed at improving initial project conception and subsequent enterprise efficiency. Without such a program, the sustainabiity of the supply response might be undermined. At present, the problems typically encountered tend to be relatively straightforward (e.g. project conception and feasibility, financial management and accounting, and using the installed equipment properly). 1.25 Donors have for some time recognized that there is insufficient private sector know-how in the aforementioned areas. In the mid-1980's for instance, the success of the first IDA line of credit was in no small part due to the presence of long-term technical assistance, financed under the Credit, which helped promoters design bankable projects. Donor initiatives, however, tended to be piecemeal, addressing only a part of the overall problem (e.g. preparing feasibility studies, but not helping promoters with their operational problems). In the larger social and economic context created by the Structural Adjustment Program, the concept of private sector development is central and requires a more global approach. In redefining the role of the State, a much more active role is envisaged for private business. Taking into account the current limited capacity of Comorians the implementation of a more global approach for helping entrepreneurs has become crucial. 1.26 In 1992, the Government, with the support of the UNDP and other donors, established an effective support system dedicated to the creation and development of small businesses in the Comoros. The Center for Assistance to the Private Sector (the CASP, 'centre d'appui au secteur privd') has been fairly successful. The CASP is a non-profit organization (presently attached to the chamber of commerce). The stated objectives of the CASP at the time of its creation were to: (i) help sustain private sector-driven growth, without government interference or intervention; (ii) encourage partnership between all active economic agents in the Comoros, including the private sector, business associations or representatives, the local banks, the state, and the donor community; (iii) increase the volume of credit through a banking system closely attuned to the needs of emerging SSEs; and (iv) enhance management and technical capacity within SSEs, through entrepreneurship enhancement and well-focused, short-term training programs. 1.27 To implement the strategy, the project was organized around two basic structures: the FASP (Fonds d'assistance au secteur prive), a fund set up to mobilize financial resources for new entrepreneurs, as well as the CASP, the technical or management support agency responsible for helping new entrepreneurs with their emerging projects. The FASP's role in the medium- to long-term will be to operate a guarantee scheme funded by donors (including CFD and UNDP). 1.28 The CASP has been conceived to work hand in hand and complement financing mechanisms through technical assistance programs to entrepreneurs. In 1993, its first year of existence, the CASP launched an identification scheme to spot potential entrepreneurs, set up a counseling desk for them, and has provided limited trouble-shooting advice to existing firms. The CASP has also completed - 8 - the preparation and adaptation of firm creation training methodologies, and started training classes for more than 51 would-be entrepreneurs. As a result, 14 fiuns have been created, and 200 promoters are waiting to benefit from the different programs of the CASP. The State has also transferred to CASP its ownership of an industrial site, the SOCOVIA, which has been transformed under the management of the CASP into a mini-industrial park, with 24 small fuims. 1.29 The CASP's strength largely rests on its good track record in helping promoters. It now needs to work more closely with the banks', thus reinforcing the link between SSE projects and sources of funds: a link made feasible by CASP's experience with SSE feasibility studies and SSE's business plan preparation as well as trouble-shooting. The long-term strategy calls for a tightly organized CASP, and strong technical and management know-how, with close links with the banks. It relies on the availability of technical competence which, after the recruitment of additional expertise, would be made accessible to new entrepreneurs. Such key experts would be financed by the Credit (para. 3.36). II. THE BUSINESS ENVIRONMENT. CONSTRAINTS AND STRATEGY 2.1 The development of the private sector has been hampered by an unfavorable business environment. Considerable progress has been made since 1991 in the area of macroeconomic and PE reform. More still needs to be done, however, in these and other areas. In particular the inadequate legal framework and judicial system needs to be overhauled to become an instrument for facilitating and securing business transactions and strengthening the property rights of all investors. Furthermore, sectoral incentives remain inadequate, lack transparency and need to be improved to encourage SSE and export-oriented investments. A. The Lepal Framework' Introduction 2.2 The evolution of the legal and judicial system of the Comoros has followed a pattern similar to that of other francophone countries of Africa. Like them, the Comoros inherited at the time of its independence a legal system that was by and large a product of the French legal system itself. But there were also important differences. The Comoros acquired independence nearly a decade after the first wave of independence in Africa, and has inherited an initially more sophisticated legal system than most of the other former French colonies. More importantly, the legal system in the Comoros has been strongly influenced as a matter of tradition by both muslim law and customary law, both of which continue to this day to have a significant impact upon the legal and business environment. 2.3 Prior to independence the power to legislate had belonged largely, but not exclusively, to the French National Assembly. Laws passed by the French National Assembly during the pre- independence period did not, however, automatically apply to the Comoros, except to the extent that they were expressly declared to be so applicable. There had also been an intervening period of some thirty years or so, during which limited legislative powers had been vested in a local territorial assembly. 51 Lncluded in the BDC busineu plan (Annex 5) 6/ For a detailed review, wee Annex 4. - 9 - Immediately after independence, in July 1975, the Provisional National Assembly passed a law providing for the continued validity of all laws in force previously. 2.4 The body of business and commercial laws that governs business transactions is derived largely from the French legal system. They include not only the Commercial Code and related legislation, but also a host of other laws, including the Civil Code, the Labor Code, the Investment Code, as well as legislation governing banks and other financial institutions, and public enterprises. These laws have had to compete with a body of well-developed principles of religious and customary laws, which can have a significant impact on business transactions. There are now entrenched constitutional and legislative provisions which have re-affirmed the continued pre-eminence of religious and customary laws. Key Features 2.5 The Commercial Code. The Comoros is in the unique situation of having two Commercial Codes: one Commercial Code, the Code of 1867, which forms part of its French colonial legacy, and another which was adopted and promulgated in 1984, but never actually put into application. The 1984 Commercial Code does not substantially depart from the French Commercial Code; but whilst it is based essentially on the liberal approach of the French version, it also includes a number of provisions which are characterized by a tendency to over-regulate. 2.6 The 1984 Commercial Code has been consistently ignored by the local legal community which continues to apply the original French Code. The 1867 Commercial Code is still basically a sound legal instrument, but it has failed to evolve since 1975. Following major changes to the provisions of the French Commercial Code that were initiated in 1967, there are now clear differences between the provisions of the French Code and the corresponding provisions of the Comorian Code. In the minds of most Comorian lawyers, the 1984 Code needs to be abrogated and the 1867 Code needs to be updated. 2.7 Comany L. The law of companies in the Comoros is governed by the French Civil Code, as it existed at the time of independence, and, in the case of commercial companies, by the 1966 French law on commercial companies. Since 1975, company law has evolved in France, but not in the Comoros. Nevertheless, Comorian law on commercial companies is relatively modern, and not unlike present-day French legislation. Comorian law recognizes five different types of companies: the socite en nom collectif, the societe en commandite simple, the societe a responsabiitE limitee (SARL), the socite anonyme (SA) and the sociEdte en commandite par actions. Because it combines the characteristics of a partnership (socidete de personnes) with those of a joint stock company (societE par actions), the SARL (the most prevalent type in the Comoros) is generally regarded as a hybrid form of company. 2.8 Company registration takes place at the Registre du Commerce (the Commercial Registry) presently attached to the Court of Appeal in Moroni. It is subject to a 5 percent tax on capital payable to the revenue services, which, encourages firms to under-capitalize. The Commercial Registry is presently kept in a disorganized and inadequate manner under the supervision of the Grefferwen-Chef of the Court of Appeal. 2.9 Civil Law. The basic principles governing a contract of sale are to be found in the Civil Code, as are the rules governing mortgages and guarantees, liens, securities and privileges. In addition, the principles of family law and, in particular, the rules governing succession and matrimonial property, have a direct impact on ownership of property and, consequently, on credits and guarantees. The interaction between the French-inspired civil law, and traditional (muslim and customary) law is now governed by the law governing the organization of the Judiciary, which provides that the courts are - 10- required to apply existing laws, except in matters reserved for the exclusive competence of muslim religious and customary laws. 2.10 Propery Law. Property law in the Comoros is based essentially on French law, in the absence of any incidence of muslim or customary law. It is precisely to avoid any possible conflict between different systems of law, and to increase reliability on title to land, that a 1931 Decree introduced the concept of land title registration. Title registration is a long, arduous and expensive process, and triggers tax considerations. The amount of duty payable on registration is in excess of 15 percent of the value of the property concerned. Registration is, therefore, not widely prevalent, which triggers the application of traditional law. 2.11 Impact of Customary and Muslim Law. The muslim practice of waqf (a donation administered by the religious authorities) and the magnahoule (a custom whereby property is donated to a woman for her own benefit and that of her female descendants), can have a profound incidence on the security of business transactions and land registration. In the absence of any form of registration, business transactions might be undertaken without full knowledge of the facts relating to the ownership of property. It is for this reason, presumably, that the General Council of the Comoros adopted, in 1947, a Deliberation relating to the opening of a special register, wherein a record would be made henceforth of every waqf, and every magnahoule, that is established. This registry has yet to function well and needs to be improved to reinforce the security of business transactions. 2.12 Labor Code. A preliminary review of the Labor Code reveals that it is a relatively modem and simple piece of legislation, applied in a liberal manner. It sets out rules for hiring (perhaps with excessive prior control provisions) and firing, and specifies that a contract of employment may be on a permanent or fixed term basis (up to 3 years). The termination of contract clauses is relatively standard, and includes payment of a relatively modest severance allowance. The Labor Code also contains non-wage provisions, affecting freedom of contract, which will need to be reviewed in due course. 2.13 Public Enterprise Law. The law on public enterprises in the Comoros is of relatively recent origin (1980). The law draws a distinction between public sector organizations (etablissements publics), on the one hand, and State-owned and State-controlled enterprises (sociEtes d'Etat et d'Economie mixte), on the other. In practice, however, many of the rules applicable to the former apply equally to the latter group of enterprises. This law confers upon the Government wide-ranging powers to interfere in the management of its public enterprises, including the power to exercise day-to-day financial control over the affairs of public enterprises, the power to approve all debt transactions, as well as the right to be kept informed of major decisions of such public enterprises and, where appropriate, to veto such decisions. The provisions of the law on public enterprises apply as of right to enterprises which are wholly owned by the State, or in which the State has a majority interest; they can be extended by decree to those in which the State has only a minority shareholding. Notwithstanding its relatively recent origin, the existing law on public enterprises appears to be based on outdated principles of public enterprise management. There are efforts under way to have the law amended and introduce a privatization law. 2.14 Investment Code. The 1984 Investment Code provides for a complex regime of fiscal preferences and subsidies, which involves a cumbersome approval process. This process is inefficient, time-consuming, arbitrary, and might also provide a channel for rent-seeking behavior. Typically, an Investment Code also seeks to reassure investors, by guaranteeing, in particular, the security of their investment operations. The present Code, however, falls well short of achieving this particular objective. The provisions governing the security of investments are totally inadequate and there is no independent - I1 - arbitration clause. The fiscal provisions of the Investment Code are presently under review in the context of an overall tax reform program (para. 3.31 (c)), designed to rationalize the tax structure and streamline the process of tax collection. The remaining provisions of the Code are due to be revised and included in a new law which would include a streamlined and transparent process of registration of investment proposals and provide potential investors with better and more reliable investment security. The Institutional Framework 2.15 Structure of Courts. The structure of judicial institutions in the Comoros is characterized as much by the complexity of its judicial system, as by the scarcity of resources, both human and physical, that it has available. Prior to the adoption of the Constitution in 1992, the organization of the Judiciary was governed by the law on the organization of the Judiciary. It comprised, in addition to the Supreme Court, a Superior Court, a Court of Appeal, a Court of Assises, First Instance Tribunals, Justices of the Peace and the Labor Tribunals. First Instance Tribunals were also declared to be competent in practically all disputes involving the administration. The new 1992 Constitution has re- affirmed the independence of the Judiciary, but by creating a high court structure, consisting of a Cour de Cassation, a Conseil d'Etat, a Cour des Comptes and a Tribunal des Conflits, it has also called in question not merely the existing court structure, but also the competence of the First Instance Tribunals in administrative law matters. Coupled with the current scarcity of human and physical resources within the Judiciary, the new court structure raises difficult legal and institutional issues. 2.16 The Court of Appeal has jurisdiction over the entire country. It sits as a bench, but, due to lack of a quorum, has been unable to hold regular sittings. As a result, there is la large bacldog of cases awaiting appeal. Following the most recent nominations within the Judiciary, it is now expected that the Court of Appeal will be regularly constituted. There is a First Instance Tribunal for each of the three islands of Grande Comore, Anjouan and Moheli. Owing to lack of resources, the tribunal of Moheli has, for all intents and purposes, ceased to operate. Subject to the special first and last instance jurisdiction of the Superior Court, the Court of Appeal and the Court of Assises, and the first instance jurisdiction of the Labor Tribunals, the Justices of the Peace and the administrative tribunals, other first instance jurisdiction belongs exclusively to First Instance Tribunals. Magistrates of First Instance Tribunals are competent to hear civil, commercial and criminal cases alike. The President of the First Instance Tribunal in Moroni also doubles up on certain days of the week as conciliation judge. There is presently no opportunity to specialize. 2.17 Both First Instance magistrates and the Justices of the Peace sit alone. In both cases, however, they need to be assisted by assessors whenever they sit to hear matters involving customary law. There is no attempt made to align the areas of competence of the various jurisdictions in accordance with the various systems of law that the jurisdictions are called upon to apply. All jurisdictions apply French law, muslim law and customary law. 2.18 Lack of Resources. All these courts lack both human and physical resources. In Moroni there is presently only one courtroom, which has to be shared out amongst the Court of Appeal, the magistrates of the First Instance Tribunal and the Labor Tribunal. As a result, even those courts which are capable of being properly constituted are unable to sit as often as they might otherwise have wished. The library consists of a few shelves, a couple of tables and chairs, and a dozen volumes dating back to the early 1900s. Many magistrates complain of an acute shortage of paper, materials and equipment. Law reporting and periodicals are unheard of, and no attempt has ever been made to compile copies of court judgments. - 12 - 2.19 Magistrates are in short supply and there are not enough of them to fill even the lower level courts, let alone the intricate structure of higher level courts that have now been established under the Constitution. There are presently only twenty magistrates in the Comoros, of whom sixteen only are confirmed appointees, the remainder being public officials appointed to act as magistrates. Of this grand total of twenty magistrates, less than half are assigned to perform duties as sitting magistrates. The rest are either investigating magistrates (uges d'instruction) or public prosecutors. 2.20 Access to the profession can be a long and difficult process. There are transitional provisions which have been introduced to facilitate access to the profession during a transition period of between three to five years. But these transitional provisions alone will not suffice to produce the increase in the number of magistrates that will be required during the next few years. In practice, candidates wishing to become magistrates are expected to undergo two and a half years' post-degree professional training, which seems excessive. Another problem is that most magistrates are poorly motivated, and have an insufficient grasp of business and commercial laws, which cause delays and increase transaction costs. 2.21 Execution of Judgments. The procedures for execution of judgments appear slow, inadequate and not always reliable. One factor is the confusion and uncertainty inherent in the laws themselves. A second factor is the shortage of ushers (only three people are recognized as such in the Comoros) and their lack of training. All three are located in Moroni. Thirdly, there is a tax on the execution of judgments, known as taxe proportionelle, which can be relatively high. The tax, which is due and payable immediately upon the delivery of a certified copy of the judgment, is widely regarded as a further disincentive in the process of execution of judgments. Finally, there are other factors, including political interventions and close community ties, particularly in rural areas, which impede the process of execution of judgments. B. The Policy Framework Financial Sector Policies7' 2.22 Banking Legislation. The banking sector is governed by two Federal Laws, dating back to 1980; the banking law, which regulates financial institutions and the central bank statutes. The laws are expressed in general terms, and some of their provisions are obsolete, particularly those regarding the banks' minimum capital (CF 100 million, US$210,000), set at a level that is too low. There are no provisions for some usual mechanisms, such as reserve requirements. These laws are now being reformulated, with the assistance of Bank of France experts, and the proposed versions have been sent recently to the International Monetary Fund for comment. The new banking law, after review by the Fund and the Bank, is expected to be in place by mid-1994. 2.23 Interest Rates. The central bank uses the interest rate as the main mechanism for regulating credit. It has not used reserve requirements, which are not authorized under the banking legislation or begun developing money market instruments. From the mid-1980s to the end of 1993, there was little change in the structure of interest rates. Maximum lending rates varied depending on the sector and length of financing, from 11.5 to 15.5 percent per annum and included at least three rates. The minimum deposit rates until November 1993 ranged between 6.5 percent and 7 percent per annum depending on the size of deposit and its maturity. 7/ See Annex 3 for details. - 13 - 2.24 Interest rates were high in real terms over the last five years, given the low inflation (under two percent), but were needed at this level to overcome the distortions introduced by the exchange rate overvaluation. The deposit rates also reflect the central bank's determination to maintain positive real interest rates, comparable to those existing in France, as a means of boosting local savings. The central bank used lending differential rates to provide preferential treatment to certain sectors and, indirecty, encouraged bank specialization. The rates fixed encouraged the commercial bank to finance low-risk short-term operations (particularly trade), to the detriment of medium-term financing of productive activities, which involved greater risks. The development bank, in turn, had its rates capped by donors, and did most of the long-term financing. 2.25 The rediscount mechanism has never been used, although the central bank has had a rediscount facility on paper, and lending rates were set in relation to the rediscount rate. Because of the large spread originally approved for the BIC, it rapidly became very liquid which meant that it did not need to resort to financing its short-term operations. 2.26 The recent devaluation of the Comorian Franc has eliminated a major distortion in the financial system. A new policy framework which begins addressing past distortions has been agreed with the Bank and the Fund. The PFP reflects the Government's commitment to major changes in the structure of interest rates. The changes introduced in February 1994 include: (i) eliminating the preferential discount rates of 6 percent and 6.5 percent, which were replaced by a single discount rate of 8.5 percent, while maintaining the differential between maximum short- and medium- and long-term lending rates (medium- and long-term operations will be subject to the same maximum lending rate of 12.5 percent), and (ii) increasing all interest rates by 1 percent. Following the devaluation, inflation in the Comoros could surpass 10 percent in 1994. This is expected to be a temporary phenomenon and according to Bank-Fund projections, inflation is expected to go down to 4 percent for the 1995-96 period. The newly-introduced rates would thus be positive in real terms. Furthermore, the central bank has agreed to review periodically interest rates to reflect inflation and macroeconomic conditions. 2.27 Impact of the Devaluation on Banks. The appraisal mission of the project undertook a detailed analysis of the impact of the devaluation on the banks. In the case of the BIC, the expected impact is expected to be positive: the bank does not have any foreign exchange liabilities and the devaluation is expected to increase demand for short-term trade credit, thus mopping-up the bank's excess liquidity. The devaluation might have a negative impact on the BDC if it is confirmed that the Bank is expected to bear the foreign exchange risk of one of the past EIB lines of credit (of CF 150 million, US$310,000 equivalent). Available information is that the Government has agreed to bear this risk. In any case, BDC is sufficiently capitalized to meet such an obligation and still be eligible to participate in the line of credit. 2.28 Bank Supervisio . The role played by the central bank in bank supervision is limited, even though it is a generally well-run institution. Apart from the thorough on-site examinations performed for the BCC every three or four years by Bank of France staff, the last one taking place in December 1993 (a smaller-scale inspection of the BIC and the BDC took place in 1992 to determine the feasibility of opening another deposit bank in the Comoros), its action is limited basically to monitoring for the BIC's principal commitments and the centralized recording of bad checks. The reason for the individualized monitoring of the BIC's principal operations is that there is a very small number of enterprises responsible for the majority of its transactions, particularly in the area of foreign trade. Since this situation results in heavy risk concentration, particular attention from the central bank is called for. A program to train central bank staff in bank monitoring and supervision is in progress, supported by the Bank of France. - 14 - Exchange Rate and Trade Policy 2.29 The Comoros benefits from an open trade regime and a currency which is convertible. One problem in the past was that the overvalued exchange rate, which discouraged exports and encouraged import substitution activities, tended to aggravate the trade deficit, and forced the authorities to rely on tight monetary policy. The January 1994 devaluation is an important step expected to improve the balance of payments situation. The continued pursuit of prudent monetary policy should help maintain low inflation and exchange rate stability. 2.30 There are no policy-induced trade restrictions in the Comoros. However, the country has strong links with France and four French suppliers provide the bulk of imports. This phenomenon is in part caused by monopolistic maritime transport links and leads to increased import costs. Alternative, lower-cost suppliers are now being sought by Comorian traders and this should result in increased regional trade (with Southern and Eastern Africa). Services transactions are also relatively free and, in particular, there are no restrictions on the repatriation of dividends and profits by foreign investors. 2.31 Trade taxes, particularly tariffs, constituted an important element of fiscal and trade policy both as a revenue instrument and as a tool for protecting local activities and overcoming the overvaluation problem. These taxes were simplified in 1993 and the two components of tariffs (customs duty and consumption tax) were rationalized by the introduction of: (i) a single customs duty of 10 percent for all products; and (ii) only four consumption tax rates. Tariffs now range from a minimum of 20 percent to a maximum of 80 percent. In addition a flat 10 percent turnover tax has been introduced, which is for the moment only collected on imports. The 1994-96 PFP calls for further tariff reforms after 1994, so as to reduce tariffs and improve the collection of the consumption-based tax. Incentives 2.32 Price Controls. Since 1975, prices in the Comoros were administered by decree, which set margins on all products. A ministerial decree signed on January 22, 1994, lifted price controls on all products, except for 12 key consumer goods. The list of these products was agreed with the Bank and the Fund in the context of the 1994-96 PFP discussion. While recognizing that prices of natural monopolies will have to continue being regulated, the PFP provides for further price liberalization in the medium term. 2.33 Corporate Taxation. The tax code of the Comoros provides for fairly high tax rates (for example, 50 percent on profits). However, up to 1993, tax collection has been very low due to institutional weakness. Since 1993, the Ministry of Finance's tax administration is being improved with the establishment of the Enterprise Taxation Unit. Vigorous efforts are now being pursued to expand the tax base, particularly by registering and collecting taxes from enterprises with annual turnover exceeding CF 20 million (US$45,000). One problem being encountered is lack of accounting in most Comorian firms, a problem being tackled progressively by the CASP. An even greater problem is the high nominal tax rates, which tend to encourage fraud. The 1994-96 PFP provides for the revision of individual taxation in 1995 and of corporate taxation later on. The project will finance the necessary studies to this effect (para. 3.31). 2.34 Investment Incentives. Incentives are presently made available to investors through the investment code, a procedure lacking transparency and subject to arbitrariness. The Government action plan calls for the introduction of transparency in the benefits by providing automatic tax incentives in the general tax code. Moreover, the investors' legal property rights need to be strengthened through - 15 - appropriate legislation (para. 2.14) as well as, for foreign investors, other initiatives such as membership of MIGA or similar schemes. 2.35 Tourism. In spite of the Galawa hotel's success, sustainable development of the tourism sector is hindered by the lack of: (a) a clear sectoral framework which specifies the institutional responsibilities, the regulatory framework and the incentives system; and (b) some of the basic infrastructure. These constraints are linked to the lack of a tourism strategy and incentives framework, insufficient consultations with existing and potential private operators, and the fact that the Galawa arrangements cannot be generalized. An appropriate sectoral framework will thus be studied under the project: issues to be resolved range from whether it is desirable to have a specific fiscal regime for tourism-related activities (such as lower direct tax rates) to what types of regulations should be put in place for operators (classification of facilities and minimum standards). The proposed IDA environment project would tackle other key issues including, preserving the wildlife, creating and maintaining hiking trails, including the one now in a state of neglect, leading to the volcano, and cleaning up the beaches. 2.36 Exports, The development of non-traditional export activities needs to be sustained by a steady and patient continuing effort. There are no specific export incentives in the Comoros at present. The development of export activities could be stimulated by: (i) granting tax and other incentives to exporters, possibly through an indirect taxation compensation scheme and income tax rebate (e.g. 10 percent of the value of exports for the former and 50 percent rebate for the latter); and (ii) establishing free-zones for export processing and re-export trade, if such arrangements are shown to have the potential to be viable. The Comoros is already committed, in the 1994-96 PPF, to enhance regional cooperation, as a member of the Preferential trade area. These possibilities will be studied under the project (para. 3.31 (d)). C. Government's Private Sector Development Strategy 2.37 The Government's vision of the Comoros 20-25 years into the future would build on effective development of the country's special assets and production potential. It would require above all a broad-based, carefully phased and articulated strategy for human resource development, including efficient primary education, innovative approaches to vocational training (for example through video correspondence courses), closer linkages with professional associations and the Comorian community abroad, and advanced communications. At the end of the period, the Comoros could become much more of a service-based economy (tourism, commercial and data services, financial services) supported by a more dynamic agricultural sector and rounded out by light manufacturing, including the following features: (a) An agriculture sector which would be more productive, competitive, and more diversified into high value 'niche" export products (e.g., herbs, spices, fruits, flowers, new sources of perfume essence); the strategy to diversify exports into high value, specialized items such as herbs, spices and perfume essences focuses on creation of a more dynamic business environment, and extension of the existing export sector to acquire market information, identify the needs of individual buyers and companies, negotiate production contracts, and attract foreign participation. (b) A tourist sector expanding initially on Grande Comore and later on Moheli, catering for a diversified range of tastes from full package charter operations, outfitter style eco- tourism and, later, full value, individual tourism. - 16 - (c) An export-oriented industry (e.g. garments, knitwear, shoes) in Anjouan and Grande Comore, where there is an abundant labor force. (d) A healthy private service and small business sector, formal and informal, engaged in a variety of services (e.g. tourism-related activities, banking and insurance) and small-scale activities geared both to the domestic market and for export. (e) Increased specialization among the islands, in line with points (a), (b), and (c) above, given their different resource potentials and more trade between them. (f) The maturing of community institutions at the level of villages and towns in the provision of social services, small-scale infrastructure (markets, common energy and water services) and protection of the environment. 2.38 To converge towards these long-term objectives, the project would tackle priority issues, which are an integral part of the Government's private sector development strategy and related policy and institutional reform measures. These are outlined in the Statement of Sectoral Policy and the matrix of reforms (Annexes 1 and 2) to be adopted by the Government before Board presentation. 2.39 The project will support the implementation of the Govermnent strategy, by implementing an approach for promoting SSEs and tackling the main constraints facing the private sector, which involves improving the productivity of SSEs, helping remove sector specific legal, regulatory and economic policy barriers, and encouraging the banks to finance SSE projects. The approach is detailed in part in the Statement of Sectoral Policy and in part in the 1994-96 PFP. The project would provide financing for investment, and assistance to promoters and for revamping the legal and judicial system, as well as for undertaking the necessary studies to formulate policy reforms. III. THE PROJECT A. Project ObWectives and Rationale 3.1 The objective of the project is to help the Government implement its development strategy (para. 2.37-38) by providing the nascent private sector with the means and incentives to engage in productive investments. To assist the Government in the implementation of this strategy, the Bank is supporting the establishment of an incentive framework conducive for private sector investment and providing resources to enhance its competitiveness. To initiate this process, the MERCAP credit supported steps towards opening the economy to internal and external competition and creating new opportunities for private promoters in areas reserved previously to the State (para. 1.5-6). 3.2 Experience with adjustment in other countries has demonstrated that to help ensure sustained private sector response, incentives, institutional, and legal and regulatory impediments to private investment need to be addressed in conjunction with macroeconomic and public enterprise reforms, particularly for the development of micro-enterprises and small-scale firms in the semi-formal and formal sectors. This experience is also relevant to the Comoros. Lacking the financial resources required and alternative financing, the Government has therefore requested Bank support in these areas, which complement reforms under the MERCAP. The project will provide such support, together with complementary resources for investment and institutional strengthening. - 17 - 3.3 To ensure complementarity, the project has explicitly taken into account the donor community's planned and ongoing efforts, including those of the IMF, the EU and French Cooperation. The project has been prepared in close collaboration with, and with the full participation of Government officials (particularly the staff of the Ministries of Finance and Justice, and the structural adjustmnent committee) and private sector entrepreneurs. Moreover, at the Government's request and reflecting its commitment, the quality of project preparation has been enhanced with a PPF, which has helped specify certain project details and provided an early start to the implementation of an improved business environment. B. Lessons from Previous Bank Experience and Bank Group Strategy 3.4 The latest Country Assistance Strategy for the Comoros was presented to the Board on December 14, 1993. To help the Comoros achieve sustained growth with equity, the Bank's assistance strategy supports the Government's development priorities in three main areas: (i) enhancing competitiveness and promoting private sector development; (ii) developing human capital, alleviating poverty, and reducing population growth; and (iii) protecting the fragile environment. As indicated in the project objectives, the project is in full agreement with, and an essential component of, this strategy, which is founded on private sector-led development. 3.5 The project has been designed to take into account lessons from previous experience. IDA extended a line of credit (Cr. 1378-COM, of May 12, 1983) to the Development Bank of Comoros (BDC). This Credit's Project Completion Report (PCR No. 8764-COM, distributed to the Executive Directors on November 1, 1990) indicated that the project was implemented faster than anticipated and attmined most of its development objectives. The report also noted that the political situation was unstable, and further deterioration, as well as the planned reductions in the number of civil servants, including some who had guaranteed debts, might have a negative impact on the BDC's portfolio, a situation that has materialized. BDC has already constituted sufficient provisions for the part of the portfolio that is affected, and is preparing a business plan to strengthen the institution and make it more responsive to SSEs. In line with approach towards broader-based and more efficient intermediation, the project (i) has moved away from a single institution approach towards multi-institution oriented operations, and (ii) supports measures aimed at improving the business environment. 3.6 The project also incorporates the lessons learnt from past Bank experience with SSE lending to ensure this target group is reached'. While highlighting the importance of ensuring conformity with Bank guidelines on financial sector operations (OD 8.30), this experience demonstrates the importance of entrepreneurs' receiving privately provided assistance during the conception of their investment projects and downstream help to overcome operational problems. The project would ensure that such assistance is made available through the CASP. 3.7 Bank experience with technical assistance projects in Africa has been mixed, due to lack of ownership by Governments, and because long-term experts have tended to substitute for their counterparts, while neither the work program nor expected results have been clearly identified. The institutional strengthening proposed for the Ministries of Finance and Justice will finance expert advice and training for local staff. This support will be provided mainly through short-term assistance provided by international and local experts, collaborating closely with qualified and motivated government 8/ See 'World Bank Lending for SMEs: Fifteen Yean of Experience," Industry and EnerV Departmet Woiking Paper, No. 20, December 1989. - 18 - counterparts. These experts are expected to have access to decision makers to ensure rapid actions, while working as a team with their counterparts and providing them with on-the-job training. 3.8 Adjustment lending in the Comoros dates back only to 1992. During the short time that has elapsed and despite difficult conditions, the Government has demonstrated its willingness to fulfill its commitments and undertake macroeconomic and PE reforms under the MERCAP. Implementation of the reform program, however, has been slower than expected, mainly because implementing agencies have lacked the necessary financial and skill resources. To ensure the proper implementation of measures aimed at improving the business environment, the project will finance the material and expert assistance (hired by the Government) requirements of institutions responsible for formulating and implementing the agreed private sector reforms. The commitment of private sector operators, Government officials and the donor community to the project, which has been ensured by involving them in various stages of project preparation, further strengthens the Government's determination to implement its strategy. C. Project Description 3.9 The total project cost is estimated at about US$7.7 million and it includes an IDA Credit to the Islamic Federal Republic of the Comoros of US$5.1 million (SDR 3.7 million). Expenditures for studies and consultants to launch policy reforms between pre-appraisal (December 1993) and Credit Effectiveness are being financed through a PPF. The project consists of four, mutually-reinforcing components: (a) a line of credit which will provide long-term resources needed by banks to finance medium- and long-term investment; (b) an enterprise development fund to help entrepreneurs improve the design of their projects and strengthen their managerial capacity; (c) training and institutional support to the Ministry of Justice to strengthen its capability to design and implement legal and judicial reforms; and (d) training and institutional support to the Ministry of Finance to undertake studies and prepare an action plan for improving the business environment, and to oversee project implementation. The project will help ensure that the major business environment and know-how constraints to the private sector are alleviated, and that long-term resources are available to finance the SSE investment. The project will help the Government implement its strategy which is spelled out in the Statement of Sectoral Policy and the policy matrix (Annexes 1 and 2). Supporting Investment: Line of Credit Component 3.10 Size of the Line of Credit. The current macroeconomic projections by the Bank and the IMF estimate that private sector investment in industry and services of between 2.5-3.5 percent of GDP annually (US$6-S8 million) is required to achieve GDP growth of 4-6 percent between 1995 and 1999. This investment estimate excludes agriculture but includes animal husbandry, agro-processing, small-scale industry, services and housing. The projection implies that the private sector's investment during the period would range between US$24 million and US$32 million. On the basis of experience in the Comoros and elsewhere in Africa, no more than 50 percent of investment is likely to be financed through investor's equity contributions and the financial sector's own resources. Based on the overall growth projections and likely availability of equity capital, the demand for term financing is estimated to amount US$12-16 million during the second half of the 1990s. 3.11 These global estimates are broadly in line with the results of the evaluation of the existing investment pipeline. During the past five years, the banking sector has financed about US$2 million per year of investment projects (US$8 million over 4 years), and this is expected to increase in response to the improvements in the business investment environment. The existing pipeline (prepared by the CASP or submitted to BDC by private promoters) of viable SSE projects and the rehabilitation requirements of tourism-related infrastructure (mainly hotels) indicates financing needs of about US$4 million. In - 19 - addition, case studies show that the rehabilitation of existing investments (other than for hotels) and permanent working capital needs of enterprises, would require financing of around US$2 million and US$1 million, respectively. Thus, investment financing requirements based on existing demand surpass US$7 million. If additional demand stemming from the expected supply response is taken into account, demand for investment financing by the banking system for the second half of the 1990s can be estimated at about US$12 million, which is consistent with the global projections. 3.12 The project proposes a line of credit of US$2.5 million, a small part of which (less than US$0.5 million) may be used for housing (para. 4.8). It is estimated that during the commitment period of January 1, 1995 - December 31, 1999, demand for IDA funds would amount to 21 percent of the conservatively estimated term credit demand of US$12 million. Remaining financing would come from resources in the banking system and from external donors, primarily the EU (European Investment Bank, EIB) and French Cooperation (CFD). These donors have already agreed to finance two lines of credit totaling US$3.5 million. The IDA line of credit would help flll some of the financing gap and complement donor financing: (a) the recently decreased lending floor of US$20,000 of the EIB line (which in the past only financed investment projects of US$70,000 or more) still excludes lending to some SSEs; (b) other donors' lines of credit limit their financing to equipment and material purchased from European suppliers, at a time when the devaluation encourages a switch to other lower-cost suppliers, and exclude certain types of investments (notably permanent working capital); and (c) the IDA line of credit would be the only refinancing facility available to the commercial bank. 3.13 IDA financing will be through a line of credit, which would finance, through eligible financial intermediaries, the foreign exchange and local cost component of investment for new and existing enterprises registered in the Comoros on condition that such projects are financially profitable and environmentally sound. Projects expected to be financed under the Credit are not expected to have an unfavorable impact on the environment (para. 5.3-5), because they will be small, labor- intensive and/or service activities. Apart from such new investments by SSEs, the line of credit will also finance investments to rehabilitate enterprises and the necessary permanent working capital of firms. In the absence of specialized financial institutions and to promote the private construction sector and cottage industries, which are run from entrepreneurs' homes, a small portion of the line of credit can be used to finance private dwellings. 3.14 Institutional Arran2ements. The development bank and the commercial bank are the only banks operating in the Comoros today. These financial institutions were appraised as per OD 8.30 (para. 3.16) and, as described in detail in Annex 3, fulfilled the eligibility criteria to participate in the line of credit. The appraisal mission also verified that both banks had adequate project appraisal capacity in- house, including that needed to undertake housing finance. To reduce administrative costs and simplify the institutional arrangements, there will not be a line of credit management institution. Instead, the line of credit will be committed on a first-come first-serve basis. Should a new bank be established in the Comoros, the Credit Agreement provides for the possibility that such a bank could qualify to use IDA resources, provided it meets standard eligibility criteria. 3.15 Proceeds from the Credit would be channelled from the Government to the commercial and the development banks (the participating financial intermediaries, PFIs), which would in turn lend to the final beneficiaries of the project. The PFIs will assume the commercial risk of the subloans granted under the Credit. Technical assistance and training of the staff of the PFIs in project appraisal and environment issues will be required, and to that effect, US$100,000 will be allocated under the enterprise development fund component (paras. 3.36 (d)). IDA will review three appraisal reports of PFIs (para. 3.22). PFIs' subloan administration and supervision will be periodically reviewed jointly by the Government and the IDA. The two PFIs have each agreed to enter into a Participating Agreement - 20 - with the Government defining their functions, under terms and conditions satisfactory to IDA. The signing of the Participating Agreement by at least one PFI is a condition of effectiveness of the Credit (para. 6.3(a)). 3.16 Participating Financial Intermediaries. Banking institutions in the Comoros are generally sound, but the difficult environment of the past few years has affected the quality of the banks' portfolios. The financial and institutional appraisal undertaken and detailed in Annex 3, has determined that BIC meets the criteria to be a PFI. The same goes for BDC, subject to the implementation of a business plan (Annex 5). BDC has already taken measures to improve loan collection and has constituted sufficient provisions for bad loans. BDC has agreed, during negotiations, to implement the business plan mentioned, containing measures aimed at: (i) putting in place a process which would be better suited to assess SSE subprojects and evaluate their risk; and (ii) reducing operational costs with respect to turnover, and intensifying supervision to increase loan recovery. The Government, on the other hand, has agreed (in December 1993) to repay BDC by end-1998 for the funds withheld from civil servants' salaries on its behalf: half of this payment has already been made (February 1994). The business plan to enhance BDC's performance is a condition of disbursement for BDC's part of the line of credit (para. 6.6(c)) and satisfactory progress on its implementation will be monitored during IDA supervision. 3.17 Participating financial intermediaries will agree to implement institution-buildingmeasures as required under the project, and to undertake annual audit of their financial statements by independent external auditors satisfactory to the Government and IDA. The PFIs' additional responsibilities, to be specified in the Participating Agreements include the following: (a) designate qualified staff to manage the subloans financed by the project; (b) perform satisfactory subproject appraisals based on agreed procedures and formats; in so doing, PFIs, in collaboration with the CASP, will pay particular attention to sensitizing project promoters to potential environmental hazards of individual subprojects, and adhering to Bank procurement and environmental guidelines; (c) maintain simple administrative, lending, guarantee, and disbursement procedures to facilitate commitment and disbursement of subloans; (d) ensure that resources are used by the final borrowers for the purposes intended; (e) supervise the implementation phase of subprojects and promptly inform the Government and IDA of major problems expected to delay disbursements and project completion; to that effect PFIs should submit periodic reports on the status of subprojects; (f) provide training for their operational staff and technical assistance to build up internal capacity and carry out the tasks described above; (g) adhere to agreed terms and conditions of lending and repayment of loans and bear the credit risk; (h) provide the Government and IDA with such information as they would reasonably request, including annual audits of their financial accounts and statements performed by qualified and independent auditors, acceptable to IDA; the project would pay for 50 percent of the cost of the audits; and - 21 - (i) maintain a satisfactory capital adequacy ratio calculated according to the method of the Cooke Committee of the Bank for International Settlements (para. 6.6 (b)). 3.18 Eligible Beneficiaries and Subprojects. All productive and extractive activities, transport, trade and all other services which contribute to the economic development of the Comoros will be eligible for financing. Ineligible projects will be the financing of land acquisition and development, office construction for rental purposes, investments by parastatals with majority government direct or indirect ownership, and working capital requirements of commercial enterprises. The line of credit will finance fixed assets and associated permanent working capital for new operations, extensions and rehabilitations. The PFIs will be able to finance housing (with limits set in para. 4.8). Self-standing permanent working capital requirements for enterprises, other than those involved in trade, will also be eligible. Eligible subprojects, other than housing, will have to meet the following criteria in order to be approved for refinancing under the Credit: (a) a minimum projected financial rate of return of at least 10 percent in constant prices; in the case of housing, the willingness to pay positive interest rates will be used as an indication of subproject viability; (b) projected debt servicing capacity (defined as the ratio of interest and principal annual payments to cash-flow generated from operations), should be no less than 1: 1.5 over the life of the subproject and the projected long term debt to equity ratio should be no more than 2.33:1 with the ratios calculated on the basis of the enterprise's total debts, inclusive of those to be incurred under the subproject; and (c) satisfactory environmental impact reviews will be undertaken according to the National Environmental Action Plan, and as deemed necessary by the Government or IDA, in cases where the technical review of appraisal reports of projects indicate they may represent potential environmental hazards' (para. 5.3-5). 3.19 In the case of housing, individual constructions for rental wIll also be eligible. In order to ensure that the target group is reached strict criteria will be used: the Credit will finance up to US$9,000 equivalent; and the total living area must not exceed 130 sq.m. These criteria have been based on a successful experience of CFD with BDC in the late 1980s, but have a narrower definition of what constitutes eligible housing. The largest mortgage represents about four years of an average civil servant's salary and maximum monthly payments calculated at 12 percent interest over 12 years would amount to about US$115 per month. 3.20 Subloan Processing and Administration. Sub-loan processing under the project will be coordinated by each PFI. Subproject appraisal reports would be prepared by the beneficiaries in accordance with the agreed project appraisal procedures and criteria with, as needed, assistance from the CASP and presented to the PFIs. The latter would review the financing requests in accordance with their own appraisal and lending criteria and internal operating procedures, and decide on whether or not to go ahead with the financing. 3.21 The PFIs are responsible for ensuring that all eligibility and financing criteria and conditions are met. This appraisal review would be carried out on the basis of a simplified appraisal 9/ As already provided by law, corab (sand or reef) would not be used for construction. Furthernore, subprojwcu will be screened to enmuro they do not intend to extract fuclwood from the natural forest. - 22 - report for projects with an estimated investment cost of US$100,000 or less and on the basis of more in-depth reports for projects with a higher investment cost. The PFIs are responsible for ensuring that subborrowers have undertaken procurement consistent with agreed Bank Group guidelines (para. 4.30). If the subproject is eligible for refinancing and satisfies the required technical and financial rates of return criteria, the PFI will use the proceeds of the Credit for the expenditures or opening of letters of credit for foreign suppliers. Subprojects requiring subloans equivalent to, and exceeding about 8 percent of the Credit component, i.e., US$200,000, would not be eligible for refinancing, unless prior approval is given by IDA. 3.22 To ensure internalization of project appraisal procedures, PFIs would require prior IDA approval of their first two appraisal reports, and the third, as long as one of the first three subloans exceeds US$100,000, or the first subsequent subproject sith a subloan exceeding US$100,000. In addition, IDA would review a representative sample of subprojects, appraisal reports, and approvals on an ex-post basis during supervision missions. Improving Business Laws and their Application: Legal Reforms and Strengthening the Judiciary. 3.23 The Reform Agenda. The project would support the strengthening of judicial institutions, and the formulation and implementation of an action program to put in place modern business laws and remove observed deficiencies. This action plan has been developed on the basis of a review of the legal and judicial framework' and the work of the appraisal team, and agreed with the Government (its detailed description is set forth in Annex 4, and key reform areas are identified in the Government's policy statement and policy matrix, Annexes 1 and 2). The proposed legal and judicial reform program involves a number of sub-components as follows: (a) compilation, consolidation and publication of existing commercial and business laws; (b) rehabilitation of the process of publication of the Official Journal; (c) establishment of a Law Reform Commission to review, and propose amendments to, existing commercial and business legislation, with particular emphasis on the Investment Code, property laws, the Commercial Code, Company Law and the Labor Code; (d) measures to streamline the litigation process in the lower courts, and enhance the capacity of such courts to dispose of commercial law cases, including the establishment of a commercial court jurisdiction, the appointment of conciliation judges, the introduction of a reporting mechanism for magistrates, and a review of the work environment of magistrates and the adequacy of court procedures; (e) development of a training program and other measures to improve the process of recruitment and the level of training of magistrates and other paralegal staff; (f) measures to strengthen the effectiveness of the Ministry of Justice and, in particular, its newly-created Legislative Drafting Division (LDD) and Legal Information Center (LIC), responsible for legislative drafting and legal information services, respectively. 10/ Robert Garron, Rapport de Mission our le Cadre Juridiquc et Judiciaim des Affairts aux Conoma, 1993. - 23 - 3.24 Law Reform Commission. To enhance the process of law revision, the Government will strengthen the newly-created LDD. It will also establish a Law Reform Commission which will have primary responsibility for the supervision of the process of revision of business laws. The Commission, which will consist of business and business law experts, including lawyers, magistrates, bankers and other representatives of both the private and the public sectors, will collaborate closely with LDD. Its role will not be to substitute its own judgment for that of LDD, but merely to offer general policy guidance to LDD on the substance of proposed drafts, and to review and approve such drafts as and when they are submitted to it from time to time by LDD. The Law Reform Commission will be established, as an Effectiveness condition (para. 6.3 (c)), and its business plan for the first fiscal year submitted to IDA for approval shortly thereafter. 3.25 Coordination. The Government will, during the first half of 1994, recruit a long-term consultant, financed initially by the PPF, to be the coordinator for the legal reform component of the project. The Legal Reform Coordinator, who will be a lawyer and, preferably, of Comorian nationality, will help ensure the implementation of the various sub-components of the legal reform component (see Annex 4 for terms of reference). The Legal Reform Coordinator will report to the Legal Affairs Director of the Ministry of Justice. He will be assisted by a steering committee, consisting of representatives of magistrates, judges, the unit responsible for the Official Journal, and other parties who may be interested in the preparation and implementation of the proposed project. 3.26 The Legal Reform Coordinator will ensure compliance with any conditionality that may be related to the legal reform component under the proposed project. In particular, he will be responsible for the procurement of goods and services, and for the selection of consultants, required under the legal reform component. He will supervise the preparation and implementation of the training program under the legal reform component. He will also be assisted by the overall Project Coordinator in the preparation and submission of disbursement requests, and will provide information needed for the management and consolidation of the accounts of the Project. 3.27 The proposed project would finance materials and equipment, including library materials, and materials, furniture and equipment to strengthen the commercial courts (including the commercial registry), the Ministry of Justice (LDD/LIC) and the unit responsible for the Official Journal (US$310,000). It would also finance short-term consultancy services to assist in the process of compilation, consolidation and publication of laws, to support the law revision exercise and, finally, to assist in the preparation and implementation of the training program (US$650,000). Finally, the proposed project would also cover the cost of the services of a long-term consultant to be the legal reform coordinator and a legal secretary (US$120,000). The total component cost is estimated at US$1.1 million, US$0.85 of which will be financed by the Credit; the rest will be financed by the Government and/or donors. 3.28 Library materials would include law books and periodicals, and ancillary materials and equipment, required to rehabilitate the law library. A tentative list of law books and periodicals is in the process of being compiled. The list will take full account of the needs of both the legislative reform program and the training program under the proposed project. Inevitably it will consist mainly of books and periodicals which are relevant to commercial and business laws. Prior to the disbursement of funds to finance library materials under the proposed project, the Government will be required (a) to submit a proposed list of law books and periodicals to IDA for approval, and (b) to satisfy IDA that it established adequate rules to control access to the law library facilities, and taken all other necessary measures, including the recruitment of a full-time law librarian, to ensure the safe-keeping of books and periodicals procured under the proposed project (para. 6.4 (b)). - 24 - Implementing the Government's Economic Strategy: Institutional Strengthening and Capacity Building 3.29 The Government has agreed on sector reform objectives and the associated timetable for actions (Annex 2) and will ensure that implementing agencies have the minimum resources required, which will be provided by the Credit. The implementation of the strategy would entail taking specific measures to tackle constraints linked to taxation and public enterprises and to promote tourism and exports. The national coordinator financed by the project would be responsible for implementing this component and the EDF component, supervising a project accountant for all the components except for the line of credit, as well as following the execution of the EDF component (paras. 3.36). The Credit will also finance short-term consultants for studies and expert advice, and training and equipment requirements. To ensure an early start of the reforms, the project coordinator was hired in March 1994 under the PPF. The PPF will also finance various priority studies and training for the Ministry of Finance. The Credit would contribute US$400,000 for the execution of this component, described below. 3.30 Taxation and Incentives. The objective of tax reforms is to strengthen the tax base while decreasing tax-related distortions. The Government's action plan calls for improving the direct and indirect taxation. Tariff reform supported by the IMF is already underway (para. 2.31). The project will provide resources for the implementation of the short-term tax reform plan, which has been agreed with the IMF. The main elements of this plan include: (i) strengthening the Ministry of Finance's tax administration department; (ii) introducing a consumption tax of 10 percent, with a deduction mechanism for industries to avoid cascading effects, and from which SSEs with turnover of FC20 million or less (US$70,000) will be exempted; and (iii) decreasing the nominal tax burden for individuals and corporations, respectively to 30 and 40 percent. Most of these reforms should be completed by December 31, 1994. 3.31 The project will finance the studies needed to formulate a medium-term tax reform and investment incentives enhancement plan, with emphasis on eliminating distortions and stimulating investment. Studies will be undertaken between 1994 and 1996 would help specify: (a) how corporate taxation can be simplified to cause fewer distortions and/or be less burdensome on enterprises (e.g., elimination of dividend taxation, faster depreciation allowance, harmonizing top company and individual tax rates to 30 percent); (b) the specific provisions of the tax system that are inappropriate for SSEs or inapplicable to them, and how they can be improved; (c) whether, and to what extent, the fiscal advantages of the investment code (income tax holiday) can be integrated into the general tax code, with little or no prior review procedures; and (d) to give tax and other incentives to exporters, how an indirect taxation compensation scheme and income tax rebate can be conceived (e.g. 10 percent of the value of exports for the former and 50 percent rebate for the latter), how export regulations can be simplified by eliminating regulatory controls, and whether it would be feasible to create a free-zone. 3.32 The studies pertaining to the above issues should be launched so that most are completed by June 30, 1996. On the basis of their results, an action plan should be completed and, following consultations with the IMF, agreed with IDA by December 31, 1996. Key actions should be implemented - 25 - by December 31, 1997. The study of free-zones should be completed by November 30, 1996, and further actions in this area will be discussed with the authorities by the mid-term review. 3.33 The project would support a first step towards developing and implementing a comprehensive program for developing the tourism sector by financing studies for elaborating the sector's incentive and legal and regulatory framework. The Government would also assess the possibility of creating an independent tourism advisory board, whose task would be to help the Government fine-tune the sectoral framework and promote the activity. Progress on this issue would be revisited at the latest during the mid-term review. 3.34 Public Enterprise Reform. Public enterprise reform is central to private sector development. PE rationalization and privatization will create new opportunities for private sector development in activities hitherto reserved for the State and reduce the high cost of service PEs (utilities and transport) while improving their quality of service. The project will build on the pragmatic approach adopted by the authorities under the MERCAP and will finance studies for the specification and the implementation of a more global approach, incorporated in the 1994-96 PFP, encompassing the following areas: (a) putting in place a legal framework for PEs, designating the Ministry of Finance as responsible for overseeing privatization, and adopting revised statutes for key PEs (EEDC and SNPT). (b) identification of public entities without formal status engaged in commercial and industrial activities, and the formulation and implementation of an action plan for the disengagement of the public sector from these activities; (c) partial or complete privatization of PEs including, SCH, Air Comoros and SOCOPOTRAM (certain commercial functions), merger of SNI and Al Watwan and adoption of private status for them, as well as for the Chamber of Commerce and COMOTEL; and (d) restructuring of the SOCOPOTRAM, EEDC, Air Comores, SNPT and Hahaya airport. 3.35 The Credit will finance training, studies, equipment and materials needed to formulate and start implementing the above action plan. The privatization of the SOCOPOTRAM's commercial activities and the Chamber of Commerce, and the restructuring of EEDC will be given priority, and progress in these areas will be reviewed periodically. Encouraging Entrepreneurship: Enterprise Development Fund (EDF) 3.36 The Credit would contribute US$850,000 to an enterprise development fund, which will provide specialized assistance programs to SSEs, on a cost sharing basis, and financial institutions financing them. These programs have been conceived within the framework of the strategy to promote SSEs, as well as human resource development and capacity building in the private sector, and have been designed to complement other donor initiatives. The CASP, would manage the EDF and execute the first two of the following three components. The last component will be executed by the Ministry of Finance. The assistance contemplated is the following: (a) short-term (about one month) expert advice to groups of about 10-20 entrepreneurs with similar problems. To minimize costs while ensuring quality advice, the experts will be - 26 - selected among the pool of international volunteers (retirees). The project will finance about 10 such interventions over a period of 4 years. (b) About 50 man-months of expertise in collaboration with Comorian experts. This includes an engineer for three months or more at a time over a period of up to four years, and a financial analyst for about two years, and the EDF principal technical adviser). The EDF manager will be the coordinator of the CASP. The Credit would contribute to about 6 man-months of the cost of the CASP's principal technical adviser (an expatriate), to reflect additional responsibilities related to implementing the EDF component. (c) Training for banks in medium- and long-term lending. Emphasis will be put on assisting the BDC implement its business plan and change its organizational culture, in the context of its restructuring plan, acquire the know-how needed to assess better tie risk of small credits and become more responsive to the needs of SSEs. In addition, special training on environmental assessment of subprojects will be provided to the PFIs. IV. THE PROPOSED CREDIT AND MAIN FEATURES A. Amount and Allocation of Funds 4.1 The proposed IDA Credit of US$5.1 million will be made to the Islamic Federal Republic of the Comoros, which would on-lend the line of credit component (US$2.5 million) to the PFIs. The PFIs will in turn on-lend proceeds of the line of credit component to beneficiary private enterprises on terms and conditions described below. US$0.4 million for institutional strengthening and US$0.85 million for legal and judicial reform will be transferred to the respective executing agencies and managed by them. The Government will allocate US$0.85 million for an enterprise development fund, which final private beneficiaries and the banks will receive as a grant on a cost-sharing basis. The Credit will also provide US$200,000 of financing for yearly audits of project components (including for PFIs for up to 50 percent of audit costs), US$140,000 for incremental operational cost associated with project implementation, and US$200,000 will be unallocated. 4.2 Estimated Project Costs and Financing Plan. Total project costs are estimated at US$7.7 million equivalent, of which US$5.38 million equivalent (70 percent) would be in foreign exchange. A summary of the project costs and expected financing is given below (Table 4.1). Table 4.1: Estimated Project Cost and Financing (million US$) Estimated Project Cost Lcal Foreign IToal (A) Investments 1.65 2.80 4.45 (B) Legal and Judicial Reform 0.20 0.90 1.10 (C) Institutional Strengthening 0.20 0.30 0.50 (D) Enterprise Development Fund 0.12 0.88 1.00 (1) Assistance to promoters (0.10) (0.80) (0.90) (2) Training for banks (0.02) (0.08) (0.10) (E) Audits 0.03 0.22 0.25 (F) Unallocated 0.05 0.15 0.20 - 27 - TOTAL 2.25 5.25 7.50 Financing Elan: Amount Percentages Investment Projects 4.45 100 Subborrowers (Private Sector) 1.00 22 Banks 0.95 21 IDA 2.50 57 L&al and Judicial Reform 1.10 100 Government 0.25 23 IDA 0.85 77 Institutional Strengthening 0.50 100 Government 0.10 20 IDA 0.40 80 Enterprise Development Fund 1.00 100 Private Sector 0.15 15 IDA 0.85 85 Audits 0.25 100 Banks 0.05 20 IDA 0.20 80 Incremental Operational Costs 0.16 100 IDA 0.14 90 Government 0.02 10 Unallocated 0.20 100 IDA 0.20 100 TOTAL&L 7.66 100 Government 0.37 5 Private Sector 1.15 15 Banks 1.00 13 IDA 5.14 67 of which PPF (0.30) (4) B. Terms and Conditions of Financing Line of Credit 4.3 The Government and the PFIs will enter into Participating Agreements. Signature of at least one Participating Agreement between one PFI (BDC or BIC) and the Government is a condition of effectiveness of the Credit (para. 6.3 (a)). The agreement will specify that the Government will pass on the proceeds of the credit component to PFIs at a variable onlending rate initially set at 6.5 percent. This rate corresponds to the cost of funds in the Comoros. This rate will be reviewed periodically (at least once a year) with the Government and changed should conditions in the Comoros and/or France (a key reference market for franc-zone countries) change significantly, particularly if inflation in the Comoros nears 6 percent or increases beyond it. The next review is expected to occur, at the latest, by early 1995, in the context of Bank/Fund discussions. 4.4 A significant increase in the inflation rate is not expected beyond the short-term impact of the recent devaluation. Recent estimates show that between 1989 and 1993, largely due to prudent monetary policy, there was almost no inflation in the Comoros (about one percent). The devaluation is - 28 - expected temporarily to cause double digit inflation. However, according to PFP projections, the inflation rate should fall to under five percent in 1995 and return to historical levels thereafter (during project implementation). In view of the expected low inflation rate and the nature of the target group of beneficiaries (SSEs), the foreign exchange risk will be borne by the Government. The Government will be compensated, by the difference between the onlending rate and the IDA rate. 4.5 The IDA-financed subloans will be reimbursed by PFIs and their borrowers in local currency, unless IDA and the Government otherwise agree. PFIs will be free to charge final beneficiaries up to the maximum lending rate, currently set at 12.5 percent, (or agreed with the IMF and the Bank in the context of the 1994-96 PFP). During negotiations, the Government confirmed these policies including the undertaking to review and adjust interest rates as necessary to ensure that they remain positive in real terms (para. 6.2 (a)). These rates will be reviewed by IDA and the Government at least once every 12 months. 4.6 PFIs would reimburse the funds to the Government in a way that matches repayment schedules and maturities for subborrowers. PFIs and subborrowers would receive IDA funds for subloans for a maximum of 15 years, including five years of grace. 4.7 Because of the scarcity of equity finance, subloans granted under the line of credit would finance up to 70 percent of the total project cost for new subprojects and 80 percent (excluding land) for extension/rehabilitation subprojects. Promoters would thus be required to finance a minimum of 20 percent of subproject cost for extensions and 30 percent of subproject cost for new projects and not to exceed a maximum long term debt to equity structure of 2.33:1. Unless the Association otherwise agrees, the maximum size of any subloan would be limited to US$200,000 for all subprojects. 4.8 To promote the private construction sector, a small part of the line of credit would be available to banks to finance construction of housing, some of which is used for cottage industries (micro- entrepreneurs operating at home) by owners or for rental (eligible housing would be relatively modest constructions with living areas of at most 130 sq.m. and maximum financing needs of US$9,000. However, to favor financing of productive investments, for every four dollars of commitments for such subprojects only up to one dollar would be allowed for housing. An exception to this rule would be in the initial stage of project implementation: in order not to constrain needlessly the banks, each PFI will be allowed to commit up to the equivalent of US$50,000 for housing (up to 4 percent of the line of credit), irrespective of conmmitments for other subprojects. Commitments under the line of credit component are expected to be completed by December 31, 1999, with disbursement terminated by June 30, 2001. 4.9 Legal and Judicial Reform. Funds allocated for the legal reform component would be managed by the Ministry of Justice and would be expected to be committed by March 31, 1999. 4.10 Institutional Strengthening. Funds allocated for the institutional strengthening component would be managed by the Ministry of Finance (mainly to undertake studies and for the project coordinator) and would be expected to be committed by March 31, 1999. 4.11 Enterprise Development Fund. The objectives of the EDF and the procedures described below were agreed with the CASP during appraisal and will be formalized in a Procedure Manual, which was discussed at the technical level during negotiations and whose adoption is a condition of the Credit's effectiveness (para. 6.3(b)). To avoid and identify abuse, the project's annual audit will include a verification of compliance with the Procedure Manual. A cost sharing scheme will be used in the case of assistance to promoters. As a condition of effectiveness, a Grant Agreement will be thus signed - 29 - between the Government and CASP (para. 6.3 (b)). For long-term consultants, and unless the Government and IDA agree otherwise, the fees charged will be in line with those applied at present, i.e., CF 12,000 (US$25) per manlday, which will be retained by the EDF institution as a compensation for management costs. To ensure that the assistance benefits as many firms as possible, unless approved otherwise by IDA, a single enterprise's access to the consulting services of the engineer and financial analyst financed by the Credit would be limited to a maximum of 45 cumulative days. In addition, access to both short- and long-term experts will be limited to private national SSEs (firms with fewer than 50 permanent employees and whose capital is in majority Comorian). For the banks, submission of a training program would be condition of disbursement under the component (para. 6.4(c)). 4.12 For short-term International experts, and unless the Government and IDA agree otherwise, the beneficiaries will be expected to contribute 30 percent of total costs, i.e., about US$300 for one month of specialized assistance. Any given private enterprise or promoter can benefit from a maximum of two such interventions, unless IDA agrees otherwise. Moreover, beneficiaries, with the help of the EDF management if required, would be expected to submit a short but clear description of their problems and proposed intervention and the expertise required in the form of standardized terms of reference. Once approved, EDF would hire qualified experts (almost exclusively amongst international volunteers who offer their services through various programs) on behalf of the beneficiaries, who will be expected to: (i) provide upfront their share of consultant's cost; (ii) sign an agreement that the grants are used for the purposes intended; and (iii) agree to provide the fund's management with information required for monitoring the impact of the interventions. The banks' training would be free (a grant from the Government), but would have to be reviewed and approved by IDA. Finally, in order to ensure that the funds are used for the purposes they were intended, the consulting services to promoters will be hired and paid by the fund. Commitments under the EDF component are expected to last through June 30, 1999. C. Proiect Management. Monitoring and Evaluation Organization and Management 4.13 No new institution would be created under this project. Existing institutions would apply the human and material resources provided by the project to improve their efficiency and the quality of their service. To facilitate project implementation and supervision, since March 1994 a project coordinator (a Comorian expert) has been identified, and will take-up his functions in June 1994. He will be working at the Ministry of Finance, reporting directly to the Minister. Additional to his other duties (outlined in his terms of reference, Annex 6), the coordinator will collaborate with and supervise a local project accountant, also located at the Ministry of Finance. The coordinator will also assist, coordinate and report on the implementation of all accounting and procurement actions, except in the case of the line of credit where the PFIs would be expected to undertake such tasks. While he will not be expected to be involved in the substance of the execution of the other components, the project coordinator will have effective authority over other executing agencies and coordinators in matters concerning operational aspects of project implementation (including procurement, accounting and whatever information may be reasonably required) and will provide the main line of communication with IDA. 4.14 A legal reform coordinator, to be located at the Ministry of Justice and answerable directly to the Legal Affairs Director of the Ministry, would coordinate and report on the inplementation of all components concerned with legal reforms and upgrading the administration of justice. The EDF management would be ensured by the CASP. Should at any time the CASP no longer be satisfactory or EDF's operations fail to meet project objectives, EDF activities would be halted or transferred to another institution acceptable to IDA. The Credit would contribute to incremental costs caused by EDF, by - 30 - financing the CASP's principal technical adviser for about 6 months (para. 3.36 (b)), the CASP would retain fees charged to promoters for some consulting services (para. 4. 11). 4.15 Responsibilities for project implementation and coordination may be summarized as follows: AfllYlfl RESPONSIBLE INSTITUTION FOR EXECUTION SUPERVISION Line of Credit BDC, BIC, other PFIs Ministry of Finance, Central Bank Legal Reform Ministry of Justice' Ministry of Justice Institutional Strengthening Tax Reform Ministry of Finance' Ministry of Finance PE Reform Ministry of Finance Ministry of Finance with other Ministries and PEs ED Help to promoters CASP Ministry of Finance' Banks' training Ministry of Finance' Ministry of Finance' Mo=: * - main responsibility of legal reform coordinator. - main responsibility of project coordinator. 4.16 Within the overall project coordination responsibility described above (Annex 6 and para. 4.13), each beneficiary institution would be responsible for implementing its own project component in accordance with the objectives and procedures described herein. All budgetary and accounting returns, except in the case of the line of credit, would end up with the project accountant, who would be located in the Ministry of Finance, for verification, consolidation and transmission to IDA. The EDF component will be supervised by the Ministry of Finance, but would be managed and executed independently the CASP. 4.17 Implementing agencies for the institutional strengthening and legal reform components would review requests for financing before submitting them to IDA for approval along with a brief justification and description of the qualification of the experts, and would also process disbursement requests. In the case of the EDF, the training program for banks will be developed by the Ministry of Finance in consultation with the banks, with CASP's assistance where needed, and subject to prior approval by IDA. 4.18 Prior to the beginning of implementation of the legal reform component and, thereafter, prior to the beginning of each following fiscal year, the Law Reform Commission shall, in consultation with LDD, prepare, and submit to the Government and IDA, an indicative business plan, including proposed targets and objectives for the rest of the program period, and a detailed work program for the forthcoming fiscal year. The extent to which the Commission succeeds in meeting its targets and objectives for each particular fiscal year will be assessed annually, and will constitute one of the key performance indicators of the legal component. 4.19 To ensure an early start of the reforms, the project coordinator was identified and approved in March 1994. He also participated in the negotiations, even though his appointment will only - 31 - be effective as of June 1, 1994), and the legal reform coordinator is expected to be hired by June 1994, with PPF financing. The hiring of the legal reform coordinator with qualifications and experience acceptable to IDA would be a condition of effectiveness (para. 6.4 (a)). The project and legal coordinators and key members of the executing agencies would be expected to participate in the first available procurement and disbursement course to be organized after Credit effectiveness. Mid-Term Review 4.20 In order to test the effectiveness of project management and implementation procedures, a mid-term review of project progress will be undertaken (para. 6.5 (b)). This review should be completed by November 30, 1996, about two years after effectiveness. It would be a joint exercise with the Government, to be undertaken with the cooperation of the implementation agencies, particularly the banks, CASP and the Ministries of Finance and Justice. This review will draw on a direct assessment by IDA, complemented by periodic reports presented by the project management and audits. Also, no later than one month prior to the Review, the Government would furnish a sufficiently detailed report covering areas to be agreed upon with IDA, including an evaluation of the progress in project implementation. The basic reference documents of such a review mission will be the policy matrix of private sector development, as well as other agreed Credit and project documents. The general scope, staffing, and timing of the review will be agreed with the Government. 4.21 The mid-term review will focus in particular on: (a) assessment of project progress with respect to agreed institutional and policy reforms as well as monitorable targets listed below (paras. 4.23-24), and of the continued relevance of the project's assumptions and provisions for the rest of the period; (b) the scope for deepening legal and policy reform; (c) impact of the assistance to the private sector (by EDF) and public agencies; (d) effectiveness of the courts in dealing with commercial disputes; (e) strength of the supply response from SSE and the private sectors to measures implemented during the first half of the project implementation and identification of other constraints; (f) development and implementation of the medium- and long-term private sector development strategy, with particular focus on implementing the recommendations of studies in the areas of legal, PE, tax and incentives reforms. 4.22 On the basis of the review's findings, IDA and the Government will agree on an action program, if necessary, for implementing additional policy measures, analytical studies as the basis for future reforms, and additional institutional reforms and strengthening measures. The IDA review mission will summarize conclusions and recommended actions for addressing outstanding issues in a detailed aide- memoire. Implementing agencies would be responsible for follow-up, to be reviewed by subsequent supervision missions. During negotiations, agreement was reached with the Government to undertake the mid-term review by November 30, 1996, with significant government participation and analytical input, and that actions agreed during the review would be implemented in consultation with IDA (para 6.5(b)). - 32 - Monitorable Targets 4.23 Key project indicators will be used to monitor implementation and to assess whether developmental objectives are met. These indicators are both global (commitments and disbursement under various components) and specific. In some cases specific prior targets have been set, while in others the absence of appropriate past benchmarks will render setting up-front objectives difficult. Prior to mid-term review, further indicators will be developed on the basis of actual experience under the project. 4.24 The following key project indicators have been developed and agreed with the Government: (a) Project Implernentation. The Credit is expected to be effective four months after Board approval. As slow disbursements have been a problem in the Comoros in the past, commitments and disbursements will be monitored and assessed according to the expected schedule. In particular the Credit should be fully committed by December 31, 1999 and at least by 35 percent by mid-term review. (b) Policy Objectives. The overall timetable for the policy reform objectives set in the Statement of Sectoral Policy will be monitored. In the case of business law and judicial and PE reforms a number of key intermediate steps have been identified and their timely completion will be followed during project implementation. (c) Private Sector Supply Response. The absence of an appropriate benchmark makes it difficult to assess the strength of the supply response. However, the SSE sector would be expected to be a key beneficiary of the project, which should be reflected in its performance. Key indicators include: (i) incorporation of new enterprises or new individual firms on a quarterly basis (commercial registry) including a target of one industrial SSE employing over 10 people, but less than 50, and one importer per quarter; and (ii) the number and distribution of firms, by type, location, and size, which benefit from the EDF's assistance. (d) Administrative Delays. One objective of the policy reforms and institutional strengthening is to eliminate needless delays. The following will be monitored: adoption rate of at least 50 percent of judges and magistrates for the monthly reporting system by November 31, 1996, and based on such reports, evidence that a rough equilibrium has been achieved between the number of cases entered in each court and the number of cases disposed of. (e) Institutional Strengthening. The purchase of about 60 percent of the office and computer equipment required by the Ministries of Finance and Justice should be completed within 18 months of Credit effectiveness. (f) Training Programs. Training programs are envisaged under the EDF, legal and judicial reforms, and institutional strengthening components. In the case of the EDF, between effectiveness and mid-term review, at least 40 promoters, from medium-scale to micro- entrepreneurs, should benefit from the short-term assistance, and 12 should be helped by the long-term assistance. Within the first year after Credit effectiveness a training program should be devised by the PFIs and the Ministries of Finance and Justice, and begin to be implemented. Such training should be 50 percent completed by the mid-term review. - 33 - (g) Banks' Performance. The use of the line of credit by the banks will be followed. The amount and types of investments financed by banks will be monitored, so will the average interest rate charged by banks and the geographical distribution of the subprojects. Targets will include, total commitments of about US$0.6 million per year covering 8 housing and 10 other subprojects. Monitoring and Evaluation 4.25 Progress reports on the execution of the various subcomponents will be prepared and submitted quarterly by the Ministries of Finance and Justice (summary of activities, use of project funds, implementation plan and progress of studies planned, and reforms under process, etc.). The PFIs and EDF management will submit six-monthly progress reports to IDA summarizing problems encountered in the course of executing the components and progress in implementation. 4.26 More specifically, the Legal Reform Coordinator will prepare quarterly reports on the progress of the legal reform component of the Project, including on the monitorable indicators, for submission to the Government and IDA. Upon taking office and, thereafter, prior to the end of each fiscal year, he will also prepare, for submission to IDA, a proposed business plan for the legal component for the forthcoming fiscal year, giving details of proposed targets and objectives for that fiscal year, and the means and strategies needed to achieve such targets and objectives. It will be for the Legal Reform Coordinator to ensure compliance with the business plan and, to the extent practicable, achievement of such targets and objectives. 4.27 A Project Completion Report (PCR), the content and format of which is to be agreed with IDA, would be submitted to IDA within six months of the project closing date. The Ministries of Finance and of Justice and the PFIs will prepare this PCR in close cooperation with the other project units. D. IDA Supervision 4.28 Due to limited experience with IDA Credits, the Ministries of Finance and Justice, the CASP and the PFIs will require intensive support and training during the initial stages of project implementation. Particular emphasis will be put on further, and timely, training in procurement and disbursement, as well as environmental safeguard procedures for subprojects under the line of credit component. In view of the many technical assistance components of the project, intensive supervision (an average of 17 staff-weeks annually) will be required during the first two years, and about 12 staff- weeks thereafter. Detailed IDA supervision plans for key activities are given in Annex 9. E. Procurement Arraneements 4.29 Local Procedures. Problems caused by cumbersome government procurement procedures have been responsible for poor project implementation and slow disbursement rates in other IDA Credits. The Government is taking steps to correct these problems with the help of the Bank. Greater emphasis is now being put on training of project management staff, which will be provided under the project, and IDA supervision efforts. Moreover, a Country Procurement Assessment Mission, scheduled for mid- 1994, is expected to focus on improving the procurement procedures. 4.30 Credit Component. Procurement for subprojects financed under the line of credit component will be made on the basis of procurement procedures consistent with Bank's Procurement Guidelines, and agreed with the participating financial institutions. These procedures will require - 34 - international shopping for contracts above US$50,000 for each beneficiary, on the basis of at least three quotations from reputable suppliers in at least two different geographical areas. Local shopping will be used for amounts under US$50,000. Contracts for goods above US$500,000 per subproject, which at this stage are not anticipated, will be subject to international competitive bidding (ICB) procedures, in accordance with Bank's Procurement Guidelines. A statement to this effect will be included in the Participating Loan Agreements between the Government and PFIs. Under the credit component, prior review of procurement documents will be required for contracts of US$500,000 and above. 4.31 Other Compnents. Procurement of equipment and material (including vehicles, office equipment, computers) will be made through local or international shopping procedures in accordance with the Bank's Procurement Guidelines, on the basis of at least three quotations from reputable suppliers. Selection of consultants will be made in accordance with the Bank's Guidelines on the Use of Consultants. In the case of the EDF the final beneficiaries (promoters) will participate in the choice of short-term consultants, who will be hired and paid for by the executing agencies through procedures acceptable to IDA. 4.32 The institutional strengthening component will be executed by three different project entities and individual consultancy contracts are not expected to exceed US$100,000. Procurement of vehicles, desk computers and other office equipment will likewise be through small contracts below US$50,000 aggregating to amounts not exceeding US$130,000, to be awarded under international or local shopping procedures. For components other than the line of credit, contracts for goods and services above a threshold of US$10,000, except for consulting firms where the threshold would be US$15,000, will be subject to prior review procedures. A summary of the procurement methods is presented in Table 4.2 below. Table 4.2: Summary of the Proposed Procurement Arrangements (million US$) Item PROCUREMENT METHOD ICB Other A/ Total A. Line of Credit 4.45 4.45 kI (2.50) (2.50) Goods, works and service k/ 4.45 4.45 k/ (2.50) (2.50) B. Legal and Judicial Reform 1.10 1.10 (0.85) (0.85) Consulting services and Training 0.67 0.67 (0.50) (0.50) Office equipment, supplies, 0.43 0.43 publications and vehicles (0.35) (0.35) C. Institutional Strengthening and capacity building 0.50 0.50 (0.40) (0.40) Consulting services and training 0.35 0.35 - 35 - (0.30) (0.30) Office equipment and vehicles 0.15 0.15 (0. 10) (O. 10) D. Enterprise Development Fund 1.00 1.00 (0.85) (0.85) Consulting Services and training 1.00 1.00 (0.85) (0.85) E. Audit 0.25 0.25 (0.20) (0.20) F. Incremental Operational Cost 0.16 0.16 (0.14) (0.14) G. Unallocated (0.20) (0.20) Notes:.4/ International and local shopping for goods. Consultants to be hired in accordance with Bank guidelines. b/ For goods contracts below US$500,000 international shopping procedures. For goods contracts above US$500,000, procurement will be through ICB. Figures in parenthesis represent amounts financed by IDA. F. Disbursements 4.33 The proceeds of the Credit would be disbursed as follows: (a) Credit Component: USS2.500.000 (i) 100 percent of expenditures for up to 70 percent of total subproject cost for new operations; (ii) 100 percent of expenditures for up to 80 percent of total cost of subprojects for extensions, modernizations and rehabilitations. (b) Legal and Judicial Reform: USS8500 (i) 100 percent of the cost of consultants, assistance and training (ii) 100 percent of the c.i.f. cost of goods directly imported; (iii) 90 percent of the local cost for materials and supplies. Consultant Services, Studies and Training 500,000 Office Equipment, Supplies, Publications and Vehicles 350,000 (c) Institutional Strengibening and Capacity Building Component: USS .000 (i) 100 percent of the cost of consultants, studies and training for the Ministry of Finance; (ii) 100 percent of the c.i.f. cost of goods directly imported; (iii) 90 percent of the local cost for materials and supplies. - 36 - Consultant Services, Studies and Training 300,000 Office Equipment and Vehicles 100,000 (d) Enterprise Development Fund: USS850. (i) Proportion of total costs for management consultants for private sector firms consistent with the agreed cost sharing schedule (70 percent for short term assistance, cost recovery of about US$25/day for the engineer and financial expert). (ii) 100 percent of consultant services for training to banks. (1) Private Promoters 750,000 (2) Banks 100,000 (e) Audits: USS200.000 (i) 100 percent of the costs for all, except for banks which will pay 50 percent of the costs. (f) Incremental Operational Cost (i) 90 percent of the cost of eligible expenditure USS140.0Q (g) Unallocated: USS200.000 TOTAL: USS5.100.000 of which PPF Funding USS300.00 4.34 The Credit disbursement schedule is based on the relevant disbursement profile for industrial development and finance projects in Africa, taking into account the particularly difficult project implementation environment of a country like the Comoros. It is expected that the investment component would be disbursed in seven years after effectiveness and the other components over five years. These estimates take into account expected improvement in the capacity for project appraisal, financing approval, and implementation. Funds under the credit component would be available for commitment until December 31, 1999. According to the schedule below (Table 4.3), disbursements would be completed by June 30, 2001, the proposed closing date. Table 4.3: Estimated IDA Disbursements (Million US$) Fiscal Year 1995 1996 1997 122I .129 200 2001 Annual 0.6 0.8 0.9 0.9 0.7 0.6 0.6 Cumulative 0.6 1.4 2.3 3.2 3.9 4.5 5.1 Special Accounts 4.35 To expedite disbursement of funds, four Special Accounts, one for each PFI, one for the Ministry of Finance and the EDF, and one for the Ministry of Justice will established in a financial institution acceptable to IDA, into which IDA would make initial deposits from the Credit, estimated to - 37 - US$200,000 for PFIs and US$70,000 and US$50,000 respectively for the Ministry of Finance and the Ministry of Justice, immediately after effectiveness. These amounts reflect the estimated requirements for operating costs, equipment procurement and consultant services, for a three-to four-month period. In parallel, the Government will by January 31, 1995, deposit in a project account counterpart funds of CF 9 million (US$20,000 equivalent) and replenish the account as needed at regular intervals. 4.36 Applications for replenishment of the Special Accounts will be submitted periodically (at least every month). The Special Accounts and associated statements of expenditures (SOEs) will be audited together annually by independent auditors satisfactory to IDA (para. 4.37). Disbursements for expenditures for all contracts for goods under US$50,000 for the line of credit and US$10,000 for the other component will be made on the basis of statements of expenditures. The documentation for withdrawals made under SOEs will be retained by the Ministry of Finance on behalf of other project units involved for one year after receipt of the final audit report and will be reviewed by Bank supervision missions. All other disbursements will be made on the basis of fully documented applications. 4.37 Auditing and Reporting. Audit requirements for all ongoing IDA Credits have been met. The project units will have their accounts, as well as the Special Accounts and SOEs audited annually by independent auditors acceptable to IDA and will furnish to IDA certified copies of their audited accounts together with the corresponding management letters within six months of the end of the fiscal year. These audits will be financed by the Credit (para. 4.1). In the case of the PFIs, the Credit will pay for 50 percent of audit costs to help encourage the practice of banks' undertaking annual audits, which is not yet prevalent. In addition, PFIs will submit to IDA quarterly and annual progress reports (including financial and budgetary accounts). V. PRO.1ECT BENEFITS AND RISKS A. Benefits 5.1 The proposed operation is a complement to the Comoros's macro-economic adjustment program already launched with Bank and IMF support. The project would build on the continuing adjustment efforts, including the recent devaluation, and help spur private investment and assist the Comoros achieve its growth objectives, with SSEs and tourism playing a leading role. Major expected benefits would stem from an enhanced supply response by private sector investors, which would create the employment opportunities that are critical for the success of the overall adjustment program. The project is expected to contribute to the achievement of these objectives by providing long-term credit; helping private firms become better managed and more competitive; and strengthening institutions responsible for ensuring the creation of a liberalized business environment, including freedom to create and operate an enterprise, and a reliable legal system guaranteeing transparent enforcement of contractual agreements between lenders and borrowers in particular. An additional benefit would be capacity building in the Ministries of Finance and Justice. Finally, by promoting better-managed banking institutions, the project would enhance the participating banks' capacity for increased resource mobilization, and diversified and expanded financing of private sector investment. B. Risks and Uncertaintv 5.2 The Comoros is undergoing a dual process of political and economic liberalization. A possible risk would be renewed political instability which could delay the Government's policy reform program and slow down the process of revamping the legal and regulatory framework. This could mean - 38 - that the implementation of a well-focused private sector development strategy, and the pace of private sector investment would be slower than expected. Another risk is the weakness of public agencies. The success of the project, however, ultimately rests upon the ability of the private sector to take advantage of new opportunities. Nevertheless, to minimize this risk, the training program financed under the project needs to be implemented quickly and fully. The final risk is associated with the recent devaluation, which may be accompanied in the short-term by higher levels of inflation. The continued pursuit of prudent monetary policies should, however, mitigate this risk and lead to a return to the historically low inflation rates. C. Environmental Impact 5.3 An area that has received considerable attention during project preparation is the need to ensure that proposed investment projects do not damage the environment. While the exact nature of subprojects to be financed is not known, the level of the Comoros's industrial development and its comparative advantage suggest that most subprojects would be undertaken mainly by micro-enterprises and small-sized activities (a maximum investment of about US$270,000, with average investment expected at around US$100,000, by firms employing a maximum of 50 people, usually less than 20), without significant environmental impact. 5.4 On December 15, 1993, the Council of Ministers adopted a new National Environmental Policy Statement, which has been discussed with IDA. Currently the Parliament is considering a National Environmental Law. The adoption of the National Environmental Action Plan (NEAP), being prepared with UN assistance, is expected in early July 1994. This plan specifies the legal tools and institutional arrangements needed for its implementation, and includes a general classification scheme and regulations for industries, and the Ministry of Public Works will be responsible for ensuring compliance when delivering building and operations permits. Moreover, under a proposed Bank-financed environment project to be implemented starting in 1996), the Ministry of Tourism and the Environment will be strengthened to ensure proper implementation of the NEAP. This capacity is expected to be functional in 1997. 5.5 Initially under the Credit, PFIs will be responsible for sensitizing subborrowers to the importance of environmental aspects of their proposed subprojects. Bank supervision would confirm that the PFIs screen subprojects to ensure that environmental aspects are covered adequately in the appraisal (para. 3.18 (c)). Banks will therefore receive specialized training in this area. Subprojects likely to cause damage to the environment, however small, will only be financed if an acceptable mitigating plan is adopted. In the medium-term, local capacity for conducting appropriate environmental tests will be created with the support of the proposed environment project. PFIs would then be able to rely on such local facilities to avoid hazardous projects and develop acceptable mitigation plans. VI. AGREEMENTS AND UNDERSTANDINGS REACHED 6.1 During project preparation and appraisal, the following have been implemented or agreed upon by the Government, mostly in connection with the adjustment program and the 1994-96 PFP: (a) Simplification of procedures for business creation and operation, elimination of redundant procedures and controls, and of prior approval of the Ministry of Finance with respect to enterprise creation; - 39 - (b) Divestiture from a number of commercial activities; (c) Formulation at the technical level of a detailed private sector development strategy in December 1993, reflected in a Government Statement of Sectoral Policy (para. 6.2 (a)); (d) Initiation of tariff and tax reform; (e) Adoption in January 1994 of a single lending rate for all investment operations (para. 2.26); (f) Selection in March 1994 a Project Coordinator, attached to the Ministry of Finance, with qualifications and experience acceptable to IDA (para. 4.19); and (g) Agreeing to review interest rates periodically to make sure they reflect inflation and macroeconomic conditions. 6.2 During negotiations, agreements on the following were reached with the Government: (a) A Statement of Sectoral Policy, including the annexed matrices of dated policy and institutional reform measures (Annex 1 and 2), and confirmation of government commitment to maintain positive real interest rates; (b) Agreement on the terms of reference of a business plan for the development bank (BDC, Annex 5); and (c) Technical agreement on draft procedures manual for the EDF (para. 4.11). 6.3 The following are additional conditions of Credit effectiveness: (a) Signature of the Participating Agreement between the Government and at least one PFI (para. 4.3). The signature of other Participating Agreements would be conditions of disbursement for the PFI concerned; (b) Signature of the Grant Agreement, and adoption and publication of a procedures manual for EDF acceptable to IDA (para. 4.11); and (c) Establishment of Law Reform commission, and appointment of the Legal Reform Coordinator (paras. 4.14, 4.19). 6.4 The conditions of disbursement will be as follows: (a) Signature of other participating Agreements (see para. 6.3 (a)); (b) Legal and Judicial. Submission of proposed list of library books and establishment of proper library procedures (para. 3.28). (c) Training for Banks. Submission of training program (para. 6.4 (c)). 6.5 In addition, other agreements were reached during negotiations, on the basis of which the Government will: - 40 - (a) Deposit by January 31, 1995, CF 9 million of counterpart funds in a project account, and replenish the account as needed at regular intervals (para. 4.35); and (b) Undertake jointly with IDA, no later than November 30, 1996, a mid-term review of progress in project implementation, with particular reference to policy and institutional reform measures, and implementing the agreed recommendations stemming from such review (paras. 4.20-22). 6.6 Conditions for participating financial intermediaries will be as follows: (a) Submission every year of independently audited and satisfactory financial accounts and statements on their financial and operating results (para. 3.17(h)); (b) Maintaining a satisfactory capital adequacy ratio (para. 3.17(i)) according to the method of the Cooke Committee of the Bank of International Settlements; and (c) For BDC only - Implementation by BDC of the agreed business plan, including putting in place an approach which would be better suited to assess SSE subprojects and evaluate their risks, revision of interest rate policy within the revised interest rate structure to reflect better risk and costs, and reducing operational costs with respect to turnover and intensifying project supervision efforts to increase loan recovery (para. 3.16). 6.7 Subject to the above agreement and conditions, the project is suitable for an IDA Credit of SDR 3.7 million (equivalent of US$5.1 million) to the Islamic Federal Republic of the Comoros on standard IDA terms with 40-years maturity. ANNEX I - 41 - Page 1 of 6 ISLAMIC FEDERAL REPUBLIC OF THE COMOROS SMALL ENTERPRISE DEVELOPMENT PROJECT STATEMENT OF SECTORAL POLICY I. INTRODUCTION 1. The objective of the Government of the Islamic Federal Republic of the Comoros is to accelerate the country's economic development through sustainable and equitable growth which would alleviate the poverty and double the per capita income within a 20 - 25 year time frame. In order to achieve this goal, the Government must foster more efficient development of the human capital more efficiently, improve the global competitiveness of the economy and nurture the proper environment to stimulate investments. It is also well aware that it must get the commitment of the private sector, a greater participation of small and medium-scale enterprises and the mobilization of foreign capital. This strategy will go beyond the Government's adjustment program and will include measures aimed at improving the business environment which will be supported by the small-scale enterprise project which is being prepared in collaboration with the World Bank. 2. Between independence in 1975 and the early 1980s, the Federal Islamic Republic of the Comoros experienced rapid growth (about 6 per cent per year), fueled essentially by an ambitious but low-return public investment program, centered for the most part on improvement of the country's infrastructure. Following the completion of the main components of that program, GDP growth in real terms slowed to an annual average of 1.2 percent in 1986-92, i.e., a decline in per capita income of some 2 percent per year. 3. At the end of the 1980s, political turbulence, together with difficulties in servicing the external debt, exacerbated the country's economic and financial crisis. In 1991, with a view to remedying these severe imbalances, the Government embarked on a program of macroeconomic reform and capacity building (MERCAP) negotiated with the Bretton Woods institutions and supported by all the donors. Its objectives are primarily to: (i) increase public revenue through reforms of the taxation system and better management of the tax base; (ii) decrease expenditures by paring the government payroll, strengthening spending controls and making the planning/budgeting cycle more efficient; (iii) improve economic competitiveness through a monetary policy designed to contain inflation; (iv) withdraw from productive activities carried out by public enterprises that could be taken over by private operators; and (v) improve the business sector's legal and institutional environment in order to establish a framework more conducive to the development of private activities. In addition, the Comorian Franc was devalued by 33 percent in January 1994. 4. With a view to carrying out the measures included in the macroeconomic reform program and spurring sustainable growth for the country, the Government wishes to strengthen its support to the private sector, which is an essential component of its recovery program for the coming years. This policy statement presents the main constraints facing the private sector, the improvements already achieved both through the MERCAP program and through other actions sponsored by the Government; sets forth the key objectives of its strategy in this regard, and identifies the specific actions to be undertaken in this sector. In this connection, the Government wishes specifically to support small and medium enterprises and to encourage the development of tourism, as these areas represent major sources of growth that were overlooked in the past. - 42 - I Page 2 of 6 IH. PRIVATE SECTOR DEVELOPNTSRAE Constraints 5. The economy of the Islamic Federal Republic of the Comoros is characterized simultaneously by: (a) a weak manufacturing sector which-together with construction-accounts for only 10 percent of GDP, as against 40 percent and 50 percent, respectively, for agriculture and services/trade; (b) a paucity of enterprises in the modern sector (200); and (c) concentration of most private-sector operations in the hands of a very few operators. Although limited in number, public enterprises either have a monopoly or occupy dominant positions in most key economic sectors - energy, maritime and air transport, tourism, import of strategic commodities (Onicor, SCH) -. Their production costs are high, particularly for the energy, transportation and communications sectors, and represent a major constraint for the country's economic development. Moreover, a number of them operate in sectors that have nothing to do with public services, and whose activities could be performed more efficiently by the private sector. 6. The small number of companies in the private sector, more particularly in the trade sector, has led to conditions of rent which do not allow for timely supplies at competitive prices. This trend is aggravated by the specialization of the financial sector which limits access to credit through legal constraints and credits earmarked for supplies which are not available to most private companies. 7. New business creation is stifled by extensive pre-establishment formalities, while existing businesses are choked by excessive controls, particularly as regards prices and unnecessary restrictions on their activities (import and export licenses). Taxation is moreover characterized by high nominal rates that are applied unevenly, owing to operational deficiencies in the tax and customs services. The incentives provided by the investment code produce distortions in competition; they sometimes result in excessive exemptions and are granted on a discretionary basis. High customs duties are reflected in ineffective protection in the import substitution sectors and often lead to evasive practices on the part of the entrepreneurs. 8. Business laws are not well known because of the lack of a legal compendium and because the official gazette has not been published for several years. In addition, some of these laws drafted during the 1980s are not operational and have not been implemented. These deficiencies pose a major constraint to the operations of the judiciary, which furthermore suffers from an acute scarcity of judges and other court officials, as well as insufficient material resources. The courts take a long time to hand down judgments, whose enforcement is even less timely. Consequendy, the banks resort to more stringent guarantees (up to two times the amount of financing sought), sometimes to the detriment of the very quality of the projects. As a result, access to credit by small enterprises is sharply curtailed. Measures already taken 9. The Government has already taken a number of measures to address these constraints, including: (i) liberalization of meat and luxury rice imports, simplification of procedures for vanilla exporters; (ii) transfer to the private sector of activities previously carried out by public enterprises (hotels, retail distribution of petroleum products, car leasing), the liquidation of enterprises that were not viable (SOCOVIA), and a strengthening of - 43 ANNEX I Page 3 of 6 control mechanisms to reduce the cost of rice imports through international competitive bidding (ONICOR); (iii) reorganization of the tax administration, reducing tariffs and adoption of a short- term plan to revise the general tax code; (iv) establishment of entities to support the private sector (CASP and FASP), streamlining of the pre-establishment formalities imposed on new businesses and institution of a single window; and (v) completion of the study of the legal framework and reorganization of the Ministry of Justice in order to improve the judicial system, etc. Private Sector Promotion Strategy 10. As important as the measures already taken are, they cannot alone ensure renewed growth based principally on an expansion of the private sector. The Government's strategy therefore aims primarily to: (a) complete its ongoing economic recovery program; (b) establish a general environment conducive to the development of the private sector; (c) eliminate specific constraints faced by small enterprises with a view to promoting the emergence of new job-creating activities; and (d) diversify exports. The main areas of emphasis of this strategy are as follows: (i) establishment of a stable macroeconomic environment that eliminates the previous distortions. The main measures involve a reduction in the budget deficit and settlement of arrears associated with the domestic and external debt, elimination of tariff and non-tariff barriers, and liberalization of access by the private sector to the various branches of the economy; (ii) continuation and finalization of State divestiture from productive activities and the restructuring of public services that will continue to be provided by the Government, with a view to improving efficiency and cutting costs; (iii) improvement in the legal environment for business, through gradual changes in legislation; (iv) establishment of a commercial court and strengthening of the judiciary; (v) lowering of nominal tax rates, in order to promote the emergence of new activities and improve collection; (vi) establishment of simplified procedures for small enterprises; (vii) technical support to small and medium enterprises in the private sector for carrying out financially feasible investments and improving their efficiency; (viii) making available long-term resources to the banks, strengthening the capacity of the financial system in areas of operations associated with long-term operations, and reduction in restrictions on SME access to credit; and (ix) formulation of a framework that provides incentives to investments, export companies, particularly in the tourism sector and ensuring the rights of investors. - 44 A-X Page 4 of 6 m. MEASURES TO SUPPORT PRIVATE SECTOR D 11. The implementation of this private sector promotion strategy will be based on a program of specific actions, the most urgent of which will be supported by the small enterprise development project, as detailed in the matrix attached to this sectoral policy statement. It will have the following three main components: (a) improvement of the business environment and introduction of efficient incentives for profitable investments, (b) implementation of specific actions to support the private sector; and (c) strengthening capacity building within the ministries to insure effective implementation of these measures and simplification of the procedures. 3-1 Improvement of the Business Environment Improving Business Laws and Strengthening the Judicial System 12. The main constraints in this area are due to: (a) ignorance of the laws; and (b) the impracticability or incoherenceof certain existing laws. It is therefore critical that an inventory of existing laws be made; that the laws be published and that steps be taken to ensure that all future laws are published on a regular basis; that certain pieces of existing legislation being revoked or recast, all as part of a cohesive plan of action. In this connection, priority will be accorded to legislation affecting or governing business matters, in particular: (a) amendments to corporate law; (b) revision of the land tenure law; and (c) repeal of the 1984 commercial code. Moreover, the Govermment will take measures to enhance the property rights of investors and provide for independent arbitration of disputes. 13. As precondition for the reform of the legal and judicial framework, it will be necessary to strengthen the judiciary and at the same time to provide the human and physical resources it needs. As part of a multi-year approach, the Government will implement an action plan gradually to increase the number of judges and paralegal staff, and to formulate an adequate training program. This action plan will also include measures to streamline the judiciary procedures and strengthen the ability of the judges to dispose of commercial disputes. Under this strategy, it should be possible, during the period of the project, to clear up the backlog of commercial cases in obeyance. Public Enterprises 14. Public enterprise reform must ensure both a reduction in costs for the main public services and continued withdrawal by the State from purely commercial sectors. For enterprises providing a public service, the Government will continue its recovery efforts, particularly as regards the Comorian Electricity and Water Company (EEDC), the National Posts and Telecommunications Company, and SOCOPOTRAM and Air Comoros. All of these enterprises provide their services at very high rates, while simultaneously suffering losses. This situation poses a major hindrance to the emergence of new activities and the economic development of the country as a whole. For these enterprises-and particularly EEDC-the Government will seek to implement all appropriate measures to lower costs, pass the savings on to users-in particular industrial users-and improve the overall efficiency of the enterprise. 15. In the years to come, the Government will complete the privatization process, which will include: (a) sale of SCR's ancillary activities while improving storage management and purchase policies; (b) privatization of SOCOPOTRAM's activities other than port management, with priority being given to the invitation to tender for handling; (c) the sale of the tourism activities of Air Comores; (d) adoption of a law giving the Chamber of Commerce private status; (e) the merger of SNI and Al Watwan and the transformation of the new company into a private entity; and (f) maintain competitiveness and transparency for rice imports through international competitive bidding. - 45 - ANNEX 1 Page 5 of 6 16. In addition, various production operations continue to be handled by government agencies without a well-defined framework; these activities will be inventoried and, as necessary, be subject to a further reorganization or divestiture program. Lastly, on the institutional side, these reforms will be overseen by the Ministry of Finance, which will have to establish flexible but sufficiently transparent procedures in order to guarantee that the process is equitable. Taxation and Custom Duties 17. The support provided by the International Monetary Fund has made it possible to prepare a detailed analysis of taxation and of customs duties as well as a matrix of short-term reforms. Some of the proposed actions have already been carried out successfully, such as: (a) the establishment of a corporate tax office within the Ministry of Finances; (b) and reduction of import tariffs. Priority in future action will be accorded to reducing the corporate taxes and establishing a fiscal framework conducive to investment that is more effective and transparent than the 1984 investment code. In particular, the Government will suppress the excessive exemptions under the previous system and, by clarifying the provisions regarding eligibility for such incentives, make the incentives automatic when the requirements are met by the applicant entrepreneur. Export Promotion 18. The Comoros' exports are still concentrated on too few cash crops. A high-potential sector such as tourism is insufficiently tapped, owing to: (a) the lack of a clear sectorial policy; (b) the bureaucratic management of the sector; (c) insufficient infrastructure; and (d) the high cost of energy. Current incentives, negotiated on a case-by-case basis, are excessive and cannot be extended to the sector as a whole. Some of these constraints will be addressed through the restructuring of the public enterprise sector. In order to remedy the other limiting factors, the Government will formulate a strategy for developing tourism in close association with the private sector, and will identify the incentives-primarily tax benefits-to be introduced. 19. Apart from the tourism sector, the development of other export sources will be considered a priority, beginning with an improvement in the processing of existing products. In developing these activities, the Government wishes to mobilize technical expertise, and study the possibilities for establishing a viable free-trade zone. 3-2 Specific Measures to Support Private Investments Encouraging Entrepreneurship 20. Companies and particularly small-scale enterprises, lack know-how in project identification, choice of technology and facility maintenance, as well as in the more general area of management. These deficiencies cause many businesses to go bankrupt, hence the reluctance of the banking sector to finance the projects they submit to them. The Private Sector Development Agency (Centre d'Appui au Secteur Prive - CASP) was established to assist entrepreneurs wishing to undertake projects as well as those whose businesses are encountering difficulties. Despite the short history of this institution, its results have already been significant. With a view to supplementing this approach, the Government will establish business support mechanisms that have as their objective: (a) strengthening of the capacity of private entrepreneurs in project conception and design; (b) training of professionals in the financial sector in project appraisal, with a view to reducing the banks' reluctance to finance such operations, in particular those submitted by small businesses; (c) provision of technical assistance on an ongoing basis to handle most of the project applications; and (d) supplementing these actions through specific support missions in specialized areas. - 46 - ANNEX 1 Page 6 of 6 Investment Financinf 21. Investment financing is limited by various constraints: (a) specialization within the financial sector and granting of a defacto monopoly to the BDC for matters involving long-term financing operations; (b) the shortage of long-term resources at the disposal of the BIC; (c) difficulty faced by the banks in collecting their guarantees; and (d) interest rates policy, which introduces sectoral distortions and prevents the banks from adjusting their rates sufficiently to reflect the degree of risk presented by the different projects. 22. The Government has already taken measures to launch a process to make the banks less specialized, and long-term resources will in the future be accessible to the two institutions. The strengthening of the judiciary, which should result in the resolution of disputes brought by the banks, will also make it possible to reduce risks for the financial sector. Lastly, with regard to interest rates, the Government has established a single discount rate with a view to eliminating unjustified disparities among sectors and will formulate clear rules for access to rediscount mechanisms. Interest rates will remain positive in real terms at a level set by mutual agreement with the International Monetary Fund and inductive to bank financing. 23. Despite the granting of long-term resources to the two banks in operation, the BDC will probably remain in the years ahead a privileged instrument of investment financing. With a view to strengthening this institution, the Government will support the bank in its efforts to be more responsive to demand, specifically from small scale enterprises. 3-3 Simplification of Procedures and Capacity Building Simplification of Procedures 24. In this exercise the Government will review in depth all the administrative procedures which the private sector has to comply with. Many of them are redundant and in the nature of red tape. The Government will therefore pay particular attention to streamlining these procedures and reorganizing the government agencies when necessary. Capacity building at the Ministry Level 25. In order to ensure that these measures are implemented under the best possible conditions, the Government will pay specific attention to capacity building for the ministerial departments responsible for program implementation, particularly the Ministry of Finance and the Ministry of Justice. In this connection, the Government plans to: (a) redeploy personnel; (b) fill key positions with qualified professionals; (c) guarantee minimum stability for professionals; and (d) establish training programs. 26. This new strategy will be implemented over several years; it will require the mobilization of substantial human and financial resources, which the country now lacks. The Government is therefore seeking the support of the international community to help initiate this program, by which it aims to ensure the country's sustainable development. ANNEX 2 Page 1 of 7 FEDERAL ISLAMIC REPUBLIC OF THE COMOROS SMALL ENTERPRISE DEVELOPMENT PROJECT ACTION PLAN FOR THE DEVELOPMENT OF THE PRIVATE SECTOR PUBLIC ENTERPRISE REFORM Contint nd objectives Previous measiue5 Actions Timetable I. INSTITUTIONAL FRAMEWORK OF PE REFORM 1. Legal framework for public enterprise; None Adoption of a new legal framework allowing for 12/31/94 Abrogation of law 8410 governing public rapid divestiture from public enterprises. enterprises and adoption of new statils for enterprises which will remain stat-owned. 2. Delegation of the procesa of State divestiture to Previously, the Ministry of Finance was in Adoption within the Council of Ministers of a 12/31/94 the Ministry of Finance. charge of the process; this responsibility has communication etting forth the procedure for been given to the Ministry of Economy. delegating these powers to the Miniser of Finance. 3. Appointment of a coordinator within the Appointment of the coordinator. 5/30194 Ministry of Finnee. 4. Establishment of procedures guaranteeing Establishment of procedures. 09/30/94 transparency of the divestiture proces. H. INVENTORY OF TIHE PE SECTOR 1. Carrying out of an inventory of the State's Portfolio comprising 16 enterprises, but no Inventory to be carried out. 12/31/95 portfolio, including enterprises or similar entities inventory done; industrial or similar units (projects no longer finaced by donors) operating continue to operate within the civil services within the government framework. without status. in. DIYV3ESTL 1. COMOTEL Three hotels have already been disposed of, Completion of the proces with the disposl of PFP either via sale (Coelacanthe, Relais de Singani) H&od Ylang Ylang or liquidation of the company. 06/30/94 or via leas (H6tel el Amal). Hotd Ylang Ylang was closed in February 1994. ANINEX 2 Page 2 of 7 ACION PLAN FOR THE DEVELOPMENT OF THE PRIVATE SECTIOR ~Content and Obje~ctives Prevous Pfeasus cto Timetable 2. SCH Disposal of gasoline tations, sale of boat (City Divestue from remaining ancillary activities (gas 12/31/94 of Nioumacboua) in October 1993. bottle recharging unit); Activities will be strictly limited to importing of 03/31/95 Existence of a de facto competition on the petroleum products; lubricant market. 3. SOCOPOTRAM Resumption of handling activities previously Study on maritime transport. Study to start by provided by SOCOMA 06/30/94 Study on restructuring and privatization for Study to start by activities other than below. 04/30/94 Invitation to tender for handling activities contract; 06/30/94 PFP divesiture from maritime transport activities. 12/31/94 PFP Completion of the restructuring program. 12/31/95 4. CHAMBER OF COMMERCE Drafting of the privatization law. Adoption of the privatization law. 12/31/94 cx 5. AL WAIWAN/SNI Staff reduction Merger of SNI and Al Watwan; establishment of an Effective adequate private status and formulation in divestiture conjunction with bilateral French aid of a plan to before 12/31/96 cut costs and make the institution sustainable. 6. Other public or similar cntits resulting from None Adoption of a restrucuring/divestitureprogram. 12/31/96 the inventory in II. IV. REORGANIZTON 1. EEDC Preparation of new satus, a wate and Finalization of negotiations for a managemt 12/31/94 electricity code, a performance contact and a contract with a partner. management agreement with an external Signature of the performance contract and the 06/30/95 partne. mgeet agreement, with the priority objective of reducing coAts, nd decreming prices in real tems to industrial usrs. Adoption of draft laws revising the statIe. ANNEX2 Page 3 of 7 ACTION PLAN FOR THE DEVELOPMENT OF THE PRIVATE SECTOR Contait and objectives ~~~previous mesre ctos ietable 2. AIR COMORES Staff reduction program. Replacement of the Fokker with a smaller capacity 12/31/96 aircraft that can make less costly and more frequent round trips between the islands, and gradual reorganization of the company in order to adapt its trucure to the now arcaft. Private airline companies will be allowed to opeate 12/3I194 inter-iand flights without any discrimination. Improvement of interational connetion PF 3. SNPr Adoption of a plan to reduce personnel and Signature of a performance conact with the 12131/94 introduce nw ses. Government. Splitting the SNPT into eparate comp nie 6/30/96 Reduction of saff through diciplinary (rdeeommunieations, Post, nd Saving bank). rneasrs Telecommnunication company will operate under v private business laws. 4. HAHAYA AMRPORT None Signature of a performance conuact with the 12/31/94 Government making self-financing porible (opertions only). S. ONICOR Eliminaton of the import monopoly for luxury Mintain International competiive bidding nd Permanent rice. tranyprency in procurement V. Selement of hIterior debt (mo soe tax Compenation of mutual debts between the In the more general perspective of the program to Implementation COMPos Government/SNPT, Government/BDC. reconcile the Government's domestic debt, of a program to formulate a timetable for the gradual mektlem of setle the debts visvis the public ector, domestic debt. ANNEX 2 Page 4 of 7 ACTION PLAN FOR THE DEVELOPMENT OF THE PRIVATE SECTOR BUSINESS ENVIRONMENT: LEGAL AND JUDICIAL FRAMEWORK - Content and Objectives Previous Measures Actions Ilmetable I. MANAGEMENT OF THE REFORMS Ensure coordination by the Ministry of Justice. Recruitment of a coordinator. 6/30/94 H. DISSEMINATION OF THE LAWS Publication of legisladtion applicable to the Study by Prof Garron in 1993 on the legal and Conduct an inventory of applicable laws, compiling Publication Comoros in accordance with the Constitution. judicial framework of the businers environment, and updating them prior to publication srtming by 12/31/94 Adoption of procedures for preparation, publication 6/30/94 and disribution of the Offticial Gat. As of 1996, include in the State budget an 12/31/95 o allocation to cover the regular publication of the Official Gaztte. 11. STRENGTHENING OF THE LEGAL Adapt and improve business legislation. Elimination of prior approval by the Ministry of Esablishment of a busines law reform 6/30/94 Finance for the establishment of a new busines. commission. Establishment of a legislation department within Repeal of the May 19, 1984 commercial code. 10/31/94 the Ministry of Justie. Revision of the commercial code and related 1994-96 legislation, including provisions related to: (i) bankruptcy and insolvency; (ii) land tenure; (iii) investment code; and (iv) labor code. ANNEX 2 Pag 5 of 7 ACTION PLAN FOR THE DEVELOPMENT OF THE PRIVATE SECTOR Content and Objectives Previous Measures Actions Timetable IV. STRENGTHENING OF THE JUDICIAL SYSTEM Improvement of the judiciary. Training in commercial and business laws of 1994-1996 judges, lawyers, and other legal and paralegal staff; Establishment of a court with jurisdiction over commercial disputes in Moroni and Anjouan; 12/31/94 Moroni Appointment of a conciliation judge to the Court of First Instance in Moroni and Anjouan. 12/31/96 (Anjouan) Establishment of procedures within the courts to provide monthly activity reports. BUSINESS ENVIRONMENT: FINANCIAL SECTOR 1. BANKING LEGISLATION Improvement of bank supervision by the Central Preparation of a draft bank law revising Law Adoption of the new law after consultations with 12/31/94 Bank of the Comoros. 808. IMF. 11. INTEREST RATES Elimination of distortions caused by sectoral Replacement of differential discount rawe by a differences in medium-term rates. single discount rate of 8.5%; medium- and long-term operations are now subject to a single maximum lending rate (12.5%) Setting of positive interest rates in real terms. Current policy of the Contral Bank of the Maintenance of positive lending and borrowing PFP Comoros. interest rates in real terms throughout the period. ANNEX 2 Page 6 of 7 ACMION PLAN FOR THE DEVELOPMENT OF THE PRIVATE SECrOR IIL DEVPINTM BANK OF THEQ Establishment of a busine plan to improve the Reimburwement by the Govemnment of CF 253 Adoption of the busine plan. 06/30/94 and Bank's operational performance. million of the funds frozen in the Public throughout the Treasury, formuation of a plan to detle the program remaining debt, nd regular payment of the amount. withheld by the Stae from the saara of government workes. Eaboration of a busins plan by the BDC Strngtheing of its lading cacity. Enforcement of court decisions on dhe S oldest 12/31/94 disputed claims. Increae in SSE's lous Improvement of procedures within the bank Pammnent IV. SUPPORT R TIH BANKING SYSTEM Improvement of the banks' capacities in arem stablisment of CASP and FASP. Organiztion of specific training cycles for bank Throughout the amociad with long-term lending operations. professionals, paticuarly in the ara of smal- and program micro-aterpruer. Support to privat nr am thr_ough CASP, Throughout te via sbort-term coaudtaacla wbose purpoe is to program make ceeta projects feible and bankable and to improve othbs. BUSINESS ENVIRONMENT: TAXALTION L REFORM OF THE TAX SYSTEM Simplifcation of legislation and reduction in rates Establishment of a single rate (10%) for the TCA's exoneration for 14 products with social 3/31/94 PFP to lighten the tax burden, stimuate investment, turnover tax (TCA) implication; expand the tax base and improve collection. Lowering of the micelaneous profits tax (IBD) 31/12/94 IMF from 50 to 30% Reduction to 6 in the number of IUR (general 31/12/94 IMO income tax) bracket and lowering of the maimum rat from 50% to 30%. Simplification and reduction in corporate ta. Action plan by 12/31/95 Adoption by 12/31/96 ANNEX 2 Page 7 of 7 ACTlON PLAN FOR THE DEVELOPMENT OF THE PRIVATE SECTOR Content and Objetves Pr:oi Me-ur c e H. REFORM OF TARIFFS Simplification, reduction and standardization of Introduction of a 4 % single administrative tax Reducing RAU rate to 3.5 % 1231/94 PFP rates in order to dliminate excessive protection (RAU). and improve collection. Standardization of tarifs with the introduction of a single rate of 10%. Clarification and reduction in the number of Evaluation and revision of the tariff poliy 12/31/96 consumer tax rates according to product including the reduction of the highest rates. classification (social, economic or fiscal). m. TAX ADMINISTRATION SUPPORT Strengthening of the tax administration. Establishment of the Business Taxation Support for training of DGI professionals. Throughout the Departmnent. program Computerization of procedures. Short-term support for legislative reforms and n assistance with the publication of laws. _ BUSINESS ENVIRONMENT: SECTORAL POLICY _ I. NEW INVESTMENTS Encourage all profitable investments. Revocation of the curreat investment code. 12/31/94 Establishment of a new incentive system, with automatic application. Ensure protcstion of the rights of investors and put in place mechanisms to motle disputes. | _____________________________________ Publication of an investor's guide 12/31/95 H. TOURISM Formulation and implemenation of a tourism Study 6130/95 strategy. Formulation of recommendations. 6l30/96 m. EXPORTS Formulation and implementation of an export Establishment of a preferential tax system. 12/31/94 promotion policy. Study of a free-urade zone. 6/30/96 Improvement of regional cooperation Permanent _ 54 _ &ANEX 3 page l of ll FEDERAL ISLAMIC REPUBLIC OF TIE COMOROS SMaALL ENTERPRISE DEY=LPMXl1T PROJEC FINANCIAL SECTOR: STRU_CTUR AND CHARACTERISTICS A. Introdpction 1. The financial sector of the Islamic Federal Republic of the Comoros is, like the country itself, small. It comprises the central bank (Banque Centrale des Comores - BCC), a commercial bank (Banque pour l'Industrie et le Commerce - Comores - BIC) with controlling interests from Banque Nationale de Paris (B.N.P.), a development bank (Banque de Developpement des Comores - BDC), and a savings bank (Caisse Nationale d'Epargne - CNE), attached to Societe Nationale des Posta et Telecommunications (SNPI). Also, up until mid-1992, the Treasury performed a number of banking functions, such as managing non-interest-bearing deposits and granting loans in the form of overdrafts. These activities have now been suspended. Lastly, without being a financial institution in the strict sense of the word, the Fonds d'Assistance au Secteur Privd (FASP) supplements the activities of the banks by providing equity funds for small and medium enterprises and guaranteeing bank loans. 2. In 1979, the Government signed a monetary cooperation agreement with France making the Comoros part of the franc zone. This agreement provides for: (i) the establishment of a system of fixed parity between the French franc and the Comorian franc (FF 1 = CF 50; CF 75 after the recent devaluation); and (ii) free convertibility between the two currencies, guaranteed by the opening of an operations account by the Comorian Central Bank at the French Treasury to handle all exchange transactions. The statutes of the Central Bank of the Comoros provide that its Board of Directors shall have a membership of eight, divided between the Comorian Government, the French Central Bank (Banque de France) and the French Government. The post of Deputy Director of the Central Bank of the Comoros is held by a Banque de France official, responsible primarily for monetary policy. 3. Measured in terms of M2/GDP, the level of development of the financial sector is comparable to the average for African countries, i.e. 22 percent. However, in contrast to developments in other countries, the Comorian financial sector remains highly specialized: with the exception of Treasury deposits, now being phased out, the BIC collects 75 percent of all deposits and makes all short-term loans, while over 95 percent of long-term loans are made by the BDC. While the financial situation of these two institutions is healthy and could not justify a financial sector restructuring program under MERCAP, the same does not apply to the CNE, whose deposits have been partially (50 percent) used to finance SNPT's operating losses. This situation is improving, however, since the counterpart of the savings accounts was close to 70 percent in 1992. In addition, the low level of CNE lending (CF 66 million in 1992) limits the risks inherent in this situation. On the other hand, the situation of the Treasury has affected the BDC since the funds deposited there were frozen: the BDC's account totaled CF 370 million by December 31, 1992, and CF 511 million by November 30, 1993. However, an agreement was reached in January 1994 providing for the immediate payment of CF 250 million by the Government. The situation of deposits and lending are as follows: DeDosits 1990 1991 1992 BIC 8,545 9,006 9,355 CNE 506 609 700 Trea-muy 1,879 1,931 2,552 TlOTAL 10,930 11,456 12,607 LaWn Short m BIC 7,128 7,523 8,137 Treaary nMy, n.av. 149 - 55 page 2 of 11 Medium term BDC 1,299 1,336 1,421 CNE 10 11 66 TOTAL 8,437 8,870 8,137 4. In contrast to other countries, the Comorian financial system as a whole is in good shape and has not required any specific restructuring operations under the SAP. Because of the Central Bank's prudent monetary policy it has been possible to hold down inflation at around 2 percent over the past few years, while real interest rates, although largely controlled, have been positive since 1985. Lastly, the government budget deficit has been financed primarily through the accumulation of arrears rather than through recourse to the banking system. Central Bank advances to the Government amounted to CF 1.8 billion at November 30, 1993. B. Monetary and Credit Poliay. Bank Supervision 5. The banking sector is governed by two Federal Laws (Federal Laws 80-08 and 80-07) dating back to 1980, the banking law, which regulates financial institutions, and the central bank statutes. The laws are worded in general terms, and some of their provisions are obsolete, particularly those regarding the banks' minimum capital (CF 100 million). There are no provisions for some mechanisms, such as the reserve requirements. These laws are now being revised, with the assistance of Bank of France experts, and have been sent recently to the International Monetary Fund for comment. 6. The central bank uses interest rates as the main mechanism for regulating credit. During the 1980s, there has been little change in the structure of interest rates, which have been fixed in relation to the discount rate. The table below shows the interest rate structure in place before the devaluation of the CF in January 1994. LaWnine Discount rate Authoried interest rate Sholt tem - Preferential discount rate (TEP): 6.5% -TEP pbhs 5% maxImum (le than 2 yea) per an Season credit (vanilla, cloves, yblng ylng, copra), export cdit, nce ipoSr - Normal dlscount rate (TEN): 8.5% per - TEN plus 7% maximum annum _____________ ~Other operations _ _ _ _ _ _ _ _ Medium term - Prefereatia discount rate ('E): 6% - TEP phs S% manImUM (2-7 ye) per annum Credit to the pnuductive sector (ariculture, livetock, fishery, craft, indury, first-home consruction for Comonan nationals) - TEN pbs 7% maxum - Normal discount rate (TEN): 8.5% per annum Other operatior_ 7. The deposit rates applicable through November 1993 on passbook accounts, term accounts and savings accounts varied between 6.5 percent and 7 percent per annum depending on whether their - 56 - ANNEXJ page 3 of 11 amounts exceeded CF 5 million and their term was for longer than three months. Deposit rates were decreased by one point in December 1993, following the reduction in the rates paid by the Central Bank on the banks' excess liquidities. 8. The deposit rate structure reflected the Central Bank's determination to maintain positive real interest rates, comparable to those existing in France, as a means of boosting local savings. The same does not apply to lending rates. The central bank used differential rates introducing unfair distortions among the different sectors, masking the true nature of the risks involved. Given the shortcomings of the Comorian legal system, the rates encourage the commercial bank to finance low-risk, short-term operations (particularly in the area of imports), to the detriment of medium-term financing of productive activities involving greater risks. This interest rate structure reflects the conditions prevailing at the beginning of the eighties, when the Central Bank authorized large spreads for short- term operations to get the BIC to agree to enter the country after the failure of the previous commercial bank In parallel, since the establishment of the BDC was to be supported through concessional funding from the donors, medium-term lending rates for productive activities were capped, generating supposedly acceptable intermediation spreads. 9. Because of the large spread originally approved for the BIC, it rapidly achieved a liquidity level obviating the need for the use of discount mechanisms for its short-term operations. In the absence of Central-Bank imposed mandatory reserves, the rediscount rates had little impact in terms of achievement of the bank's goals. They helped to make the banking system even more specialized, as BIC chose not convert its sight deposits into long-term funds and thus grant medium- or long-term credits. 10. After the recent devaluation of the Comorian franc, a major distortion has been removed and a new policy framework has been agreed with the Bank and the Fund. This document reflects the Government's commitment for major changes in the structure of the interest rates that have been already implemented: (i) the preferential discount rates of 6 percent and 6.5 percent were eliminated and replaced by a single discount rate of 8.5 percent, (ii) while maintaining the current structure of differential lending rates, medium- and long-term operations are now subject to the same lending rates (12.5 percent) and, (iii) all the interest rates have been increased by 1 percent. These measures were implemented in February, 1994. Furthermore, the Central Bank has agreed to review periodically interest rates to reflect inflation and macroeconomic conditions. 11. The role played by the Central Bank in the area of bank supervision is limited. Apart from the thorough on-site examinations performed for the BCC every three or four years by Banque de France staff, the last one taking place in December 1993 (a smaller-scale inspection of the BIC and the BDC took place in 1992 to determine the feasibility of opening another deposit bank in the Comoros), its action is limited basically to monitoring of the BIC's principal commitments and the centralized recording of bad checks. The reason for the individualized monitoring of the BIC's principal operations is that there is a very small number of enterprises generating the majority of its transactions, particularly in the area of foreign trade. Since this situation results in heavy risk concentration, particular attention from the Central Bank is called for. A program to train Central Bank staff in bank monitoring and supervision is in progress, supported by Bank of France. C. Banking Environment 12. The BIC operates under a non-preferential tax system, paying the normal 50 percent profits tax, which is slated for reduction as part of the upcoming tax reforms. Loan-loss provisions are deductible. Interest paid to savers has to be declared by the latter on their tax returns. If the banks do not report those payments, then the savers enjoy a de facto exemption. - 57- ANNE 3 page 4 of 11 13. While the banks are not unduly restricted by this system of taxation, as demonstrated by BIC's good profitabilty over the past few years, the entire legal system presents a number of constraints to the banking system, in particular in terms of guarantee enforcement and recovery. Such constraints are the result of lack of familiarity with the applicable laws, the content of the laws themselves, and the way the legal system is organized and operates. 14. Even before independence, the legal system of the Comoros was somewhat unusual in that not all the French laws were applied. This situation worsened since 1976, and the the irregular appearance of the Official Gazette makes it impossible for people to become acquainted with new legislation. Moreover, certain laws enacted since independence, in particular the Commercial Code of 1984, are inapplicable, either because some of their provisions contradict those of other laws or because the implementing regulations have not yet been enacted. 15. Although on paper the country has a three-tiered judicial system (Court of First Instance, a Court of Appeals and a Supreme Court), only the first two of these levels actually exist. In addition, there is no specific court or procedure to deal with commercial disputes. This deficiency is compounded by the shortage of officials (six judges for an annual average of 1,125 cases at the Court of the First Instance) and of equipment and supplies for the different courts. Time-consuming procedures, political interference and the reluctance of the police to enforce-judgments only compound the shortcomings of the system, which appears to be in a complete shambles. In this environment, the banks are virtually powerless when it comes to enforcing guarantees. 16. The preparation and implementation of a specific plan of action to remove these judicial constraints is one of the conditions of disbursement of the second MERCAP tranche. A UNDP- financed study has already been completed by a team of legal experts, leading to the formulation of an appropriate plan of action, to be implemented within the framework of the SME development project. Among the priority measures included in this plan of action is the settlement of disputes brought by the banks and still pending today. D. Banque nour l'Industrie et le Commerce - Comores 17. This bank was set up in 1982 as a successor to the liquidated Banque Commerciale des Comores. Its CF 300 million equity was distributed among the BIAO (51 percent), the Comorian Government (34 percent) and private Comorian citizens (15 percent). In 1990, when the BIAO network was sold by its majority shareholder, Banque Nationale de Paris, the Banque pour l'Industrie et le Commerce - Comores (BIC) was excluded from the transaction, and the shares formerly held by BIAO were taken over by BNP International to strengthen its network in the Indian Ocean. 18. The BIC is the Comoros' sole commercial bank. Its network consists of five agencies, two operating full time and the other three part time. It opened an agency in France, but this had poor results and soon closed. The BIC has a total staff of 57, including 2 expatriates seconded by BNP who serve as Managing Director, and Commercial and Operations Director. It is managed in accordance with BNP guidelines for major banks. Apart from the internal controls performed by its majority shareholder, the BIC is subject to regular examinations carried out by Bank of France staff on behalf of the Central Bank of the Comoros, the last three such examinations having been performed in 1989, 1992 and 1993. The BIC's accounts are also certified each year by two auditors accredited by the Central Bank, but their audits are not consistent with international standards. One of the eligibility conditions for the participation in the line of credit component will be annual audits, whose cost would be partially financed by the project. 19. By virtue of its quasi-monopolistic position, the BIC holds nearly all deposits in the country. Not having long-term resources, and lacking a rediscount facility at the Central Bank, it lends only short-term financing, even though it would like to participate in medium- and long-term operations. pae 5 of 11 Its absence from the medium-term financing market also goes back to a tacit anrangement made at the time of its establishment, when it agreed not to compete with the BDC. Trends in deposit and lending transactions over the past four years are shown below: (CF miions) 1989 1990 1991 1992 1993 (6 months) Sight deposs 4,209 4,215 5,210 4,308 3,255 Savings coowts 1,582 1990 2,228 2,641 3,003 Tcrn accounts 2,371 2,179 1,301 2,047 2,294 Others 57 133 267 359 1,034 TOTAL DEPOSrrS 8,219 8 ,4S 9,006 9,355 9,586 Mediwn4tern m aN 173 133 127 114 naV. Short-term lhn 1,404 3164 3,559 3,44S n.av. Accounts receivablb 2,332 3,885 3,921 4,648 nav. Others 633 67 36 82 nav. TTrAL CREDIT 4-542 7,249 7,560 8,289 7,345 20. Since 1990, when BNP took it over, the BIC has been following a less restrictive lending policy, with the result it has doubled its volume of credit to the economy in four years. Despite its increased lending, the BIC has remained highly liquid. This situation of excess liquidity intensified in 1993, mainly because of the low rate of economic growth and the fall in the producer price of vanilla, resulting in a drop of around CF 500 million in seasonal credit. 21. The BIC's portfolio is monitored by the Central Bank because of its risk concentration. The inspection performed by Bank of France in 1989 revealed that 70 percent of BIC lending consisted of loans to 10 customers, of which the 2 largest alone accounted for 42 percent of the total. The policy followed by the bank since then and the gradual liberalization of certain sectors of the economy (vanilla exports in particular) have helped to reduce this exposure. In July 31, 1992, 62 percent of BIC lending was concentrated on 12 clients, the 2 largest of these accounting for 25 percent of the total. However, whenever a loan is granted, a guarantee is required, the most common form being the chattel mortgage, which is easier to enforce than mortgages on real estate. 22. Despite the unfavorable legal environment referred to above, the BIC's portfolio is solid. 1989 1990 1991 1992 Perfonming loans 4,363 7,078 7,413 8,020 Non perfonnung and doubtful 178 171 237 270 TOTAL % of doubfdl loan 3.9% 2.4% 3.0% 3.3% provision as % 41.9% 70.7% 53.3% 56.7% of doubtfdl hans 23. At December 31, 1992, provisions for doubtful loans and contentious loans representend44 and 82 percent of the amounts due, respectively. Because of the judicial constraints, the audit completed by a Bank of France staff in December 1993 recommended an increase of CF 57 mllion in the provisions. 24. The less restrictive lending policy introduced in 1990 has enabled the BIC to double its revenues in three years. The higher interest paid on loans compared with short-term deposits at the central bank or other financial institutions has resulted in improved spreads, despite the growing share of interest-bearing accounts (term accounts and savings accounts). This situation, together with successful measures to contain overhead, has produced substantial results without causing a ANNEX 3 - 59 page 6 of 11 deterioration in portfolio quality. Its net profits have increased 2.5 times over a three-year period. These results have enabled the bank to obtain a high return on its capital and strengthen its equity position while paying dividends to its shareholders: 1990 1991 1992 Ope s profit/aveage OJ 4.0% 3.90% 4.21% Opating profitaverage equity 58.92% 56.S3% 50.74% Profit after taxes/average asesa 2.20% 1.95% 2.10% Profit aftr taxes/average equity 29.46% 28.41% 25.37% 25. This high return has strengthened the capital base of the BIC and its capital adequacy is above the level required by the Cooke Committee of the Bank of International Settlements. Following is the position at December 31, 1992 (CF millions): Total net et 12,358 Weighted 10,144 Capital requiremrent (lat tier) 4% 405 Available capital 816 Surmlus 411 Equity requirmernt ('n tier) 8% 811 Available equity 1,3 15 Surulus S04 26. Because of the large operating profits, the increase in provisions recommended by the audit will not weaken the capital base of the BIC. Also, because of it does not have an exposure in foreign currencies, the recent devaluation did not affect the bank. Credit to the private sector is expected to expand and will reduce the BIC's excess of liquidity. F. Bangue de Dveloppement des Comores 27. The Development Bank of the Comoros (BDC) was created in 1981 to replace Societe de Credit pour le Developpement des Comores, which was liquidated because of financial difficulties. Law No. 81-026/PR establishing the BDC, states that its objective is to contribute to the country's economic development through the medium- and long-term financing of productive activities and equity participations. Its capital distribution is as follows: 67 percent held by the State (50 percent: Comorian Government) and the Central Bank of the Comoros (16.7 percent), the remaining third being shared equally between Caisse Francaise de Developpement (CFD) and EIB. The BDC is active in all sectors of the economy, but principally in the industrial and transport sectors and in housing finance, which represent 45 percent and 27 percent, respectively of its total lending since its inception. Average loan size is CF 2.9 million. Its main office is in Grande Comore and it has a branch in Anjouan. 28. The Board of Directors comprises six members, four of whom are representatives of the Government and the Central Bank. Of the two seats assigned to foreign shareholders, only the CFD representative regularly attends Board meetings; EIB has not appointed a representative. Although this situation means that the government representatives virtually dominate the decision-making process, the approval mechanisms introduced by the donors for loan refinancing operations serve as a counterbalance. Moreover, the personality of the General Manager who held office until 1992 helped to strengthen the bank's independence and ability to withstand government interference. 29. Since its creation, the BDC has received substantial support from various donors: CFD, IDA, UNDP and EIB. In addition to providing lines of credit, the donors have offered considerable support in the form of technical assistance. Under the IDA project, a consultant was financed for four years ANNEX 3 - 60 - page 7 of ll to establish and subsequently support an SME promotion unit. CFD has been financing an adviser to the General Manager since 1983 and a computer specialist since 1988. In addition, senior officials in the Credit Department and the Administrative and Financial Department have received specialized training. 30. Apart from its capital of CF 300 million (fully subscribed), the BDC derives its resources solely from lines of credit granted by international development agencies, broken down as follows: DONOR AMOUNT DAT TERMS TARGET CF mlons E DA 680 1985 RPi 5% All mactors, except libeal profeusaw Term 10 yea including 5 of grmce and housing CFD 1 250 1985 Rate 5% All sectors except residntial h Term 15 yea including 5 of grace CFD 2 250 1990 Rate 1.8% Sane a abovc Term 30 year including 10 of graoe CFD 3 250 1991 Samn tenns above Sanm aa above EIB 1 697 1987 Rate 2% Industry, transport, tourism. Term 15 yea including 5 of gace Subp jCCts for a minimm of CF 11 miliuon. BDC is diqensed from reimbursaeet if the borower becomer insolvent EIB 2 670 1991 Same tem as above Same Wer as above: the minrmun t1reshold for subprojects is CF 18 mollon. 31. The expatriate General Manager financed by CFD when the bank was established was soon replaced by a Comorian General Manager, who remained in office until 1992. This stability together with the external support provided to the bank, enabled it to strengthen its organization and procedures. The Bank has two departments, the Credit Department and the Administrative and Financial Department, headed by individuals suitably qualified to manage a total staff of 23. Manuals of Procedures have been prepared for both lending and accounting operations. Where lending is concerned, the BDC may not grant loans of less than CF 500,000. Loans of up to CF 2 million are authorized by the General Manager, while larger operations require the approval of the Board of Directors, which meets four times a year or more if needed. The Procedures Manual establishes loan terms that vary depending on the sector concerned, donor conditions, nature of loan and guarantee requirements. Although these procedures are clearly defined, they are sometimes rather loosely applied. This is particularly noticeable in the case of small loans for which the conditions of acceptance are not always clear. Moreover, it is not possible to know which project applications have been refused and why. In addition, although standard financial analysis models for judging the quality of the projects have been introduced, the quality of the analyses themselves is still inadequate. When the donors require it, these financial calculations are supplemented, on an ex-post basis, by economic rate of return analysis, but these are not used for decision making. In the accounting and financial area, the procedures are also standardized, and while they seem to be correctly applied in the majority of cases, it can happen that loans are not clearly classified and moratory interest is not properly recorded. The accounting system is computerized and can provide accounting statements and performance indicators in real time. Although glitches in the computer system recently led to duplicate postings of the interest on certain loans, the auditors did not regard this as a reason for rejecting the financial statements submitted by the bank. ANNEX3 - 61 - page 8 of 11 32. While this organization offers a number of guarantees, particularly in terms of compliance with prudential standards, it is hampered by administrative procedures that are both cumbersome and costly given the small size of the loans it makes. Moreover, the bank's monopolistic situation has led it to become very bureaucratic. Loan decisions are largely based on the quality of the guarantees offered (joint security, co-signer) rather than on the intrinsic quality of the projects, so that project applications from small industrial concerns tend to be rejected. Given the constraints imposed by the legal framework within which the enterprises have to operate, such an approach is partially understandable, but remains a major obstacle to the financing of industrial micro-enterprises whose owners can offer no guarantees. It also reflects the limited industrial expertise of the bank's staff. Moreover, in the matter of interest rates, apart from the constraints resulting from the Central Bank's control procedures, the BDC's policy does not reflect the risks involved. The largest percentage of loans in arrears are in the fishery, agriculture and crafts sectors, even though they pay the lowest interest rates. The approach to setting interest rates needs to be reexamined. It has been the experience of other African countries implementing micro-projects that high interest rates neither affect the demand for loans nor result in a larger number of loans in default. 33. The BDC has always been profitable although its profitability has been low in the past four years reflecting high operating costs and deteriorating portfolio. The Project Completion Report prepared in 1983 (Credit 1378-COM) stressed that although the BDC had achieved most of its objectives in terms of lending, operating and financial performance, its sustainability was questionable, mainly because of the deterioration of its portfolio following the worsening economic environment. At December 31, 1992, the BDC's key indicators were as follows: (CF millions) 1989 1990 1991 1992 1993 (1I months) Commitments 328 331 537 418 228 Number of loans 128 118 130 116 36 Average loan size 2.5 2.8 4.1 3.6 6.3 Loans outstanding 1,398 1,299 1.336 1.420 1,354 non operating and doubtful 15.2% 15.4% 14.0% 16.6% n.av. Armars 8.3% 11.7% 10.3% 10.7% 12.3% (% of portfolio) Provisions 27.9% 46.3% 59.4% 63.7% n.av. (% of doubtful loans) Recovery rate n.av. 77.4% 79.9% 79.7% n.av. Retum on assets 0.1% 0.2% 0.4% 0.4% Retum on equity 0.5% 0.5% 1.1% 1.1% 34. The deteriorating economic situation led to a stagnation of its outstanding portfolio, which at end of 1992, following a 10 percent drop, was back down to the 1988 level. Over the same period, doubtful and disputed loans increased as breakdowns in the judicial system made recovery increasingly difficult. This was despite the BDC's privileged position with the Treasury, which enabled it to request the Treasury to freeze deposits of its clients in other banks. The Treasury's lack of liquidity resulted in delays of up to three months in payment of civil service salaries, a situation that directly impacted the BDC as more and more loans fell into arrears. This was the main reason why, at the end of 1992, 62 percent of a total of 758 loans, representing an amount outstanding of CF 580 million (i.e. 40.8 percent of total outstanding loans), were in arrears. These arrears, totaling CF 156 million, were broken down as follows: - 62 -ANEX3 page 9 of 11 .m. LOAM Arrears Amer. u % of o b outsanding Len than 3 months 220 20 9.0 3 to leas thn 6 nxhs 105 24 23.2 6 to leg wn 12 month 50 22 43.8 Over 12 months 205 90 44.1 TOTAL 580 156 27.1 35. Provisions currently cover 64 percent of the above arrears and should be increased by CF 14 million after the last audit. The unfavorable environment, combined with the BDC's high level of operating costs and the blockage of its funds at the Treasury (CF 511 million at end 1993), has affected its profits, which have averaged CF 4.5 million over the past four years, against CF 20 million over the period 1985-88. Despite declining results and increasing arrears, the BDC is still in a sound position, and is doing considerably better than many other African Development Banks. Its present equity is 2.5 times over its starting level and now represents 35 percent of its balance sheet total. Capital adequacy (12131/92) (CF millions) Weighted ets 1,595.01 Capital rquireneit (lot tier) 5% 79.75 Available capital 678.41 Surplus 598.66 Equity (2nd tier) 10% 159.50 Availble equity 854.97 Surplus 695.47 36. Although, the status of the BDC does not allow the bank to borrow in foreign currencies, the foreign exchange risk of the second line of credit granted by EM is in fact borne by the BDC. Because of the recent devaluation, the BDC could face losses as high as CF 150 millions. However, an agreement has been reached between EI, BDC and the Government to transfer this risk to the Goverment. The Government would then be compensated by BDC's continued repayement of CFD lines of credit that have recently been subject to a debt forgiveness initiative from France. 37. Despite its frozen funds at the Treasury (CF 511 million as of November 30, 1993), BDC surplus liquidity at the Central Bank totaled CF 606 million at the same date. Apart from the accounting impact of these funds frozen at the Treasury (CF 30 million of income in a full calendar year), this situation has led the CFD to request BDC to: (a) clear 50 percent of the government debt; (b) recover 30 percent of the amount at issue in the five oldest doubtful debts cases now settled. Thanks to an EDF grant to the Comorian Government, the first of these conditions has already been met. 38. In terms of resources, the reduction in the outstanding portfolio has resulted in increased liquidity and wIll have a negative impact on the bank's profitability because of the drop in the central bank's short-term deposit rate and the amounts of funds still frozen at the Treasury; in addition, it is carrying too much overhead for its present level of business. -63 ANNEX 3 - 63 - page lOot 11 39. Over the past few years, the BDC has had to operate in an unfavorable environment, in terms both of economic context and of the legal and judicial framework. While the measures taken under MERCAP and the recent devaluation of the Comorian franc should pave the way for a return to higher growth rates, certain measures, such as the reduction in force within the civil service, could result in new arrears. Moreover, as a result of this general context and also by reason of its monopolistic situation, the BDC has developed a administrative approach that tends to look more at prospective guarantees than at the quality of the applications submitted. This approach has made borrowing difficult for the SMEs. Lastly, the results obtained by the BDC, despite high operating costs, are largely attributable to the extremely concessional terms of the resources made available to it by its donors. This situation does not guarantee the bank's sustainabiity. The move to impose conditions reflecting those of the market and to open up the sector to competition will thus call for a new strategy on the part of the BDC. G. Private Sector Development Agengv and Fund 40. With a view to promoting the development of small and medium enterprises in the Comoros, at the end of 1991 the UNDP financed a technical assistance project to provide support to private sector entrepreneurs. The entity set up, the Private Sector Development Agency (CASP), attached to the Union of Chambers of Commerce, Industry and Agriculture, seeks primarily to provide assistance for the establishment of new businesses, support existing businesses and facilitate the search for employment by job seekers through the establishment of an information system on available work opportunities in the business world. Specifically, the fund supports: (i) feasibility studies to serve as a basis for bankable projects; (ii) simplification of the procedures for establishing new businesses through the establishment of a single window; (iii) diagnostic studies of existing businesses and provision of support for their management/rehabilitation. The CASP also handles monitoring and recovery activities of direct loans granted by the Caisse Frangaise de Developpement as part of its support for basic production initiatives (Appui aux Initiatives Productives de Base - AIPB). The team set up to carry out these three objectives consists of three expatriate consultants-the project manager, a management specialist and a production engineer-and seven Comorian experts. 41. With a view to facilitating the financing of SME/SMI projects, a Private Sector Assistance Fund (FASP) was also set up. Established in the form of an association under the 1901 law, the Fund seeks to supplement bank operations by: (i) providing equity capital to SMEs whose financial structure is not strong enough to meet the banks' requirements; (ii) guarantee the loans made by the banks; and (iii) provide training programs. The Fund-managed by a board of directors which includes representatives of the donors, local banks, the Central Bank, the Ministry of Finance and non- governmental organizations-now has at its disposal US$500,000, provided essentially by the CFD. 42. Since its inception, the CASP has provided substantial support to the private sector thanks to the motivation of its team and the innovative approach it has taken in certain areas. This is especially true in the establishment of new businesses: entrepreneurs wishing to start a business are brought together and projects finalized through successive training/validation modules covering all aspects of the project concerned (technology, market, finances, etc.). Four cycles of this type attended by 66 entrepreneurs have been completed and have resulted in the development of 17 projects that are now pending financing; three other cycles are under way. In the area of support to existing businesses, seven of these went through a strengthening/rehabilitation exercise supervised by the CASP production engineer. A mini-industrial zone was established following acquisition through lease/sale of the SOCOVIA premises that was liquidated as part of the privatization process. Lastly, the Ministry of Finance authorized the CASP to open -a single window to centralize the procedures for the establishment of new businesses. 43. While the CASP contribution has been substantial, the function of the FASP should be clarified on two key points: its assistance with respect to guarantees and the provision of equity - 64 - ANNEX3 page 11 of 11 capital. The provision of equity capital typically takes the form of a loan at an interest rate of 12 percent, repayable within one year with a possible grace period, but in any event with a shorter term than other bank loans. This approach does not represent a true equity contribution and is not acceptable to the banks unless they waive their own rules with regard to minimum equity. As for the guarantee mechanisms, although only the principal amount would be covered, the proposed rates of coverage, which can be as high as 100 percent, seem excessive and might prompt the banks to pass the commercial risk on to the FASP. Likewise, the timeframe (180 days) in which the FASP would assume the rights of the banks appears too short given the current situation of the judicial system. - 65 - Page I Of 17 ISLAMIC FElDERA;L REPUBLIC OF TIHE COMOROS SALENTERPRISE DEVE3LOPMENT PROJEC LEGAL REFRM I. DINTRODUCTION 1. The evolution of the legal and judicial system of the Comoros has followed a pattern which is not unfamiliar within the group of francophone countries of Africa. Like other francophone countries, the Comoros inherited at the time of its independence a legal system that was by and large a product of the French legal system. But there were also important differences: first, the Comoros acceded to independence nearly a decade after the first wave of independence in Africa and has, to that extent, inherited an initially more sophisticated legal system than most of the other former French colonies. More importantly, however, the legal system in Comoros has been strongly influenced as a matter of tradition by both muslim law and customary law, both of which continue to this day to have a significant impact upon the legal and business environment. H. THE LEGAL AND lUDICIAL SECTOR A. Te Laws 2. It was not until after independence in July 1975 that the Comoros acquired the exclusive right to regulate its own affairs. Prior to independence the power to legislate had belonged largely, but not exclusively, to the French National Assembly. Laws passed by the French National Assembly during the pre-independence period did not, however, automatically apply to the Comoros, except to the extent that they were expressly declared to be so applicable. Prior to independence there had also been an intervening period of some thirty years or so, during which limited legislative powers had vested in a local territorial assembly (ater renamed the chamber of deputies). It was to preserve this rich legacy of pre-independence legislation that, immediately after independence, the Provisional National Assembly passed a law" providing for the continued validity of all laws in force at the time of independence. 3. The body of business and commercial laws that govern business transactions are derived largely, but not exclusively, from the French legal system. They include not only the Commercial Code and related legislation, but also a host of other laws, including the Civil Code, the Labor Code, the Investment Code, as well as legislation governing banks and other financial institutions, and public enterprises. These laws have had to co-exist with a body of well-developed principles of religious and customary laws, which can have a significant impact on business transactions. There are now entrenched constitutional and legislative provisions which have re-affirmed the continued pre-eminence of religious and customary laws. Commercial Code and Related Legislation 4. The 1984 Commercial Code. The Comoros is in the unique situation of having two Commercial Codes: one Commercial Code, which forms part of its French colonial legacy and another one which was adopted and promulgated in 1984, but never actually put into application. The 1984 Commercial Code does not substantially depart from the French Commercial Code; but while 'I Law No. 7504ANP, daZ July 29, 1975, provides u follows: 'tous ls texltes en vigueur restent ea vigueur & Pexceptdon des textes orgaint le territoire." - 66- ANNEX 4 Page 2 of 17 it is based essentially on the liberal approach of the French version, it also includes a number of provisions which are characterized by a tendency to over-regulate. 5. The 1984 Commercial Code was, by all accounts, hastily put together by expatriate consultants, and promulgated with, apparently, little or no involvement on the part of the local community. It has been consistently ignored by the local community of lawyers and magistrates, who continue to apply its original French counterpart. The Code has no transitional or consequential amendment provisions and, in lieu of any attempt to define the impact that it is bound to have on other related legislation, it merely provides for the abrogation of provisions to the contrary. In the minds of most Comorian lawyers, it is the 1984 Code itself which needs to be abrogated. 6. The French Commercial Code. Subject to any uncertainty resulting from the promulgation of the 1984 Commercial Code, the Commercial Code actually in force appears to be the French Commercial Code, as it existed, at the time of independence, subject to any amendments which may have been made by the National Assembly since independence. The French Commercial Code, as it existed at the time of independence, consisted of the original Code of 1867, as amended over the years by those later supplementary laws Oois annexes) which were declared to be applicable to Comoros. 7. The Commercial Code is still basically a sound legal instrument, but because it has failed to evolve since 1975, to keep pace with the evolving business environment, it has now fallen behind in a number of significant respects. Following major changes to the provisions of the French Commercial Code that were initiated in 1967, there are now clear differences, which are often overlooked, between the provisions of the French Code and the corresponding provisions of the Code, as it now exists in the Comoros. 8. It is hardly surprising, therefore, that Comorian lawyers and magistrates alike have systematically - but erroneously - assumed that the French law of July 13, 1967, on bankruptcies and liquidations, applied in the Comoros. It has now been demonstrated that, notwithstanding the fact that the 1967 French law pre-dates independence, it has never been made applicable to bankruptcies and liquidations in the Comoros, which continue, therefore, to be governed by Articles 437-614 of the original Code. Conversely, the French law of September 23, 1967, on the restructuring of financially-distressed companies, represents a fairly modern approach to company legislation, which was extended, but without the necessary implementation decree, to the Comoros. 9. Company Law. The law of companies in the Comoros is govemed by Articles 1832-1873 of the French Civil Code, as it existed at the time of independence, and, in the case of commercial companies, by the French law of July 24, 1966, on commercial companies. Since 1975, the definition of a company under Article 1832 has evolved in France, but not in the Comoros, to include not only a contract entered into to make a profit, but also one whose objective is merely cost reduction. This disparity between French law and Comorian law, however, is more apparent than real, since cost reduction is now an objective which can also be pursued under the law of September 23, 1967, on Groupenents d'Int&ft Economique, which applies in the Comoros. On the other hand, bearing in mind that the law of July 24, 1966 applies in the Comoros, it follows that the Comorian law on commercial companies is still fairly modern, and not unlike present-day French legislation, even though the corresponding provisions of French law have meanwhile undergone a series of further modifications. 10. In the Comoros, as in France, there are five different types of companies which are recognized under the law: the societe en nom collectit, the societe en commnandite simple, the societ k responsabilite limitee (SARL), the societe anonyme (SA) and the societ en commandite par actions. Because it combines the characteristics of a personal type of company (sociae de personnes) with those of a joint stock company (societe par actions), the SARL is generally regarded as a hybrid form of company. Nowadays, in the Comoros, it is also the most prevalent type of company. The ANNEX 4 -67- Page 3 of 17 minimum capital requirement for company registration is CF 5,000,000, in the case of a SA, and CF 1,000,0002, in the case of a SARL. Company registration takes place at the Registre du Commerce presently attached to the Court of Appeal in Moroni. It is subject to a 5 percent tax on capital payable to the revenue services, which serves to keep the nominal capital of companies to the strict minimum. 11. Registre du Commerce. The law governing the Registre du Commerce is still a matter of some controversy. For reasons which remain unclear, the French Law creating the Registre du Commerce, dated March 18, 1919, continues to be applied in the Comoros, even though a later French Decree governing the Registre du Commerce, dated March 23, 1967, has been extended to, and, at least in theory, still applies in, the Comoros. The 1919 Law, as indeed the later 1967 Decree, provides for the registration of newly-created companies. It also provides for the registration of changes in the data provided at the time of registration, and of other transactions affecting the assets or status of a company. 12. In the Comoros the Registre du Commnerce is presently kept in a haphazard and thoroughly inadequate manner under the supervision of the Greffier-en-Chef of the Court of Appeal, who shows neither the expertise nor the inclination to have the Register perform its functions as prescribed by law. Other than its role in connection with the registration of newly-created companies, the Registre du Commerce, as presently constituted, serves little or no practical purpose. Civil Law 13. Many of the rules governing businesses are also to be found in the Civil Code. The basic principles governing a contract of sale are to be found in the Civil Code", as are the rules governing mortgages and guarantees, liens, securities and privileges5'. Similarly, the principles of family law and, in particular, the rules governing succession and matrimonial property, have a direct impact on ownership of property and, consequently, on credits and guarantees. 14. The interaction between the French-inspired civil law, muslim law and customary law is now governed by Articles 9-14 of the law governing the organization of the Judiciary6. Article 9 of the 1987 law provides that the courts are required to apply existing laws, except in matters which are reserved for the exclusive competence of muslim religious and customary laws. Article 10 of the same law provides that all matters relating to personal and family law are governed by muslim law, whilst the effect of Articles 11, 12 and 13 is to re-affirm the exclusive competence of customary law in all matters relating to unregistered land, to the extent that such customary laws actually exist. 15. Property Law. Whilst it is generally correct to consider that property law in the Comoros is still based essentially on French law, such a proposition, however, only holds true in the absence of any incidence of muslim or customary law. It is to avoid any possible conflict between different systems of law, and to increase reliability on title to land, that a Decree was introduced in the 2/ The Comorian Franc or CF is the currency of the Comoros. The figures shown am the equivalats of the correspondinS anounts in French Frnca indicted in the original French provisions, baed on the parity which applied at the de of independence. Following the devaluation of the CP on January 12, 1994, it is arguable that theme figur ought now to be revised to read CF 7,500,000 and CF I ,500,000, respetively. '/ Decree no. 67-237, dated Mrch 23, 1967. 4/ Civil Code, Articles 1101-1369 mnd 1582-1685. 5I Civil Code, Articles 2011-2204. 'I Law No. 87-021, dated September 23, 1987 - 68 ~~AN I X4 - 68 - . Page4 of 17 Comoros on June 9, 1931, to introduce the concept of land title registration and ensure the conclusive nature of such registered land title. 16. The effect of the 1931 Decree was to extend to the Comoros a previous Decree governing land title registration in neighbouring Madagascar7'. The Decree prescribes detailed procedures, involving publication in the Official Journal and an elaborate land adjudication procedure, for the registration of title, and of transactions affecting such title. It provides that registered title is both dfinitif and inattaquable", and is governed by the Civil Code. The Decree does not affect title to land to which customary law applies, except to the extent that title to such land has been registered. 17. Title registration is a long, arduous and expensive process, and invariably triggers tax considerations. The amount of duty payable on registration is in excess of 15 percent of the value of the property concerned. Not surprisingly, registration is not widely prevalent. The absence of registration invariably triggers the application of muslim and customary laws. 18. Customary Law. It has not always been easy to measure the precise impact of customary laws on business transactions, not least, because the precise nature and contents of such laws have never been ascertained. Notwithstanding the provisions of the law governing the organization of the Judiciary', which call for the codification of all applicable customs, no attempt has ever been made to date to draw up an inventory of all customs which are presently recognized in the Comoros, or to determine the contents thereof. In the absence of any codification of existing and recognized customs, the only custom that could be invoked with any certainty is a custom known as magnahoule. It is the only custom to which an express reference has been made in any legislation, since the adoption of the law governing the organization of the Judiciary'. The magnahoule refers to an ancient custom whereby property is donated to a woman for her own benefit and for the benefit of her female descendants. 19. Muslim Law. There are a number of principles of muslim religious law which may have an impact on business transactions. First, there is the principle whereby, for purposes of succession, women do not enjoy the same rights as men. Even though its impact on business transactions may be relatively limited, this particular principle appears to contravene at least one provision of the Constitution"', which prohibits discrimination on grounds of sex. Second, again in matts of succession, under muslim law, a deceased person's heirs inherit the assets of the deceased only, not his liabilities. This rule, which represents a sharp departure from the French maxim 'le mort saisit le vir, can have adverse consequences on business transactions, to the extent that creditors have not been paid prior to completion of the succession. Thirdly, there exists under muslim law a common practice, known as waqf, whereby parties may donate property to Allah, who becomes the owner thereof, but for the benefit of specified beneficiaries or for specific purposes. 20. Inpact of Muslim Religious and Customary Laws. The muslim practice of waqf, as indeed the magnahoule, can quite obviously have a profound incidence on the security of business transactions. There is a real danger that, in the absence of any form of registration, business 'I Decree, daed Pebnuuy 4, 1911, on land titl security in Madapar. I/ idem, Article II '/ Law No. 87 021, dae September 23, 1987, Article 14 so/ we foobtoto no. 9 "1/ Section 3 of the Conmiuon povides as follows: 'L'Eplltd des dtoyens at asurEe devant 1 bl sm dklacdoa d'orgine, de race, de sexe, de relWon ou de croyance. - 69 - . Page 5 of 17 transactions might be entered into without full knowledge of the facts relating to the ownership of property. It is for this reason, presumably, that the General Council of the Comoros adopted, on August 26, 1947, a Deliberation relating to the opening of a special register, wherein a record would be made henceforth of every waqf, and every magnahoule, that is established. The Deliberation of August 26, 1947, has not, however, resolved the issue entirely for a munber of reasons: first, the register does not refer to the Registre du Commerce, but to a special register kept by the religious authorities; second, the register only covers transactions entered into after the date of the Deliberation; and, third, the requirement of documentary evidence to prove the existence of a magnahoule established after August 26, 1947, has done little to reinforce the security of business transactions, with respect to unregistered land. Labour Code 21. The Labour Code"t is a relatively modem piece of legislation. Although it is based on its French counterpart which has been widely replicated throughout francophone countries in Africa, it is a relatively simplified and liberal version. 22. The Code provides for freedom of contracting, subject only to the limited restrictions specified under the Code. Under Article 36 of the Code, a contract of employment may be on a permanent or fixed term basis, or for a specific assignment. In the case of a fixed term contract, the duration thereof cannot exceed a maximum of three years. Article 38 provides that a contract of employment for a duration of more than three months, or involving the relocation of the employee, must be in writing and is subject to a process of approval by default by the Labour Inspectoratel. 23. The termination of contract clauses are relatively standard. Termination of the contract of employment invariably gives rise to payment of severance allowance. Termination must be based on legitimate grounds, failing which an aggrieved party may be entitled to a claim in damages. Where termination is based on grounds of misconduct on the part of the employee, severance allowance is not normally due, but in such a case the employee has the right to be heard. The amount of severance allowance is relatively modest: according to the number of years of service completed, it can range from 20 to 30 percent of the monthly salary for each completed year of service. 24. Article 51 recognizes the right to terminate employment on economic grounds, but requires the employer in such cases to draw up a retrenchment plan and to discuss the details thereof with both the Labour Inspectorate and the employees' representatives. Finally, it is worth noting that, under Article 121 of the Labour Code, a deceased man's widow is required, following her husband's death, to take leave on full pay for a period of four months and ten days to observe certain muslim religious rites. Public Enterpise Law 25. Like the Labour Code, the law on public enterprises in the Comorost' is of relatively recent origin. The law draws a distinction between public sector organizations (fablissements publics), on the one hand, and State-owned and State-controlled enterprises (socid d'Eat et d'economle mlxte), on the other. In practice, however, many of the rules applicable to the former apply equally to the latter group of enterprises. ILaw No. 40IUPR, dt Febuay 18, 1984. U/Ih effect of Article 38 of the Labour Code im that a conhrat of employment, which bam _n iaed to the auhrite for approval, shal be deemed to havo ben so pproved, if, within a period of 30 days, the auhorities have ailed to rspond. '4/ Law No. 80-10, dd June 13, 19S0 - 70 - ANNEX 4 Page 6 of 17 26. The law on public enterprises confers upon the Government wide-ranging powers to interfere in the management of its public enterprises, including the power to exercise day-to-day financial control over the affairs of public enterprises, the power to approve all debt transactions, as well as the right to be kept informed of major decisions of such public enterprises and, where appropriate, to veto such decisions. The provisions of the law on public enterprises apply as of right to enterprises which are wholly-owned by the State, or in which the State has a majority interest; they can be extended by decree to those in which the State has only a minority shareholding'. 27. Notwithstanding its relatively recent origin, the existing law on public enterprises appears to be based on outdated principles of public sector enterprise management. There are efforts under way to have the law amended. Investment Code 28. The Investment Code'5 is also relatively recent. It provides for a complex regime of preferences, which are governed by the terms and conditions set out in the Code. The regime of preferences is subject to a complex approval process, involving approval by an inter-ministerial commission, coupled with an elaborate set of administrative procedures and controls. The preferences are not granted according to any transparent or automatic procedure, but on the basis of a set of subjective criteria and according to the size and nature of each proposed activity. There are also provisions enabling the Government under certain circumstances to withdraw preferences already granted and require the beneficiary thereof to reimburse the value of acquired benefits. The overall process is not only inefficient, time-consuming and arbitrary; it also provides a unique recipe for rent- seeking behaviour. 29. Typically, an Investment Code also seeks to reassure foreign investors, by guaranteeing, in particular, the security of their investments operations. The present Code, however, falls well short of achieving this particular objective. The provisions governing the security of investments are totally inadequate. There is no independent arbitration clause. 30. The fiscal provisions of the Investment Code are presently under review in the context of an overall tax reform program, designed to rationalize the tax structure and streamline the process of tax collection. The remaining provisions of the Code are due to be revised in order to streamline the process of approval of investment proposals and make it more transparent, and provide potential investors with better and more reliable investment security. Leaoi Laws 31. Leasing is a technique whereby assets, such as plant, equipment and machinery, are acquired by a financial institution (the lessor), and leased to an enterprise (the lessee), who thereby obtains physical possession of such assets and the prospect of acquiring definitive title thereto at the end of the lease, subject, of course, to payment of the agreed price. In the context of an environment in which the process of land title registration remains highly problematic, such a technique provides a useful alternative financial instrument, which has yet to be fully explored. Whilst the benefits of 131 Law no. 80-10, Articl 5, providcs as foUow.: .... [Les socEits d'1conomle mlte] sout auuJettes aux con&rles prEvnu par i prisente bo - de pkin drolt si la partcipation de P,Etat el des coLectivitEs publiques est feale ou sup&ieuve b 50 % du captal - par Uacrelndividuel si ladite participation est infrieure h SO % du capital sodaL- "I LAw No. 84-0MPR, dad May 25, 1984. - 71- ANNEX 4 Page 7 of 17 leasing are fairly self-evident, such benefits would have to be examined in the light of the potential cost of leasing in the Comoros, which, in the case of rare or specialized plant, machinery or equipment, could turn out to be exorbitant. 32. Leasing continues to be governed by French legislation on leasing"', as it existed immediately prior to the independence of the Comoros. However, even though such French legislation on leasing has been extended by law"' to the Comoros and other overseas territories, no implementation decree has ever been adopted to define the procedures to be used for the application of such legislation in the Comoros. Considering that such French legislation on leasing is already applicable in the Comoros, it is arguable, from a purely legal perspective, that only an implementation decree is now needed to introduce the technique of leasing in the Comoros. B. Publication of Laws 33. In the Comoros, as in most other jurisdictions, there are entrenched constitutional provisions which provide for the mandatory publication of laws. It is such constitutional provisions, presumably, that form the basis for the principle that ignorance of the law is no defence. Notwithstanding the existence of such a provision in its Constitutioni', there has never been any systematic process of publication of laws. 34. Following the destruction of the national legal archives shortly after independence, the only collection of pre-independence laws which is available for consultation is to be found, not in the Comoros, but in France. Notwithstanding the fact that not all pre-independence French legislation applied to the Comoros, there has been no systematic attempt to distinguish between those laws that apply in the Comoros and those that do not. It has been generally assumed - erroneously, as it turns out - that all pre-independence legislation is bound to be so applicable. 35. For identical reasons locally-adopted legislation did not fare any better. The Official Journal has never appeared regularly since independence and, accordingly, laws have never been systematically published. As we have seen also, notwithstanding the express provisions of Article 14 of the law on the organization of the Judiciary', there has been no attempt to codify the customary laws that are recognized as such in the Comoros. 36. The Government has recently established a special unit located within the Secrtariat GEnral du Gouvernemnent to be responsible for the Official Journal. It has also reorganized the services of the Ministry of Justice in order to create therein a specialized Legislative Drafting Division (LDD) to be responsible, inter alia, for drafting of civil, commercial, criminal and procedural legislation, as well as a Legal Information Center (LIC) to be responsible for the collection, conservation and dissemination of information of a legal and judicial nature. These units have yet to be provided with the resources that they require to make an impact. 37. The complex mix of legal systems that have in turn produced the Comorian legal system has been a source of some confusion and uncertainty. The absence of any systematic publication of laws has compounded the problem and resulted in a chaotic situation, in which knowledge of the law, and 17/ Law no. 66-455, dated July 2, 1966, a amended by Ordinance no. 67437, dated Septmber 28, 1967. as1 Law no. 73446, dated April 25, 1973, Article 1. "/ Article 53 of the Conaibion prvides tht lawa shall be published in the Official Jounal as oon a pouaibl. after they have been enacted. 2/ See footnote no. 6. - 72 -ANNEX 4 Page 8 of 17 even of applicable provisions, has become a matter of pure speculation. Such a situation provides a window of opportunity for corrupt and unscrupulous public officials and others, who will not hesitate to take advantage of their position to abuse their own authority and exercise power arbitrarily at the expense of economic operators and other defenseless victims. C. The Institutions Structure of Courts 38. The structure of judicial institutions in the Comoros is characterized as much by the complexity of its courts' system, as by the scarcity of resources, both human and physical, that it has available. Prior to the adoption of the Constitution in 1992, the organization of the Judiciary was governed by the law on the organization of the Judiciary'. It comprised, in addition to the Supreme Court, a Superior Court, a Court of Appeal, a Court of Assizes, First Instance Tribunals, Justices of the Peace and the Labour Tribunals. Under Article 3 of the law on the organization of the Judiciary', First Instance Tribunals were also declared to be competent in practically all disputes involving the administration. 39. The new Constitution has re-affirmed the independence of the Judiciary, but by creating a high court structure, consisting of a Cour de Cassation, a Conseil d'Etat, a Cour des Comptes and a Tribunal des Conflits, it has also called in question not merely the existing court structure, but also the competence of the First Instance Tribunals in administrative law matters. Coupled with the current scarcity of human and physical resources within the Judiciary, the new court structure raises delicate issues. A first attempt to establish the Cour de Cassation has already prompted a five-week strike by magistrates, severely straining an already tense relationship between the Executive and the Judiciary. 40. The Court of Appeal has jurisdiction over the entire country. It sits as a bench, but, due to lack of a quorum, it has been unable to hold regular sittings until the end of last year. There is obviously a huge backload of cases awaiting appeal. Following the most recent nominations within the Judiciary, it is now expected that the Court of Appeal will be regularly constituted. 41. There is a First Instance Tribunal for each of three islands of Grande Comore, Anjouan and Moheli. Owing to lack of resources, the tribunal of Moheli has, for all intents and purposes, ceased to operate. Subject to the special first and last instance jurisdiction of the Superior Court, the Court of Appeal and the Court of Assises, and the first instance jurisdiction of the Labour Tribunals, the Justices of the Peace and the administrative tribunals, it is provided that first instance jurisdiction belongs exclusively to First Instance Tribunals. Magistrates of First Instance Tribunals are competent to hear civil, commercial and criminal cases alike. The President of the First Instance Tribunal in Moroni also doubles up on certain days of the week as conciliation judge. There is no opportunity to specialize. 42. Under the law on the organization of the Judiciary', Justices of the Peace are competent to sit to hear minor civil cases, involving claims not in excess of CF 1 million. Except in cases involving claims not exceeding CF 250,000, a right of appeal to the Court of Appeal has been provided. Justices of the Peace were designed also to hear cases involving muslim law and customary 21/ See footnote no. 6. `I See footne no. 6. Is/ See footnote no. 6. -7 3 ANNEX 4 Page 9 of 17 law and, thus, supersede the jurisdiction of the Cadis. In practice, however, the Justices of the Peace have yet to be established, and Cadis meanwhile continue to operate. 43. Both First Instance magistrates and the Justices of the Peace sit alone. In both cases, however, they need to be assisted by assessors whenever they sit to hear matters involving customary law. There has been no attempt made to align the areas of competence of the various jurisdictions in accordance with the various systems of law that the jurisdictions are called upon to apply. All jurisdictions apply invariably French law, muslim law and customary law. 44. Theoretically, there is attached to every First Instance Tribunal a Labour Tribunal, which is competent, pursuant to Article 192 of the Labour Code, to hear all labour disputes arising in the course of employment between an employer and an employee, or between employees. The Labour Tribunal consists of a magistrate, assisted by one assessor representing employers and another assessor representing employees. It has ceased to hold regular sittings ever since the Government fell behind in the payment of the allowance which, under Article 198 of the Labour Code, is due to an assessor for each sitting. Lack of Resources 45. Physical Resources. All these courts have one feature in common: they all suffer from a critical lack of both human and physical resources. In Moroni there is presently only one courtroom, which has to be shared out amongst the Court of Appeal, the magistrates of the First Instance Tribunal and the Labour Tribunal. As a result, even those courts which are capable of being properly constituted are unable to sit as often as they might otherwise have wished. The library consists of a few shelves, a couple of tables and chairs, and a dozen or so very ancient volumes, all of them covered with dust. Many magistrates complain of an acute shortage of paper, materials and equipment. Law reporting and periodicals are unheard of, and no attempt has ever been made to compile copies of court judgments. 46. Magistrates. Both in numbers and in terms of quality, magistrates are in short supply. There are not enough magistrates to fill the lower level courts, let alone the intricate structure of higher level courts that have now been established under the Constitution. There are presently twenty magistrates in the Comoros, of whom only sixteen are confirmed appointees, the remainder being public officials appointed to act as magistrates. Of this grand total of twenty magistrates, less than half are assigned to perform duties as sitting magistrates. The rest are either investigating magistrates (uges d'instruction) or public prosecutors. 47. In the Comoros, as in many other francophone countries in Africa, access to the profession can be a long and difficult process for all but a handful. Under the law governing the profession of magistrates', there are transitional provisions which have been introduced to facilitate access to the profession during a period of between three to five years. But these transitional provisions alone will not suffice to produce the dramatic increase in the number of magistrates that will be required during the next few years. Under an Ordinance?' adopted pursuant to the law governing the profession of magistratesm', magistrates are required to undergo formal training in a training school for magistrates prior to their admission into the ranks. This requirement has been interpreted in practice to mean that no one can qualify as a magistrate in the Comoros without undergoing an average of two and a half 2'/ Law No. 87-01. dated January 22, 1991. 2I Ordinanx No. 92-007/PR, dae September 2, 1992. 2XI See footnote no. 21. ANNEX4 - 74 ~ Page 10 of 17 years' post-degree professional training, consisting of one year of pre-school training in the Comoros followed by one and a half years' of actual professional training in a training school. 48. If there is a correlation between the length of training and professional competence, such correlation is not evident in the Comoros. Most magistrates are poorly trained and ill-equipped to discharge their functions, particularly in commercial and business law cases. They are also poorly motivated. There are constant complaints about magistrates' poor grasp of business and commercial laws, their lack of diligence and, above all, their failure to even grasp the full impact of delays on transaction costs. Execution of JudgMents 49. There are also complaints about the procedures for execution of judgments which, by all accounts, are slow, inadequate and not always reliable. One factor is, undoubtedly, the confusion and uncertainty inherent in the laws themselves and, more particularly, in respect of land ownership. A second factor is the shortage of ushers and, presumably, their lack of training. Thirdly, there is a tax on the execution of judgments, lcnown as taxe proportionelle, which ranges from 4 percent of the judgment award, in the case of an award not exceeding CF 50,000, to 6 percent of the award, in the case of an award in excess of CF 50,000, to 10 percent of the award, in the case of an award in excess of CF 500,000. The tax, which is due and payable immediately upon the delivery of a certified copy of the judgment, is widely regarded as a further disincentive in the process of execution of judgments. Finally, there are other factors, including political interventions and close community ties, particularly in rural areas, which impede the process of execution of judgments. 50. The role, functions and status of ushers are dealt with in an Acte adopted, by the Comorian Chamber of Deputies prior to independence, on December 31, 1970. The Acte provides for the liberal exercise of the profession of ushers. There are presently only three ushers who are recognized as such in the Comoros. All three are located in Moroni. M. THE REF1ORM AGENDA The Lgal and Judicial Reform Pro=ram 51. The proposed legal and judicial reform program involves a number of sub-components as follows: (a) compilation, consolidation and publication of existing commercial and business laws; (b) rehabilitation of the process of publication of the Official Journal; (c) establishment of a Law Reform Commission to review, and propose amendments to, existing commercial and business legislation, with particular emphasis on the Investment Code, property laws, the Commercial Code, Company Law and the Labour Code; (d) measures to streamline the litigation process in the lower courts, and enhance the capacity of such courts to dispose of commercial law cases, including the establishment of a commercial court jurisdiction, the appointment of conciliation judges, the introduction of a reporting mechanism for magistrates, and a review of the work environment of magistrates and the adequacy of court procedures; (e) budgetary and other measures to improve the process of recruitment and training of magistrates and other paralegal staff; and ANNEX 4 - 75 Page 11 of 17 (f) measures to strengthen the effectiveness of the Ministry of Justice and, in particular, its newly-created units (LDD/LIC), responsible for legislative drafting and legal information services, respectively. Publication of Laws 52. Existing Laws. The Government takes the view that no reform program can be meaningful unless it proceeds initially to take full cognizance of its acquired stock of existing legislation. In this regard it has decided as a matter of priority to carry out an inventory of all existing commercial and business laws of the Comoros and verify their continued validity, and thereafter to have them published as a complete set for the benefit of all public and private-sector employees, judges, magistrates, lawyers and all other interested parties. A consultant, financed by IDA, has already been recruited to assemble the complete set of legislation which was in effect at the time of independence. This part of the exercise is being conducted at the French national archives in Aix-en-Provence. A similar exercise will be conducted in Moroni with respect to laws that have been passed since independence. 53. Publication of existing laws is designed to improve the legal system and demystify the contents thereof, streamline the process of justice, and enhance the degree of certainty with which the outcome of disputes can be predicted. Considering that such laws are already in force, in theory at least, no further legislative approval of their contents is technically required prior to publication. It will be necessary, however, in due course to seek legislative approval in order to have various minor modifications not affecting substance introduced into all such laws, either to update the language or enhance the coherence, or to incorporate consequential amendments introduced implicitly or expressly in subsequent legislation. Prior legislative approval is also required to enable the published version of existing laws to be regarded as the authentic version of the laws of the Comoros. 54. 1984 Commercial Code. In order to pave the way for the publication of existing laws, and at the same time put an end to the confusing situation which has been brought about as a result of the adoption of the 1984 Commercial Code, the Government will also take necessary steps to have the Code abrogated at the earliest available opportunity. 55. Official Journal. The Government will seek to ensure that laws and regulations are published henceforth without delay. To this end, it will undertake, with effect from December 31, 1995, to make adequate annual budgetary allocations to ensure the regular publication of the Official Journal. In order to streamline the process of publication of the Official Journal, the Government will strengthen the services of the newly-created unit responsible for the Official Journal, as well as the newly-created LIC. It will also issue a circular, setting forth detailed instructions governing the process of preparation of draft legislation, and the printing, distribution and sale of the Official Journal. 56. The Government has agreed that the adoption of enabling legislation to validate the process of publication of existing laws, the abrogation of the 1984 Commercial Code and the issue of the circular governing the Official Journal will all be completed, not later than June 30, 1994, and that the process of compilation, consolidation and publication of existing commercial and business laws will be completed, not later than December 31, 1994. Legislative Reform 57. Law Reform Commission. In order to enhance the process of law revision, the Government will strengthen the newly-created LDD. It will also establish a Law Reform Commission which will have primary responsibility for the supervision of the process of revision of business laws. The Commission, which will consist of business and business law experts, including lawyers, magistrates, ANNEX 4 76 - Page 12 of 17 bankers and other representatives of both the private and the public sectors, will collaborate closely with LDD. Its role will not be to substitute its own judgment for that of LDD, but merely to offer general policy guidance to LDD on the substance of proposed drafts, and to review and approve such drafts as and when they are submitted to it from time to time by LDD. 58. Prior to the beginning of implementation of the legal reform component and, thereafter, prior to the beginning of each following fiscal year, the Commission shall, in consultation with LDD, prepare, and submit to the Government and IDA, an indicative business plan, acceptable to IDA, including proposed targets and objectives for the rest of the program period, and a detailed work program for the forthcoming fiscal year. The extent to which the Commission succeeds in meeting its targets and objectives for each particular fiscal year will be assessed annually, and will constitute one of the key performance indicators of the legal component. 59. It has been agreed that the Law Reform Commission will be established, and its business plan for the first fiscal year submitted to IDA for approval, not later than June 30, 1994. 60. Legislative Reform Program. The existing Investment Code, property laws, Commercial Code, Company Law and Labour Code will feature prominently among the targets and objectives of the Commission during the program period. The weaknesses and inadequacies of such laws have already been highlighted. The existing Investment Code will need to be revised in order to streamline the process of approval of investment proposals and make it more transparent, and provide potential investors with better and more reliable investment security. The provisions of the Commercial Code relating to liquidations, bankruptcies and company restructuring, will also need to be revised, so as to ensure that such provisions are consistent with modern business needs and practices. Similarly, it may be appropriate to revisit some of the restrictive practices now embodied in the Labour Code and, if need be, eliminate them. Last but not least, there is a clear need for an in-depth review of existing property laws, with a view to have such laws revised to provide therein better and more reliable security of tenure. 61. Land Reform. The lack of any effective security of tenure has had a pernicious effect not merely on the application of land tenure laws themselves but, more importantly, on the effectiveness of the system of justice as a whole. Several Comorian lawyers have expressed the view that the time may have come for the development of a fully-integrated legal system that combines the best of the different legal systems that presently co-exist in the Comoros. This proposal raises delicate issues of religious sensitivity and appurtenance to the community, which are best left to the Commission to consider. 62. But while there may be some room for manoeuvre to improve existing property legislation, clearly it will take much more than legislative changes to ease concerns about security of tenure. The duality of legal systems which characterizes existing property laws is only one of several factors which stand in the way of better and more reliable security of tenure. Other factors are an in-born resistance to change, which is deeply embedded in the social fabric and cultural values, particularly in rural areas, and the long and intricate process of registration, which an exorbitant rate of registration duty has done little to ease. In order to have a better understanding of these issues, the Government has decided to sponsor a pilot project, covering one or more geographical districts, preferably in an urban environment, which will be mapped out and properly demarcated so as to re-create therein the required conditions for enforcement of the property laws, as indeed they were intended to be enforced. The proposed project will support the pilot project. It is expected that the results of the pilot project will serve to highlight the strengths and weaknesses of the existing laws, and thus pave the way for more lasting solutions to what remains a very sensitive matter. ANNEX 4 - 77 - Page 13 of 17 Commercial Litigation 63. A number of measures will be taken to streamline the litigation process in the lower courts and enhance the capacity of such courts to dispose of commercial cases. First, a specialized court will be set up as an integral part of every First Instance Tribunal, to be responsible for the disposal of all commercial cases falling under the jurisdiction of the Tribunal. A similar arrangement will apply in respect of civil and criminal cases. Second, the conciiation procedure, which exists in practice, but not in law, within the First Instance Tribunal of Moroni will be institutionalized, and a conciliation judge appointed. Finally, the Government will, through the Ministry of Justice, establish a reporting mechanism, whereby all magistrates of the First Instance Tribunals will be required to submit monthly statistics, giving details of the number of cases entered and disposed of during the month, the number of cases which have remained pending for an inordinate length of time, or have been unduly delayed or repeatedly postponed, together with the reasons which account for such delays or postponements. 64. These measures will be first introduced on an experimental basis in Moroni, not later than December 31, 1994, and, on the basis of the results thereof, will be progressively extended to the rest of the country, not later than December 31, 1996. Legislation will be adopted for the establishment of the commercial courts, as well as for the institutionalization and appointment of the conciliation judge. The reporting mechanism for magistrates can be phased in without any delay, inasmuch as many magistrates have already experimented with such a mechanism and are fairly familiar with it. Such a mechanism constitutes a useful tool, with which to assess magistrates' performance and, in particular, their ability to handle their respective workload. In due course, when such a mechanism would have been generalized, it will constitute one of the elements for performance evaluation of magistrates, under Articles 46-48 of the law governing the profession of magistrates-7, and generally for purposes of advancement and promotion. Training and Recruitment 65. Recruitment. Regarding training and recruitment, the objectives of the Government are to increase the number of qualified magistrates, while at the same time enhancing their level of competence and, in particular, their knowledge of business laws and procedures. These apparently conflicting objectives pre-suppose that adequate budgetary allocations, including provisions for additional positions in the Judiciary, will be made available in the on-going redeployment exercise in which the Government is presently engaged. 66. But budgetary positions alone will not suffice, if the number of qualified candidates to fill the positions is inadequate. A situation in which the number of available positions exceeds the number of prospective candidates would tend to suggest either that there is a shortage of qualified candidates or that the required qualifications are unrealistic, or both. The effect of the transitional provisions of the law governing the profession of magistrates2' has been to lower somewhat the entrance requirements for magistrates during the transition period. This is a correct approach to build up the numbers in the short term, which needs to be fully exploited during the next few years. In the longer term, however, the Government has also indicated its willingness to review the process whereby qualified lawyers are made to undergo in practice an average of two and a half years' post-degree professional training in order to qualify as magistrates. Efforts are currently under way to bring about a substantial reduction in the length of the training period for magistrates, thereby greatly facilitating their access to the profession, without, necessarily, lowering the level of proficiency expected. '/ Law No. 87.01, datod January 22, 1991. 22/ idem. - 78 ~~~ANNEX4 - 78 - Page 14 of 17 67. The Government has agreed to create ten additional budgetary positions in the Judiciary, out of which not less than half will be filled not later than December 31, 1994, and the balance, not later than December 31, 1996. It has also agreed that the review of the rules governing the post-degree professional training for magistrates will be conducted, and the results thereof communicated to IDA, not later than December 31, 1995. 68. Training. The proposed reform program places special emphasis on the need for training and human resources development. Training will be provided mainly, but not exclusively, for magistrates, lawyers and other groups involved in the administration of justice, including court registrars, ushers and potential law students. Other groups, including other public officials and private entrepreneurs, will also be encouraged to participate. 69. The training program will consist principally of training in commercial and business laws and procedures. Initially, during the first couple of years, the program will focus on the core subjects typically included in a business law course. Such subjects include a review of examples and definitions of commercial transactions (actes de commerce), an examination of the role of commercial and business laws, and their relationship with traditional principles set forth in the Civil Code and other legislation, the different types of companies, and, finally, the rules governing the assets of companies (fonds de commerce) and access to short-term and investment credit. The scope of the training program will be enlarged in subsequent years to include intellectual property law, bills of exchange (effets de commnerce), banking law, and maritime and air transport laws. The contents of the training program will kept under constant review, and adjusted from time to time to take into account new priorities and, in particular, the evolution of the legislative reform program. 70. For the most part training will be in the form of lecture courses lasting up to two months per year. In order to reach as wide an audience as possible, lectures will be scheduled to last no more than a couple of hours a day, preferably during afternoons after normal business hours. Specialized talks and seminars will also be scheduled to address topical issues which may arise from time to timie, particularly in the context of the progress of the on-going legislative reform program. Finally, the Government also plans to revive the Course in Basic Law (Capacite en Droit) that used to be organized until 1976 with the assistance of French Law Professors for the benefit of potential law students and paralegal staff. A detailed training program is currently under preparation. It is due to be finalized and submitted to IDA for approval, not later than June 30, 1994. Qther Measur 71. Finally, the Government also plans to implement a number of measures designed to improve the administration of justice and streamline due process. First, the Government recognizes that regular court sittings constitute a basic pre-condition for a speedy and efficient system of administration of justice. To this end, it will seek to identify additional facilities that could serve as courtrooms, and thus relieve the existing pressure on the one and only courtroom presently in use in Moroni. Secondly, space constraints notwithstanding, there is now growing awareness that the existing backlog of outstanding court cases will persist, unless and until judges and magistrates can be prevailed upon to convene considerably more than the two monthly sittings that they currently hold. A large and spacious courtroom, such as the one currently in use in Moroni, is no doubt imposing and highly desirable, but hardly a prerequisite for a court sitting, albeit a public one. Thirdly, the Government recognizes that the existing tax on execution of judgments (taxe proportioneDe) constitutes a major disincentive for the execution of judgments; accordingly, it will review the effectiveness of such a tax, and its raison d'&tre, with a view to have such tax abolished or reduced, as the case may be. Fourthly, in collaboration with magistrates, the Government will, through the Ministry of Justice, explore ways and means of speeding up the course of justice, particularly in cases where the parties resort to delaying tactics. Such measures may include added emphasis on summary judgments (jugements reputes contradictoires) or, in appropriate cases, recourse to a procedure whereby cases - 79 ANNEX4 - 79 ~ ' Page 1S of 17 may be struck out for want of diligence on the part of the plaintiffs. Lastly, the Government will take appropriate steps to provide judges and magistrates with the tools that they require to discharge their functions, including materials and equipment, library facilities and adequate means to ensure the regular publication and conservation of court decisions. 72. Considering that these proposed measures all raise delicate issues affecting directly the work environment or prerogatives of magistrates, the Magistrates' Association has decided to take the lead and form a working party to examine such proposed measures and make detailed recommendations thereon for consideration by the Government and IDA. It has been agreed that the findings and recommendations of the working party will be transmitted to the Government and IDA, not later than June 30, 1994, and that, subject to any reasonable reservations that the Government or IDA may have thereon, such recommendations will be implemented forthwith. IV. THE PROJECT Coordination and Reportine 73. Under the proposed Small-scale Enterprise Development Project, the Government will be required to recruit a long-term consultant to be the coordinator for the legal reform component of the project. The Legal Reform Coordinator, who will be a lawyer and, preferably, of Comorian nationality, will be responsible for the coordination of the various sub-components of the legal reform component. The Legal Reform Coordinator will report to the Legal Affairs Director of the Ministry of Justice. He will be assisted by a steering committee, consisting of representatives of magistrates, judges, the unit responsible for the Official Journal, and other parties who may be interested in the preparation and implementation of the proposed project. 74. In the exercise of his functions under the Project, the Legal Reform Coordinator will liaise closely with the overall Project Coordinator, IDA and other donors interested in the legal reform program. As Legal Reform Coordinator, he will be primarily responsible to ensure that the legal reform component is implemented according to plan, and that the objectives thereof are adequately met. Should the need arise, he may also be required to initiate appropriate action to secure additional donor financing for the legal reform component. 75. The Legal Reform Coordinator will ensure compliance with any conditionality that may be related to the legal reform component under the proposed project. In particular, he will be responsible for the procurement of goods and services, and for the selection of consultants, required under the legal reform component. He will supervise the preparation and implementation of the training program under the legal reform component. He will also be assisted by the overall Project Coordinator in the preparation and submission of disbursement requests, and will provide information needed for the management and consolidation of the accounts of the Project. 76. The Legal Reform Coordinator will prepare quarterly reports on the progress of the legal reform component of the Project, including on the monitorable indicators, for submission to the Government and IDA. Upon taking office and, thereafter, prior to the end of each fiscal year, he will also prepare, for submission to IDA, a proposed business plan for the legal component for the forthcoming fiscal year, giving details of proposed targets and objectives for that fiscal year, and the means and strategies needed to achieve such targets and objectives. It will be for the Legal Reform Coordinator to ensure compliance with the business plan and, to the extent practicable, achievement of such targets and objectives. 77. The Legal Reform Coordinator will be hired on the basis of an initial contract of one year, including a probation period of three months. Any renewal of the contract thereafter will be subject to approval by IDA, based on a satisfactory performance evaluation under the initial contract. It is - 8- ANNEX 4 Page 16 of 17 expected that the Legal reform Coordinator will be recruited, and the steering committee established, not later than June 30, 1994. IDA Financine 78. The proposed project would finance materials and equipment, including library materials, and materials, furniture and equipment to strengthen the commercial courts (including the Registre du Commerce), the Ministry of Justice (LDD/LIC) and the unit responsible for the Official Journal ($310,000). It would also finance short-term consultancy services to assist in the process of compilation, consolidation and publication of laws, to support the law revision exercise and, finally, to assist in the preparation and implementation of the training program ($650,000). Finally, the proposed project would also cover the cost of the services of a long term consultant to be the legal reform coordinator and a legal secretary ($120,000). 79. Library materials would include law books and periodicals, and ancillary materials and equipment, required to rehabilitate the law library. A tentative list of law books and periodicals is in the process of being compiled. The list will take full account of the needs of both the legislative reform program and the training program under the proposed project. Inevitably it will consist mainly of books and periodicals which are relevant to commercial and business laws. 80. Prior to the disbursement of funds to finance library materials under the proposed project, the Government will be required (a) to submit a proposed list of law books and periodicals to IDA for approval, and (b) to satisfy IDA that it established adequate rules to control access to the law library facilities, and taken all other necessary measures, including the recruitment of a full-time law librarian, to ensure the safe-keeping of books and periodicals procured under the proposed project. V. LEGAL REFORM COORDINATOR TERMS OF REFERENCE 81. General. The legal and judicial environment has a critical role to play in the development process. It not only serves to build up investor confidence and guarantee security of transactions; it also ultimately reduces the cost of doing business. In the Comoros the legal and judicial system has failed to measure up to these standards. A recent study of the legal and judicial environment in the Comoros has served to expose the inadequacies of the system as a whole and, in particular, its ability to contribute to growth and development. Leeal Reform 82. Under the proposed Small-scale Enterprise Development Project, the Government plans to use available donor support to implement a series of measures designed to promote the development of the private sector. The proposed Project includes, inte ijL, a legal reform component, which will be used as the vehicle for reform of the legal and judicial sector. More specifically, the proposed legal reform component consists of the following sub-components: (a) compilation, consolidation and publication of existing commercial and business laws; (b) rehabilitation of the process of publication of the Official Journal; (c) establishment of a Law Reform Commission to review, and propose amendments to, existing commercial and business legislation; (d) measures to streamline the litigation process in the lower courts, and enhance the capacity of such courts to dispose of commercial law cases; (e) budgetary and other measures to improve the process of recruitment and training of magistrates and other paralegal staff; and 8~~~~~~~ ANNEX 4 81 Page 17 of 17 (f) measures to strengthen the effectiveness of the Ministry of Justice and, in particular, its newly-created units (LDD/LIC), responsible for legislative drafting and legal information services, respectively. 83. In order to ensure the smooth implementation of the legal reform component, the Government has decided, in consultation with IDA, to recruit a long-term consultant to be the coordinator for the legal reform component of the project. A Project Coordinator to be responsible for the overall coordination of the Project as a whole has already been designated. Legal Reform Coordinator 84. Profile of Coordinator. The Legal Reform Coordinator must be a lawyer, dynamic and energetic, full of initiative, and capable of inter-acting with senior Government officials and other higher-level executives. He must be the holder of at least a master's degree in law, with not less than four years' post-degree work experience in a legal or judicial capacity. Preference will be given to Comorian nationals. 85. Role and Functions of Coordinator. The Legal Reform Coordinator will be responsible for the coordination of the various sub-components of the legal reform component. He will report to the Legal Affairs Director of the Ministry of Justice, and will be assisted by a steering committee, consisting of representatives of magistrates, judges, the unit responsible for the Official Journal, and other parties who may be interested in the preparation and implementation of the proposed project. 86. In the exercise of his functions under the Project, the Legal Reform Coordinator will liaise closely with the overall Project Coordinator, IDA and other donors interested in the legal reform program. As Legal Reform Coordinator, he will be primarily responsible to ensure that the legal reform component is implemented according to plan, and that the objectives thereof are adequately met. Should the need arise, he may also be required to initiate appropriate action to secure additional donor financing for the legal component. 87. The Legal Reform Coordinator will ensure compliance with any conditionality that may be related to the legal reform component under the proposed project. In particular, he will be responsible for the procurement of goods and services, and for the selection of consultants, required under the legal reform component. He will supervise the preparation and implementation of the training program under the legal reform component. He will also assist the overall Project Coordinator in the preparation and submission of disbursement requests, and in the management and consolidation of the accounts of the Project. 88. The Legal Reform Coordinator will prepare quarterly reports on the progress of the legal reform component of the Project, for submission to IDA. Upon taking office and, thereafter, prior to the end of each fiscal year, he will also prepare, for submission to IDA, a proposed business plan for the legal component for the forthcoming fiscal year, giving details of proposed targets and objectives for that fiscal year, and the means and strategies needed to achieve such targets and objectives. It will be for the Legal Reform Coordinator to ensure compliance with the business plan and, to the extent practicable, achievement of such targets and objectives. 89. Terms and conditions of employment. The Legal Reform Coordinator will be hired on the basis of an initial contract of one year, including a probation period of three months. Any renewal of the contract thereafter will be subject to approval by IDA, based on a satisfactory performance evaluation under the initial contract. The Legal Reform Coordinator will receive an attractive salary and other benefits, which will be determined on the basis of the actual qualifications and experience of the successful candidate. It is expected that the Legal reform Coordinator will be recruited not later than June 30, 1994. - 82 - ~~~~ANNEX S - 82 - Page 1 of 4 ISLAMIC FEDERAL REPUBLIC OF THE COMOROS SMALL ENTERPRISE DEVELOPMENT PROJECT DEVELOPMENT BANK OF THE COMOROS BUSINESS PLAN Background 1. Since the liquidation in 1981 of Societe de Credit pour le Developpement des Comores, the provision of long- and medium-term financing for private operators in the Islamic Federal Republic of the Comoros has been the exclusive responsibility of the Development Bank of the Comoros (BDC). With the constant support of the Government and donors, and thanks to a prudent policy, the BDC has contributed significantly to the country's economic development. Despite a difficult environment characterized mainly by a limited number of economic operators, deficient business accounting and management systems, and an inadequate legal and judicial framework, the BDC granted over 1,400 loans, totaling CF 3 billion, over the period 1982-1993. Of these, 73% went to the productive sector, while the balance was allocated to the financing of social and residential housing. During this time, the bank constantly posted positive net results, which, despite adequate provisioning for risk and doubtful loans, enabled it to more than double its equity, which by December 31, 1993, stood at CF 850 million, representing approximately one third of its total balance sheet and 75% of outstanding loans. Both in absolute terms and by comparison with numerous African development banks, these results are way above average and have enabled the bank to substantially strengthen its financial structure. 2. However, despite this undeniable success, the BDC has been operating since the late eighties in a steadily deteriorating environment, this being primarily attributable to the following factors. (i) The worsening economic crisis and the climate of political uncertainty contributed to the decline in the demand for investment. (ii) The Government's budgetary deficit was reflected in delays of sometimes more than three months in the payment of civil service wages; this situation in turn resulted in arrears impacting the bank's loan portfolio. In addition, the Government's financial difficulties prevented it from transferring to the BDC amounts withheld from civil servants' wages to cover loan repayment. The blockage of such transfers represented a serious loss of income for the BDC. (iii) The preparation of a reduction in force program for the civil service could be expected to have an impact on the bank's portfolio, since some 50% of its loans have been made to civil servants or else are guaranteed by government employees. Added to this is the fact that the joint security mechanisms on which the lending system used largely to be based are likely to be less accessible in the future. (iv) There was a substantial reduction in lending operations in 1993. (v) The persistence, and even intensification, of the. dysfunctions within the judicial system made it difficult for the bank to get a court to enforce an insolvent borrower's real guarantees; court decisions that were handed down almost three years ago concerning five loans, together accounting for some 60% of the bank's doubtful and disputed loans, have still not been executed. - 83-ANNEXS Page 2 of 4 3. The combination of the above factors has led to a deterioration in the BDC's financial situation over the past few years. (i) After peaking in 1988, the loan portfolio steadily dwindled to approximately CF 1.2 billion, with net lending totaling a mere CF 228 million in 1993. Portfolio quality also deteriorated over the same period; the volume of outstanding loans overdue by more than 10 payments tripled from CF 123 million in 1989 (44 loans) to CF 358 million in 1993 (72 loans). This directly impacted the collection rate, which was less than 80% in 1992. An off-shoot of the drop in the outstanding loan portfolio was the substantial increase in liquidity, such that the bank's present cash position is on a level with its outstanding loan portfolio. (ii) Because the BDC's prudential regulations prohibit it from making any new loans in sectors where arrears are over 10%, the bank's Board of Directors has repeatedly had to grant waivers so that it can continue to lend to the crafts, fishery and agriculture sectors; (iii) While its outstanding loan portfolio is dwindling, the Bank is seeing an increasingly share of its intermediation spread absorbed by its overhead, equivalent to 4.3% of the bank's average assets and 6.2% including provisions. 4. In addition, the action taken by the Central Bank in September 1993 to cap the interest paid on the BDC's liquidities at the level of its equity will, together with the drop in money market rates, also have a significant impact in the future if the outstanding loan position continues to decline. Another point worthy of consideration is that the monopoly situation that the bank has enjoyed up to now should gradually be phased out in favor of a more competitive environment. 5. Thanks to the notable economic recovery measures taken by the Government over the past two years, the country should gradually see a return to growth rates that are higher and more compatible with its needs. However, despite the general measures already put in place or slated for implementation within the framework of support to the private sector, such as the establishment of the Private Sector Development Agency (CASP), the setting up of a guarantee fund, and the program to overhaul the legal and judicial system, the reform process will not achieve its full impact for some time yet. Meanwhile, the BDC will need to be able to meet the new challenges facing it, namely: (a) the decline in its outstanding loan portfolio; (b) the limitations of a decision-making process based chiefly on security or guarantee mechanisms; (c) limited financing granted to certain sectors of the economy and in particular to small promoters; (d) deteriorating portfolio quality. Business plan 6. The strategy that the BDC proposes to implement over the next few years to cope with this complex environment will need to take into account a number of measures affecting the different aspects of the bank's operations: (a) improvement of its loan appraisal and monitoring capacities; (b) establishing closer links with its customers whose needs should be better taken in account; (c) containment of overhead costs; (d) gearing of its loan facilities to projects, through simultaneous interest rate and final maturity date adjustments; (e) intensification of monitoring and collection procedures; (f) putting in place a medium-term strategy. Improvement of loan appraisal and monitoring capacities 7. The Loan Directorate presently has a staff of four, for an average of 120 loan applications processed in a normal year, half of which are in the real estate sector. Decisions to award loans have often been based more on the value of the guarantees presented than on the quality of the applications -84- ANNEXS Page 3 of 4 themselves and of their promoters. In an environment where it is particularly difficult to recover guarantees and where liens on equipment have little value because of the often unique nature of the projects, it is essential that the quality of the appraisal procedures be enhanced. The relatively small proportion of loans granted to small businesses (6.9%) and the size of the arrears in this sector are indications, apart from the risks inherent in small businesses, particularly those of recent creation, of the need to put in place specific appraisal procedures enabling the bank to keep its finger on the pulse of their evolving needs. 8. The need to process very diverse applications and the new demand deriving partly from the CASP's operations make it essential to strengthen the loan department through a specific training program. Taking account of the fact that the BDC has limited resources and that it is essential that it keep its overhead to a minimum, a two-fold approach is proposed: (a) the BDC will make use of existing programs, in particular those offered by the CASP; and (b) it will approach donors for aid in the form of grants to finance specific on-the-job training courses to be given by external consultants. 9. Apart from measures to improve its loan appraisal procedures, the BDC proposes to set up subproject monitoring mechanisms to enable it to rapidly detect any difficulties arising and to take the necessary corrective action, either by providing the operator with technical support, when that is possible, or through credit rescheduling or the application of protective measures. This monitoring process will be used for operations in sectors other than real estate, and will be tailored to the particular nature of the project concerned. It may be either implemented directly by the BDC, entrusted to the CASP, with payment of a commission, or, in cases presenting difficulties of a specific nature, handled by targeted short-term missions made available to the BDC by the donors. 10. Lastly, should the need arise, the BDC will also use the guarantee fund mechanisms set up within the Private Sector Assistance Fund (FASP), which will enable it to partially offset the small size of certain traditional guarantees and to finance certain projects that might not otherwise be acceptable. ResDonsiveness to ,Drvate sector needs/ Adequacy of offer 11. Given its past situation as the only bank granting long- and medium-term loans, and since its loan portfolio showed a steady growth for some years, the BDC has developed a bureaucratic approach and insufficiently taken in account the needs of its customers. This 'poor image' was intensified in 1992-1993 when no definite reasons were given for the curtailment of lending operations and by the dynamic communicationpolicy of the CASP. In addition, the sometimes excessive length of time taken for the bank to respond to promoters has not helped to reinforce its image as a dynamic institution. 12. In this area, and this will be the responsibility both of the Loan Department and of the General Manager's Office, the BDC needs to get closer to its customers. This can be done in several ways: (a) increased field presence, particularly in terms of enhanced monitoring activities; (b) measures to expedite response to the applications submitted as well as regular examinations of this indicator by the General Manager's Office; and (c) improved relevance of the bank's loan facilities through simultaneous adjustments to interest rates, final maturity dates, and repayment procedures. Containment of overhead 13. The overhead of a bank generally consists of fixed costs that cannot easily be altered to reflect changes in its level of business activities, especially in the case of a bank as small as the BDC. However, because of the impact of this item on interest rate levels, and because of the BDC's particular situation of an outstanding loan position in decline, a particular effort will be made to -85- ANNE" Page 4 of 4 contain overhead as much as possible. With its present staff of 23, it needs to avoid recruitment and instead should aim to reorganize the programs of its various units and redeploy its resources accordingly. For example, staff employed in lending operations will be assigned to strengthen the collection operations team. All changes in wages and other costs will also be carefully monitored to avoid slippage, despite the recent devaluation of the Comorian franc. Interest rates 14. Where interest rates are concerned, the BDC is aware of the need to offer rates that are as low as possible, thereby making its own contribution to economic recovery. However, changes in interest rates depend on different factors, some of which, such as the following, are completely or at least partially beyond the control of the BDC: developments affecting the macroeconomic framework, inflation rates, policies of the Ministry of Finance and of the Central Bank, fixing by donors of the cost of BDC funds, etc. Those factors that do come within the BDC's control are chiefly linked to the level of overhead (and to the average size of the loan applications) and to the assessment of the risk inherent in the specific sector or project. 15. Because the proportion of doubtful loans in the agriculture, crafts and fishery sectors has in the past led the BDC to suspend financing to those sectors, and because of the need to address the demand of small businesses, it has become necessary to widen the interest rate band to take account of the specific risks of each individual loan while keeping within the authorized overall spreads. Loans for small industrial, agricultural or crafts projects tend to generate substantial administrative and monitoring costs, with higher risks of default. The same goes for the projects of newly created enterprises. If the BDC is going to be able to finance such operations, it must be allowed to have greater control over its interest rates. The Manual of Procedures and the By-Laws will be updated accordingly, and the draft texts are to be submitted to the Board of Directors. Collection 16. The BDC will continue to reinforce its actions in the area of loan collection through the adoption of measures at several different levels. First of all, an inventory will be taken of loans granted to or guaranteed by civil servants. This approach will enable the bank to gauge the direct impact of the proposed reductions in force on its portfolio and to proceed without delay to any action that needs to be taken. In addition, the loans will be subjected to a quarterly process of reclassification, so that the status of the portfolio can be continuously monitored and the causes and origins of instances of default identified, thus allowing prompt action to be taken in conjunction with the lending operations staff. 17. The bank will continue to strengthen its procedures in the area of loans in dispute. However, recent experience has shown that its efforts will have only limited effect without specific support from the Government. Given this constraint, continued efforts will be made to sensitize Ministry of Justice staff, and a dialogue will be maintained with the Government with a view to obtaining by a reasonable deadline the enforced execution of judgments against borrowers who are quite clearly solvent. In this area, priority will be given to the five cases mentioned in point 2 above. - 86 - ANNEX6 Page 1 of 2 ISLAMIC FEDERAL REPUBLIC OF THE COMOROS SMALL ENTERPRISE DEVELOPMENT PROJECT PROJECT COORDINATOR, TERMS OF REFERENCE General 1. The Small Enterprise Development Project consists of four, mutually reinforcing components: (a) a line of credit which will provide the term resources needed to finance medium- and long-term investment; (b) an enterprise development fund to help entrepreneurs improve the design of their projects and strengthen their managerial capacity; (c) training and institutional support to the Ministry of Justice and the legal profession to strengthen their capabilities to design and implement legal and judiciary reforms aimed at improving the legal system; and (d) training and institutional support to the Ministry of Finance to undertake studies to design reforms aimed at improving the business environment, and to oversee project implementation. 2. The project is a comprehensive program addressing the main constraints affecting the private sector development. Because of the diversity of its components, each beneficiary institution will implement its actions independently within the framework agreed on with the Government. Despite the autonomy of the components, a coordination will be put in place to ensure the correct implementation of the measures. Key Duties 3. The project coordinator will be directly in charge of the component (d); in this context, he will specifically: (i) establish on a yearly basis a work program within the framework of the Government's statement of sectoral strategy; (ii) hire the experts to undertake the studies agreed on with the Government and supervise their work; (iii) be the adviser of the Ministry of Finance for private sector development matters and be one of the Ministry's representatives on the Structural Adjustment Committee; (iv) act as accountant for the whole project and put in place the management's procedures. 4. Concerning the other components, he will supervise the work of the institutions in charge, namely: (i) the coordinator of the legal reform; (ii) the director of the EDF institution (the CASP); and (iii) the participating financial institutions for the line of credit. He will specifically: (i) ensure that all the institutions (EDF, legal reform and PFI) establish annual coherent work program and budgets consistent with the objectives of the project; - 87 - ANNEX6 Page 2 of 2 (ii) put in place quarterly reporting mechanisms for all the components; (iii) act as accountant for the project; (iv) ensure that the accounts of the project, statements of expenditures and PFI are audited in a timely manner; and (v) support the managers of all the components in administrative and management matters. 5. The coordinator will act as the primary channel for forwarding project documents to IDA. The coordinator would prepare and submit to IDA progress reports, at regular intervals of at most three months. He/she would also collect and prepare the necessary background documents (related to project implementation as a whole, including project indicators, reports by other executing agencies and others requested by IDA) prior to arrival of supervision missions and participate in such missions. The coordinator, with the help of his secretary, should collect and compile key documents, including recent studies on public enterprises, private sector constraints and policies, and relevant donor activities. These documents should be kept in a reference library. Institutional Arrangements 6. The coordinator will be attached to the Ministry of Finance and report directly to the Minister, thus acting as his advisor on economic affairs pertaining to private sector development, as broadly defined in the Government's statement of sectoral strategy. In this context, the coordinator would be one the Ministry's representatives on the Structural Adjustment Committee. Qualifications 7. The coordinator, a Comorian national, should be an economist/financial analyst with a university degree and about five years experience and strong analytical skills. Past involvement in economic policy making at a senior technical level would be highly desirable, so would familiarity with Bank procedures. The position is expected to last through the life of the project, i.e. until end-1999. The coordinator would be hired for a period of one year, under a renewable contract. - 88 - Page 1 of 1 ISLAMIC FEDERAL REPUBLIC OF THlE COMOROS SMALL ETRISE DEVELOPMENT PROJC Selected Documents and Data Available In the Project file 1. Ranport de mission sur le cadre juridiaue et judiciaire aux Comores. Robert Garron, Robert Ahn6e, Binty Mady, Jean Bernard Toinette, August 1993. 2. Etude sur le secteur Drive. GCF, Paul Saada, March 1991. 3. Renforcement des capacitds de gestion. volet entreprises nubliques. Raport de mission. Programme des Nations Unies Pour le Developpement, Patrick Tardy, Consultant, March 1992. 4. Entreprises publigues de la Republigue Federale Islamigue des Comores. Etats Financiers Consolides et raDport d'Audit: Price Waterhouse, January 1991. 5. Situation au 5 juillet 1993 sur la restructuration en cours des Entreprises Publiques: Ministere des Finances, July 5, 1993. 6. Rapport d'Ins2ection dela BDC et de la BIC: Banque Centrale des Comores, Caparello et Houssein Cheikh, December 1993. 7. Development Bank of Comoros. Proiect Completion Report: Staff Report, October 22, 1990. 8. Macro-Economic Reform and Capacity Building Credit: Staff Appraisal Report, May 24, 1991. 9. Policy Framework Paper for 1994-1996: World Bank Staff, February 24, 1994. 10. Review of the Public Enterprise Sector: World Bank Staff, February 1994. 11. Statistical Tables on the Financial Sector: World Bank Staff, February 1994. - 89 - ANNEX8 Page 1 of 1 ISLAMIC FEDERAL REPUBLIC OF THE COMOROS SMALL ENTERPRISE DEVELOPMENT PROJECT Schedule of Disbursements (million US$) Estimated Disbursement Quarterly For Year For FY Total 1995 March 31 0.40 0.40 June 30 0.20 0.60 0.60 September 30 0.20 0.80 December 31 0.20 1.00 1.00 1996 March 31 0.20 1.20 June 30 0.20 1.40 1.40 September 30 0.20 1.60 December 31 0.20 1.80 1.80 1997 March 31 0.20 2.00 June 30 0.30 2.30 2.30 September 30 0.30 2.60 December 31 0.20 2.80 2.80 1998 March 31 0.20 3.00 June 30 0.20 3.20 3.20 September 30 0.20 3.40 December 31 0.20 3.60 3.60 1999 March 31 0.20 3.80 June 30 0.15 3.95 3.95 September 30 0.15 4.10 December 31 0.15 4.25 4.25 2000 March 31 0.15 4.40 June 30 0.15 4.55 4.55 September 30 0.15 4.70 December 31 0.15 4.85 4.85 2M1 March 31 0.15 5.00 June 30 0.10 5.10 5.10 - 90 - ANNEX 9 Page 1 of 2 ISLAMIC FEDERAL REPUBLIC OF THE COMOROS SMALL ENTERPRISE DEVELOPMENT PROJECT Bank Supervision of Key Activities ARroximan Activity Expected Skills (SW) Date September 1994 Supervision Mission - (a) finalization of project Operations Officer (2) implementing arrangements, schedules, staffing and Lawyer (1) consultancy requests for EDF and Ministry of Finance and Disbursement/ Industry; (b) continue studies of legal framework; (c) follow Procurement expert (1) up on conditions of effectiveness, if needed, and disbursements; and (d) familiarize all executing agencies with Bank procurement and disbursement. February 1995 Supervision Mission - (a) review of progress for Operations Officer (2) studies/reforms/action plans to completed by end-1994; (b) Financial Sector review interest policies and evaluate the implementation of Specialist (1) the line of credit; and (c) finalize work program for 1995, Disbursement (2) l______________ including studies and training actions. September 1995 Supervision Mission - (a) Assessment of progress in project Operations Officer (2) implementation during 1995; and (b) prepare work program Lawyer (1) for 1996. Economist (1) February 1996 Supervision Mission - Review implementation of covenants. Operations Officer (2) Assess EDF's operation. Preparation of detailed terms of Lawyer (2) reference, staffing and schedule of execution of Mid-Term Institutional Expert (2) Review of project implementation. Review of project implementation. November 1996 Joint Bank/Government Mid-Term Review of Progress in Economist (2) Project Implementation Lawyer (2) Financial Sector Specialist (2) Disbursement (1) May 1997 Supervision Mission - Presentation and review of issues, Operations Officer (2) conclusions and recommendations of Mid-Term Review. Lawyer (2) Preparation of follow-up action plan and implementing Consultant (2) calendar. November 1997 Supervision Mission - Follow up of Mid-Term Review on Operations Officer (2) possible project restructuring and revised policy action plan. Industrial/Regulatory Economist (2) April 1998 Supervision Mission - Review of progress in project Operations Officer (2) implementation and of outstanding issues. Lawyer (1) - 91 - ANNEX9 Page 2 of 2 December 1998 Supervision Mission - Review of progroe in project Operadons Officer (2) implementation. Financial Sector Specialist (2) Lawyer (1) June 1999 Su ision Misso - (as above) Operaions Officer (2) Financial Sector Specialist (2) January 2000 Suoervision Mission - (as above) Operations Officer (2) Financial Sector Specialist (2) January 2001 Supervision Mission - (as above) Oprations Officer (2) Financial Sector Specialist (2) June 2001 Supervision Mission - PCR preparation Operations Officer (2) Financial Sector Specialist (2) 36 40;-4448 The kbx, coakis, cnin: 0m! 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