World Bank Document · 2016. 8. 29. · document of the world bank report no: 25799-cv project appraisal document ona proposed credit in the amount of sdr 8.5 million (us$11.5 million

Document of

The World Bank

Report No: 25799-CV

PROJECT APPRAISAL DOCUMENT

ONA

PROPOSED CREDIT

IN THE AMOUNT OF SDR 8.5 MILLION

(US$11.5 MILLION EQUIVALENT)

TO THE

REPUBLIC OF CAPE VERDE

FOR A

GROWTH AND COMPETITIVENESS PROJECT

Apnl 21, 2003

Private Sector UnitCountry Department 14Africa Region

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CURRENCY EQUIVALENTS

(Exchange Rate Effective April 10, 2003)

Currency Unit = Cape Verde Escudo (CVE)108.95 CVE = US$1US$.00918 = CVI

FISCAL YEARJanuary I - December 31

ABBREVIATIONS AND ACRONYMS

AGOA African Growth Opportunities ActAP Adminstra,ao PuTblicaARM Multi-sector Regulatory AgencyATM Automatic Teller MachinesBCV Banco de Cabo VerdeCAS Country Assistance StrategyCBPPSP Capacity Building Project for Private Sector PromotionCIMA Conference Inter-Africaine sur les Marches d'AssuranceCPAR Country Procurement Assessment ReviewCQ Consultant's QualificationsDCA Development Credit AgreementEGA Emolumentos geraisERR Expected Rate of ReturnFAIMO Frente de Alta Intensidade de Mdo de ObraFDI Foreign Direct InvestmentFIAS Foreign Investment Advisory ServicesFMR Financial Management ReportFMS Financial Management SystemGDP Gross Domestic ProductGLIN Global Legal Information NetworkGPN General Procurement NoticeIADE Institute for Enterprise DevelopmentIAPSO Inter-agency Procurement Service OfficeICB International Competitive BiddingIDA International Development AssociationILO International Labor OrganizationIMF International Monetary FundINPS Instituto Nacional de Previdencia SocialI-PRSP Interim Poverty Reduction Strategy PaperIS International ShoppingLC Least CostMIGA Multilateral Investment Guarantee AgencyMFPRD Ministry of Finance, Planning and Regional DevelopmentMOJ Ministry of JusticeMOU Memorandum of UnderstandingNCB National Competitive BiddingNDP National Development Plan

NPL Non-performing LoansNPV Net Present ValueNS National ShoppingOHADA Organisation pour I 'Harmonisation en Afrique du Droit des AffairesPCU Project Coordination UnitPIM Project Implementation ManualPIP Project Implementation PlanPOS Point of SalePRCBP Privatization and Regulation Capacity Building ProjectPRGF Poverty Reduction and Growth FacilityPROMEX Center for the Promotion of Tourism Investment and ExportsPRSP Poverty Reduction Strategy PaperPSM Pensdo Social MinimaQCBS Quality and Cost Based SelectionSAC Structural Adjustment CreditSISP Sociedad Interbancaria e Sistemas de PagamentosSME Small and Medium EnterprisesSOE Statement of ExpensesSPN Specific Procurement NoticeSS Single SourceTACV Transportes Aereos de Cabo VerdeUEMOA Union Economique et Monetaire OuestAfricanVAT Value-added TaxWTO World Trade Organization

Vice President: Callisto E. MadavoCountry Manager/Director: John McIntire

Sector Manager/Director: Demba BaTask Team Leader/Task Manager: Sherri Archondo

CAPE VERDEGROWTH AND COMPETITIVENESS PROJECT

CONTENTS

A. Project Development Objective Page

1. Project development objective 22. Key performance indicators 2

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 32. Main sector issues and Government strategy 33. Sector issues to be addressed by the project and strategic choices 12

C. Project Description Summary

1. Project components 142. Key policy and institutional reforms supported by the project 163. Benefits and target population 174. Institutional and implementation arrangements 18

D. Project Rationale

1. Project alternatives considered and reasons for rejection 192. Major related projects financed by the Bank and/or other development agencies 203. Lessons learned and reflected in the project design 214. Indications of borrower commitment and ownership 235. Value added of Bank support in this project 24

E. Summary Project Analysis

1. Economic 242. Financial 253. Technical 254. Institutional 255. Environmental 276. Social 277. Safeguard Policies 28

F. Sustainability and Risks

1. Sustainability 292. Critical risks 293. Possible controversial aspects 30

G. Main Conditions

1. Effectiveness Condition 302. Other 31

H. Readiness for Implementation 31

I. Compliance with Bank Policies 32

Annexes

Annex 1: Project Design Summary 33Annex 2: Detailed Project Description 41Annex 3: Estimated Project Costs 49Annex 4: Cost Benefit Analysis Summary, or Cost-Effectiveness Analysis Summary 50Annex 5: Financial Summary for Revenue-Earning Project Entities, or Financial Summary 54Annex 6: (A) Procurement Arrangements 55

(B) Financial Management and Disbursement Arrangements 61Annex 7: Project Processing Schedule 65Annex 8: Documents in the Project File 66Annex 9: Statement of Loans and Credits 67Annex 10: Country at a Glance 68Annex 11: Post Privatization and Divestiture Reform 70Annex 12: INPS: Diagnosis and Reforms 73Annex 13: Letter of Sector Development Policy 80

MAP(S)IBRD 27215

CAPE VERDEGrowth and Competitiveness Project

Project Appraisal DocumentAfrica Regional Office

AFTPS

Date: April 21, 2003 Team Leader: Sherri Ellen ArchondoSector Manager/Director: Demba Ba Sector(s): General industry and trade sector (40%),Country Manager/Director: John McLntire General finance sector (20%), Compulsory pension andProject ID: P074055 unemployment insurance (20%), General publicLending Instrument: Specific Investment Loan (SIL) admmistration sector (20%)

Theme(s): Other financial and private sector development(P), Regulation and competition policy (S), Other publicsector governance (S)

Project Financing Data[]Loan [X] Credit [ Grant ] Guarantee [ ] Other:

For Loans/Credits/Others:Amount (US$m): $11.5

Proposed Terms (IDA): Standard CreditGrace period (years): 10 Years to maturity: 40

Service charge: 0.50%Financing Plan (US$nm): 'Source -Local!", '-'Foreign TotalBORROWER 0.12 0.10 0.22IDA 6.30 5.20 11.50SUB-BORROWER(S) 1 08 0.70 1.78Total: 7.50 6.00 13.50

Borrower: GOVERNMENT OF CAPE VERDEResponsible agency: MINISTRY OF FINANCE, PLANNING AND REGIONAL DEVELOPMENTAddress Avenida Amilcar Cabral, 100, C.P. 30Contact Person: Dr. Joao SantosTel: (238) 618282 Fax: Email: [email protected] Agency(ies):PCUAddress: P.O. Box 323Praia, Cape VerdeContact Person: Isabel InahonyTel: (238) 61-47-48 / 612319 Fax: (238) 61-23-34 Email: [email protected]

Estimated Disbursements ( Bank FY/US$m):FY 2004. 2005 2006 2007 - 2008

Annual 2.30 3.50 3.00 2.20 0.50Cumulative 2.30 5.80 8.80 11 00 11.50

Project implementation period: September 2003-August 2007Expected effectiveness date: 09/15/2003 Expected closing date: 02/28/2008

A. Project Development Objective

1. Project development objectAve: (see Annex 1)

The project's overall objective is to broaden the base of private participation in Cape Verde's economicgrowth and enhance private sector competitiveness and further develop its financial sector. This wouldbe achieved through a series of actions supported by the project, notably: (a) financial sector reform,including pension reform; (b) investment climate reform, which includes, but is not limited to: (i) taxreform, (ii) alleviation of administrative barriers, (iii) improved supply chains, and (iv) legal reform; (c)post privatization and divestiture reforms; and (d) private sector and institutional capacity building. Theproject would thus help sustain the Government's poverty alleviation efforts by generating increasedemployment opportunities through improved international competitiveness.

2. Key performance indicators: (see Annex 1)

The principal indicators selected for measuring progress towards the project development objective arethe following:

Pension reform is well underway and by end-project, measures have been adopted to ensure thepension system's sustainability, namely: (a) a strategy is in place to gradually unify the twoexisting schemes; (b) criteria of benefits for the labor intensive work program (Frentes da AltaIntensidade da Mao de Obra - FAIMO) have been clearly defined; (c) parametric changes havebeen made to the structure of the national institute of social security (Instituto Nacional daPrevidencia Social - NPS).

The financial sector is strengthened and by mid-term review: (a) at least one on-site visit is madeto each commercial bank every two years and all banks are in compliance with prudential norms;(b) the commercial banks have a reduction in non-performing loans to 8 percent of the totalportfolio; and (c) three islands are linked with VISA, which would generate 600 transactionstotaling US$5 million annually. By end-project: (a) the commercial banks will have a furtherreduction in non-performing loans to 7 percent of the total portfolio; and (b) six islands arelinked with VISA, which would generate 950 transactions totaling US$8 million.

As a result of tariff and tax reform, by end-project, the corporate tax rate has been reduced to 25percent and tariffs are consistent with international best practice and regional UEMOA (UnionEconomique et Monetaire Ouest African) norms.

Investment climate has improved and by mid-term review, an action plan including measures forreducing administrative barriers has been adopted and by end-project, at least tworecommendations from the action plan have been fully implemented.

With respect to the post privatization and divestiture, by mid-term review: (a) a new telecomregulatory framework has been adopted; (b) at least one value-added service has been developed;and (c) a draft strategy for private participation for infrastructure in relation to airportmanagement has been prepared. By end-project, at least three value-added services have beenintroduced into Cape Verde.

Measures will be introduced to improve the judicial climate and by mid-term review: (a)regulations and procedures for the labor code have been adopted; (b) a draft arbitrationlegislation, as an alternative means for commercial disputes, has been completed; (c) a system for

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the dissemnination of legal information (either through web-site or another means) has beenestablished; and (d) a legislative action plan, for accession to the World Trade Organization(WTO), has been prepared. By end-project, the notaries on all islands are electronicallyinter-connected and the time to register a business has been reduced from three weeks to 72hours, once the request file is complete.

At least one report on the status of governmental participation in private enterpnses has beenproduced by the Ministry of Financing, Planning and Regional Development (MFPRD) bymid-term review, and by end-project, the research and studies department at the MFPRD isestablished and operational.

Through investment promotion efforts, by mid-term review, foreign direct investment (FDI) inthe country has increased by US$100 million with 2,000 jobs created and by end-project, FDI inthe country has increased by US$225 million with 5,000 jobs created.

Finally, as a result of the matching grant fund, on average, by mid-term review, the entrepreneurshave: improved efficiency ratios, which will be measured by the percentage of operating costsover revenue (sales) of at least 5 percent; and an increase in production and/or services of at least5 percent. By end-project, these ratios are 10 percent.

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1)Document number: 22506 Date of latest CAS discussion: 8/28/2001

The Country Assistance Strategy (CAS) progress report for Cape Verde was considered by the Boardon August 28, 2001. The last full CAS was presented to the Board in December 1997. IDA hassupported Government programs aimed at creating an enabling environment for private sectordevelopment. The proposed project complements other projects in the Bank's CAS, which also relate toadvancing Cape Verde's international competitiveness. These projects include the ongoing Privatizationand Regulatory Capacity Building Project (PRCBP, Cr. 3121-CV), as well as the Capacity BuildingProject for Private Sector Promotion (CBPPSP, Cr. 2864-CV) which closed in 1999. The proposedproject, which was highlighted in the CAS Progress Report as a complement to the ongoing privatizationproject, would support the CAS by addressing problems associated with hidden and/or contingentliabilities of the Government, such as underfunded pension plans, as well as providing support to growththrough the development of the private and financial sectors. The project also reflects the CAS emphasison an integrated Bank Group approach to private sector development, including FIAS (ForeignInvestment Advisory Services) on tax reform and administrative barriers, SME (Small and MediumEnterprises) Department which evaluated institutions working with SMEs, and MIGA (MultilateralInvestment Guarantee Agency) which works with investment promotion agencies. These institutionswere associated with project preparation and will be involved in the implementation phase.

2. Main sector issues and Government strategy:

Cape Verde is a volcanic archipelago of 10 islands, 600 kilometers west of Senegal. It is a country withlimited natural resources, but a recent history of democracy and economic stability and a well-educatedlabor force. The country's sahelian climate means that rainfall is limited and arable land is scarce. Thereare no known mineral or non-renewable energy resources in Cape Verde. This limited economic potentialhas led to a history of emigration. In 2000, there were approximately 435,000 persons living in thecountry and it is believed that about twice as many Cape Verdeans live abroad.

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Cape Verde has a well-developed poverty reduction strategy based on the 1997-2000 NationalDevelopment Plan (NDP), which sets macroeconomic stability, private-sector led growth and social andenvironmental sustainability as key objectives. An interim poverty reduction strategy paper (I-PSRP)was completed in March 2002. Government has recently completed the NDP for 2002-2005, that formsthe foundation of the poverty reduction strategy paper (PRSP) which it expects to complete in 2003. Thecornerstone of Cape Verde's PRSP remains economic growth and employment, in conjunction withimprovements in infrastructure and social services. The program calls for the renewal of economicgrowth with equity and improvement in the productive capacities of the poor, by focusing on training. Inaddition, Government has updated its development framework, or the Grand Options Plan, whichoutlines Government's priorities, including: (i) promotion of good governance; (ii) support ofprivate-sector led growth and the broadening of the productive base; (iii) development of human capital;and (iv) balanced development of infrastructure. High rates of real economic growth will be necessary tosignificantly reduce poverty. The Government intends to give priority to the following:

o Maintaining macroeconomic balances that were weakened during 1999/2000 by internal (domesticconsumption) and external (oil shock) factors, and undertaking structural measures to make thebudget process more sustainable;

a Continuing progress achieved in modernizing the financial sector and reforming the pensionssystem; and

o Sustaining high levels of growth by increasing private sector competitiveness, improving thebusiness environment and developing sectors with untapped potential including tourism, fishing,trade and transport.

Macroeconomic Stability. Progress made in both structural reforms and policy coordination over the pasttwo years has considerably strengthened the macroeconomic situation. It represents the firmest evidenceof the Government's commitment to economic stability, a critical prerequisite for sustaining export-led,broad-based growth and private sector confidence. These reforms have helped sustain economic growthin 2002 at close to 4 percent of Growth Domestic Product (GDP).

The last two years (2001-02) have been a time of change and experimentation with institutionalarrangements and policies, while redressing a difficult macroeconomic situation. Through amacroeconomic program supported by the IMF's Poverty Reduction and Growth Facility (PRGF),covering the period January 2002-December 2004, fiscal deficits have been gradually brought down from26.5 percent of GDP (excluding grants) in 2000, to about 9.5 percent in 2001, and 8.0 percent in 2002.Lower financing requirements from the central government have: (i) allowed it to lower the interest rateit pays on Treasury Bills (currently 6.5 percent for six months bills, down from double digits in 2001);(ii) limited the crowding out of private lending by commercial banks; and (iii) allowed the Central Bankto decrease its discount rate by 1.5 percentage points, to 10 percent. Commercial banks subsequentlylowered their lending rates to the private sector to 13.7 percent, but they remain high in real terms. Thishas contributed to a limited expansion of credit to investors beyond credit secured by collateral (e.g.mortgage loans), while the amount of unremunerated cash in the banks has increased substantially, andraises concerns about their operating margins.

In addition, a World Bank Structural Adjustment Credit (SAC, Cr. 3587-CV) supported a number of keystructural measures, mainly in the areas of privatization and tax reform and provided part of the budgetsupport needed to sustain macroeconomic stability. A major petroleum sector reform has beenimplemented, which has reduced financial risks associated with fluctuations in oil prices. In addition, aspart of the program, a comprehensive tax reform program was initiated which also covers private sectortaxation. In June 2002, the Government significantly simplified import duties. There are now only seven

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(7) rates of customs duties (from 0 percent to 50 percent), and other taxes due on imports wereeliminated. As a result, capital goods and raw materials now carry total customs duties of either 0percent or 5 percent, down from a level of about 20 percent. The Government also modified domesticindirect taxes, with the introduction of a single-rate value-added tax (VAT) of 15 percent, and theelimination of a consumption tax. Lastly, the Government began a process of reforming direct taxation,including the reducion of the corporate income tax to 30 percent of net profits, down from 35 percent;and changing the treatment of dividends. Following a study on the tax system (February 2002), FIAS hasrecommended changes in the tax structure, which are being considered by Government.

The financial sector is comprised of four commercial banks, one off-shore bank, two insurancecompanies, one venture capital company, a foreign exchange agency and a credit card company. Inaddition, there are two main pension schemes for formal sector workers, while some companies arestarting corporate pension plans to supplement future income.

The Government's efforts for financial sector reform, which began in 1991, were accelerated in 1996with the implementation of recommendations from the financial sector study and subsequent supportfrom the CBPPSP. Substantial reforms were successfully undertaken, including, but not limited to theprivatization of the two largest commercial banks (Banco Comercial do Atlantico and Caixa Econ6micade Cabo Verde, of which the public sector still has a share, although the golden share has beenrelinquished), updating the Central Bank Act, implementing a credit risk system (manual), and creating astock exchange. The financial sector strategy (2000-2004), takes the reform to the next stage ofliberalizing the sector, while ensuring that sector institutions remain sound and that depositors funds aresafe. The primary objective of the strategy is to deepen the sector by expanding access and lengtheningthe term structure, as well as introducing new instruments into the market. In particular, the strategyemphasizes four principal areas: (a) development of the bankihg system on two levels: (i) the opening ofthe financial sector to sound private institutions, and (ii) ensuring better financial discipline in thesystem; (b) the strengthening of the capacity of the Banco de Cabo Verde (BCV) in its role to manage themonetary policy and as the regulator and supervisor of the banking and insurance sectors; (c) thepromotion for the diversification of financial products; and (d) the development of non-banking financialinstitutions, such as insurance companies.

During the last several years, Cape Verde's banking system has been modernized, as key state-ownedbanks were privatized, new financial instruments were introduced into the system and BCV operationswere strengthened. In the past twelve months, banking sector deposits in the two dominating banks haveincreased by about 9.5 percent and the loan portfolio by about 15 percent, while non-performing loans(NPL) have been stable and in the case of the largest bank, have dropped to 8.5 percent of the totalportfolio. Both banks are well provisioned for NPL and showed positive results for 2001 and 2002.Lack of credit information on both the corporate and individual clients has been a constraint for financialinstitutions in making informed lending decisions. To facilitate accurate assessment of repayments andbetter allocation of credit, a credit risk system was designed in 1999 with support from CBPPSP. Thecommercial banks provide information to the BCV on a monthly basis and receive credit information onpotential borrowers upon request. However, commercial banks want more ready access through anon-line system.

The banking sector has an imbalance of maturities, with about 80 percent long-term loans (primarily realestate loans) and 20 percent short-term against only about between 36 to 48 percent long-term deposits.Banking systems often have such mismatches; risks associated with maturity mismatch are compensatedthrough variable rates and collateralized with real estate. The challenge for further developing thefinancial sector remains overcoming banks' reluctance to lend long-term resources for capital investment.

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Monetary policy, in the next few years, will be oriented towards price stability and the continuedstrengthening of intemational reserves. In early 2002, the Government drafted a revised central banklaw which was unanimously approved by the National Assembly. The new law: (i) establishes pricestability as the overriding objective of the central bank; (ii) prohibits the extension of central bank creditto Government except for a temporary overdraft facility that must be cleared by the end of each year; (iii)limits the central bank's "lender of last resort" financial support to commercial banks; and (iv) establishesa transparent process for appointing the central bank governor and board members. In its efforts toimprove the definition of roles and policy coordination, the BCV has led an adroit monetary policy,slowly accumulating international reserves while lowering the discount rate. External developmentsremain cautiously favorable, as tourism shows surprising resilience in the face of a worldwide economicdownturn (both in the form of foreign direct investment and tourist arrivals). However, the trade balancehas deteriorated somewhat, with export levels remaining disappointingly steady, and imports increasingto more than six (6) times the level of exports. The gap is filled by services and capital transfers.

In addition, efforts have been made in recent years to improve regulations governing financialinstitutions. The BCV is implementing a number of measures designed to reinforce its operational andoversight responsibilities by continuing to strengthen banking supervision through the training of staff,increasing the number of on-site examinations, updating the off-site reporting system and strengtheningsupervision of its offshore financial institutions. A new anti-money laundering law was approved onDecember 16, 2002, and work has already begun on the preparation of the regulations which willaccompany it. A training program for BCV, as well as the commercial banks and other implicatedinstitutions in this area, is anticipated.

In its effort to deepen the financial system in Cape Verde by strengthening financial infrastructure, aswell as strengthen private-partnerships in the financial sector, the Sociedade Interbancaria e Sistemas dePagamentos, SARL (SISP) was created in 1997. SISP was capitalized with 100 million escudos(approximately US$1 million equivalent) with shareholders consisting of the BCV (30 percent), the fourcommercial banks (40 percent), Cabo Verde Telecom (10 percent), the Government (Department of theTreasury, 10 percent), and two private enterprises (SIBS and UNICRE, 5 percent each). The institute'smandate is to manage activities related to electronic banking, including the payment systems, ATMs(Automatic Teller Machines), and electronic transfers. Since its creation, over 30 ATMs have beeninstalled on five islands and clients can make automatic payments on their bills via the more than 150point of sale (POS) machines that have already been distributed. SISP receives 3.5 percent on all creditcard transactions which is reinvested into its investment expansion program. SISP is ready to move on tothe next phase of its development strategy and has entered into an agreement with VISA International tooffer electronic VISA services, which will support tourism, as well as provide business opportunities andbring foreign exchange into the country. With the development of the VISA program, Governmentanticipates that within three years, three islands would be linked with VISA, generating 600 transactionstotaling US$5 million annually. By end-2007 six islands would be linked to the system, generating 950transactions totaling US$8 million.

The insurance market of Cape Verde is limited. The major activity consists of providing mandatoryautomobile insurance which provides little or no long-term capital, and life insurance which comprisesless than two percent of the total market. Legislation and regulation of the insurance sector are out-datedand regulated tariffs appear inadequate. Within the framework of its strategy, Government intends tocontinue working towards eliminating constraints to the development of the insurance sector, byimproving the regulations, as well as building the supervisory capacity in this area. Govermment had

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considered joining CIMA (Conference Inter-Africaine sur les Marches d'Assurance), the regional bodyfor insurance regulation, however has decided, at this stage, against doing so.

Pensions represent an important element of the social safety net put in place by the Government. Theyalso represent an important potential source for longer-term resources for investment financing. Thereare two main pension schemes for formal sector workers, which together cover one quarter of the formallabor force and pay pensions to about 6,000 people. The Adminstragao Publica (AP) coversapproximately 13,000 civil servants while the Instituto Nacional de Previdencia Social (INPS) had anestimated 31,000 contributors in 2001. The Pensao Social Minima (PSM) is available to the poor andelderly in general. The PSM is paid to about 6,500 individuals. Finally, there are about 10,000 workersparticipating in the labor intensive work program, FAIMO.

Government recognizes the importance of strengthening the pension system and intends to undertake acomprehensive reform. In January 2001, Governnent passed a framework law which establishes thebroad parameters of the pension system. This law takes into account the need for a safety net for theelderly poor as the first tier of the system; a mandatory, contribution-based scheme as the second, and athird tier comprising voluntary, private pension provisions. Legislation, which includes changes to thebenefit formula, indexation, eligibility requirements for disability and pension, retirement age and otherswill be drafted during 2003. This legislation will be the first step towards reducing the existing liabilityand ensuring the sustainability of the system.

The INPS was designed as a partially-fiunded, defined-benefit scheme. While it continues to runsurpluses in its pension scheme, previous governments had effectively forced the INPS to purchasegovernment bonds in order to finance central budget deficits. As a result, the INPS portfolio is heavilyweighted towards non-tradeable government bonds which has a direct effect on the long-term finances ofthe scheme. A number of issues face the pension system. Civil service pension liabilities are high bothby international standards and relative to the INPS resources, and has resulted in a large and increasingburden on the budget. Since only a fraction of annual spending is covered by the eight percentcontribution levied on civil service salaries, and no assets have been set aside to meet this obligation,future pension spending represents a significant and unreported liability of the Government. To cover itsarrears to INPS, Government has issued treasury securities to the INPS that covers most of theoutstanding obligations.

Government intends to gradually shift civil servants into the INPS. The expected eventual merger of thetwo schemes will help ensure efficiency and equity. Technical work to prepare the sector reform wasinitiated during Fall 2001 and will form the basis of a sector policy reform strategy. However, a studyneeds to be carried out so that the appropriate legislative changes required are based on solid fiscalnumbers and that the budget for 2004 explicitly reflects the costs to the Government of taking thismeasure. Cape Verde has been selected as one of the African countries to be included in a nine-countryWorld Bank pilot pension reform program.

Investment Climate. International experience points to the importance of improving the investmentclimate as part of the private sector-led growth strategy and FDI for Cape Verde. The concept ofinvestment climate relates to rules and regulations pertaining to the entry and operations of private firmsand to questions that affect the competitiveness of the economy, such as a level playing field, executionof contracts and property rights' enforcements. The broad concept encompasses diverse areas such asreduction of administrative barriers, tax reform, as well as in the legal environment in which theyoperate. Since 1988, Government has promoted the liberalization and diversification of the economy.An ambitious privatization program has already resulted in the sale of a number of state-owned

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enterprises and Government is working to attract foreign investment in small-scale industry, fishing and

tourism.

Government recognizes that, in light of its limited natural resources, Cape Verde is sensitive to external

shocks. The present environment in Cape Verde has led to growth of the real sector by 4 percent in 2002

with inflation around 1.5 percent. The recent approval of certain African Growth and Opportunity Act

(AGOA) clauses is expected to result in new export-oriented foreign investments. The Government is

aware that growth is not sustainable unless critical issues such as factor costs and availability of serviceinfrastructure are addressed. While standards in terms of telecommunications are high, access to water

and electricity are relatively low. Moreover, the price of utilities is high and has a negative impact on the

viability and profitability of business. With support of the SAC and PRCBP, reforms in the utility sector

are already underway, including: (i) the adoption of a modernized legal and regulatory framework to

increase competition wherever possible; (ii) privatization and private participation in infrastructure; and

(iii) creation of a multi-sector regulatory agency (ARM). The Government's public investment program

will continue to focus on improving the basic infrastructure (roads, water, power and

telecommunications) to set the foundations for private investment. Additionally, Government is currently

reviewing the country's labor laws to further remove constraints to employment and is working to

eliminate administrative barriers to foreign and domestic investment.

Administrative barriers are seen as those constraints that private investors face when establishing and

operating a business in Cape Verde. Government has already begun to take measures to reduce

administrative barriers facing private enterprises. As a result, Cape Verde compares favorably to other

African countries. Nevertheless, given Cape Verde's potential exposure to external shocks, it needs to be

able to do better than other countries in order to remain competitive. A recent survey of 120 companies

(Regulatory and Administrative Cost Survey, August 2002), provided a first assessment of the main

bottlenecks (in terms of time and costs) that private investors face when they establish and operate an

enterprise in the country, as well as to provide a baseline for subsequent surveys to evaluate the impact of

ongoing reforms and improvement in the business environment. The study revealed that only about one

out of five companies is in some way dissatisfied with the quality of regulations, administrativerequirements and bureaucratic behavior. About 25 percent of surveyed companies consider that the

regulations which most affect their companies are customs and taxes, while the cost of financing is the

main problem to the development of their companies (37.5 percent). The Government recognizes that its

new policies to attract more foreign investment are being frustrated by red tape and in October 2002,

FIAS launched the Review of Administrative Barriers to Investment Study (or Investor's Road Map). On

the basis of this study, the Government and stakeholders will formulate an action plan to improve the

interface between the public and private sector.

Development of Supply Chains. Increasingly, enterprises compete through the efficiencies and the

adaptability of the supply chains of which they are a part. As part of its private sector strategy and to

complement its work on tax reform and reduction of administrative barriers, Government will target three

priority sectors and develop a clear sector strategy. A supply chain analysis will be carried out on the

selected sector to establish what prerequisite actions are needed to resolve constraints by Government

(infrastructure, regulation etc), and by the private sector (gaps in technical skills or lack of upstream

and/or downstream activities). These studies will identify the cross-cutting issues within the sector and

define the policy, as well as sector specific requirements. These recommendations will be fed back to the

public and private sectors for debate and the development of a clear strategy and sector policy.

Improving the legal environment for business development is essential to private sector activity. Cape

Verde had initially considered modernizing its business laws by joining OHADA (Organisation pour

I'Harmonisation en Aftique du Droit des Affaires). It would have benefited from an efficient,

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regionally-harmonized and comprehensive body of legal framework in the area of business law.However, after careful consideration of the alternatives, Government decided that at this stage, it did notwish to join. The Government has recently completed a comprehensive study on the "State of Justice inCape Verde" which identifies legal constraints in Cape Verde's judicial framework. These constraints,which may also be considered "administrative barriers", have a direct negative impact on the privatesector and the Government intends to address the following areas:

* Enforcement of judicial decisions is a major constraint and the study supports reform of the legalsystem (including the civil procedure code) in order to speed up and simplify the enforcement ofjudicial decisions (and in the future of arbitral awards).

* Arbitration, which is an effective means to resolve business disputes, is not provided for in the CapeVerdean legal system. The adoption of an arbitration law, the creation of arbitration centers, and theratification of the New York Convention of 1958 on the recognition and enforcement of arbitralawards thus constitutes a priority.

* The company registry is efficient and inexpensive, but the registration of intellectual property rights(critical element in setting-up a business) is not reliable. Moreover, the linkage between differentregistries and government agencies (company registry; social security administration; intellectualproperty; payment incidents) is inadequate. In addition, the company registry does not ensureadequate information and protection of third parties and creditors, as payment incidents andbankruptcy procedures (not commonly used), are kept separate. The procedure for registration as aforeign investor remains complex, involves a relatively large number of agencies and has anelaborate screening process.

* Cape Verde is a candidate to the WTO accession and officially applied on November 12, 1999. Tobecome a member, Cape Verde will have to reform some of its legislative framework and present aLegislative Action Plan, particularly in the area of intellectual property which suffers from alegislative vacuum. This is important to Cape Verde, which has an untapped potential, particularly inthe area of author rights for music. The Government thus intends to create a legal framework whichwould include suitable institutional arrangements.

* Land titling, which affects investment and bank lending, is a serious issue. There is no land registryand therefore no reliable land zoning and delimitation programs. The transfer of real property isdone by public deed, but the registration in the land registry is not immediately compulsory. Thedemand for public deeds is so great that public notaries cannot meet it. In addition, land belongingto the State or to the Municipalities is not clearly defined, and there is uncertainty regarding theownership status of lands, which were expropriated a few years ago without appropriatecompensation to the owners.

* Lack of flexibility of the present labor legislation remains an issue for the private operators.Enterprises complain, in particular, about the high cost of severance payments (equivalent to twomonths payment per year worked in the company). In order to obviate this cost, all companies hiretheir personnel through short-term contracts. A new labor law has been approved, but newregulations need to be prepared.

* Legal information and legal training need to be more readily accessible. Although Cape Verde hasan efficient system for the publication of laws in the official gazette (Dioio Oficial da Republica deCabo Verde), improvement of the dissemination of laws and related information is necessary. Legal

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training is also a priority, not only for the judiciary, but for civil society in general and forentrepreneurs in particular.

Post Privatization and Divestiture Process. During the past decade, Cape Verde's economy has gonethrough a remarkable change during which private ownership and participation became dominant in allsectors of the economy, including infrastructure and utilities. At present, the port and TACV (Transportes Aereos de Cabo Verde) remain the main activities for which privatization has been initiated,but will only be completed during 2004. Airports are the only publicly-owned infrastructure withoutprivate participation.

Some of the expected benefits of private participation have already accrued. Nevertheless, there is stillroom for improvement in terms of access. While standards in telecommunication are high, both access towater and electricity are relatively low (see Annex 11), due in part, to factors specific to Cape Verde,such as the lack of underground water resources and the highly fragmented generation system splitbetween 15 cities. Other factors have also contributed to the situation in water and electricity, especiallythe poor performance of infrastructure entities, due in part, to noneconomic pricing and cross-subsidies, alack of service definition and standards for monopolies, high costs due to operational inefficiencies, lackof competition and an uncertain regulatory framework. The record so far indicates two shortcomings inthe reform process. First, insufficient attention was paid to competition in the context of sector reformand divestiture. Second, an effective regulatory mechanism that would, among others, regulate prices ofprivate monopolies is yet to be established. The Government strategy, when the program was initiated in1997, called for divestiture actions to be accompanied by the establishment of a multi-sector regulatoryagency, and related capacity building to ensure that it would quickly become operational. ARM neverbecame operational, partly because there was no national consensus and understanding of the importanceof regulation, and partly because of the broad scope envisaged for ARM (multi-sector and multipurpose,covering economic, technical and environmental regulation).

Faced with urgent regulatory issues in telecommunications, water and energy (electricity and petroleum),following a National Seminar facilitated by international experts and regulators, the Government decidedin November 2002 to abolish ARM and create a new agency responsible for economic regulation of keyinfrastructure sectors. However, Government has decided that these would, for the moment, be addressedthrough collaboration between the line ministries, the regulators and other agencies. In parallel, theMinistry of Transport and Infrastructure would stimulate added competition to the telecom sector, with aview to take further reform measures to reduce cost and improve economic competitiveness.

Support to public sector institutions dealing with the private sector. For the private sector strategy tosucceed, public/private partnerships and related institutional arrangements would have to bestrengthened. Government intends to concentrate on capacity building of selected Government ministriesand agencies which interact most intensively with private firms. This will be done in a manner to addresstwo key objectives: (a) enhancing the capabilities of private and public institutions to deliver businesssupport services; and (b) support Government agencies in their efforts to promote business development,including improving their capability to identify and ease bureaucratic rigidities.

In addition to PROMEX (Center for Promotion of Tourism Investment and Exports), there are otherpublic institutions that work with private sector which would need to establish a strategy and focusedprogram. One example is LADE (Institute for Enterprise Development), that does not have a clearstrategic vision of its mission with respect to private sector development nor as a public sector interfacewith the private sector. Government intends to provide a framework for these selected institutions tosupport the private sector.

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PROMEX was created with the mandate to support the ongoing reforms and encourage FDI, as well asexports. PROMEX has been successful so far by disseminating information to potential investors,assisting the Government in its general promotion activities abroad, and in designing new regulations andlaws for FDI. Over time, PROMEX has been asked to do a little of everything; not only has the agencybeen responsible for investment and export promotion, but also for managing industrial parks, sponsoringtourism operations, and assisting small and medium local companies. Today, it faces a number ofchallenges which require the agency to refocus on its core mandate and to adjust its operations on thebasis of a clearly defuned strategy.

According to PROMEX's Business Plan 2002, the agency's priorities for the immediate future will shiftto the promotion of Cape Verde's image abroad and encouragement of foreign investment in Cape Verde.Major program areas include a marketing and communication program to disseminate information onCape Verde as an investment location, export base and tourism destination, and a program to attractincreased levels of FDI, not least in export-oriented industries and in the tourism sector. These prioritieswill be supported by an institutional development program, through which the agency intends tostrengthen staff skills, as well as internal processes and systems.

The Ministry of Finance, Planning and Regional Development is expected to improve its capacity tomonitor and provide financial management of autonomous public institutions, as well as managingGovernment shares in private companies. Government intends to strengthen the Ministry's capacity toreport on the status of government participation in private enterprises annually. In addition, it plans toestablish a research and studies department which would be capable of producing economic reports anddrafting the economic framework for the national budgeting process.

Private Sector Capacity Building. During recent years, the private sector has become more vibrant andorganized. There are two Chambers of Commerce; one for each group of islands (Sotavento andBarlavento), which were created to represent private enterprises' interests in all sectors. While thechambers do not cover all of the private sector, membership is growing. The chambers are responsible forbuilding private/public partnerships and under this mandate, organize, at least twice a year, a forum forprivate enterprises to further the dialogue between the Government and the pnvate sector. The forumsprovide the opportunity for Government agencies, dealing with private enterprises, to meet and discussissues concerning the private sector. Government plans to follow-up on the agreements made at theforums. In an effort to systematize and strengthen the dialogue between Government and the privatesector, Government will work with the leaders of the private sector, as well as representatives of theassociations on a regular basis to exchange ideas on pending economic and social issues.

The environment for technical learning and assistance in Cape Verde continues to be underdeveloped.The mechanisms by which private firms transfer technology and raise their technical capabilities areweak and while foreign investment in the country is increasing, technology transfer via this channelremains limited. Until recently, all tertiary education, as well as vocational and technical training, wasprovided abroad. The private sector strategy calls for capacity building for private operators, especiallySMEs. There is substantial demand by the private sector for these services and the two Chambers ofCommerce are trying to accommodate it with their programs.

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3. Sector issues to be addressed by the project and strategic choices:

Macroeconomic Framework. The Government has given priority to maintaining macroeconomicbalances and settling arrears, and it is working with the IMF and key donors in implementing measuresthat ensure this objective. As described in section B2, tax reforms have been undertaken. TheGovernment, in collaboration with stakeholders, will formulate an action plan for further tax reforms(including implementation of VAT), which would result in a system that encourages investment whileminimizing economic distortions. This work will be implemented with support under the project.

Modernizing, Strengthening and Restructuring the Financial Sector. The financial sector hasimproved over the past years. As described in section B2, new instruments have been established. Bankshave been linked to the SWIFT network, a credit risk system was developed, agreements withinternational branches of credit card companies have been negotiated, and an interbank network forautomatic tellers has been established. In the context of its financial sector strategy, the Government,with the leadership of the BCV, will continue its efforts to further strengthen and develop the financialsector in Cape Verde. The CBPPSP provided support to get the process underway and the project willprovide the necessary support for the next phase of development. There are certain elements of thestrategy that require further analysis. Targeted studies in the financial sector will help define requisitepolicy measures to improve financial intermediation, such as increasing access for investment tolong-term funds or accessing international capital markets (including the necessary legislation andregulations) and the further development of new financial instruments (e.g. leasing, venture capital). Theprevious study on the banking sector was in 1995.

While the regulatory framework and the supervisory capacity of the BCV over the financial sector hasimproved, Government recognizes that its efforts in these areas need to continue, as well as providetechnical assistance to other financial institutions. Government will takes steps to strengthen thefinancial infrastructure to improve sector efficiencies. To this end, with support of the project, it willfinance, on a cost-sharing basis with the BCV, updating its information technology network, includingthe telecommunications system, modernizing the electronic payments and transfer systems, including theintroduction of VISA, as well improving the technology to enable the commercial banks to access thecredit risk system and monetary information. In addition, targeted training will be provided to strengthenthe Central Bank's analytical and regulatory capacities. The BCV will extend these training programs toother Governmental institutions, as well as financial and non-financial enterprises that could benefit fromthe training programs. These improvements would enhance the central bank's supervision capabilities,reinforce the banking system by supporting their efforts to further strengthen their portfolios, as well asenhance the attractiveness of Cape Verde as an international business center.

As described in section B2, the Government intends to create sustainable pension scheme for all formalsector workers by creating a streamlined mandatory pension scheme that would encourage voluntaryprivate funds to play a role in the overall system. The project will support Government's efforts toestablish a procedure to ensure that its contributions are made on behalf of the civil servants to the INPS.With support of the project, studies will be undertaken to get the necessary financial and actuarialinformation to draft new legislation, which would include changes to: the benefit formula, indexation,eligibility requirements for disability and pension, retirement age and others. In the interim,Government, with support of the project, will carry out an audit of AP of the current pensionerpopulation and install a mechanism for ensuring that accurate records are maintained.

To ensure the momentum of the pension reform, Government has formed a Steering Committee whichwill be comprised of the Project Coordinator, the pension component manager, the INPS and two private

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sector individuals. The Steering Committee will formalize the process of consultation through a series ofworkshops. The options for systemic reform will be studied under the project, but these are seen aslong-term issues to be dealt with only after the initial phase of the reform, including integration of thecivil servants into the INPS scheme were achieved. This would lay the foundation for any discussionabout privatizing part of the new, rationalized and unified system. An international pension expert wouldvisit Cape Verde several times a year to advise the committee on its next steps.

Enhancing Private Sector Competitiveness. As described in section B2, since 1998, Government hasmade important strides to enhance competition. With support of the project the Government intends toaddress the issues which have been raised as constraints to Cape Verde's competitiveness. In addition, itintends to address critical issues such as factor costs and availability of services in the infrastructuresectors. Regulatory work which has not been fully completed at the time the PRCBP closes in December2003 will continue under the project.

As described in Section B2, administrative barriers have been a serious brake on business activities.Based on the Administrative Barriers Study, by FIAS, the Government and stakeholders will formulateand implement an action plan for further reforms in areas that would improve the interface between thepublic and private sector and reduce the cost of doing business. This "living" plan and subsequentupdates, would be implemented with the support of the project.

Improving the Legal Environment for Business. As described in section B2, the Government, under theleadership of the Ministry of Justice (MOJ) who has shown a strong leadership in legal and judicialreform, has taken a number of measures to improve the legal environment, including reforms in the areasof access to justice and legal information. Under the Second Public Sector Reform and CapacityBuilding, several important steps were taken such as extensive training programs for members of thelegal professions and the adoption of several codes (including the Labor Code). The project will buildpnthese reforms by supporting Government's efforts in the area of regulations, improvements of registriesand courts, dissemination of legal information and introduction of arbitration procedures and steps toensure Cape Verde's accession to the WTO.

Post Privatization and Divestiture Process. As described in section B2, it had been anticipated that thisproject will provide the necessary support for the operations of a fully functional regulatory agency andhelp Government resolve the main outstanding sector issues. These efforts will be continued under theproject.

Support of public sector institutions which work with private sector. Government intends to undertake anintensive review of the role that Government ministries and agencies play in the development of theprivate sector and particularly SME's. Following the study, Government will develop a strategy toestablish a governance structure and provide support for institutional strengthening of these institutions.

Capacity Building for SMEs. Government has made a strategic decision to support SMEs and other localenterprises to build their technical capacities to be able to better compete in the international markets.Through this project, Government will support national businessmen in these efforts by providing a50:50 cost-sharing grant, using an approach and procedures successfully tested and developed in otherIDA projects. The Chambers of Commerce, who are increasing their membership on a steady basis andare linked into the private sector community, will take the lead in this effort. They already manage sucha program, which provides training and technical services on a cost-sharing basis and have themechanisms in place to administer this program.

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C. Project Description Summary

1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed costbreakdown):

The proposed project will support the following major elements in the Government's private sector-ledpoverty alleviation strategy. The total cost of the project will be US$13.5 million, with IDA financingtotalling US$11.5 million equivalent. The project will finance consultants, goods, training andworkshops, small civil works and funds for the matching grant facility. Cape Verde is not eligible forgrant financing.

Component 1. Modernizing, Strengthening and Restructuring the Financial Sector (US$3.40million, of which US$2.80 million equivalent is financed by IDA). As the financial sector in CapeVerde expands, it becomes critical for Government to increase its efforts to diversify and deepen thefinancial instruments in the sector. Within the context of the financial sector strategy, the proposedsubcomponent aims to reinforce the foundations of the financial sector by strengthening capacity of theCentral Bank to play its role in regulation and supervision (both in terms of its human resource skills andtechnology), as well as expanding the financial infrastructure by increasing the availability of creditinformation, enhancing the national payments system, including international integration (VISA) andestablishing deterrents to financial fraud and money laundering. The component will finance technicalassistance, training and equipment, especially information technology to upgrade the equipment at theBCV and provide real time connection with the commercial banks for the payment system, credit risk andloan concentration databases. This will improve the availability of credit information on both thecorporate and individual clients, which has been a constraint for financial institutions in making informedlending decisions. In addition, the project will support Government efforts to update the regulatoryenvironment for insurance, as well as undertaking some studies to develop other non-bank financialinstruments, such as leasing and venture capital. Given the financial sector's (including BCV) ability togenerate sufficient internal resources, activities will be financed on a 50:50 cost-sharing basis.

The pension reform subcomponent will support Government to implement a series of parametric reformsaimed at establishing a financially viable and sustainable pension system. In addition to alleviating apotential contingent liability risk in the budget, another expected result of the reform is to help mobilizelonger-term resources that could be channeled through the financial sector to finance private investments.The project will provide financing for technical assistance in the following areas: (a) independent auditsand an actuarial review; (b) an information system needs assessment; (c) consultancies to: (i) produce anew investment policy, (ii) evaluate valuation rules, reporting and disclosure standards, (iii) civil serviceintegration study/cost analysis, (iv) study the development of contractual savings, regulatory/supervisionissues, (v) analysis of the social assistance scheme and FAIMO, and (vi) coverage strategy; (d) trainingprograms for: (i) trustees and (ii) technical workshops; and (e) translation of technical materials. Inaddition, the project will finance hardware and software.

Component 2. Enhancing Private Sector Competitiveness (US8$.00 million of which US$6.70 millionequivalent is financed by IDA.) As discussed in Section B2 of this report, companies in Cape Verdehave responded well with the opening of markets to private initiatives. However, growth in privatesector activities has not been accompanied by sufficient measures to streamline the administrativerequirements for business operations, the legal framework and the judiciary. This component will becomprised of four subcomponents. In an effort to improve the investment climate and make CapeVerdean companies more competitive and attractive to investment, the credit will finance activities toimprove the investment climate which is comprised of tax reform, alleviation of administrative barriers(which may include tariff studies), development of supply chains and modernization of the legal

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environment. Post Privatization and Divestiture reform, including regulatory reform, will be continued.The project will provide the necessary support for the operations of a fully functional regulatory agencyand help Government resolve the remaining issues for the telecom, airport and port sectors. For theGovernment's strategy to succeed, public/private partnerships and related institutional arrangementswould have to be strengthened. Concentration will be on capacity building of selected Governmentministries and agencies which interact most intensively with private firms, which includes: (a) enhancingthe capabilities of these institutions to deliver business support services; and (b) supporting their effortsto improve their capability to identify and ease bureaucratic rigidities. Finally, to develop capacity in theprivate sector, the project will include a matching grant fund by which private firms, as well as informalenterprises through associations, share the costs (50:50) in their efforts to improve their technicalcapacities to become more competitive. The two Chambers of Commerce, whose mandate is to representthe private sector with Government, as well as provide these services, will also benefit from the grant asmanager/administrator of the matching grant facility.

Component 3. Supporting Project Implementation (US$1.15 million, of which US$1.05 millionequivalent is financed by IDA).

The project will, in substance, be implemented by the beneficiaries. In addition, a professional projectcoordination unit (PCU) has been established. The PCU will oversee the financial management,procurement, reporting, monitoring and evaluation, audit, public information and related functions, aswell as manage several cross-cutting sector issues, such as pensions and regulatory reform. The creditwill thus finance a team of high caliber local professionals located at the PCU and the related supportstaff. The PCU will also be responsible for ensuring adequate monitoring and evaluation, preparingquarterly reports, and facilitiating the mid-term review and orderly closing of the project.

,Indicatlve Bank- c , %,of4 Co'mponent,%of ' firancing Bank-

. \ta ,( M) Total.:(US$M) financing1. Modernizing, Strengthening and Restructuring theFinancial SectorA. Financial Sector Development/BCV 1.00 7.4 0.50 4.3B. Pension Reform 2.40 17.8 2.30 20.02. Enhancing Private Sector Competitiveness 0.0 0.0A. Investment Climate Reform 2.00 14.8 2.00 17.4B. Post Privatization and Divestiture 1.30 9.6 1.30 11.3C. Institutional Capacity Building 2.10 15.6 2.10 18.3D. Private Sector Capacity Building 2.60 19.3 1.30 11.33. Supporting Project Implementation 1.15 8.5 1.05 9.14. PPF Refinancing 0.60 4.4 0.60 5.25. Unallocated 0.35 2.6 0.35 3.0

Total Project Costs 13.50 100.0 11.50 100.0Total Financing Required 13.50 100.0 11.50 100.0

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2. Key policy and institutional reforms supported by the project:

With support of both the SAC, as well as the CBPPSP, the PRCBP, the Energy/Water Project, and theTransport Infrastructure Project, Government has taken policy decisions which have included privatizing,as well as liquidating several Govermnent-owned companies (as of May 20, 2002, divestituretransactions have been concluded for 21 out of a total 28 public enterprises in the privatization program).Work is underway to strengthen the regulatory capacity in three areas: (i) air transport; (ii) infrastructureand economic regulation; and (iii) food safety and drugs regulation. In addition, work has begun onimproving the investment climate as well as has begun on pension reform. Finally, efforts are beingmade on tax reform, with the new tariff law and code approved by Parliament.

The project will finance targeted key policy reforms and institutions, including the following:

o Accelerated legal reform to modernize laws by updating the codes of the commercial registry, realproperty registry and the civil registry. The project will also support efforts to improve contractenforcement through arbitration and improve the distribution of legal information;

o Alleviation of administrative barriers, elimination of red tape and strengthening supply chains. Anindirect effect of these reforms will be in the form of improved governance through the reduction ofrent-seeking behavior by public officials. In addition, this will reduce the transaction costs of doingbusiness and create efficiencies in the market system;

o Continued simplification of the tax regime, expansion of the tax base and reduction of tax-induceddistortions;

o A harmonized and sustainable pension scheme for all formal workers will be established. This willultimately result in less strain on budget resources and provide the financial market with a source oflong-term resources for investment;

o Improved regulatory framework for infrastructure through the development of an operationalmulti-sector regulatory agency;

o Increased efficiency of public institutions that interface with the private sector, in particular,PROMEX, to be able to play their role in providing business facilitation and investment promotionservices and improving their capacity to identify and ease bureaucratic rigidities;

o Enhancing the regulatory capacity of the BCV to be able to fulfill its mandate for regulation andsupervision of commercial banks and insurance companies. There is a need for continued capacitybuilding at BCV for the supervision of bank and non-bank financial institutions in order to reachinternational standards;

o Increased financial services and improved financial intermediation, through the introduction ofVISA, electronic payments systems, as well as real-time access for credit information by commercialbanks; and

o Enhancing the capabilities of private firms, particularly SMEs through a 50:50 matching grant funddesigned to boost competitiveness of private firms doing business in Cape Verde by supportingtechnology transfer and strengthening their access to and use of support services external to the firm.

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3. Benefits and target population:

The proposed operation is a technical assistance project which aims to strengthen the capacity of thefinancial sector to deliver financial services to the private sector, as well as strengthen the private tocompete in a very competitive environment. Several benefits have been identified, including:

Private sector (enterprises and promoters): The project is expected to enhance and stimulate privatesector-led employment and economic growth by improving the business environment, encouraging directand indirect viable private investment and increasing productivity. The project will benefit entrepreneursby reducing uncertainties and transaction costs of doing business in Cape Verde by: (a) providingtransparent commercial legislation and improving the function of the judiciary on commercial activities;(b) reducing production costs through improved efficiencies in the administration and tax distortions; (c)better working supply chains in three targeted sectors; and (d) improved technology and capacity inprivate enterprises. A more sound funding strategy of the pension scheme by Government can strengthenthe certainty of incentives for labor market decisions. Finally by strengthening the financial sector todeliver services to the private sector, as well as providing technical assistance and learning opportuntiesvia the matching grant fund, enterprises anticipate an increased output from production efficiencies, aswell as capital investment by long-term funding sources, which should lead to job creation.

Local population. The project is also expected to increase the welfare of the local population, bystrengthening the pension system to ensure that pension promises that are made can be kept and that theinstitution can deliver a fair allocation of resources between different generations. By strengthening theenterprises capacity to compete, the project would create increased employment opportunities. Byimproving the notary and modernizing the codes for the various registries (commercial, housing andcivil), civil society would be able to utilize real assets as collateral for securing financing for smallbusinesses and other economic activities.

Government. The project will benefit Government in a number of ways. First, public revenue collectionwould be enhanced. By eliminating the administrative barriers, which encourage companies to by-passformal routes, more companies will operate in the formal, rather than the informal sector, which willresult in increased revenues from taxation. Better government financial management due to pensionreforms by putting less strain on budget resources. Improved efficiency, governance and morepredictable decision-making in the judicial process would increase public confidence in the judiciary. Byenacting parametric reforms in the pension system which would reduce the costs to Govermnent ofsupporting pension benefits, fiscal savings can be utilized for social safety nets and other vehiclessupporting the Government's efforts to alleviate poverty. It is anticipated that productivity gains in theprivate sector will lead to additional income, in the form of increased taxes. Finally, improving thetechnical skills of Government to manage their shares in private enterprises will reduce uncertainties infinancial management.

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4. Institutional and implementation arrangements:

Implementation Period: Four years, September 2003-August 2007, with the closing date of February2008.

Steering Committee(3 private sector & 3 Government(headed by Minuster of MFPRD)

Technical Team

Pension Reform--focal point for pensions

f Project Coordinating Unit G --PRSPProject Coordinator

Post Privatization & Divestiture

Financial Management & Administration(procurement specialist, accountant, program officer)

Beneficiaries

BCV, Public Institution (working with private institutions), MFPRDChambers of Commerce, MOJ, (pension reform institutions, PROMEX

The project will be overseen by a Steering Committee, headed by the Minister of MFPRD and supportedby a professional project coordination unit (PCU), which was established under the ongoing PRCBP. Itwill monitor project implementation on a quarterly basis, review achievements, work programs andbudgets. The PCU will be responsible for all aspects of financial management, including budgeting and

auditing, procurement, quality assurance, monitoring and evaluation and reporting, etc. Responsibility ofthe remaining privatization program will also be the responsibility of the PCU. The PCU is headed by aproject coordinator, who will be supported on a full time basis by a team of professional nationalcounterparts, most of whom already work in the PCU of the PRCBP. The PCU includes a procurementspecialist, an accountant, technical specialists (who will deal with cross-cutting issues), a program officerand an administrative assistant. The PCU will be responsible for providing the necessary guidance forthe selection of consultants, the procurement of goods and services, and monitoring and evaluation, andwill be directly involved cross-cutting issues such as investment climate, post divestiture issues andpublic/private dialogue, and pension reform By using an existing PCU, the Government will benefitfrom existing experience and create economies of scale. The PCU will also be strengthened on acontinuous basis through appropriate training. As needed, short-term national or intemational specialists

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to assist in the implementation of its work program will be contracted. With the project closing, it isexpected that the PCU would cease to exist, unless the Government decides to use the establishedcapacity to implement a yet undefined project funded by IDA or another donor.

Implementation arrangements seek to delegate the maximum feasible operational responsibility to theinstitutions or government departments selected to implement the project components. For example, theBCV and other financial sector institutions will each implement a part of the financial component, andthe Ministry of Justice will take the lead role in the legal component. Each beneficiary will beresponsible for preparing the terms of reference for the required technical assistance, as well as quarterlyreporting on the status of its component and updating the quarterly work plan.

Project Monitoring and Evaluation: Monitoring and evaluation of project activities are key functionsthat will be carried out by the PCU. A quarterly monitoring table and progress reports will be preparedby the PCU and discussed with the Steering Committee. A draft Project Implementation Plan (PIP), aFinancial Management Plan and overall Procurement Plan have been prepared and incorporated in aProject Implementation Manual (PIM). The PIM includes among others, all period reporting, andmonitoring and evaluation throughout the project cycle. Apart from periodic reports and standardmonitoring arrangements, an impact assessment will be carried out approximately 18 months into theproject. In addition, a mid-term review is planned for 30 months into the project, which would includean update of the administrative barriers study. Another assessment will be carried out one year prior tothe project's closing. The objective of the review would be to assess progress and, if necessary, redirectthe project integrating additional lessons learned and the realities on the ground.

D. Project Rationale

1. Project alternatives considered and reasons for rejection:

The breath and complexity of the project were considered. Many of the reforms and activities which arebeing supported in the context of this operation are either underway but need technical support tocomplete, or are part of the NDP and are expected to be implemented within the four-year time horizonof the project. This project provides the financial and technical support needed by Government toexecute its program. As such, while the project appears to be complex and have many components, itwould not represent a burden to Government's institutional capacity to implement it.

Government and the World Bank considered a hybrid investment/adjustment credit. In August 2001, adecision was made to separate the proposed macroeconomic reform component from the rest of thisproject. As such, detailed work on pension and investment climate, which entailed considerabletechnical assistance and institutional reform and which were initiated under the SAC, are continuedunder the proposed project.

The creation of a separate PCU was considered. However, Government would like to strengthen itscapacity to manage donor projects, in particular those of the World Bank. As such, it was agreed that theexisting PCU of the ongoing PRCBP would be strengthened with new staff and trained to take over thisnew function.

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2. Major related projects financed by the Bank and/or other development agencies (completed,ongoing and planned).

Latest SupervisionSector Issue Project (PSR) Ratings

(Bank-financed projects only)

Implementation DevelopmentBank-financed Progress (IP) Objective (DO)Water and Energy Sector Project: Credit 3205-CV (ongoing) S SSupport to the sector reform, includingprivatization of ELECTRA.

Transport and Infrastructure Project Credit 2466-CV (ongoing) S SSupport to port, airport andinfrastructure development

Privatization Technical Assistance Credit 2377-CV (closed on S SProject: PE sector reform, divestiture December 31, 1997)and private sector promotion

Capacity Building Project for Private Credit 2864-CV (closed on S SSector Promotion: Support to private December 1999)and financial sector reform

Privatization and Regulatory Capacity Credit 3121-CV (ongoing) S UBuilding Project: Regulatory reformand increasing private participation inkey economic sectors

Structural Adjustment Credit:key Credit 3587-CV (ongoing) HS HSstructural measures, mainly in the areaof privatization and tax reformOther development agencies-Support to macroeconomic reform, European Uniontrade liberalization and EMPArestructuring-Development of local capital markets Swedishto increase resource mobilization andsupply of medium-term financing-Support to pension reform ILO-Support to banking supervision Portuguese-Support to WTO Accession; AGOA Americanweb-site at PROMEX; Grant fundingto SMEs for capital and technology-Studies on the 3 Industrial Zones UNDP

IP/DO Ratings. HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)

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The Growth and Competitiveness Project will build upon efforts by Government under closed projects,as well as ensure that reforms implemented under ongoing projects will be sustainable. For the financialsector, this project will build upon activities by the CBPPSP whose development objective was to createa well functioning financial sector. As noted in section B2, the financial sector has seen substantialprogress during the last several years. This project will take it one step further by developing a VISAsystem for payments, as well as strengthening the BCV as a monetary authority, regulator and supervisorof the banking and insurance sectors.

On the private sector, the project will support efforts started by the CBPPSP to strengthen PROMEX tofulfill its mandate for investment promotion activities and bringing new FDI into Cape Verde. Theproject will also strengthen the Chambers of Commerce (also a recipient of support under the CBPPSP),who are the primarily interlocutors between the private sector and Government, and who will work withprivate sector and other associations to strengthen their operations by providing financing on a matchinggrant basis to secure technical assistance, as well as training.

On judicial reform, the project will build upon efforts made by several of the above project, notably theSecond Public Sector Reform Project and the CBPPSP. Under the project, three codes will be completed(commercial, civil and housing registries), the regulations for the labor code will be written. In addition,judicial information will be disseminated, as well as the appropriate training provided to magistrates,other judicial personnel, private sector and civil society.

Finally, the project will build on the work started by the PRCBP on privatization, divestiture andregulatory reforms. It will ensure that steps taken for establishing a multi-sector regulatory body havebeen completed and that the agency is operational. In addition, other post pnvatization and divestitureactivities will be completed in an effort to ensure sustainability, such as a PPI study on airport operations.Although the project is currently rated "U" in achieving development objectives, this was due to theslowness of the privatization program, given the fact that political decisions need to be made on verysensitive issues, in which national consensus needs to be developed to facilitate the refeorms. However,the other parts of the project, are working well and this performance will not affect the implementation ofthis project.

3. Lessons learned and reflected in the project design:

Particular attention has been paid to ensuring that the project design reflects not only the Bank'sexperience in Cape Verde and Sub-Saharan Africa, but also integrates approaches being currentlypursued in other developing countries. Project preparation significantly benefited from the inputs ofvarious parts of the Bank Group, including FIAS and MIGA. The important lessons and approachesintegrated into the project include the following:

* Building on existing work helps maintain a momentum towards reform. The project builds uponwork already completed under the closed private sector support projects (CBPPSP and Second PublicSector Reform Project) and work already started under ongoing projects PRCBP and the SAC, aswell as other bank projects.

* A simple and delegated project design is compatibility with political realities and institutionalabsorptive capacity. The scope and design of the project will be sufficiently flexible to take intoaccount existing and changing local conditions. The project design is based on the I-PRSP, as wellas the NDP, forming the basis of the PRSP currently being designed.

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o Stakeholder involvement in the design and execution of the project and development of localexpertise. Experience dictates that local ownership of a project of this type results in a betterdefinition of the constraints faced by the private sector and the initiatives to address them, effectiveproject execution and sustained achievement of project objectives.

o Use of local capacity which has been developed through other projects lowers the learning curveand increases efficiency and productivity. By using an existing PCU, the Government canconsolidate experiences and create econornies of scale. This will enable a transfer of skills from oneproject to another, including procurement, financial management and disbursement expertise. Inaddition, the implementation arrangements will ensure that there is an entity formally responsible forproject technical coordination and monitoring that has the incentives to solve problems in a timelymanner.

o Matching grant fund operational procedures must ensure expeditious processing of the applicationswhile ensuring the stakeholders fiduciary and governance responsibilities. The present projectbuilds upon the Chamber of Commerces' past satisfactory experience to: (i) strengthen theinstitutional and financial sustainability of the two Chambers; (ii) maintain sufficient independenceof the grant management to minimize the risk of capture by special interests; and (iii) ensure goodmonitoring and evaluation capacity. The Chambers of Commerce are already implementing aparticipatory grant program so the private sector has been exposed to this type of support. Theproject will enable the Chambers to enlarge the program, using the same stringent criteria and reachmore of their members, as well as expand the program to other associations, such as theMicrofinance Association and the Women Jurist Association.

o Business Environment. Thanks to the participation of FIAS in the design and implementation of taxand administrative barrier reforms, Africa-wide and international experience is fully reflected in theproject. One lesson learnt is that initially promising reforms do not necessarily lead to sufficientimprovements in the investment climate. In view of this, reforms need to be underpinned by surveysand quantitative follow-up methods, and monitored vis-a-vis national and intemational indicators.The other lesson learnt, especially with respect to alleviation of red-tape, is that the reform process isiterative, and requires strong stakeholder participation and ownership.

o Improving the legal environment. The experience under several projects has shown the limitation ofimplementing reforrns without the full implication of the Ministry of Justice. This has been takeninto account in the project design and should be a key to sustaining reforms started earlier andaddressing immediate needs. Such operations should recognize that: (i) judicial reforms are part of along-term process; (ii) sustainability of the reforms depend on building strong institutions; and (iii)the right balance should be found between guidance provided by comparative law experience and theparticular requirements of the national legal systems.

o Pension Reform. The conceptual ground for the pensions reform in Cape Verde began with supportfrom the International Labor Organization (ILO). Bank lending in support of such reforms is usuallythrough fairly substantial adjustment operations (see for instance, the examples of the RussianFederation, and Bulgaria). This approach facilitates the necessary financial restructuring, but suffersfrom the fact that the timeframe for adjustment operations is shorter than the one needed to ensuresustainability through appropriate systems and capacity building. There are also examples of pensionreform being supported under investment operations, for instance in Mali and at the municipal levelin Brazil. Such approaches are partial, as they tend to respond to capacity building needs withouttackling significant policy reforms. Taking this experience into account, and even though financing

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of government liabilities to pension schemes is not yet eligible under investment operations, thepresent project aims to support both ambitious policy reforms together with comprehensive capacitybuilding. The team also looked at lessons learned from pension reform projects in other regions. Inall cases, a strong and stable implementing unit was key. In addition, a Steering Committee wasessential to ensure strong management support from within the Borrower organization that couldmake strategic decisions and make commitments to ensure that the project continues to driveforward. The members of the Steering Committee should come from parts of the organization whichare most involved in the project.

* Infrastructure Regulation. The importance of adequate regulatory capacity in the context ofsustainable infrastructure reform has been clearly identified in the context of the recent workshop onregulatory refortn in Praia. The project builds on the PRCBP, as well as international experience,notably Latin America, where the importance of building independent regulatory capacity, preferablyprior to divestiture, has been demonstrated. In practice, most of the support under the project isfocused on the new multi-sector regulatory agency and cross-cutting issues will be identified and willbe tackled.

* Public-Private Consultations. The importance of building an effective means of private-publicdialogue is identified as a key area in the Africa region's private sector development strategy. Sincethe late 1990's Cape Verde has attempted to improve public-private dialogue, however it isrecognized that this remains weak and that a concerted effort needs to be made on both sides toimprove this.

* Institutional Support for Investment Promotion. IDA has been supporting promotion agencies inAfrica since at least the early 1990s. This experience has highlighted the importance of goodcorporate governance, independence of the agency, and clear directions, all of which would apply toPROMEX.

* Implementation Arrangements. The implementation arrangements follow current best practice inprivate sector projects (e.g., Mozambique) whereby beneficiaries manage their own subcomponent,while strong financial management, procurement, and monitoring and evaluation capacity is providedby a centralized project management unit.

4. Indications of borrower commitment and ownership:

The Government has been working consistently to improve the economic and business environment inCape Verde. These efforts will continue with the re-engineering of the Ministry of Industry, which hasbecome the Ministry of Industry, Growth and Competitiveness. The difficult decisions taken by theGovernment to implement its structural reform, financial restructuring and privatization programs and theresulting achievements are evidence of its commitment to providing an enabling environment for privatesector and export development. The Government requested additional support from the Bank (they arecurrently implementing a SAC, as well as the PRCBP), to ensure that the momentum for improving theeconomic and business environment continues. The Government requested this support for its privatesector development program fully recognizing the need to continue to include local entrepreneurs in theeconomy's growth, to obtain political support for their ambitious economic reform program and the needto create jobs.

As mentioned in sections B2 and B3, the Government has shown its high comittment with pensionreform. First, Government has taken the political decision to move the civil servants to INPS in thefuture. This would enable the project to support the integration of the two small schemes for efficiency

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and social policy reasons. Government has taken steps to clear up its arrears with INPS; it has issuedtreasury securities to INPS to cover most of its outstanding obligations. At the same time, it is takingsteps to reduce further liabilities. Legislation has been proposed which will include changes to: thebenefit formula, indexation, eligibility requirements for disability and pension, retirement age and others.Together, these would likely meet the objective of reducing the liability by 20 percent or more. Finally,the Government is also taking steps to increase internal efficiency and reduce administrative costs of theINPS. The INPS is also working with the ILO on improving internal processes, and human resourcecapacity.

As mentioned in section D3, the proposed program, with support from MIGA and FIAS, Government'swill continue its efforts to improve the competitiveness of the economy and make the private sector themain engine of growth. It builds upon efforts of previous World Bank projects and provides continuityof the reform program, which the Government has publicly and officially committed itself to, and whichis embodied in its Letter of Sector Development Policy and the NDP which was recently adopted byParliament.

To ensure upfront stakeholder ownership, the project has been prepared in a participatory manner. Thisapproach will be continued during project implementation where project and component oversight willbe ensured by a Steering Committee and varnous task forces. Substantial responsibility for theimplementation of the reform and financial sector components will be devolved respectively to theMFPRD and the BCV. The establishment of a joint private-public steering committee to oversee theproject is a further signal of Borrower commitment. The PCU has been empowered to orchestrate theprivatization program, which is progressing at a steady pace.

5. Value added of Bank support in this project:

The Bank is seen by the local actors, donor community and private sector as having credibility in thefield of privatization, legal and regulatory issues and competition policy. The Bank has successfullysupported Government's previous efforts in these areas through its policy dialogue and various technicalassistance projects. Its participation in the financial sector and private sector development throughimprovement of the enabling economic and regulatory environment would enhance the credibility ofGovernment's efforts, particularly regarding the transparency and soundness of its regulatory framework.Bank support will further provide resources to Government to implement essential policy reforms andcapacity building efforts. In undertaking this type of project, the Bank provides an opportunity for otherbilateral and multilateral sources to leverage the Government's effort to develop its financial and privatesector development program.

E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8)

1. Economic (see Annex 4):O Cost benefit NPV=US$ million; ERR = % (see Annex 4)

0 Cost effectiveness

O Other (specify)The economic analysis of this type of private sector development project presents special difficulties,particularly when there is an indirect relationship between the project's actions and the stream ofbenefits. Moreover, for the project's matching grant's scheme, it should be noted that it is difficult toestimate the amounts and types of investment, incremental production and exports generated from thesupported firms. Nevertheless, a cost-benefit analysis has been used to calculate the Net Present Value(NPV) and Economic Rate of Return (ERR) in a "with" and "without" project framework for thematching grant component and is summarized in Annex 4 to this report.

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2. Financial (see Annex 4 and Annex 5):NPV=US$ million; FRR = % (see Annex 4)

Given the technical assistance nature of the project, there are no clear revenue streams that would pennita straightforward financial analysis. However, it is assumed that financial costs and benefits are equatedto economic costs and benefits.

Fiscal Impact:

The main beneficiaries of the project will be: (i) the two chambers of commerce, their memberassociations, and a minimum of 200 small and medium enterprises with better access to businessdevelopment services; (ii) the private sector with a more business friendly environment and a reductionin the cost of doing business, which should lead to increased taxable income; (iii) the financial sectorwith better regulations, more financial services and products, and improved financial intermediation; and(iv) the public sector, the Government in particular, with strengthened and streamlined institutions.These improvements m the business environment should bring about an expected increase in jobs by1,200 and an anticipated fiscal impact of approximately US$4.2 million.

3. Technical:

The project is technically sound and takes into account international best practices in its design. Theproject's two major components are mutually reinforcing, building upon work which is ongoing or hasbeen completed under other World Bank operations. The project will complete activities initiated underother operations, thus assuring their technical success and sustainability. Best technical practices arereflected in the reform programs, such as the pension and legal reform, as well as in the setup forproject-supported schemes, such as the matching grant. The project will help attract private investment,bringing new technology and management know-how to the private sector. New entrepreneurs may availthemselves to services offered by the Chambers of Commerce and the matching grant fund for trainingand technical support, using practices which have been developed elsewhere and which are proving to besuccessful vehicles of improving local skills and strengthening operations and governance practices.

4. Institutional:

As mentioned in C4, The project institutional arrangements seek to ensure stakeholder participation andwill use a PCU and experienced staff who have managed other World Bank-financed private sectorsupport projects. Informal and formal mechanisms to ensure coordination of all parties concerned (i.e.various ministries, private sector representatives and donors) will be established. Stakeholderconsultations are thus an integral part of the project design. Project and component oversight will beensured by a high level Steering Committee representing beneficiary institutions, as well as the privatesector. The committee will act as an advisory board for the project and will monitor projectimplementation, review achievements, work programs and budgets. Additional coordination mechanismsmay be created as needed.

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An indepth review will be carried out on the institutional capacity of PROMEX during mid-2003. A newstrategy and well-defmed work program will enable the institution to become more focused andgoal-oriented (its focus is currently very fragmented, trying to do too much with its available resources).The staff are very qualified and committed to the job, but an operational assessment will permitmanagement to realign the skills necessary for PROMEX to carry out its mandate. At the same time, thegoverning body which had been dissolved during the past year due to financial constraint of Government,will be reinstated.

The Chambers of Commerce are well-positioned to manage the matching grant program. The Chambersare integrated into the private sector community and also manage a cost-sharing program which providestraining and technical assistance to their members. They are well-run organizations and have asatisfactory governing board in place. Their financial statements are well prepared. The project willoffer resources to the Chambers, in lieu of a management fee, for them to continue to reinforce theirorganizations and expand their services to their members.

4.1 Executing agencies:

The MFPRD will have overall responsibility for implementing the project. Each beneficiary will beresponsible for the technical aspects of its program in a manner consistent with their strategies andbusiness plans which have been agreed between the Government and IDA.

4.2 Project management:

The Ministry has already established and staffed the PCU (under the ongoing PRCBP) and delegatedproject management to it. The scope of responsibility of the PRCBP PCU has been expanded so that itcan provide administrative, financial and procurement support to all private sector projects. The PCUteam is taking steps to reinforce its capacity to ensure the high levels of performance which it previouslyshowed are maintained.

As described in C4, monitoring and evaluation of project activities will be carried out by the PCU. Aquarterly monitoring table and progress reports will be prepared each semester. A draft PIP, FinancialManagement Plan and overall Procurement Plan has been designed and has been incorporated in a PIM.The PIM includes, inter alia, all period reporting, monitoring and evaluation throughout the projectcycle. Apart from periodic reports and standard monitoring arrangements, an impact assessment will becarried out approximately 18 months into the project. In addition, a mid-term review is planned for 30months into the project. Another assessment will be carried out one year prior to the project's closing.The objective of the reviews will be to assess progress and, if necessary, redirect the project integratingadditional lessons learned and the realities on the ground.

4.3 Procurement issues:

There are no procurement issues. The PCU will be the coordinating and responsible agent for allprocurement carried out under the Project. This function will be handled by a team in the PCU whichhas a good track record in World Bank procurement. The team will handle the procurement requestsaccording to monthly procurement schedules submitted by each implementing agency. A procurementplan for the first twelve months has been prepared.

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4.4 Financial management issues:

There are no financial management issues. The PCU will be responsible for ensuring that financialmanagement and reporting procedures under the proposed project are acceptable. An action plan hasbeen prepared to reinforce the capacity of the staff. A financial management assessment for the projectwas carried out, as part of project appraisal, based on the Guidelines established by the World Bank. Thefinancial management team will be the same one that is currently operating for the PRCBP and which hasproven its ability to maintain good financial accounts and prepare quality financial statements. Theassessment confirmed that the PCU has put in place acceptable financial management arrangements asrequired by the Bank's policies, including a reliable system of accounting, reporting, auditing and internalcontrols. The accounting and financial management system of the PCU will update the chart of accountsfor the project and will segregate the various project accounts, in a manner satisfactory to IDA. Theprocedures will be included in the project manual. Independent auditors acceptable to the Associationwill be recruited to audit the project accounts.

5. Environmental: Environmental Category: C (Not Required)5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (includingconsultation and disclosure) and the significant issues and their treatment emerging from this analysis.

No environmental issues.

5.2 What are the main features of the EMP and are they adequate?

not applicable

5.3 For Category A and B projects, timeline and status of EA:Date of receipt of final draft:

not applicable

5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EAreport on the environmental impacts and proposed environment management plan? Describemechanisms of consultation that were used and which groups were consulted?

not applicable

5.5 What mechanisms have been established to monitor and evaluate the impact of the project on theenvironment? Do the indicators reflect the objectives and results of the EMP?

not applicable

6. Social:6.1 Summarize key social issues relevant to the project objectives, and specify the project's socialdevelopment outcomes.

The major social issue is the strengthening of the INPS and AP to ensure that there is a secure andsustainable pension system. Pensions represent an important element of the social safety net put in placeby the Government. The program calls for measures that will ensure that the Government can meet theneeds of the people, without putting an undue strain on the fiscal situation.

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6.2 Participatory Approach: How are key stakeholders participating in the project?

There will be several methods to ensure stakeholder participation. It will be the responsibility of thePCU to ensure that stakeholder participation is consistent. First, the beneficiaries have been activelyinvolved in preparing the project. Most of the beneficiaries already have 2-5 year work plans under theNDP and Investment Strategy, a portion of which have been developed into project components, withperformance indicators which they feel are attainable within the project timeframe.

Second, during preparation, there were extensive consultations with the donor community to avoidduplication of support and to seek their views on the economic and financial environment in Cape Verde.The donor community is not very active in private sector development in Cape Verde. The Americansare working in three areas: (a) WTO accession, of which the project would finance only those areaswhich are not being covered; (b) AGOA, in which they have established a web connection at PROMEX;and (c) they are planning to scale up a current program for support to SMEs, which provides funds forcapital investment and technical know-how. Finally, private sector forums organized by the Chambers ofCommerce (for geographical representation) were organize. The forums discussed key issues affectingthe sector and remedial actions translated into project subcomponents.

6.3 How does the project involve consultations or collaboration with NGOs or other civil societyorganizations?

(see 6.2 above)

6.4 What institutional arrangements have been provided to ensure the project achieves its socialdevelopment outcomes?

A Steering Committee, comprised of Government and representatives from the pension institutions (APand INPS) has been established to work with Government on pension reform. In addition, there is onemember of the PCU dedicated to pension reform. Technical expertise, on an "as needed" basis will beprovided to ensure that these reforms are implemented according to international best practices.

6.5 How will the project monitor performance in terms of social development outcomes?

The project will put into place measures to ensure the pension system's sustainability so that whenliabilities to its members are due, the system will have the resources to pay.

7. Safeguard Policies:7.1 Are any of the following safeguard policies triggered by the project?

Policy TriggeredEnvironmental Assessment (OP 4.01, BP 4.01, GP 4.01) U Yes C No

Natural Habitats (OP 4.04, BP 4.04, GP 4.04) U Yes U NoForestry (OP 4.36, GP 4.36) ( ) Yes ( No

Pest Management (OP 4.09) U Yes U No

Cultural Property (OPN 11.03) ( Yes U NoIndigenous Peoples (OD 4.20) (U) Yes (U9 No

Involuntary Resettlement (OPIBP 4.12) (U9 Yes (9 No

Safety of Dams (OP 4.37, BP 4.37) (U9 Yes (9 No

Projects in International Waters (OP 7.50, BP 7.50, GP 7.50) U Yes U No

Projects in Disputed Areas (OP 7.60, BP 7.60, GP 7.60)* (U) Yes U No

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7 2 Descnbe provisions made by the project to ensure compliance with applicable safeguard policies.

not applicable

F. Sustainability and Risks

1. Sustainability:

The project provides financial, technical assistance and associated institutional and policy support for awell-defined, time-bound process involving financial sector strengthening, investment climate reform andpromotion of private sector investment. The irreversible nature of most of these actions and theundisputed commitment of the current Government on these reforms, enhances the likelihood that, onceimplemented, they will be sustainable. One risk concerns the possibility that the implementation of someof the measures may be incomplete. This risk is being mitigated by IDA support that will help ensurethat human and other resources are available for implementing the programs. By building theparticipatory approach into the design of the project, timely feedback will be ensured so that correctivemeasures can be taken. The sustainability will also depend on the success of the cost-sharing grantscheme in catalyzing the private sector. The demand for the grant scheme was established duringpreparation of the project, and the participatory approach built into the project implementationarrangements will help ensure that private sector concerns in the operations of the grant are addressed asthey arise. Sustainability is also contingent on the receptivity of public agencies to ease regulatoryobstacles.

2. Critical Risks (reflecting the failure of critical assumptions found in the fourth column of Annex 1):

The Government has shown its commitment to improving private sector competitiveness. As mentionedin section B2, with support of the SAC, Government has surpassed its commitment to implement toughrefonns, elevating the project rating to highly satisfactory. A new central banking act has been enacted,substantial tax reforms have been undertaken, several measures for the privatization program havealready been undertaken, as well as steps taken to improve the regulatory mechanisms. The team doesnot foresee any substantial risks to the success of this project.

Risk Risk Rating - Risk Mitigation MeasureFrom Outputs to ObjectiveMacroeconomic and political stability is M Continued dialogue with Government in thenot maintained context of the Public Expenditure Review and

proposed Poverty Reduction Strategy Credit

Government deviates from its N Ongoing Government partnership withcommitment to strengthening the commercial banks; on-site supervision andfinancial system capacity building. Recruitment of qualified

consultants as needed

Systemic and parametric pension reforms M Strong upfront policy commitment fromare not implemented institutional stakeholders and technical

assistance will be provided under project

Matching grant fund does not yield N Strong monitoring and evaluation; partnershipsresults with beneficiaries and advertising

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Improvement to investmnent climate is M Upstream participatory forums (FIAS), strong

insufficient due to incomplete tax and comittment and technical assistanceadministrative barrier reforms, as well aslegal reform

Backtracking/delays in implementing S Strong Government policy comnmittment and

regulatory and divestiture reforms Government understanding with stakeholders;capacity building resources.

Evolving institutional framework for key M Involvement of MIGA and technical assistance

promotion agencies (notably PROMEX)undermines their performance

Inadequate design of reforms and no N Consultancies and public information

uptake for funds

From Components to OutputsProject complexity hinders M Training and capacity building will be on animplementation ongoing basis to ensure that the necessary

expertise is available at the PCU to carry outthe project.

Government does not provide sufficient N Government has indicated its intention to

counterpart funds allocate the necessary budgetary resources. Inaddition, activities which require counterpartfunds, will have the funds delivered on an"upfront" basis prior to the purchase of thegoods and/or services

No uptake for the matching grant funds N Public information campaigns

Overall Risk Rating M

Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk)

3. Possible Controversial Aspects:

The cost implications of merging the two pension plans and establishing procedures to ensure that

Government can pay its financial obligations to INPS (in the form of treasury securities), both sides

(INPS and Administra ao Publico) are working together in an effort to create sustainable pension reform.

G. Main Loan Conditions

1. Effectiveness Condition

o The Government has adopted the Project Implementation Manual in form and substance satisfactory

to the Association;o The Project Account has been opened and the initial deposit equivalent to $30,000 has been paid into

the Account;o A memorandum of understanding (MOU) between the Government and the Chambers of Commerce

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has been executed in a manner aceptable to the Association;* the Government has established a financial management and accounting system for the Project, in

form and substance satisfactory to the Association; and* The Government has appointed an independent auditor

2. Other [classify according to covenant types used in the Legal Agreements.]

* Before signing the legal documents, the Association must receive from the Borrower letters ortelexes appointing a representative to execute and deliver the Development Credit Agreement andrelated documents for the above-mentioned Project

* A report will be prepared by the Government and reviewed by IDA by June 30 and December 31 ofeach year, which integrates the results of monitoring and evaluation activities in the implementationof the project and achievements of project objectives.

* Accounts will be audited annually by a qualified auditor and the audits will be sent to IDA no laterthan March 31 of each year (which is the standard six months following the year-end).

* Conduct in collaboration with IDA a mid-term review of the project no later than March 31, 2006* Maintenance of the PCU under MoFP in the form and with functions, staffing and resources

acceptable to IDA* Meeting the agreed performance indicators

Disbursement Condition

* The Board of Governors for PROMEX will be established and operational in a manner satisfactory tothe Association (a separate category 3a has been established in the DCA).

H. Readiness for Implementation

D 1. a) The engineering design documents for the first year's activities are complete and ready for thestart of project implementation.

1. b) Not applicable.

2. The procurement documents for the first year's activities are complete and ready for the start ofproject implementation.

3. The Project Implementation Plan has been appraised and found to be realistic and of satisfactoryquality.

X 4. The following items are lacking and are discussed under loan conditions (Section G):

As noted in section, items (c), (d), and (e) are included in an agreed on action plan and will be completedprior to the proposed effectiveness date

(a) The Project Account has been opened and the initial deposit equivalent to $30,000 has been paid intothe Account;(b) A memorandum of understanding between the Government and the Chambers of Commerce has beenexecuted in a manner aceptable to the Association;(c) The Government has adopted the Project Implementation Manual in form and substance satisfactoryto the Association;(d) The Government has established a financial management and accounting system for the Project, inform and substance satisfactory to the Association; and(e) The Government has appointed an independent auditor

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0. Compliance with Bank Policies

0 1. This project complies with all applicable Bank policies.D 2. The following exceptions to Bank policies are recommended for approval. The project complies

with all other applicable Bank policies.

Sherri Ellen Archondo b a MclntireTeam Loader Sector Manager/Director Country Manager/Director

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Annex 1: Project Design SummaryCAPE VERDE: Growth and Competitiveness Project

Ke'y'P'rformance Data Collection StrategyHierarchy,of Objectives Indicators . Critical Assum'ptions

Sector-related CAS Goal: Sector Indicators: Sectorl country reports: (from Goal to Bank Mission)Increased private sector-led Achieve private investment of Macro-economic reports * Continuedeconomic growth at least 8 percent of GDP by macroeconomic and

year-2007 Trade Statistics political stability* Govemment's

commitment to economic,financial and tradereforms;

* Continued support forprivate sectordevelopment throughdecreased in rent-seeking,fraudulent behavior

Project Development Outcome / Impact Project reports: (from Objective to Goal)Objective: Indicators:The Project's overall objective Measures have been adopted Baseline survey and then * Macroeconomic andwould be to broaden the base to ensure the pension follow up survey policy stability isof private participation in sustainability, namely: (a) a maintainedCape Verde's economic strategy is in place to Government reports andgrowth and enhance private gradually unify the two statistics * Direct jobs created by thesector competitiveness and existing schemes; (b) criteria project lead to "indirect"further develop its financial of benefits for FAIMO have job creation of 1:2sector. been clearly defined; (c)

parametric changes have been * Folitical commitment tomade to the INPS PSD reform is sustained

Financial system has been * Master plans result instrengthened and all investmentcommercial banks are incompliance with prudentialnorms; NPL decreases to 8percent by June 2005 and 7percent by August 2007

Tariff and tax reform brings areduction of the corporate taxrate to 25 percent, as well ashaving tariffs consistent withinternational best practice andregional UEMOA norms

Investment climate hasimproved and by mid-termreview, an action planincluding measures forreducing administrativebarriers has been adopted and

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by end-project, at least tworecommendations from theaction plan have been fullyimplemented.

With respect to the postprivatization and divestiture,by mid-term review: (a) a newtelecom regulatory frameworkhas been adopted; (b) at leastone value-added service hasbeen developed; and (c) adraft strategy for privateparticipation for infrastructurein relation to airportmanagement has beenprepared. By end-project, atleast three value-addedservices have been introducedinto Cape Verde.

Improvement in the judicialclimate which includes: (a)regulations and procedures forthe labor code have beenadopted; (b) draft arbitrationlegislation has beencompleted; (c) a system for thedissemination of legalinformation has beenestablished (either throughweb-site or other means); (d)Cape Verde has completed alegislative action plan foraccession to the WTO and (e)the notaries on all islands areelectronically inter-connectedand the time to register abusiness has been reducedfrom three weeks to 72 hours,when the request file iscomplete;

At least one report on thestatus of governmentalparticipation in privateenterprises has been producedby MFPRD and the researchand studies department at theMFPRD is established andoperational;

Through promotion efforts,FDI has increased by US$100million with 2,000 jobs

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created by mid-2005 andUS$225 million with 5,000jobs created by end project.

As a result of the matchinggrant facility, on average, bymid-term review, theentrepreneurs have: (a) animprovement in the efficiencyratios, which will be measuredby the percentage of operatingcosts over revenue (sales) of atleast 5 percent; and (b) anincrease in production and/orservices of at least 5 percent;and by end-project, theseratios will increase to 10percent.

Output from each Output Indicators: Project reports: (from Outputs to Objective)Component:Financial Sectorhas been modernized,Strengthening andRestructuring the

1.0 The financial sector hasbeen strengthened

1.1 Quality of loan portfolio Banking supervision is Supervision reports Government remainshas improved efficiently implemented with BCV progress reports committed to strengthening the

at least one on-site visit will be financial system andmade to each commercial bank eliminating distortionsevery two years

All banks are connected to areal-time, credit risk system

1.2 Increase in foreign Through the implementationexchange in the country as a of an electronic VISA system,result of global payment 600 transactions totaling US$5system (VISA) million in foreign exchange

annually by mid-term and 950with US$8 million byend-project

1.3 Insurance sector can Legislation has been updatedprovide long-term resources to Life insurance has increasedfinancial sector from 2 percent of total to 5

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percent of total insurancebusiness by end project

1.3. A sustainable pension Improved targeting of public INPS reports Government sustains itssystem is established pension payments and commitment to social security

actuarial performance of reform and pays its arrearspension system by end-project. due to the system

Government does notGovernment liabilities to INPS undertake parametric reformsare paid and a system is in partiallyplace to ensure timelypayments for civil servantswho move to the private sectorby mid-term review

Audits and actuarial reviewsare carried out and work plansprepared by mid-term review

Equipment (hardware andsoftware) has been purchasedand installed by end-project

Evaluation of technical rules,reporting and disclosurestandards has been carried out,as well as a study of thedevelopment of contractualsavings by mid-term review.

Coverage strategy has beenprepared by mid-term review

New investmnent policy hasbeen prepared and investmentpolicy for the portfolio hasbeen developed for thepension fund by end-project

Administrative efficiency willbe improved as measured byan increase in timeliness and adecrease in error rates inrecordkeeping, while costswill be reduced

1.4 Other non-bank financial Targeted sector studies areinstruments are developed completed (leasing, venture

capital, etc) and strategy isprepared

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Private SectorCompetitiveness is enhance

2.0 Business Environment hasimproved

2.1 New tax and tariff reform VAT will become effective Progress reports, supervision * Govemment is committedwill be implemented reports by implementing to reducing barriers by

Existing incentive scheme will agencies simplifying regulationsbe streamlined by end-project and tax structures,

Supervision reportsImposto de Selo of 0.7 percent Updated FIAS/RPED studyon sales will be eliminated by IMF reportsend-project

A study on tax treatment forexport processing zones will Baseline survey andbe carried out by mid-term subsequent surveyreview

2.2 Administrative barriers for Report on Reduction ofinvestors has been reduced Administrative Barriers Study

will be reviewed and an actionplan prepared by mid-termreview

Procedures to sell or transferstate-owned land and realestate will be simplified by Supervision reportsend -project Codes

A study to create a landregistry (cadastre) system willbe prepared by mid-termreview and work will bestarted by end-project

Company registration fees willbe reduced and import licensefees will be analyzed byend-project

2.3 Supply response and At least three sector studiescompetitiveness stimulated in will be completed and Financial resources to developkey sectors or entry points strategic plans for developing the communication network

the sector will be prepared by will be availableend-project

2.4 Legal and Judicial Computers and software haveinstitutional framework been installed to link notaries

on all islands by end-project

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codes for commercial, housingand civil registries will becompleted by mid-term review

legal information is broughttogether to make it available tothe public by mid-term review

3.0 Post Privatization Reform Support to multi-sector Progress report and Bank o Public sector institutionsregulatory agency - structured supervision report prepared to change theirand on-the-job training, study corporate culturestours and exchange programs,and advisory service for posttraining aftercare will becompleted.

Advisor to Minister ofTransport will be hired and anaction plan to addressoutstanding issues will beprepared

4.0 Investment facilitation is Strategically-focused Quarterly progress report,supported through an effective investment plan will be supervision report, MIGAand efficient investment developed by mid-term review assessment, client surveys andpromotion agency operational audit

PROMEX's annual businessplan will be implemented(annually)

At least four masterdevelopment plans have beenprepared (by mid-term review)

Marketing materials will beupdated including the web-siteby mid-term review

Staff skills will be realigned tofit PROMEX focus bymid-term review

Investor tracking system willbe installed and intranet willbe upgraded by end-project

5.0 MFPRD is actively Status of govemment shares in Annual reportsmanaging the PEs and private enterprises would begovemment shares produced; and

The research and studiesdepartment at MFPRD will beestablished and operational(capable of producing

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economic reports and draftingthe economic framework forthe national budgetingprocess) by end-project

6.0 Firm learning, skill Outreach campaign isacquisition and technological implemented by mid-term * Firms and workers buildand managerial knowledge are review on training received, areenhanced responsive to

At least 80 percent of the recommendations forobjectives proposed by the change, use availablematching grant beneficiaries business serviceswill be achieved by effectivelyend-project

6.1 Private-public dialog has At least 20 percent of the totalimproved actions agreed upon at the

forums will be carried out bymid-term review and anadditional 20 percent will becompleted by end-project. * Government remains

committed toGovernment and private sector private-public dialog as arepresentatives are meeting at method of improving theleast twice annually by business environmentmid-term review

Project Implementation

7.0 High quality project Effective project management Progress reports and bank * PCU does not have theimplementation will be and coordination supervision reports capacity to fulfill itsensured mandate in institutional

Timely budgeting, reporting Operational and financial reform and projectand auditing audits implementation.

High quality financial Prior and post-procurementmanagement and procurement review

Project Components / Inputs: (budget for each Project reports: (from Components toSub-components: component) Outputs)Component 1. Modernize, US$ 3.40 million Disbursement reports Government does not continueStrengthen and Restructure Progress reports partnership with the financialfinancial sector Supervision mission reports sector institutions on reform

US$ 1.00 millionSubcomponent l.A -Financial Sector Reform

Subcomponent l1.B - US$ 2.40 millionIPension Reform

Component 2. Enhance US$ 8.00 million

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Private SectorCompetitiveness

Subcomponent 2.A - US$ 2.00 millionInvestment Climate Reform

Subcomponent 2B- Post US$1.30 million Government remainsPrivatization & Divestiture committed to implement

regulatory framework in aSubcomponent 2.C - US$ 2.10 million manner to promoteInstitutional Capacity Building competition and efficiency

Subcomponent 2.D - Private US$ 2.60 million Private sector is not receptiveSector Capacity Building to the increase in cost-sharing

for business services (from30/70 to 50/50)

Component 3. Supporting US$ 1.15 million Government does not provideProject Implementation counterpart funds on a timely

basis.

Project complexity hindersimplementation

PCU is not capable ofmanaging program

PPF Reimbursement US$ 0.6 millionNon-allocated US$0.35 millionTOTAL PROJECT COST US$13.50 million

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Annex 2: Detailed Project DescriptionCAPE VERDE: Growth and Competitiveness Project

The project's overall objective is to broaden the base of private participation in Cape Verde's economicgrowth and enhance private sector competitiveness, as well as further develop its financial sector. Thiswill be achieved through a series of actions supported by the project, notably: (a) financial sector reform,including pension reform; (b) investment climate reform, which includes, but is not limited to: (i) taxreform, (ii) alleviation of administrative barriers, (iii) improved supply chains, and (iv) legal reform; (c)post privatization and divestiture reforms; and (d) private sector and institutional capacity building. Theproject will thus help sustain the Government's poverty alleviation efforts by generating increasedemployment opportunities through improved international competitiveness.

By Component:

Project Component 1 - US$3.40 million

Modernizing, Strengthening and Restructuring the Financial Sector (US$3.4 million, of whichUS$2.8 million equivalent is financed by IDA). Government recognizes the importance of a strongfinancial sector to support private sector development and economic growth. With support of the project,it will take requisite actions to improve the health of the financial sector and particularly the country'scommercial banks and other financial institutions and instruments, including the pension schemes andpayment systems. Much work has already been undertaken and this component will deepen the reformsinitiated under the CBPPSP. It will consist of the two subcomponents described below, the largest ofwhich is pension reform.

A. Financial Sector Development/BCV (US$0.50 million equivalent is financed by IDA). As thefinancial sector in Cape Verde expands, it becomes critical to strengthen the institutional infrastructure ofthe Central Bank to be able to play its role as a regulator and enable the broader financial sector tointegrate itself into the international financial arena. Within the context of the financial sector strategy,the proposed subcomponents aim to reinforce the foundations of the financial sector by strengthening theregulator (both in terms of its human resource skills, as well as its technological base), enhancing the roleof credit information, strengthening the national payments system, including international integration(VISA) and establishing deterrents to financial fraud and money laundering. Given the financial sector's(including BCV) ability to generate sufficient internal resources, the following financial sector activitieswill be financed on a 50:50 cost-sharing basis.

BCV Supervision and Regulation. The project will provide financial support to the central bank toimprove its capacity to regulate and supervise the banking and insurance sectors. BCV has establishedits supervisory department and economic database systems, but continues to lack sufficient institutionalcapacity. Government recognizes, however, that institution building is a long-term effort that needs to besustained for several more years. The project will therefore finance capacity building for banksupervision. Training under the project includes, but is not limited to: (i) accounting and auditing; (ii)insurance regulation; (iii) analysis and management of bank risks; (iv) implementation of the anti-moneylaundering law; and (v) banking supervision under the new Basel 2 criteria. The training programs willbe made available to other Governmental institutions, as well as other financial and non-financialenterprises which could benefit from this training. This assistance will also include the purchase someequipment.

Lack of credit information on both the corporate and consumers clients has been a constraint for financial

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institutions in making informed lending decisions. To facilitate accurate assessment of repaymentproblems and better allocation of credit, the commercial banks provide information to the BCV on amonthly basis and receive information on an "as needed" basis. However commercial banks feel thatthey would benefit by having more ready access through an on-line credit risk and loan concentrationsystem, with the goal of reducing the NPL further to 7 percent by the end of the project. In the area ofinformation technology, the system must be further developed in order to link the financial institutions ona real time basis. The system will be housed at the Central Bank and no fees for information will becharged; the commercial banks confirmed their confidence in the security of the information in thisarrangement. The project will finance equipment, especially information technology (including on-lineconnection to payment system and bank IT networks for risk and loan concentration databases) andtraining.

The project will also support the strengthening of financial infrastructure. SISP manages activitiesrelated the development of electronic banking and payment systems. During the last several years, SISPhas implemented ATMs and TPA (debit system used at commercial establishments). It anticipatesadopting the infrastructure necessary to implement a network of VISA and create a critical mass oftransactions which permit the economic and financial sustainability of the system. This would also be abeginning for international integration of the financial system. The project will provide funds (onlyGovernment and BCV's share) for the necessary hardware, software and training for the implementationof the VISA applications.

The life insurance market of Cape Verde is limited. The major activity consists of providing mandatoryautomobile insurance, which provides little or no long-term capital. Legislation and regulation of theinsurance sector are out-dated and regulated tariffs appear inadequate. The project will therefore financean updated study of the insurance sector, as part of a series of studies on specific needs of the financialsector. Subsequently, the project will provide funding for technical assistance to the insurance sector,which will likely include the updating of the regulatory framework.

Finally, the project will finance some targeted studies for expanding financial intermediation throughnon-bank financial instruments, which includes leasing and venture capital, both of which are included inthe context of the financial sector strategy.

B. Pension Reform (US$2.30 million equivalent isfinanced by IDA). Pensions represent an importantelement of the social safety net put in place by the Government. They also represent an importantpotential source for longer-term resources for investment financing. The Government intends to create asustainable pension scheme for all formal sector workers by creating a streamlined mandatory pensionscheme that would encourage voluntary private funds to play a role in the overall system. The objectiveof this subcomponent will be to help Government implement a series of parametric reforms aimed atestablishing a sustainable pension system. Reforms will: (a) ensure any pension promises that are madecan be kept. The project will support efforts by Government to establish a procedure to ensure thatGovernment contributions are made on behalf of the civil servants to the INPS. This may have to be tiedinto the way the payment system works for paying public servants; (b) avoid the need for a call on theGovernment budget to meet future benefits; and (c) deliver a fair allocation of resources betweendifferent generations. Since the decision has been made by Government to shift civil servants into theINPS, the studies must be conducted quickly so that legislative changes required are based on solidfinancial information. Finally, in the interim, the project will support a unit within the AP to audit thecurrent pensioner population and install a mechanism for ensuring that records are accurate. This willfacilitate the integration of civil servants into INPS.

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The technical work to prepare the sector reform will form the basis of a sector policy reform strategywhich will adopted by Government. Cape Verde has been selected as one of the African countries to beincluded in a World Bank pilot pension reform program and has already participated in severalworkshops on pension reform. The project will provide financing for technical assistance in thefollowing areas: (a) independent audits and an actuarial review; (b) an information system needsassessment; (c) purchase of hardware and software; (d) consultancies to: (i) produce a new investmentpolicy, (ii) evaluate valuation rules, reporting and disclosure standards, (iii) civil service integrationstudy/cost analysis, (iv) study the development of contractual savings, regulatory/supervision issues, (v)analysis of the social assistance scheme and FAIMO, and (vi) coverage strategy; (e) training programsfor: (i) trustees, and (ii) technical workshops; and (f) translation of technical materials.

Project Component 2 - US$8.00 million

Enhancing Private Sector Competitiveness (US$8.00 million of which US$6.70 million equivalent isfinanced by IDA). Companies in Cape Verde have responded well with the opening of markets toprivate initiatives. Since 1995, there has been an acceleration in the emergence of new companies andthe development of the private sector has also involved direct foreign investments through the allocationof export-onented foreign companies. However, the dynamics of the private sector has not beenaccompanied by sufficient judicial and legal measures to modernize the sector and make it more supple.In addition companies report that there continues to be excessive state regulation and bureaucraticprocedures and emphasizes the need for greater clarity in establishing corporations and activityregulation processes, including tax reform.

The "second generation" of reforms which Cape Verde intends to call for a sustained long-termcommitment across multiple fronts. The immediate challenge is to make sufficient progress inaddressing the obstacles so that progressively more private actors can share in the fruits of economicgrowth. The aim of the following component is to sustain high private sector growth and increasedcompetitiveness, by enhancing the investment climate, institutional capacity building and improvingsupply chains in key subsectors. Its activities will work towards improving the enabling investmentenvironment, especially by facilitating the policy, legal and regulatory interface, and the dialogue processbetween the public and private sectors. The medium-to long-term objective (end of project) is to bringabout permanent improvements in the quality of the interface between the private and public sector. Thiswill be measured through decreased financial and time costs of doing business. The objective will beachieved through judicial reform, a better business environment and trade facilitation, enhanced capacityto regulate and resolve post-privatization issues. Once activities by the project are implemented, privatetransactions would be facilitated and transaction costs (in terms of delays and financially) would bereduced.

A. Investment Climate Reform (US$2.0 million equivalentfinanced by IDA). In an effort to improvethe investment climate and promote new investment opportunities, as well as make Cape Verdeancompanies more competitive, the credit will finance the following activities:

* Tax reform (US$300,000 equivalent). Government recognizes that the large number of customs andtax exemptions undermine its objectives of creating a level playing field in the business environmentand fiscal policy and could subsequently provide more resources for its anti-poverty programs. Assuch, the Government recently took important steps to rationalize private sector taxation. The projectwill finance specialized legal assistance to the tax office at the MFPRD on the Investment Code andspecialized assistance on the evaluation of the fiscal revenue impact of the proposed measures overtime, as well as related capacity building initiatives. In addition, the project will finance the cost ofdisseminating information on the new tax rules (including VAT), as well as providing necessary

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training for Government staff and the private sector.

O Alleviation of Administrative Barriers (US$500,000 equivalent). The Administrative Barriers toInvestment Study, which follows several World Bank sponsored FIAS studies in Cape Verde, waslaunched in October 2002. Based on the recommendations from the study, Government andstakeholders will formulate an action plan for further reforms in this area that would improve theinterface between the public and private sector. This plan and subsequent updates, will beimplemented with the support of the project.

O Development of Efficient Supply Chains (US$300,000 equivalent). As part of its private sectorstrategy and to complement its work on tax reform and reduction of administrative barriers,Government will target three sectors, which may include tourism, fishing, trade, construction and/ortransport, and develop a clear sector strategy. A supply chain analysis will be carried out on theselected sector to establish what prerequisite actions are needed to resolve constraints byGovernment (infrastructure, regulation etc), and by the private sector (gaps in technical skills or lackof upstream and/or downstream activities). These studies will identify the cross-cutting issues withinthe sector, defining the policy, as well as sector specific requirements. These recommendations willbe fed back to the public and private sector for debate and a clear strategy and sector policy will bedefined. Activities to support the implementation of the sector policy will be financed under theproject.

O Modernizing the Legal Environment for Business (US$900,000 equivalent). This component willsupport work that had been started under the PRCBP and provide assistance in putting in place aninstitutional and a legal framework conducive to the development of the private sector. The projectwill provide legal technical assistance, as well as some equipment which is necessary to undertakethis task. In particular, the project will provide support to the Department of the Registry, Notaryand Identification to speed up the process of registering companies, buildings, etc. from almost threeweeks to 72 hours by developing computerized links among the various municipal offices on thedifferent islands. The software has already been developed, therefore the project will finance thehardware (computers). The communication link will be provided with support from the RAFEproject.

In an effort to respond to the requests to simplify the procedures, the project will finance technicalsupport to elaborate the code for the commercial registry, housing registry and civil registry. Inaddition, the project will finance the technical assistance necessary to elaborate the regulations andprocedures which accompany the labor code; of which substantial work on the code has already beenundertaken (under PRCBP). Workshops and training sessions will accompany the process.

Arbitration has been identified as an effective means of resolving commercial disputes. The twoChambers of Commerce of Sotavento and Barlavento could be used as arbitration centers. (Ministryof Justice will prepare the appropriate legislation and regulation, while the Chambers of Commercewill establish the Arbitration Centers). The project will therefore finance capacity building andequipment in order to set two arbitration centers in Cape Verde.

Cape Verde is in the process of joining the WTO. In 1993-1994, Cape Verde lost the historicalopportunity to become a founding member of the WTO. It must now undergo an accessionprocedure. While the USAID is offering some technical assistance in order to help Cape Verde inthe accession procedure, the project will finance important technical assistance not covered orenvisaged under the USAID accession scheme (such as training in legal and policy aspects ofinternational trade, harmonization of domestic laws, etc.) In the partial context of the accession to

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the WTO (including TRIPS, Agreement on Trade Related Intellectual Property Rights), Cape Verdewill have to set up a legal and institutional framework for the effective exercise of intellectualproperty rights. Indeed, this aspect has been stressed as being a pressing and urgent necessity amongbusiness circles. This is all the more important in a country such as Cape Verde whose music isexported worldwide.

The project will provide support to efforts to making laws and judgments more accessible bypublishing the related documents and making key laws available on the internet. One of theidentified bottlenecks in the improvement of the business enviromnent in Cape Verde is the total orpartial ignorance of the legal business framework by domestic and international investors. Theproject will therefore finance business law dissemination and information by: (i) making laws andjudgments more accessible and available through the publication of business laws and judicialdecisions (including on the internet perhaps through the Global Legal Information Network, GLIN),and (ii) organizing training and capacity building sessions (possibly in PROMEX and in theChambers of Commerce) for Judges, Lawyers, Businessmen and all interested public or privatestakeholders, WTO, intellectual property, anti-money laundering and arbitration. Finally, the projectwill finance the costs of dissemination of information, as well as training judicial and legal staff.

B. Post Privatization and Divestiture (US$1.3 million equivalent is financed by IDA). Regulatoryreform and capacity building was strongly supported by IDA through the ongoing PRCBP. It had beenanticipated the PRCBP would provide the necessary support for the operations of a fully functionalregulatory agency and help Government resolve the main outstanding sector issues. In view of its closingdate, these objectives will only be partially reached. To sustain important actions, this subcomponentwas added to the design of this project. It will be aimed at addressing the main outstanding divestitureactions and thus improve Cape Verde's competitiveness in the infrastructure sector. . The intendedoutputs and outcomes of the subcomponent include: (a) a fully operational multi-sector regulatory agencycapable of handling routine issues internally and more complex ones with limited expert support; (b)completion of the private participation agenda, including the port and, possibly, the airport; (c) a morecompetitive telecommunication sector, with at least one more operator present and number internet usersper 1,000 people similar to relevant comparators; and (d) well-functioning inter-island and urbantransport systems that do not require significant subsidies from the state.

More specifically the project will finance mainly consultants and training to help implement thefollowing activities: (a) completion of telecoms reform and with the sector law, which encompass: (i)the renegotiation of the existing contract to remove internal inconsistencies, clarify the liberalization ofvalue-added services, revised pricing policy, including access fees, and liberalization of the sector in linewith WTO commitment concerning local and international markets, and (ii) award of a new cellularlicense; (b) support to multi-sector regulatory agency, which will be mainly in the form of structured andon-the-job training, study tours and exchange programs, and advisory service for post training aftercare.The latter would involve availing experts to the regulators to help them resolve specific regulatory casesbrought to the regulator; (c) port and Airport reform and divestiture in which the project will provideresources to complete the privatization of the port and study the scope for private participation inairports; and (d) Other transport reform. The project will finance international and local advisors to helpthe Ministry of Transport address outstanding policy issues mentioned earlier.

C. Institutional Capacity Building (US$2.1 million equivalent isfinanced by IDA). For the strategy tosucceed, public/private partnerships and related institutional arrangements would have to bestrengthened. The project comprises just part of a broader program of pro-private sector reforms.Concentration will be on capacity building of selected Government ministries and agencies which

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interact most intensively with private firms. This subcomponent is designed to address two keyobjectives: (a) enhancing the capabilities of private and public institutions to deliver business supportservices; and (b) supporting Government agencies to improve their capability to identify and easebureaucratic rigidities. Capacity building assistance will be extended to the following institutions:

PROMEX (US$1. 0 million equivalent) was created with the mandate to support the ongoing reforms andencourage foreign direct investment as well as exports. PROMEX has been successful so far bydisseminating information to potential investors, assisting the Government in its general promotionactivities abroad, and in designing new regulations and laws for FDI. According to PROMEX's BusinessPlan 2002, the agency's priorities for the immediate future will shift back towards the promotion of CapeVerde's image abroad and towards the encouragement of a stronger internationalization of Cape Verde'seconomy. Major program areas include a marketing and communication program to disseminateinformation on Cape Verde as an investment location, export base and tourism destination, and aprogram to attract increased levels of foreign direct investments, not least in export-oriented industriesand in the tourism sector. These substantial priorities will be supported by an institutional developmentprogram, through which the agency intends to update staff skills, internal processes and systems. Thesubcomponent will assist PROMEX in this process by providing support for strategy development,capacity building and the preparation and execution of key operational activities related to the corefunctions of the agency. In particular, the support will focus on: (i) the development of a strategicallyfocused investment promotion strategy; (ii) an institutional capacity/skills building for PROMEX staff;(iii) the preparation of up-to-date marketing materials, including revamping the PROMEX website; (iv)introduction and upgrading of necessary systems and processes (investor tracking system, Intranet); and(v) support of a number of outreach/promotion activities in priority sectors.

PROMEX has emphasized that having area master plans are important for land development, particularlyfor the industrial and tourism sectors, where special care is taken to conserve the environment. Twoplans, for the islands of Maio and Boavista have already been completed and investors are waiting forapproval by Government. In addition, there are a substantial number of potential investors interested ininvesting on the islands of Sao Vincente and Santiago (in four areas) who have put their investment planson hold while awaiting the preparation of these master plans. The project, therefore will finance thepreparation of four (4) master plans to be carried out on the basis of priority to maximize investmentopportunities.

Public institutions that interface with private sector (US$500,000 equivalent). In addition to PROMEX,there are other public institutions that work with private sector, which would need: (i) to establish astrategy, with guidance from Government; and (ii) support for internal strengthening and programs. Theproject will provide support to Government to establish a framework for private sector development, aswell as implement its program.

Ministry of Finance, Planning and Regional Development (US$600,000 equivalent). The MFPRD isexpected to play an important, but indirect role in promoting private sector development. A moreproactive stance under MFPRD's responsibility could significantly contribute to private sector promotionby improving its capacity to monitor and provide financial management of autonomous publicinstitutions, as well as managing Government shares in private companies. The project will providefinancing for: (i) technical assistance to provide financial management support of autonomous publicinstitutions and manage government shares in private companies; (ii) capacity building for MFPRD'sstaff, including two trade missions during the four years; and (iii) institutional support for the researchand studies department, which would include equipment and training.

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D. Private Sector Capacity Building (US$1.30 million to be financed by IDA). The environment fortechnical leaming and assistance in Cape Verde continues to be underdeveloped The mechanisms bywhich private firms transfer technology and raise their technical capabilities are weak and while foreigninvestment in the country is increasing, technology transfer via this channel remains limited. Untilrecently all tertiary education, as well as vocation and technical training, had to be provided abroad,leaving a gap in the ability to train staff on modern technology and processes. The private sector strategycalls for capacity building within private operators, especially SMEs. There is substantial demand by theprivate sector for these services, of which the two Chambers of Commerce are trying to accommodatewith their programs.

The project will support this additional demand by private operators and enable the Chambers to expandthe services to their members, as well as other associations, such as the Association of Micro-enterprisesor the Association for Women Jurists, through a 50:50 matching-grant, using an approach and proceduressuccessfully tested and developed in other IDA projects. This subcomponent will focus on the technicalcapabilities of Cape Verdean firms, in manufacturing and services (both domestic and for export).Funding will be used to: (i) improve firm competitiveness by providing access to supporting servicesextemal to the firm (this may be in the form of technical assistance or managerial expertise); and (ii)address the constraints in staff training. The two Chambers of Commerce, whose mandate is to representthe private sector with Govemment, as well as provide these services, will also benefit from the grant asmanager/administrator of the matching grant. They will be able to also access this grant to strengthentheir capacity to deliver services to its members. The grant will be demand-driven and managed on a firstcome/first serve basis. However, the Chambers may target certain industries which are priority sectors,but not at the exclusion of other Cape Verdean enterprises. In addition the project will finance, asneeded, the dissemination of business related-information which would: (i) widen the dialogue onbusiness environment reforms, (ii) help to raise awareness among business community, as well aspolicymakers, and (iii) educate and build consensus among the concemed actors.

Project Component 3 - US$ 1.15 million

Supporting Project Implementation (US$1.15 million of which US$1.05 equivalent is financed byIDA). The project will, in substance, be implemented by the beneficiaries. In addition, a professionalPCU has been established. The PCU will report to a Steering Committee, comprised of high level publicand private sector professionals. The PCU will oversee the financial management, procurement,reporting, monitoring and evaluation, audit, public information and related functions, as well as manageseveral cross-cutting sector issues, such as pensions and regulatory reform. While most of theinstitutions have the capability to manage the activities supported by the project, strong complementaryimplementation capacity may be needed to ensure that the project objectives are met. The credit willthus finance a team of high caliber local professionals located at the PCU and the related support staff.

The PCU will be comprised of a project coordinator, procurement specialist, accountant, technicalspecialists (who will deal with cross-cutting issues), program officer and an administrative assistant. Itwill be responsible for providing the necessary guidance to the beneficiaries for procurement ofconsultants, as well as goods and services, monitoring and evaluation, and be implicated in the overallpension reform and cross-cutting issues such as investment climate, post divestiture issues andpublic/private dialog. To minimize project implementation costs, the accountant and procurementspecialist, who are currently attached to the PRCBP, will also provide support to this project during thefirst year. At the close of the PRCBP, the necessary staff will be transferred to the project unless analtemative arrangement is proposed by Government and accepted by IDA. Use of local capacity whichhas been developed through other projects lowers the learning curve and increases the efficiency andproductivity. By using an existing PCU, the Government can consolidate experiences and create

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economies of scale. However, wherever necessary, technical assistance (on a punctual basis) will besought to strengthen the team. This will enable a transfer of skills from one project to another, includingprocurement and disbursement expertise. In addition, the implementation arrangements will ensure thatthere is an entity formally responsible for project technical coordination and monitoring and has theincentives to solve problems in a timely manner.

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Annex 3: Estimated Project CostsCAPE VERDE: Growth and Competitiveness Project

.Local Foreign Total-Project Cost.By Component' US,$million JS $nillion US $million

1. Modernize, Strengthen & Restructure Financial Sector 1.50 1.90 3.402. Enhance Private Sector Competitiveness 5.20 2.80 8.003. Supporting Project Implementation 0.75 0.40 1.154. Reimbursement of PPF 0.00 0.60 0.605. Non-allocated 0.05 0.30 0.35Total Baseline Cost 7.50 6.00 13.50

Physical Contingencies 0.00 0.00 0.00Price Contingencies 0.00 0.00 0.00

Total Project Costs 7.50 6.00 13.50Total Financing Required 7.50 6.00 13.50

., Local'; Foreign -Total'"P project Cost.By.Category' US $million .,:US.$millidn US!$miliion

Goods and equipment 1.85 0.70 2.55Works 0.05 0.05 0.10Consultant services, including audits 3.35 2.60 5.95Training and workshops 0.70 0.90 1.60Operating Costs 0.30 0.45 0.75Matching Grant 1.20 0.40 1.60Reimbursement of PPF 0.00 0.60 0.60Non-allocated 0.05 0.30 0.35

Total Project Costs 7.50 6.00 13.50Total Financing Required 7.50 6.00 13.50

Identifiable taxes and duties are 0 (US$m) and the total project cost, net of taxes, is 13 5 (US$m) Therefore, the project cost sharing ratio is 85 19%of total project cost net of taxes

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Annex 4

CAPE VERDE: Growth and Competitiveness ProjectEconomic Anzlysis

Introduction

The economic analysis of this type of private sector development project presents special difficultiesparticularly when there is an indirect relationship between the project's actions and the stream ofbenefits. Moreover, for the project's matching grant's scheme, it should be noted that it is difficult toestimate the amounts and types of investment, incremental production and exports generated from thesupported firms. Nevertheless, a cost-benefit analysis has been used to calculate the Net Present Value(NPV) and Economic Rate of Return (ERR) in a "with" and "without" project framework.

The economic analysis has produced an NPV of about US$ 4.5 million at a discount rate of 12 percentand an ERR of 18.8 percent.

Table 1: Economic Analysis Summary (a)

Matching Grant Institutional OverallDevelopment

Net Present Value $3.5 million $4.7 million $8.2ERR 40.2 19.5 23.0

(a) Using a discount rate of 12 percent.

Cost-Benefits Analysis

Summary of Benefits and Costs:

Present Value of FlowsEconomic Analysis Financial Analysis (b) Taxes Subsidies

Benefits (US$ million) 20.4 4.2 n.a.Costs (US$ million) 12.2Net Benefits (US$ 8.2 4.2 n.a.million)

IRR(%) 23.0

Note: The discount rate usedfor the economic analysis is 12percent.It is assumed that the financial costs and benefits are equated to economic costs and benefits.

Base Case Results.The cost-benefits analysis of this type of competitiveness project is delicate and presents the limitsencountered in all similar project evaluation. The difficulty in quantifying the economic benefits resultsmainly from the indirect relationship between the project's interventions and the stream of benefits; and

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from the lagged effects of the project on the performance of the different sectors directly supported.Nevertheless, a cost-benefit analysis has been used to calculate the NPV and ERR in a "with" and"without" project framework. The numeraire used in the objective function is output, which is expectedto grow mainly as the result of: (i) improved efficiency of the matching grant-supported SMEs, and (ii)increased private national and FDI.

The NPV of the overall project is estimated at about US$8.2 million for a 12 percent discount rate. Thecorresponding internal economic rate of return is estimated at 23.0 percent. A minimum of 1,160 jobsare expected to be directly created by the matchinggrant-supported SMEs. Jobs generated through amultiplier effect are also expected. The positive impact on government income estimated at about $4.2million result from increased direct and indirect corporate taxes, and taxes on incremental wages.

The cost-benefit analysis was done for two main categories: (i) matching grant (private sector capacitybuilding), which is analyzed separately, since the estimation of its direct impact on output growth and jobcreation can be isolated; and (ii) institutional development, which, for the purpose of the analysis,includes the two components "enhancing private sector competitiveness" (excluding the matching-grantsub-component) and "modernizing, strengthening and restructuring the financial sector". For bothcategories, as shown in the table below, the ERRs are greater than the discount rate of 12 percent,indicating that the project is robust.

Table 1: Summary results by components

Matching Grant Instttutional Overall(Private sector Develooment Proied

capacttybuildino)

NPV (US$ million) 3.5 4.7 8.2ERR 40.2 19.5 23.0

Main Assumptions:

1. Stable macroeconomic environment as projected in the I-PRSP with a 5 percent real GDP per annumon average; and an inflation rate under 2.5 percent.

2. Capacity at PROMEX is effectively and timely strengthened to better attract FDI.

3. A minimum of 200 firms are expected to benefit, either directly or through their associations, from thematching grant scheme with an average amount of US$7,500 per firm. It is assumed that the scheme,through the provision of technical assistance and training, would increase productivity of the recipientsand would yield an increase in outputs at a multiple of 8 times the amount of support. This conservativeassumption is made based on empirical evidence in similar schemes in East Asian countries, whereoutput increase at a multiple of 15 times the matching grant amount

4. For the supported firms, the rate of job creation has been calculated using recent labor productivityindicator with an estimated worth of output per worker of US$3,500.

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5. The additional output created by assisted firms is defined as the difference between the level of outputachieved by firms assisted by the project and the level of output these same firms would have achieved inthe absence of the project.

6. It is assumed that financial and institutional sustainability of the two chambers of commerceimplementing the matching grant scheme will be timely strengthened. This is necessary to better servetheir members and reach other associations such as the Microfmance Association and the Women JuristAssociation. It is also assumed that the matching grant scheme will be correctly managed, especially withrespect to decisions and allocations of the grant.

7. It is assumed that there is no mismanagement of grant received by firms or associations.

8. In the base case, the increase in firms' output is discounted by 66 percent to take into account thesocial costs of other crucial resources in the economy that are diverted into the project from otheractivities not directly supported by the project.

9. Measurement of economic benefits of the financial sector and private sector competitivenesscomponents of the project is difficult because they furnish provision of services to firms indirectly. It wasassumed that the support provided would, with an average lag of two years, increase efficiency of thesupported recipients and would yield an increase in economic outputs at a multiple of 2 times the amountof support.

Sensitivity Analysis

Four sensitivity tests were carried out by switching values of critical variables. The results are presentedin table 2 below.

(i) The first test decreased the social cost of resources diverted into the project from 66 percent to 50percent; the NPV jumped to US$22.0 million with a corresponding ERR of 36.4 percent.

(ii) The second test assumed a 75 percent social cost of resources diverted into the project, the NPVsharply decreased to US$1.8 million while the ERR dropped to 14.8 percent.

(iii) The third test assume a higher increase in output for each firm from 8 to 15; the results showed aNPV of US$13.4 million and ERR of 29.0 percent.

(iv) The fourth test elongates the disbursement period by two years, the NPV decreased to US$7.5million while the ERR came down to 21.6 percent.

The project has a positive impact on government income in all of the different scenarios analyzed. Interms of job creation, it should be noted that although the number of new jobs generated under the basecase scenario and under the slow disbursement scenario are the same, the effect is mainly on theemployment rate which, ceteris paribus, increases faster in the base case scenario. The overall resultsconfirm the project's soundness.

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Table 2: Sensitivity Analysis Summary

Scenario Sensitivity Performed Cases Variable Amount NPV ERR Fiscal Jobs(SMill) (%) Impact create

($Mill)

Overall Project

Delayed Project Elongated disbursement (a) Base (a) Regular Disbursement 8.2 23 0 4 2 1,166Implementation penod

(b) Alternate (b) Slow Disbursement 7 5 21 6 3 8 1,166

Change in Diversion Percent reduction in (a) Base (a) 66% Reduction 8 2 23 4 2 1,166Assumption increase in Output

attributed to diversion (b) Alternate (b) 75% Reduction 1.8 14 8 2 9 857from other sources

(c) Alternate (c) 50% Reduction 22 0 36 4 7.0 1,714

Expected Change in Increase in expected (a) Base (a) 8 Times 8 2 23 0 4 2 1,166Output for each firm change in output for

each firm (b) Alternate (b) 15 Times 13.4 29.0 5 4 2,186

Benefits from the project

The main economic benefits and the monitoring tools are presented below:

Nature of benefits / Indicators Monitoring Toolsincreased pnvate national and Foreign direct Investment statisticsnvestmentsIncreased productivity and outputs in the Base case / end of project output levelsmatching-grant supported SMEs

Job creation in the SMEs sector Number of employees at beginning / end ofroject

Improved business environment (reduced End-of-project survey on administrativeadministrative barriers, reduced effective barmiers and cost of infrastructure servicesmarginal tax rate; reduced cost ofinfrastructure services, etc)Improved financial system New financial services; compliance with

rudential regulation - BCV progress reportImproved pension system Reduction of the unfunded pension liabilities

in the two formal pension schemes - INPSreport

Main Beneficiaries.

The main beneficiaries of the project would be: (i) the two chambers of commerce, their memberassociations, and a minimum of 200 small and medium enterprises with better access to businessdevelopment services; (ii) the private sector, with a more business friendly environment; (iii) thefinancial sector, with better regulations, more financial services and products, and improved financialintermediation; and (iv) the public sector, the Government in particular, with strengthened institutions,and wider tax base and healthier fiscal position.

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Annex 5: Financial Summary

CAPE VERDE: Growth and Competitiveness Project

Years EndingJune

Year I Year 2 | Year 3 | Year 4 | Year 5 | Year6 | Year7Total Financing RequiredProject CostsInvestment Costs 2.4 3.7 3.2 2.3 0.4 0.0 0.0Recurrent Costs 0.3 0.3 0.4 0.3 0.2 0.0 0.0

Total Project Costs 2.7 4.0 3.6 2.6 0.6 0.0 0.0Total Financing 2.7 4.0 3.6 2.6 0.6 0.0 0.0

FinancingIBRD/IDA 2.3 3.5 3.0 2.2 0.5 0.0 0.0Government 0.1 0.1 0.1 0.1 0.1 0.0 0.0

Central 0.0 0.0 0.0 0.0 0.0 0.0 0.0Provincial 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Co-financiers 0.0 0.0 0.0 0.0 0.0 0.0 0.0User Fees/Beneficiaries 0.3 0.4 0.5 0.3 0.0 0.0 0.0Other-non-allocated 0.0 0.0 0.0 0.0 0.0Total Project Financing 2.7 4.0 3.6 2.6 0.6 0.0 0.0

Main assumptions:

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Annex 6(A): Procurement Arrangements


Procurement

Introduction: A national procurement code does not exist in the Republic of Cape Verde except forsome specific arrangements for procurement of works; this is the reason why no Country ProcurementAssessment Review (CPAR) has been conducted to date. One is scheduled during fiscal year 2005.Nevertheless, the general procurement environment is good since the person responsible for procurementmatters of the project, understands the World Bank procedures of an IDA-financed project. Besidesreferring to World Bank procurement procedures and using the standard bidding documents, it isimportant for the country to have a national procurement code. This would enable National CompetitiveBidding (NCB) for goods and works under national procedures and simplify the procurement process.

General: IDA will finance civil works, goods, consultancies, training and other local activitiesnecessary to implement the project. The procurement of goods, works and services will be done inaccordance with the Bank's Guidelines on Procurement under IBRD Loans and IDA Credits (January1995, Revised January and August 1996, September 1997, and January 1999) and the Guidelines onSelection and Employment of Consultants by World Bank Borrowers (January 1997, revised September1997, January 1999 and May 2002). The Bank's standard bidding documents for goods and the standardforms of contract and request for proposals for consulting services will be used under the project. Anygoods or services not financed by the Bank will be procured in accordance with the public procurementregulations of the country or the co-financing institution's procurement regulations.

Advertisement: A general procurement notice (GPN) has been prepared, approved by IDA and waspublished in the United Nations Development Business, announcing goods and consultant services to beprocured and inviting interested eligible suppliers and consultants to express interest. SpecificProcurement Notice (SPN) in Development Business will also be required for all consulting assignrmentsexceeding US$200,000 per contract. Notification and advertising will be carried out in accordance withthe provisions in the Guidelines. The GPN will be updated annually to include those contracts still to belet. The GPN will be issued in the national press of the official gazettes for contracts to be let underNCB and the SPN for goods and works will be advertised in the national press which has a widecirculation and internationally for large contracts. Sufficient time should be allowed to obtain the biddocuments.

Implementation: As mentioned in section C4, responsibility for all procurement under the project restswith the PCU. The project provides for strengthening of the procurement capacity, however, this projectwill be utilizing an existing PCU, which has been instrumental in executing two other World Bankprojects (PRCBP and SAC) and which has shown a good track record in procurement according to WorldBank procurement rules.

General assessment of procurement unit capabilities: An assessment of the PCU capacities inprocurement was conducted during appraisal and found to be satisfactory. The PCU has had significantexperience with the World Bank procedures and the person responsible for procurement is qualified andhas experience in fulfilling the procurement tasks which are required. Her contract expires December2003, at which time, the performance will be evaluated and if satisfactory, the contract will berenegotiated for an additional period.

* Historical and general environment of the PCU. The PCU has been functioning since 1999. At first,

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the agent responsible for procurement matters also handled other tasks. In July 2001, with increasedstaffing of the PCU, the procurement position became more focused on procurement and the PCUhas shown a good performance in terms of reducing delays and improving the quality of procurementdocuments.

o Organization and distribution of roles. Within the PCU, there will not be a procurement unit, but anindividual assigned to procurement of goods and services (there is not sufficient work to warrantmore than one person). This person will report to the project coordinator, which removes it fromsituations where there may be a conflict of interest. The procurement specialist will be fullyresponsible for procurement matters and ensuring expedition of processing and quality of theprocurement documents and evaluation reports. The procedures manual will fully define the role andresponsibility of each staff within the PCU. The manual will also include a section on "ethics".

o The rules which will be used. Generally, the World Bank procedures are used and fully respected bythe Cape Verdeans. As noted above, there is no national code in procurement with adequate standardbidding documents. Consequently, there will be no proposition of exception included in theDevelopment Credit Agreement (DCA).

o Management of the procurement cycle. In general, the procurement cycle is well managed by thePCU, although there have been some cases of delay in awarding the contract. These exceptionalsituations have been generally caused by the lack of availability of evaluation committee memberswho are not always available at the same time. One of the reasons is lack of motivation because thiscommittee is not paid and they have more urgent activities to follow-up in their offices or job sites.

o Quality of procurement documents filing and recordkeeping. The filing of procurementdocumentation is excellent; it is done by the procurement specialist. However, it is recommendedthat this task be assigned to an assistant-level staff to enable the procurement specialist to focusbetter on her main activities.

o Ethics and basis of transparency. In general, there is low risk of corruption in Cape Verde and lackof transparency has not been a major problem in any of the PIUs. The PCU for the PRCBP, whichwill continue working for this project, has performed to high standards, ensuring that relevantinformation on procurement are distributed to the interested bidders; it is, for example, mandatory tomake the written records on procurement (results of the contract award) publicly available. Therehave been few complaints from bidders and these complainants have accepted the reasons providedto them.

o General conclusion on the procurement environment analysis and risk assessment. The reputation ofthe PCU on procurement is very good and the risk of poor performance is "low". An action plan hasbeen prepared and discussed with the PCU to further strengthen it to be able to implement anadditional project. Carrying out the action plan in the agreed timeframe ensures that the project teamwill be ready for implementation upon effectiveness.

Procurement methods (Table A)

A general procurement plan reflecting the bid packages for the entire period has been prepared. Thisplan will include contract cost estimates, contract packaging and applicable selection criteria. Procedureswill be furnished to the World Bank for its review and approval prior to the issance to consultants of anyrequests for proposals. These plans will be updated semi-annually during project implementation and

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each update will be provided to the World Bank for its review and approval. The procurement includesrelevant information on all goods and service contracts under the project as well as the timing of eachmilestone in the procurement process. The detailed procurement schedule will be updated every sixmonths and submitted to IDA. The procurement specialist will monitor the progress of procurement andimplementation of each contract under the project and will ensure effective and timely project execution.

Procurement of Consulting Services

As noted above, the selection and employment of consultants will be in accordance with the guidelines,the Selection and Employment of Consultants by World Bank Borrowers (January 1997, revisedSeptember 1997, January 1999 and May 2002). Except otherwise stipulated, all consulting servicecontracts will be awarded using the Quality and Cost-based Selection (QCBS) method. Consultingservice contracts estimated to cost less than US$50,000 for finms may be awarded through theConsultants Qualifications (CQ) selection method in accordance with the provisions of paragraphs 3.1and 3.7 of the Guidelines. For contracts of a routine nature estimated to cost less than US$50,000 andwhere well established practices and standards exist, such as financial audits, Least-cost (LC) selectionmethod may be used in accordance with the provisions of paragraphs 3.1 and 3.6 of the Consultant'sGuidelines. All consulting services of individual consultants will be procured under individual contractsin accordance with the provisions of paragraphs 5.1 to 5.3 of the Guidelines. In exceptional cases and/orservices which are estimated to cost less than US$25,000 equivalent per contract, may, with IDA's prioragreement, be procured by a Single-source (SS) selection would be used in accordance with theprovisions of paragraphs 3.8-3.11 and 5.4. Concerning specifically the recruitment of consultant underthe matching grant facility, the beneficiaries may procure services in accordance with commercialpractices acceptable to the World Bank and defined in more details in the PIM.

The Bank standard request for proposals will be used and forms of contracts as needed (lump-sum,time-based and/or simplified contracts for short-term assignments and individual consultants) as well asthe sample form of evaluation report for the selection of consultants.

Procurement of Goods

As noted above, the purchase of goods and services will be in accordance with IDA procurementguidelines. All contracts for goods estimated to cost over US$100,000 equivalent per contract shall besubject to International Competitive Bidding (ICB). To the extent possible, contracts for goods will begrouped in bid packages estimated to cost US$100,000 or more each. There is a preference fordomestically manufactured goods and domestic contracts; the provisions 2.54 and 2.55 of the Guidelinesand Appendix 2 will apply to goods manufactured in Cape Verde. Goods and works estimated to costless than $100,000 equivalent per contract, up to an aggregate amount not to exceed $5,000,000equivalent for goods and $300,000 equivalent for works, may be procured under contracts awarded inaccordance with the provisions of paragraphs 3.3 and 3.4 of the Guidelines. Goods estimated to cost lessthan US$50,000 equivalent per contract, up to an aggregate amount not to exceed US$3.5 millionequivalent may be procured under contracts awarded on the basis of intemational or national shoppingprocedures in accordance with the provisions of paragraphs 3.5 and 3.6 of the Guidelines. Goods,including vehicles and computers, estimated to cost less than US$50,000 equivalent per contract, may beprocured from the Inter-Agency Procurement Services Office (LAPSO), up to an aggregate amount not toexceed US$1.5 million equivalent, in accordance with the provisions of paragraph 3.9 of the Guidelines.

Civil Works

Works estimated to cost less than $100,000 equivalent per contract, up to an aggregate amount not toexceed US$ 300,000 equivalent, may be procured under National Competitive Bidding (NCB). Works

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estimated to cost less than $50,000 equivalent per contract, up to an aggregate amount not to exceedUS$1,000,000 equivalent, may be procured under lump-sum, fixed-price contracts awarded on the basisof quotations obtained from three (3) qualified domestic contractors in response to a written invitation.The invitation shall include a detailed description of the works, including basic specifications, therequired completion date, a basic form of agreement acceptable to the Association, and relevantdrawings, where applicable. The award shall be made to the contractor who offers the lowest pricequotation for the required work, and who has the experience and resources to complete the contractsuccessfully.

Operational Costs

Operating costs include incremental operating costs incurred on account of project implementation,management and supervision, including office supplies, communication costs, travel allowance of projectstaff, but excluding salaries of the Borrower's civil service.

Tlraining

Training will generally cover individual training attached to specific institutions, group training,on-the-job training of technical staff assisted by consultants and international experts, and hiringconsultants for developing training materials, conducting training and support for training activitiesthrough seminars, workshops and training abroad based on individual needs as well as grouprequirements. A detailed training program, giving categories of training, number of trainees, duration oftraining, staff months, timing and estimated costs, etc. will be submitted to IDA for review and approvalon a semi-annual basis.

Table A: Project Costs by Procurement Arrangements(US$ million equivalent)

Procurement Method-Expenditure Category ICB MCB -Other N.B.F.' Total Cost

1. Works 0.00 0.10 0.00 0.00 0.10(0.00) (0.09) (0.00) (0.00) (0.09)

2. Goods 0.92 0.70 0.62 0.31 2.55(0.75) (0.31) (0.46) (0.14) (1.66)

3. Services 0.00 0.00 7.55 0.00 7.55including training and workshops (0.00) (0.00) (7.35) (0.00) (7.35)4. Operating Costs 0.00 0.00 0.75 0.00 0.75

(0.00) (0.00) (0.65) (0.00) (0.65)5. Matching Grant 0.00 0.00 1.60 0.00 1.60

(0.00) (0.00) (0.80) (0.00) (0.80)Ref PPF & non-allocated 0.00 0.00 0.95 0.00 0.95

(0.00) (0.00) (0.95) (0.00) (0.95)Total 0.92 0.80 11.47 0.31 13.50

_ _________(0.75) (0.40) (10.21) (0.14) (11.50)

Figures in parentheses are the amounts to be financed by the IDA Credit. All costs include contingencies.21Includes civil works and goods to be procured through national shopping, consulting services, services of contracted

staff of the project management office, training, technical assistance services, and incremental operating costs relatedto (i) managing the project, and (ii) re-lending project funds to local government units.

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Prior review thresholds (Table B)Prior Review Thresholds

Goods. All contracts for goods and equipment estimated to cost US$100,000 equivalent or more wouldbe subject to IDA review of bidding documents, including draft contracts and technical specificationsprior to inviting bids and IDA review of the bid evaluation prior to the award of the contract prior tosignatuie and notification to the supplier.

Consultant Services. With respect to each contract for the employment of consulting firms estimated tocost the equivalent of US$ 1 00,000 or more, the procedures set forth in paragraphs 2, 3 and 5 of AppendixI to the Consultant Guidelines shall apply.

With respect to each contract for the employment of individual consultants to be selected on a solesource basis, or estimated to cost the equivalent of US$50,000 or more, the report on the comparison ofthe qualifications and experience of candidates, the qualifications, experience terms of reference andterms of employment of the consultants shall be furnished to the Association for its pnor review andapproval. The contract shall be awarded only after the said approval shall have been given. Theprovisions of paragraph 3 of Appendix 1 to the Consultant Guidelines shall also apply to such contracts.

With respect to each contract for the employment of: (i) consulting firms estimated to cost more thanUS$50,000 equivalent but less than US$100,000 equivalent; and (ii) individual consultants estimated tocost more than US$30,000 equivalent but less than US$50,000 equivalent, the terms of reference of theconsultants shall be fumished to the Association for its prior review and approval. The contract shall beawarded only after the said approval shall have been given.

Post Review Thresholds

Contracts that are not subject to prior review would be selectively reviewed by the Bank during projectimplementation and would be governed by the procedures set forth in paragraph 4 of Appendix I to theguidelines.

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Table B: Thresholds for Procurement Methods and Prior Review'

Contract Value Contracts Subject toThreshold Procurement Prior Review

Expenditure Category (US$ thousands) Method (US$ millions)1. Works >200,000 ICB 0

<100,000 NCB<50,000 Proc of small works

2. Goods >100,000 ICB 1,644<100,000 NCB<50,000 Nat. or int. Shopping

3. ServicesFirms >100,000 QCBS and other 3,905Individual Individual Consultants 1,625

Total value of contracts subject to prior review: US$7.17 millionOverall Procurement Risk Assessment: Average

Frequency of procurement supervision missions proposed: One every 6 months(includes special procurement supervisionfor post-review/audits)

Thresholds generally differ by country and project. Consult "Assessment of Agency's Capacity to ImplementProcurement" and contact the Regional Procurement Adviser for guidance.

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Annex 6(B): Financial Management and Disbursement ArrangementsCAPE VERDE: Growth and Competitiveness Project

Financial Management

1. Summary of the Financial Management Assessment

A financial management assessment was carried out in March 2003. The objective of the assessment wasto evaluate whether the PCU, which will be responsible for the implementation of the Project, has putinto place acceptable financial management arrangements as required by the Bank's policies, includingentities' system of accounting, reporting, auditing and internal controls. Overall, the PCU has satisfactoryfinancial management capacity. Financial management will be undertaken by the same PCU for thePRCBP. Staff have been trained and have a good track record for financial management. The chart ofaccounts is being updated in the current financial management system (FMS) to accomodate the newproject prior to effectiveness. An action plan to further strengthen its capacity for financial managementhad been agreed with the PCU. The plan includes updating the computenzed financial managementsystem which includes customizing the agreed format for the quarterly Financial Monitoring Reports(FMR), finalizing the PIM and selecting an auditor.

Staffing and Implementation arrangements. The PCU, since it is the same for the ongoing PRCBPwill benefit from its experience in managing IDA funds. This PCU comprises a project coordinator, anaccountant, a procurement specialist, technical specialists, a program officer and an administrativeassistant. The PCU will be responsible for providing especially the necessary guidance for allprocurement and financial management aspects of the project. By using an existing PCU, which isfamiliar with IDA procedures, the Government will benefit from existing experience and create economyof scale. A computerized financial management system was installed for PRCBP in 1998 and will beused for the current project to generate the FMR. The accountant of the project will assume all theaccounting and financial duties of the project. She has satisfactory qualifications and professionalexperience and has been trained in World Bank procurement, disbursement and financial managementprocedures.

Accounting Policies and Procedures. The PCU has been applying satisfactory procedures underPRCBP and the SAC. A manual of administrative, accounting and financial procedures was developedfor the PRCBP in November 1998 and a new manual will be prepared to include administrative,accounting and financial procedures for this project. It will also include procedures foi implementingaccounting policies, definition of respective duties with a good segregation, budgeting system and allrelevant administrative and financial procedures, as well as relationships between the components of theproject. All the institutions or Government department and private institutions which will implement theproject components must trained in those new procedures.

Reporting and Monitoring. The PCU will prepare quarterly FMRs. The format of the FMRs wasdiscussed and is included as part of the action plan. The quarterly reports will cover financialmanagement, procurement and physical progress monitoring, covering all activities financed under theproject regardless the source of funding. No major problem is expected with the financial andprocurement reports Areas of concern are with the physical progress monitoring report, where the PIMlacks experience and which would requires additional efforts. Those physical progress reports will bebased on the outcomes indicators.

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2. Audit Arrangements

The accounting and administrative procedures for the annual audits will be handled by the current PCU.Although the PCU will be in charge of the financial arrangements for this project and PRCBP, the auditfunction for the current project will be procured under a competitive process prior to effectiveness.Project accounts, special accounts and disbursements under SOE's will be audited annually according tointernational auditing standards by an independent auditor acceptable to IDA. The annual report will besubmitted to IDA within six months of the end of each fiscal year. An independent auditor must berecruited by the project before effectiveness. The terms of reference and the short list will be submittedto IDA for review.

3. Disbursement Arrangements

The project will disburse using traditional disbursement mechanisms which are transaction-baseddisbursements (as opposed to report-based disbursements). The overall project FMS will include projectmanagement reporting capabilities from the start of the project's implementation. As the financial teamis the same as that of PRCBP, the same procedures, which have been successful, will also be utilized.

Disbursements will be made for goods and services that are eligible for IDA financing. Allreplenishment or reimbursement applications will be submitted monthly or when the Special Account isreduced by one-third, whichever comes first. All replenishment or reimbursement applications will befully documented except for contracts under the prior review threshold to be determined as a result of theprocurement assessment. SOE documentation will be retained at the PCU for review by Bank staff andannual audits.

Disbursement will be made for eligible services contracted under the matching grant facility. Allreplenishment or reimbursement applications will be submited for the full amount of the expenditure.IDA will reimburse 50 percent of the total costs. The Chambers of Commerce would administer theprogram based on eligibility criteria agreed to between the Borrower and the Chambers and incorporatedinto the PIM and the DCA. On a regular basis, the Chamber would send a list of eligible grant recipientsto the PCU against which the PCU would advance the funds to the Chambers to pay to the suppliers.When the PCU submits a replenishment application of the Special Account to IDA, a copy of the listwould accompany the request.

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Allocation of credit proceeds (Table C)

Table C: Allocation of Credit Proceeds

'Expenditure Category Amount,in US$million -, -': Finarncing,Percentage

Goods, including vehicles 1.66 100% of foreignexpenditures and 90% of

local expendituresConsultant Services including audits 6.03 100% of foreign

expenditures and 90% oflocal expenditures

Matching Grants for sub-projects and 0.80 50% of all eligible expendituresinstitutional support for Chamber ofCommerceTraining and Workshops 1.32 100%Operating Costs 0.65 90%Minor Civil Works 0.09 90%Reimbursement of PPF 0.60

Non-allocated 0.35

Total Project Costs 11.50

Total 11.50

Use of statements of expenditures (SOEs):

Goods: expenditures under contracts of less than US$100,000 equivalent;Individual consultants: contracts of less than US$ 50,000 equivalent;Consulting Firms: contracts less than $100,000 equivalent; andTraining, workshops, matching grants and operating expenses less than $50,000 equivalent (consultantsthat provide training would be paid out of consultant category)

Special account:A special account will be opened at the BCV for IDA's share of eligibile expenditures.

To facilitate timely project implementation, the Borrower will establish, maintain and operate, underconditions acceptable to the Bank, a special account in the Banco de Cabo Verde (BCV). The totalauthorized allocation of the special account will be US$800,000, which will be made upon effectiveness.Replenishment applications should be submitted at least once per month and must include reconciledbank statements, as well as other appropriate supporting documents. In order to make a direct paymentto the supplier, the minimum application amount must be greater than or equivalent to 20 percent ofaccount deposit. Disbursement categories and the percentage financed are shown in Table C above.

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Project account

Prior to credit effectiveness, the Government will be required to make the initial deposit of thecounterpart funds equivalent to US$30,000 to the Project account. Government will also maintain thevalue of the project account throughout its implementation, by replenishing it when it has reached a levelof 25 percent its requirement, or in this case US$6,500.

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Annex 7: Project Processing Schedule


Project' Scheduie ; -Pl'ann"d ,Actual

Time taken to prepare the project (months)

First Bank mission (identification) 09/10/2001 09/10/2001

Appraisal mission departure 01/07/2003 02/15/2003

Negotiations 03/27/2003 04/04/2003

Planned Date of Effectiveness 09/15/2003

Prepared by:

Ministry of Finance, Planning and Regional DevelopmentMinistry of JusticeCentral Bank of Cape VerdeSISP (of which commercial banks are members)Chamber of Commerce of SotaventoChamber of Commerce of BarlaventoProject Coordination Unit

Preparation assistance:PPF No. Q348-0-CV, totalling US$600,000

Bank staff who worked on the project included:Name Speciality

Sherri Archondo Sr. Operations Officer, AFTFSIradj Alikhani Sr. Economist, AFTPSShenhua Wang Sr. Private Sector Development Specialist, AFTPSRobert Palacios Sr. Economist, HDNSPXavier Forneris Sr. Investment Policy Officer, PSAFIIsabella Micali-Drossos Sr. Counsel, LEGAFBeat Heggli Sr. Investmnent Promotion Officer, MIGIMSiaka Bakayoko Sr. Financial Management Specialist., AFTFMFily Sissoko Financial Management Specialist, AFTFMBourama Diaite Sr. Procurement Specialist, AFTPCAmadou Dem Economist, AFTPSCharles Schlumberger Sr. Financial Sector Specialist, AFTFSHermina Martinez Consultant (Quality Assurance), AFTPSMark Dorfman Sr. Economist (Peer Reviewer), PRMHPMarie-Adele Tchakounte Assistant (Costab), AFTU2Sidonie Jocktane Program Assistant, AFTPS

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Annex 8: Documents in the Project File*


A. Project Implementation Plan

Detailed Cost TablesDraft Project Implementation Manual

B. Bank Staff Assessments

Aide Memoires from identification, pre-appraisal and appraisalFIAS: Study of Administrative Barriers - 2002Tax Assessment StudyINPS Diagnostic Study (summary is included as Annex 12)

C. Other

Government Draft Private Sector Policy StatementFinancial Management AssessmentProcurement AssessmentRegulatory and Administrative Costs Survey (MoFP)Banco de Cabo Verde, Strategy 2000-2004Chamber of Commerce (Sotavento) Strategy 2003-2005State of Justice in Cape Verde*Including electronic files

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Annex 9: Statement of Loans and Credits

CAPE VERDE: Growth and Competitiveness Project26-Mar-2003

Difference between expectedand actual

Onginal Amount In US$ Millions disbursements

Project ID FY Purpose IBRD IDA GEF Cancel Undisb Ong Frm Rev'd

P075700 2003 Structural Adjuestment Supplement 0 00 4 00 0 00 0 c0 0 00 0 00 0 00

P074249 2002 HfV/AIDS 0 00 9 00 0 00 0 00 9 21 1 06 0 s0

P075700 2002 Structural Adjustment Credit 0 00 15 00 0 00 0 00 0 00 -4 51 0 00

P040990 1999 CV ENERGYhSATER PROJECT 0 00 17 50 5 50 00 10 06 10 36 0 00

P000432 1999 SOCIAL SECTOR DEVELOPMENT 000 1610 000 000 403 311 000

P055467 1999 PRIVATIZATION TA 0 00 9 00 0 00 0 00 1 75 1 22 0 93

P055468 1999 EDUC & TRAINING CONSOLID. & MODERNIS 0 00 6 03 0.00 0 00 1 59 1 42 0 00

P000435 1993 TRANSPORT INFRASTRUCTURE 0 00 5 00 0 00 0 00 3 64 -1 49 1 21

Total 000 8163 550 000 3048 1117 264

CAPE VERDESTATEMENT OF IFC's

Held and Disbursed PortfolioJun 30 - 2002

In Millions US Dollars

Committed DisbursedIFC IFC

FY Approval Company Loan Equity Quasi Partic Loan Equity Quast Paric

1992 AEF Growela 0.15 0 00 0 00 0.00 0.15 0 00 0.00 0 002001 SEF Moura 0.55 0.00 0.00 0.00 0.00 0.00 0.00 0 00

Total Portfolio: 0.70 0.00 0.00 0.00 0.15 0.00 0 00 0.00

Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Partic

Total Pending Commitment: 0.00 0.00 0.00 0.00

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Annex 10: Country at a GOanceCAPE VERDE: Growth and Competitiveness Project

Sub- Lower-POVERTY and SOCIAL Cape Saharan middla-

Verde Africa Income Dovolopment dlamond'2001Populatfon, mid-year (millons) 0.45 674 2,164 Life expectancyGNI per capita (Atas method, USS) 1,310 470 1,240GNI (Atas method, US$ billions) 060 317 2,677

Average annual growth, 1995-01

Population (%) 2 9 2 5 10 G GLabor force (%) 3 9 2 6 1.2 GNI Gross

per pnmaryMost recent estimate (latest year available, 199541) capita enrollment

Poverty (% of population below national poverty line)Urban population (% of totalpopulabon) 63 32 46Life expectancy at birth (years) 69 47 69Infant mortality (per 1,000 live births) 37 91 33Child malnutntlon (% of children under 5) , 11 Access to Improved water sourceAccess to an improved water source (% of population) 74 55 80Illiteracy (% ofpopulatbon age 15+) 25 37 15Gross primary enrollment (%of school-age population) 144 78 107 CapeVerde

Male 146 85 107 Lower-middle-Income groupFemale 143 72 107

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1981 1991 2000 2001Economic rntlos-

GDP (USS billions) 0 35 0.56 0.59Gross domestic investmentUGOP . 26 2 19 3 17.8Exports of goods and serviceslGDP 11 0 23 4 25.6 TradeGross domestic savings/GDP . -4 2 -19.0 -13.5Gross nabonal savingslGDP . 21 4 28 8.3

Current account balancelGDP -4 8 -16.5 -11.3 Domestc IvteInterest paymentslGDP . 0.8 0.6 0 6 saviInvesmentTotal debtGDP 38.4 52 5 511 sTotal debt servicelexports 8 9 16 3 14 7Present value of debWGDP ,, 31 5 30 7Present value of debt/exports 84 6 73 3

Indebtedness1981-91 199141 2000 2001 200145

(average annual growth)GDP 83 68 3.0 40 Capa VerdeGDP per capita 3 4 3 6 01 1 5 Lower-middle-ncome groupExports of goods and services 14.8 29 2 13 7 3.0

STRUCTURE of the ECONOMY1981 1991 2000 2001 Growth of Investment and GDP (%)

(% of GDP) 20Agriculture 134 118 110Industry 214 17.6 16 8 o

Manufactunng 96 91 81 -20 " i 05 0 01

Services 851 70.6 72 2 *40

Pnvate consumption 88 5 93 7 100.6General govemment consumption 15 7 25 3 12 9 GDI -GDPImports of goods and services 41 5 61.7 571

(1981-91 199141 2000 2001 Growth of oxports and Importo (%)(average annual growth)Agriculture 6.6 3 6 15 40Industry 53 12 2 4 5

Manufactunng . 56 45 47 20Services . 6 5 5 9 2 8

aPnvate consumpbon 1 5 1 9 10 6 s. oi9General govemment consumption 61 39 3 -47.6 -20Gross domestc investment -2 3 -1 4 -5.0 Exports =ImportsImports of goods and services 8 3 14 0 -4.6

Note 2001 data are preliminary eslimates.The diamonds show tour key indicators in the country (in bold) oompared with its Income-group average. If dale are missing, the diamond will be lncomplete

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Cape Verde

PRICES and GOVERNMENT FINANCE1981 1991 2000 2001 Infaton

Domestic prices(% change)Consumer pnces 2.5 -2.4 5 0Implicit GPP deflator 14 8 4 3 0 3 4.3

Government flnance o(% of GDP, includes current grants) go 07 98 99 01Current revenue 22 7 20 5 19 9Current budget balance 4 9 -13 5 -11 - GDP deflator '-O-CPI

Overall surplus/deficit -4 3 -24 6 -8 6

TRADE1981 1991 2000 2001

(USS millions) Export end Import levelr (USS mii.)Total exports (fob) 4 24 31 300

Bananas 2 2 2Fish 0 1 j 2WManufactures 1 0 0

Total imports (cif) 147 238 236Food 41 55 58 10 *Fuel and energy 8 20 26Capital goods 65 106 106 a

flu to 9 98 es to 01Export pnce Index (1995=100) 85 126 131Import price index (1995=100) 74 136 135 UExporls a impOrtsTerms of trade (1995=100) 114 92 97

BALANCE of PAYMENTSS s19 1991 2000 2001 Current account balance to GDP (%)

(US$ millions)

Exports of goods and services 24 39 131 152 oImports of goods and services 103 146 344 336Resource balance -79 -107 -214 -184 -s

Net Income 1 0 -12 -14Net current transfers 35 89 133 132 .10

Current account balance -43 -17 -92 -6 6 5

Financing Items (net) 38 7 71 71Changes In net reserves 5 10 21 -5 -20

Memo:Reserves Including gold (USS millions) 38 65 93 106Conversion rate (DEC, locallUSS) 48 7 714 115.9 118 2

EXTERNAL DEBT and RESOURCE FLOWS1981 1991 2000 2001

(USS millions) Composition of 2001 debt (USS mill)Total debt outstanding and disbursed 39 135 293 301

IBRD 0 0 0 0IDA 0 17 89 98

Total debtservice 0 9 34 36 B asIBRD 0 0 0 0IDA 0 0 1 1

Composilon of net resource flowsOfficial grants 34 69 82Official creditors 21 0 23 10Private creditors 0 0 0 0Foreign direct investment 0 1 31 23Portfolio equity 0 0 D 125

World Bank programCommitments 0 0 3 20 A - IBRD E -Bilateral

Disbursements 0 3 10 8 a - IDA 0 -Other mulUlateral F -PrivatePrincipal repayments 0 0 0 0 C -IMF G -Short-tarmNet llows 0 3 10 8Interest payments 0 0 1 1Net transfers 0 3 9 7

ueveiopment Economics YIZJIU

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Additional Annex 11Post Privatization and Divestiture Reform


During the past decade, Cape Verde's economy has gone though a remarkable change during whichprivate ownership and participation became dominant is all sectors of the economy, includinginfrastructure and utilities. At present, the port and the national airline, TACV, remain the mainactivities whose privatization has been initiated, but will only be completed during 2003/2004.Otherwise, the airports are the only publicly-owned infrastructure without private participation.

Some of the expected benefits of private participation have already accrued. Nevertheless, Table Ibelow, which compares some selected indicators of Cape Verde with a regional benchmark (Egypt) andother regions with similar levels of economic income, show there is still room for improvement in termsof access.

Table 1: Selected Indicators of Infrastructure and Development

Indicators 2000 Cape EGYPT LStL America MSIDDLE EAST EAST ASIA &(1999 DATA In parentheses) Verde & caribboan & NORTh PACIFIC

______ ____ _____ AFRICA

Gross National Income per capita (USS) 1,330 1,490 3,640 1,427 1,060

Access to water (% total pop ) 74 0 95.0 84.9 89.5 74.8Access to sanitation (% total pop.) 95 0 98.0 87.0 93.3 73.9Freshwater resources/capita (m3) 680.3 1,070.7 32,904.5 1,427.4 NA

Energy use per capita (KwH) NA (899.7) (1,470.1) (1,288.8) (814 5)

Teledensity (main + mobile)/1,000 people 171.6 107.7 270.6 121.9 170.6Aver. Cost of local call (US$/3 mm) 0.0 0.0 0.1 0.0 0.0Personal computers/1,000 people NA 22.1 43.6 31.2 21.7Intemet users (in 1,000's of people) 8 450 19,100 1,900 51,900

Paved Roads (% of total) 78.0 78 1 (29.4) (66.4) (23.8)Aircraft departures (in thousands) 13.0 47.4 1,951 440 1,437

Sources World Development Indicators (2002), ITU, ICAO

The above benchmarking shows that results achieved so far in term of access vary largely from sector tosector. While standards in term of telecommunication are high, both access to water and electricity arerelatively low due in part to factors specific to Cape Verde such as the lack of underground waterresources and the highly fragmented generation system split between 15 cities. Despite these constraints,other factors have also contributed to that situation, especially:

o The poor performances of infrastructure firms due in part to noneconomic pricing andcross-subsidies;

o A lack of service definition and standards in the case of monopolies;o High costs, due in part to inefficiency and lack of competition; ando Uncertain regulation framework that is not yet fully operational.

With hindsight, the record so far indicates two inter-related shortcomings in the reform process. First,insufficient attention was paid to building in the possibility of competition in the context of sector reformand divestiture. Second, an effective regulatory mechanism that would, amongst others, regulate pricesof private monopolies, is yet to be establish. From this standpoint, Cape Verde's reform experience

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differs from international best practice (such as Chile) where regulatory capacity led or was put in placein parallel with the opening of the infrastructure to private competition. Such a situation had not beenanticipated in 1997, the time when the private participation program in Cape Verde infrastructure wasconceived. Indeed, the Government strategy called for divestiture actions to be accompanied by theestablishment of a multi-sector regulatory agency (ARM), and related capacity building to ensure that itwould quickly become operational. Due to a series of setbacks, ARM never became operational. One ofthe reasons was that there was no national consensus and understanding of the importance and the role ofregulation in the privatized economy. The broad scope envisaged for ARM (multi-sector andmultipurpose, covering economic, technical and environmental regulation) also contributed to theseproblems.

Faced with urgent regulatory issues in telecoms, water and energy (electricity and petroleum) issues,following a National Seminar facilitated by international experts and regulators, the Governmentdecided, in November 2002, to abolish ARM and create a new agency responsible for economicregulation key infrastructure sectors. The importance of technical and environmental regulation was alsorecognized in the new approach. However, it was decided that these would, for the moment, beaddressed through collaboration between line ministries, the regulators and other agencies. In parallel,the Ministry of Transport decided to stimulate added competition in key sector, notably telecoms, with aview to take further reform measures to reduce cost and improve economic competitiveness.

Regulatory reform and capacity building was strongly supported by IDA through the PRCBP. It hadbeen anticipated that this project would provide the necessary support for the operations of a fullyfunctional regulatory agency and help Government resolve the main outstanding sector issues. In view ofthe closing date of December 31, 2003, these objectives will only be partially reached.

To sustain important actions initiated in the context of PRCBP the proposed project will thus include asubcomponent of about US$1.3 million, aimed at addressing the main outstanding divestiture actions andthus improve Cape Verde's competitiveness in the infrastructure sector. The intended outputs andoutcomes of the subcomponent would include: (a) a fully operational multi-sector regulatory agency,capable of handling routine issues internally and more complex ones with limited expert support; (b)completion of the private participation agenda, including the port and, possibly, the airport; (c) a morecompetitive telecommunication sector, with at least one more operator present and number internet usersper 1000 people similar to relevant comparators; and (d) well-functioning inter-island and urban transportsystems that do not require significant subsidies from the state.

More specifically the project will finance mainly consultants and training to help implement thefollowing activities:

* Completion of telecoms reform - This would encompass: (i) the renegotiation of the existingcontract to remove internal inconsistencies, clarify the liberalization of value-added service, revisedpricing policy, including access fees, and liberalization of the sector in line with WTO commitmentconcerning local and international markets; and (ii) award of a new cellular license.

* Support to multi-sector regulatory agency - The support will be mainly in the form of structuredand on-the-job training, study tours and exchange programs, and advisory service for post trainingaftercare. The latter would involve availing experts to the regulators to help them resolve specificregulatory cases brought to the regulator.

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o Port and Airport reform and divestiture - The project will provide resources to complete theprivatization of the port and study the scope for private participation in airports.

o Other transport reform - The project would finances international and local advisor to help theMinistry of Transport address outstanding policy issues mentioned earlier.

The design of this subcomponent integrates lessons learnt in Cape Verde and internationally. First andforemost, the actions supported by the project, especially on the regulation side, have been derived by agood understanding of the reasons underlying them and a consensus amongst stakeholders concerningtheir importance. It was the lack of such a consensus that derailed the efforts under PRCBP. Second,international experience (for instance, see Sri Lanka, Cr. 2837, ICR, report number 22398, dated June 22,2001) clearly shows that building a long-term sustainable regulatory and institutional capacity in newlycreated entities takes time. The project would thus help avoid the risk of the multi-sector regulatoryagency failing because it does not have sufficient capacity. Third, much has been learnt during the past 5years on how to design telecom reforms, especially the need to take into account the rapid technologicaladvancement that is taking place and to ensure a transparent bidding procedures to attract new operators.Project implementation will benefit from these lessons. Finally, stakeholders believe that the mosteffective advisory services are those that match international experience with solid in-countryknowledge, and both types of expertise will be financed by the credit.

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Additional Annex 12: INPS: diagnosis and reformsCAPE VERDE: Growth and Competitiveness Project

Overview

1. Pensions represent an important element of the social safety net put in place by the Government.They also represent an important potential source for longer-term resources that could fuel investments.Government is concerned about the sustainability and fiscal effect of the present system and the impactof pension liabilities on the budget. There are two main pension schemes for formal sector workers. TheAdminstracao Publica (AP) covers approximately 13,000 civil servants while the Instituto Nacional dePrevidencia Social (INPS) had an estimated 31,000 contributors in 2001. Together the schemes cover onequarter of the formal labor force and pay pensions to about 6,000 people. The Pensao Social Minima(PSM) is available to the poor and elderly in general. The PSM is paid to about 6,500 individuals. Inaddition, there are about 10,000 workers participating in the FAIMO program.

2. Membership of the INPS is mandatory for workers in the private sector. Taking account also ofthe special scheme for civil servants, roughly one in five of the labor force is a member of a formalpension scheme. The INPS pension scheme only began operation in 1983. INPS's demographics, likethe scheme itself, are young. With a small ratio of pensioners to contributors, the scheme has runsurpluses and has accumulated substantial assets. These surpluses will continue for a number of yearseven if the INPS is untouched. However, the benefit level in the current system is unsustainably high.

Five primary issues face the pension system in Cape Verde which are summarized below.

(a) Civil service pension liabilities. In general, civil servants receive pensions after reaching age 60,although teachers, police and the military can retire at lower ages. After 34 years of employment, anew retiree would receive 100 percent of his pre-retirement salary. The target benefit is high both byinternational standards and relative to the INPS, and has resulted in a large and increasing burden onthe budget. Since only a fraction of annual spending is covered by the eight percent contributionlevied on civil service salaries, and no assets have been set aside to meet this obligation, futurepension spending represents a significant and unreported liability of the Government.

(b) Government arrears to the INPS. Currently, the INPS claims that Government owed it 2.6 billionescudos (approximately US$25 million) including interest and penalties which it has subsequentlycovered with treasury securities. There are three sources of arrears. First, when early retirement wasused during the privatization process to shed excess labor, the Government promised to transferfunds to cover the incremental liability of the INPS but had not done so. Second, contributions forapproximately 1,000 employees at institutes and decentralized entities have not been made to theINPS. The situation is made worse by the fact that the Government apparently deducts the eightpercent contribution from the employee before making the budget transfer to these entities. Finally,for civil servants who move to the private sector, the law requires that they be credited with theyears they participated in the AP and that the Government make a transfer to cover this liability, atransfer which has not been made in most cases. Continuing this practice has several negativeeffects. First, it makes it increasingly difficult to implement a policy shifting younger civil servantsinto the INPS, a policy that would have positive fiscal and labor market impacts. Second, it increasesthe unfunded liability at the INPS and weakens its long run sustainability. The arrears problem needsto be resolved in short order so as not to impede progress in other areas of pension reform.

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(c) INPS investment policy and partial funding. The INPS was designed as a partially funded,defined benefit scheme. While it continues to run surpluses in its pension scheme, previousgovernments have effectively forced the INPS to purchase government bonds in order to financecentral budget deficits. As a result, the INPS portfolio is heavily weighted towards non-tradablegovernment bonds. This has a direct effect on the long-term finances of the scheme since it reducesrisk-adjusted returns relative to a diversified portfolio. Moreover, it suggests that Governmentspending has been greater than it would have been if this source of financing had not been available.

(d) Governance. The use of pension reserves as way to finance deficits is one example of theconflict of interest that governments face when they run public pension funds. In order to avoidconflict of interest problems in Cape Verde, reforms to the current governance structure will beconsidered and a number of measures designed to remove political discretion implemented.

(e) Financial deterioration in other programs administered by the INPS. In addition to pensions, theINPS administers programs for sickness and maternity, family allowances and other benefits.Currently, the INPS faces financial problems related to a rapid increase in health related spending,especially pharmaceuticals where fraud is known to be a serious problem. This indirectly affectspension system finances because pension reserves may be used to cover health system deficits in thefuture. Also, given that pensioners are major consumers of health services, as their number growsdramatically in the coming years, so too will health expenditures.

3. Reforms are needed rapidly to ensure any pension promises that are made can be kept, to avoidthe need for a call on the Government budget to meet future benefits, and to deliver a fair allocation ofresources between different generations. Delaying reform until the short-term financial position requiresit would disproportionately benefit older generations at the expense of younger ones. If the Govermnentwere to pay for unfunded liabilities, this would be costly for all Cape Verdeans, not just the members ofINPS.

Benefits

4. The INPS benefit formula is: pension = eamings base x (20% + 0.015% x years of coverage).The earnings measure used in the formula is the best three years' salary during the final five years ofparticipation in the scheme. Only three years of membership are required to receive a pension. The'replacement rate' relative to the scheme's earnings measure is 86 percent. The replacement rate relativeto average real earnings is higher than the replacement rate relative to the eamings measure used in theINPS formula (142 compared with 86 percent). This is because real earnings are assumed to riseconstantly across the career, so final earnings are above lifetime average pay. In contrast, measured inearmngs terms, the replacement rate is lower than the formula rate (77 compared with 86 percent). Thisis because the best three of final five years earnings are not adjusted for growth in eamings or inflation.Eamings as measured by the formula are lower than the lifetime revalued average. Replacement rates inCape Verde are very high by intemational standards.

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Women

5. The INPS is more generous to women than it is to men because they can retire at 60 rather than65. Women also tend to live longer than men do. Both of these factors increase the average length ofretirement for women relative to men. However, earlier retirement means that women accrue feweryears' pension rights. This means that their replacement rate at the point of retirement after a full careeris 78.5 percent compared with 86 percent for men. This translates into replacement rates of 137.5percent relative to average real earnings and 68.5 percent relative to average revalued earnings.

Earnings measure

6. There are two main reasons commonly cited for adopting short averaging periods for earnings inthe formula of defined-benefit pension plans: first, they are a simple way to correct the effects of highand volatile inflation; and secondly, they are administratively simpler than tracking work andcontribution records right across the working life. However, they can lead to high costs, strategicmanipulation of earnings profiles and disproportionately higher benefits going to higher-income workers,because they tend to have more steeply rising age-earnings profiles.

7. In the baseline case, the individual's earnings grow in line with the economy-wide average. Twoalternative paths for individual earnings have been considered: a steeper one and a shallower one.Individual earnings grow one percentage point faster and slower than the economy-wide in thesealternative scenarios. In the case of steeper earnings growth, earnings measured by the INPS final salaryformula are higher than the measures looking at lifetime average pay. Thus, the replacement rate relativeto average real earnings increases from 142 to 165 percent and that relative to average revalued earningsincreases from 77 to 94 percent. In contrast, the individual with a shallow age-earnings profile loses out.The real replacement rate falls from 142 to 120 percent while the revalued replacement rate falls from 77to 63 percent. These results show the arbitrary way in which pension benefit formulae, based on alimited number of final or best years, redistribute systematically between different groups of individuals.The redistribution from workers with shallow age-earnings profiles to those without is why manycountries have moved to extend the averaging period in their defined-benefit pension formula.

Accrual structure

8. The INPS accrual rate (the pension earned for an additional year's contributions) varies with thenumber of years' contributions. The structure of pension benefits relative to years of participation in theINPS is called 'non-linear'. The first three years' contributions yield a benefit of 8.17 percent ofearnings while for subsequent years', the reward is 1.5 percent of pay. As noted previously, three yearsof coverage gives a pension of 20 + 4 x 0.015 = 24.5 percent. This is equivalent to 23 percent of averagereal earnings and 22 percent of average revalued earnings. The replacement rates are also shown forworkers with 10 and 20 years' contributions.

9. This accrual structure is exceptionally generous to workers with short contribution periods byinternational standards. The majority of public and mandatory pension systems around the world have a'linear' accrual structure: each year of participation - from the first to the last - earns the samepercentage of pay in pension. All OECD countries (except Austria and Spain) and most low-incomecountries fall into this category.

10. The INPS is clearly exceptional in two ways. First, the scale of the accrual rate in this range iswell beyond that found in any other countries' pension system. The maximum accrual rate in other

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countries at any point is four percent a year, while in Cape Verde it exceeds eight percent for the firstthree years. Secondly, the vesting period of three years is very short. The next shortest vesting period iseight years, and this is adopted in just three countries. The average period is nearly 18 years.

A ceiling

11. The next notable feature of the INPS is the absence of a ceiling to the earnings eligible forcontributions and benefits. Only four of the 15 countries have no ceiling. But these countries haveradically different pension systems to Cape Verde. In Finland and the Netherlands, these benefits comefrom occupational pension schemes (that are statutory in Finland and have near universal coverage in theNetherlands through industrial-relations agreements). In Australia, the public pension is means-tested,but there is no ceiling to mandatory contributions to a private, defined-contribution pension plan. Theaverage ceiling for public pension programs is double economy-wide average earnings.

12. The question of whether to have a pension ceiling or not, and if so, how large it should be,depends on the relative weight of two views of Government's role in retirement income provision:

o if the Government's objective is to ensure that all workers have a reasonable pension relative totheir pre-retirement living standards, then there should be an earnings-related pension scheme withno ceiling at all; buto if the Government's aim is to ensure all pensioners meet a basic standard of living, then thereshould be a flat-rate or means-tested pension and workers above with earnings above this minimumlevel should then voluntarily provide for retirement incomes.

13. Few governments have based their pension system purely on the latter objective. (The onlyexamples that come to mind are Botswana, Namibia, New Zealand and South Africa.) There are morethat have adopted the former: what can be termed a 'comprehensive social-insurance' system,particularly in continental Europe. But most countries lie on a spectrum in between. Canada and theUnited Kingdom, for example, have public pension schemes that are heavily weighted towards universalflat-rate and means-tested benefits. Their earnings-related schemes have relatively low ceilings. Thismeans that replacement rates for higher-income workers are relatively low. Nevertheless, the outcomesfor retirement incomes look little different from other OECD countries. This is because the provision oflow public pensions for middle- and high-income workers leaves space for private, voluntary provision todevelop. Both of these countries have occupational and personal pension plans with broad coverage.(See Disney and Whitehouse, 2002 and OECD, 2001 on this issue of substitution of public and privatepension provision.)

14. The argument for a ceiling is therefore that low- and middle-income earners are guaranteed acertain replacement rate. High-income workers are left to their own devices. The Government hasensured that they meet a generous retirement standard of living already. Secondly, this leaves space forthe growth of private pension savings among higher-income workers, with benefits for the developmentof financial-services industries and capital markets. A ceiling of 150 to 200 percent of economy-wideaverage earnings, upgraded annually in line with earnings, is probably appropriate.

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Indexation

15. Pensions in payment have been adjusted periodically, as shown in the table below. There is noautomatic procedure for indexation. Over the period 1984-1997, indexation overall has beenapproximately half of prices.

Periodic adjustments to pensions in progress, 1984-97

Year Monthly pension amounts Increase (%)1984 under 4000$00 35.0

from 4000$00 to 8000$00 28.0above 8000$00 25.0

1986 all 17.51988 all 16.21994 below 10000$00 15.0

from 100001$00 a 20000$00 12.5200001$00 to 40000$00 10.0above 40000$00 8.0

1995 All pensions in payment 5.01997 All pensions in payment 5.0

Source Sociedade Nacional de Empreendimentos e Desenvolvimento Economico (1999)

16. Most countries have now adopted some sort of automatic indexation procedure in their pensionsystems. In OECD countries, these changes were made in the 1960s and 1970s in response to the rise ofinflation against a period when prices had remained relatively stable. Today, most index pensions inpayment to prices. Protecting the real living standards of pensioners is important. Pensions can be paidfor periods of 20 years or more. Even relatively low inflation over such a period erodes much of the realpurchasing power of the pension. It is estimated that the increases in Cape Verde in the table come toaround one half the rate of price inflation over the period.

Sustainability

17. Simple measures of replacement rates provides little indication of the viability of the currentINPS in the long-term. Two measures are shown. The first is the rate of return on contributions. Thiscompares the flow of pension contributions made to INPS with the flow of benefits received. It iscalculated as follows. First, the flow of pension benefits is turned into a 'stock' figure: the net presentvalue of future benefits at the time of retirement. This uses standard actuarial techniques. Using theCape Verde mortality data, an 'annuity factor' is calculated as the sum over time of the probability thatan individual will survive to that age, discounted by a fixed rate, multiplied by the pension value at thatpoint. This calculation therefore allows for the effect of post-retirement indexation procedures onpension values. The rate of return on contributions is then calculated such that the sum of contributionsand the (notional) returns equal this stock of pension wealth at retirement.

18. The second measure is the equilibrium contribution rate. This shows, in steady state, thecontribution rate that would be necessary to finance INPS benefits. In the baseline case, the rate of returnon contributions for a full-career worker is 4.7 percent for men and 6.6 percent for women (the differencereflecting women's earlier retirement and longer life expectancy).

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19. What, then, is a viable rate of return? The sustainable rate of return on contributions in apay-as-you-go system is the rate of growth in the contribution base. This is simply the growth of thenumber of contributors plus the growth of earnings over time. This is the central result of the economicanalysis of pensions. If the rate of return paid to contributors were any higher, then benefit expenditurewould increase more quickly than contribution revenues. Thus, the contribution rate would have to riseor there would be permanent deficits requiring external financing (typically from the general governmentbudget). In the case of Cape Verde, continued expansion of the labor force is anticipated and realearnings growth, giving a sustainable rate of return of 4-5 percent over the coming decades. In the longterm, however, the rate of labor force growth is likely to slow. Thus, in steady state, it is shown that thecontribution needed to finance INPS benefits is 15 percent for men and nearly 22 percent for womencompared with the ten percent of the lNPS contribution presently ear-marked for pensions. Note that theINPS administers a number of social programs. The total contribution is 8 percent of earnings foremployees and 15 percent for employers. Of this total, 10 percent is ear-marked for the pension system,divided 3/7 percent between employees and employers respectively.

20. This full-career case is extremely unrealistic. First, the scheme has only been in existence for theshort time (in pension-system terms) of 20 years. So the average length of membership of recent retireesis less than 15 years. Secondly, even in steady state, it is expected that people to spend less than fullcareers in formal sector, INPS-covered employment. Although replacement rates are lower for shortercontribution periods, the effect is a less than proportional reduction because of the non-linearities on theaccrual structure. Thus, a worker with 20 years' contributions effectively earns a return of nearly ninepercent of those contributions compared with less than five percent for a full career of contributions. Atten years, the rate of return exceeds 20 percent a year. For a worker with the minimum three years'coverage, the rate of return is a whopping 134 percent. For this worker, the contribution rate that wouldfinance this benefit would be over 60 percent. Even for longer contribution histories of 10 to 20 years,the equilibrium contribution rate is around double the current rate. For women, the rates of return andequilibrium contribution rates would be higher still.

21. It is important to note that current indexation practices have been incorporated in thesesimulations. An automatic procedure is recommended to up rate pensions in payment in line withchanges in prices. This increases the cost of providing pensions by 17 percent. Thus, the rate of returnon contributions is 5.3 percent with a price-indexed benefits compared with 4.7 percent for theunder-indexed pension. For women, price updating pensions in payment increases the rate of return from6.6 on current practice to 7.5 percent. The equilibrium contribution rate increases from 15 to 17.4percent for men and from 21.8 to 26.7 percent for women.

22. These results from an individual-level model suggest that the INPS is not sustainable in the longterm. Changes will be necessary to the benefit formula to avoid increases in contribution rates in thefuture.

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Reform

23. Two changes to the INPS benefit formula have been considered. The first would abolish theextra accrual for the first years of service. The accrual rate would then be 1.5 percent per year of service;that is, a fully linear schedule. The male replacement rate relative to the INPS measure falls from 86 to66 percent and by the same 20 percentage points for women. The reduction in the other replacementrates is proportionally the same. This target replacement rate of 59 percent for men and 51 percent forwomen is close to that of the OECD countries. This reform would reduce the rate of return oncontributions from 4.7 to 3.6 percent for men and from 6.6 to 5.3 percent for women. The equilibnumcontribution rate is then just 11.5 percent for men and 16.2 percent for women.

24. If this change were introduced along with price updating, the gains would be rather smaller.Although the replacement rate at the point of retirement is the same, the cost of providing pensions isincreased because the flow of pensions is higher than with a policy of under-indexation of pensions inpayment. The rate of return on contributions in this scenario is 4.2 percent for men and 6.2 percent forwomen and the equilibrium contribution rates are 13.3 and 19.9 percent respectively.

25. The third scenario includes these two changes plus a shift to average lifetime earnings in thebenefit formula rather than the measure of final salary currently used. Again, it can be argued thatpension systems around the world are moving to longer averaging periods, to avoid arbitraryredistribution between different beneficiaries and to prevent manipulation. This reform reduces the rateof return on contributions to just two percent for men and 3.6 percent for women. The equilibriumcontribution rate falls below the current rate for men and is only 11.4 percent for women.

26. Most OECD countries have shifted to equal retirement ages for men and women. This wouldseem to be a sensible long-term goal in Cape Verde. An equal retirement age can be phased in over aperiod of ten-to-twenty years, to protect older female workers' reasonable expectations about the age atwhich they are able to retire. Once in place, this will increase women's replacement rates at the point ofretirement because they will accrue more years of service. Women's rate of return on contributions fallsfrom 6.6 percent in the baseline case to 5.4 percent. It remains above the rate of return for men, ofcourse, because of women's longer life expectancy. The last line shows the effect on women of the fullreform package (equalizing pension ages, abolishing the 20 percent additional accrual, prices indexationof pensions in payment and using the lifetime average in the earnings formula). The rate of return oncontributions for women is three percent (compared with two percent for men) and the equilibriumcontnbution rate is 10 percent.

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Additional Annex 13: Letter of Sector Development PolicyCAPE VERDE: Growth and Competitiveness Project

Mr. James D. WolfensohnPresidentWorld BankWashington, DC

Apnl 4th, 2003

Subject: Statement of Development Policies for Private Sector Development

Dear Mr. Wolfensohn,

For the past twelve years, the Government of Cape Verde has taken major steps to steer the economyfrom a state-run economy into one based on market forces. These reforms have significantlycontributed to improve the business climate and to private sector participation in the developmentprocess. However, these reforms need to be strengthened and furthered in order to fully realize theprivate sector's potential.

In the spirit of productive dialogue and cooperation that exists between Cape Verde and the WorldBank, I would like to present you the program of policy reforms that the Government has alreadyundertaken or intends to develop and implement initiated to strengthen the domestic private sector aswell as further promote private sector investment in Cape Verde address the additional needs of theprivate sector, aiming at its full participation in Cape Verde's development process.

I will also refer to the policies, programs and activities the Government intends to develop andimplement over the coming four years in the context of promoting domestic private sectordevelopment.

Recent developments

Macro-economic stability is one of the main objectives set forth in the Government Program for2001-2006 period. Accordingly, the Government has elected as top priorities fiscal and budgetpolicies aimed at a sustainable reduction in the budget deficit and consolidation of the parity of theCape verdean currency.

In line with the above policies, over the past two years the Government has been actively working tocorrect the major macro-economic imbalances which had occurred in the years 1999 and 2000. To thisend, comprehensive stabilization programs were drafted and implemented with technical and financialsupport of the donor community, namely the World Bank, the International Monetary Fund, and theEuropean Union. In particular, the

With the World Bank, Government signed a Structural Adjustment ProgramCredit with the WorldBank, which provided for the definition and implementation of structural reforms to the Cape verdeaneconomy.

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In addition, Further, after a four-month informal program with the IMF (SMP-Staff MonitoredProgram), Cape Verde signed a formal, three-year program with the Fund, supported under thePoverty Reduction and Growth Facility (PRGF); and a.

A third structural adjustment support program was signed with the EU, launching further reforminitiatives.

Cape Verde has performed well under these programs and, in fact, even surpassed some of theperformance criteria agreed upon: the inflation rate is lower, real economic growth is higher, the fiscaldeficit is smaller, and the balance of payments is stronger. Real economic growth in 2002 was in theorder of 5%, against the projected 2.5%, whereas inflation was about 1.7%, against the 3% forecastedin the program.

The improvement in the macro-economic situation registered during the second half of 2001 continuedthroughout 2002, as shown by the compliance with the criteria established under the PRGF. Thisimprovement is particularly evidenced by the correction of the budget and external imbalances, aswell as by the trend for lower inflation, which in turn led to stronger external competitiveness andlower interest rates.

The lower interest rates reflect the lower rates applicable to Treasury securities, which in turn are aresult of lower financing needs of the Government. This positive trend is a direct result of themeasures applied in 2001 and continued throughout 2002 - general expenditure contention, improvedfiscal collection, and resumption of foreign aid as a result of renewed donor confidence.

Performance on the fiscal front was also better than programmed, reflecting stronger revenueperformance and the restraint of current expenditures. Capital expenditures were also higher thanprogrammed, owing to a more rapid pace of donor disbursements than programmed. The Governmenthas also cleared all domestic arrears and honoured all rescheduled external arrear payments.

There has also been considerable progress in key structural areas: (i) a new Central Bank organic lawwas approved by Parliament, establishing the independence of the central bank, namely by prohibitingcredit to the Government; (ii) significant progress was made in the process of implementation of anautomatic and transparent mechanism for retail petroleum products, aimed at shielding the budgetfrom fluctuation in world crude prices and in improving the efficiency of the sector; (iii) a new valueadded tax (VAT) law and a new customs tariff schedule were approved, thus reducing the cost to userswhile also simplifyiing the process; (iv) two large loss-making public enterprises were liquidated (foodimport/distribution, and urban transportation) thus reducing the indirect drain on the national budget,while also opening up new opportunities for private operators.

The new central bank law addresses key problems with the previous law. It (i) establishes pricestability as the overriding objective of the central bank; (ii) prohibits the extension of central bankcredit to Government except for a temporary overdraft facility that must be cleared at the end of eachyear; (iii) limits the central bank's "lender of last resort" financial support to commercial banks; and(iv) establish a transparent process for appointing the central bank governor and board members.

At the sectoral level, it is worth pointing out recent developments in the financial sector. During thelast several years, Cape Verde's banking system underwent a period of fundamental transition andmodernization. Over the past twelve months, the banking sector of the country has further improved.The banking sector has grown during that period by an overall estimated increase of 9.5% in deposits,and 14.8% in loans. Both major banks, Banco Comercial do Atlantico (BCA) and Caixa Economica

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de Cabo Verde (CECV) have increased both their deposits and their loan portfolio, while reducing thenon-performing loan portfolio. Both banks as well as have shown had a positive result for 2002.

In a further effort to modernize the financial system in Cape Verde, the Sociedade Interbancaria eSistemas de Pagamentos (SISP) was created in 1997. Its shareholders include the Banco de CaboVerde (BCV), the four commercial banks (BCA, CECV, BTA and BI), Cabo Verde Telecom, theGovernment (Department of the Treasury), and two Portuguese corporations (SIBS and UNICRE).SISP's mandate is to manage activities related to electronic banking, including the payment systems,ATMs, and electronic transfers. Since its creation, over 30 ATMs have been installed on five islandsand clients have the opportunity to make automatic payments on their bills (more than 140 terminalshave already been installed).

The Government recognizes that without a solid legal system, the fostering of private sectordevelopment would be constrained. Having due regard to this fundamental pillar of economicdevelopment, and with resources from an earlier IDA project (Capacity Building Project for PrivateSector Promotion) the legal environment has significantly been improved in the last few years,including steps towards simplification of company registration procedures, and strengthening of lawenforcement conditions, including preparation of new civil and penal codes. Work is also under wayto reform the labour code, to raise its flexibility, a major concern for private operators at present; adraft Labour Code is currently under discussion among all stakeholders.

On the strategic front, the Government completed the National Development Plan (NDP) for2002-2005 and made significant progress in preparing a poverty reduction strategy paper (PRSP).Cape Verde's strategic approach to reducing poverty identified in the interim-PRSP, which waspresented to the World Bank in January 2002 (full PRSP is scheduled for the current year) includes:(i) the renewal of economic growth with equity; (ii) the linkage between poverty reduction strategiesand macroeconomic and sector policies; and (iii) the improvement in the productive capacities of thepoor, by focusing on the need to provide training. The growth policy underlying the NDP, on whichthe i-PRSP is built, seeks to promote sustainable, long-term economic, social and human development,reflected in growing improvement in the welfare and living conditions of the population and in theprogressive reduction of poverty. Promoting entrepreneurial capacity, competitiveness and growth,and expanding the productive base is one of the five major pillars of the NDP.

The excellent macro-economic performance notwithstanding, the Government has been aware fromthe beginning that macro-economic stability is not an end in itself but a groundwork for a new era ofeconomic development, based on a sustainable growth pattern, focused on adequate supply of goodsand services to the population, without disregard for social concerns.

With this in mnind, the Government Program also calls for raising the competitiveness of the domesticprivate sector, by means of its modernization, export promotion and promotion of partnerships withexternal investors.

The current trend of improvement in the macro-economic situation is very important considering therole reserved for the private sector in the development process: first, lower financing needs of theGovernment has meant more resources available to the private sector; second, the stability andpredictability associated to the macro-economic stability gives renewed confidence to the privatesector to undertake new investment ventures.

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To achieve the twin objectives of stabilization and rapid economic development, the Governmentintends to improve economic management, push ahead with economic modernization and promotesectors with untapped potential, by addressing the following key areas:

* Maintaining macroeconomic balances that were weakened during 1999/2000 by internal(domestic consumption) and external (oil shock) factors and undertaking structural measures;

* Continuing progress achieved in restructuring and modernizing the financial sector andreforming the pensions system; and

Sustaining high growth through increased private sector competitiveness, improved businessenvironment and the development of promising sectors, primarily tourism,fishing and transport.

The private sector should be a natural partner to the Government in pursuing the objectives in theeconomic area, namely with regards to increasing output and raising competitiveness, employmentpromotion and poverty alleviation. Indeed, following a period of some 18 months during which theGovernment's focus was on recovering macro-economic stability, the Government is now re-focusingits attention on the real sector, aiming at resuming economic growth in a sustained and sustainablefashion.

The National Development Plan (NDP) Main Options are the framework for this new focus, whichwill be set in motion by means of specific programs. The overall goal of this strategy is to bring aboutsignificant changes in the real sector, particularly with regards to private initiative. This new strategywill be further developed and implemented through initiatives in various areas, including investmentclimate improvement, private sector development, tax reform, financial sector development,infrastructure development, and external investment and export promotion

A. Investment climate improvement

Cape Verde's experience with private sector development points to the importance of improving theinvestment climate, as part of the private sector-led growth strategy, and foreign direct investment(FDI) is crucial.

The immediate challenge is to make sufficient progress in addressing the obstacles so that,progressively more private actors can contribute to the economic growth. The objective is to improvethe enabling investment environment, especially by facilitating the policy, legal and regulatoryinterface, and the dialogue process between the public and private sectors. The objective will beachieved through judicial reform, a better business environment and trade facilitation, enhancedcapacity to regulate and resolve post-privatization issues.

In this regard, the Government will address the following inter-related issues:

Reduction of Administrative Barriers. In November 2002, FIAS launched the Administrative BarriersStudy, which was received by the Government in March 2003. Based on the results of the survey, theGovernment and stakeholders will formulate an action plan which will be implemented. As part of theprocess, Government will establish clear and transparent procedures to sell or transfer state-ownedland and a land registry (cadastre) system will be developed. Based on these actions, Governmentexpects to see an improvement in the business environment, which has lead to reduction of time and

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costs of starting and operating a business (based on subsequent surveys).

In the end the Government intends, among many other aspects, to reduce company registration fees.Import license fees will be re-analysed, as they are perceived by potential investors as an unnecessarycost of business. At the same time, Government is aware that these license fees are a significantsource of the Chambers' revenue and an alternate mechanism to earn resources will have to beestablished before their elimination can be considered.

An important aspect of this process is that it will be a participatory one. In fact, the Government plansto continue the productive dialogue enjoyed this far on the study of these matters, with activeparticipation from stakeholders, both public and private. To this end specific task forces and steeringcommittees will be set up to ensure adequate stakeholder participation.

Development of Efficient Supplv Chains. As part of its private sector strategy and to complement itswork on tax reform and reduction of administrative barriers, Government will target three sectors,which may include tourism, fishing, trade, construction and/or transport, and develop a clear sectorstrategy. A supply chain analysis will be carried out on the selected sector to establish whatprerequisite actions are needed to resolve constraints by Government (infrastructure, regulation etc),and by the private sector (gaps in technical skills or lack of upstream and/or downstream activities).These studies will identify the cross cutting issues within the sector, defirung the policy, as well assector specific requirements. These recommendations will be fed back to the public and private sectorfor debate and a clear strategy and sector policy will be defined. Activities to support theimplementation of the sector policy will be implemented in the coming four years. As outcomes, atleast three studies will be carried out, a strategy defined and implementation begun. Throughimplementation of appropriate policies, the Government hopes to stimulate the growth of thesesectors.

Modernizing the Legal Environment for Business. Intervention in this area will support work that hadbeen started in putting in place an institutional and a legal framework conducive to the development ofthe private sector. In particular, the Department of the Registry, Notary and Identification will take thenecessary steps to speed up the process of registering companies, buildings, etc from almost 3 weeksto 72 hours by developing computerized links among the various municipal offices on the differentislands. The software has already been developed, therefore the hardware (computers) will bepurchased. Comrnunication link will be provided with support from the RAFE project.

In an effort to respond to the requests of the citizens in general and the investors in particular tosimplify the procedures, the Government will elaborate the codes for the commercial registry, housingregistry and civil registry. In addition, the Government will elaborate the regulations and procedureswhich accompany the labor code; of which substantial work on the code has already been undertaken.Workshops and training sessions will accompany the process.

Government and the private sector agree on the need to establish "arbitration" as a means of resolvingcommercial disputes. To this end, the two Chambers of Commerce of Sotavento (Praia) andBarlavento (Mindelo) will house the arbitration centers. The Ministry of Justice will prepare theappropriate legislation and regulation, while the Chambers of Commerce will establish the ArbitrationCenters. Specific initiatives include capacity building activities and provision of equipment in order toset up two arbitration centers. At present, the Government is reviewing the different arbitrationoptions available in order to decide on the basis of the arbitration law and regulations.

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Cape Verde is a candidate to World Trade Organization (WTO) accession and officially applied onNovember 12, 1999. To become a member, we will have to reform some of the legislative frameworkand present a Legislative Action Plan, particularly in the area of intellectual property which suffersfrom a legislative vacuum. Indeed, this aspect has been stressed as being a pressing and urgentnecessity among business circles. This is all the more important in a country such as Cape Verdewhose music is exported worldwide. The Government anticipates to finalize the accession process inthe coming four years.

One of the identified bottlenecks in the improvement of the business environment in Cape Verde is thetotal or partial ignorance of the legal business framework by domestic and international investors.The Government will disseminate business law and information by (i) making laws and judgmentsmore accessible and available through the publication of business laws and judicial decisions, throughworkshops as well as maintaining the web-site on a regular basis, and (ii) organizing training andcapacity building sessions (possibly in PROMEX and in the Chambers of Commerce) for Judges,Lawyers, Businessmen and all interested public or private stakeholders, WTO, intellectual property,anti-money laundering and arbitration.

Post Privatization and Divestiture During the past decade, Cape Verde's economy has gone though aremarkable change during which private ownership and participation became dominant in all sectorsof the economy, including infrastructure and utilities. At present, the port and the national airline(TACV) remain the main activities whose privatization has been initiated, but have not beencompleted. The Government is currently working on these two cases to have their privatizationcompleted by 2004. Otherwise, the airports are the only publicly-owned infrastructure without privateparticipation. Some of the expected benefits of private participation have already accrued.

With hindsight, the Government recognizes two inter-related shortcomings in the reform process.First, insufficient attention was paid to building in the possibility of competition in the context ofsector reform and divestiture. Second, an effective regulatory mechanism that would, amongst others,regulate prices of private monopolies is yet to be established.

This situation had not been anticipated in 1997, the time when the private participation program inCape Verde infrastructure was conceived. Government strategy had called for divestiture actions tobe accompanied by the establishment of a multi-sector regulatory agency (ARM), and related capacitybuilding to ensure that it would quickly become operational. Due to a series of setbacks, ARM neverbecame operational. One of the reasons was that there was no national consensus and understandingof the importance and the role of regulation in the privatized economy. The broad scope envisaged forARM (multi-sector and multi-purpose, covering economic, technical and environmental regulation)also contributed to these problems.

Faced with urgent regulatory issues in telecommunications, water and energy (electricity andpetroleum) issues, a National Seminar facilitated by international experts and regulators, was held inNovember 2002. The Government has abolished ARM and is in the process ofwill create creating anew agency responsible for economic regulation of key infrastructure sectors. The National Assemblyhas approved a framework law for the establishment of regulatory agencies. The importance oftechnical and environmental regulation was also recognized in the new approach. However, it wasdecided that these would, for the moment, be addressed through collaboration between line ministries,the regulators and other agencies. In parallel, the Government decided to stimulate added competitionin a key sector, notably telecommunications, with a view to take further reform measures to reducecost and improve economic competitiveness.

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To sustain important actions regulatory capacity building will be part of the Govermment's efforts toimprove the investment climate. In addition, the Govermment intends to (a) establish a fullyoperational multi-sector regulatory agency capable of handling routine issues intemally and morecomplex ones with limited expert support; (b) complete the private participation agenda, including theport and, possibly, the airport; (c) establish a more competitive telecommunication sector and developinformation and communication technology opportunities, with more value-added services and thenumber of internet users per 1,000 people similar to relevant comparators; and (d) create awell-functioning inter-island and urban transport systems that do not require significant subsidies fromthe state.

Specifically, in order to improve the regulatory environment, the Government will (a) complete thetelecommunications reform, which encompass: (i) the renegotiation of the existing contract to removeintemal inconsistencies, clarify the liberalization of value-added service, revised pricing policy,including access fees, and liberalization of the sector in line with WTO commitment concerning localand international markets; and (ii) additional value-added services; (b) develop a multi-sectorregulatory agency, through structured and on-the-job training, study tours and exchange programs, andadvisory service for post training aftercare; (c) proceed with Port and Airport reform and divestiture,whereby the privatization of the ports will be completed and a study of the scope for privateparticipation in airports will be undertaken.

Infrastructure development: a number of important economic infrastructure projects with direct andimmediate impact on the investment climate were recently completed, are currently under way or willtake off shortly, including: (a) completion of the Praia airport and respective access road, thusimproving the city's image as a business hub, and facilitating the development of the island ofSantiago's potential in the sectors of agriculture and rural tourism; (b) studies for the construction of abeltway around the city of Praia, which will facilitate circulation in the capital and communicationwith the hinterland; (c) construction of a new power plant in the city of Praia, thus improvingelectricity and water supply to domestic as well as industrial clients; (d) recent completion of newpower plants in the islands of Sal and Sao Vicente, therefore improving conditions for the mainactivities in these islands, respectively tourism and light manufacturing; (e) rehabilitation of powerplants for the other islands are currently under way; (f) major road projects under way in the islands ofSantiago (Sao Domingos - Assomada), Fogo (Campanas - Atalaia) and Santo Antao (Janela - PortoNovo); (g) rehabilitation of the ports of Praia and Palmeira; and (h) considerable investments in thetelecommunications sector, including an optic fiber network linking the different islands. Theseactivities, which will be fully developed and/or completed over the next four years are hard proof ofthe government's commitment to further improving the country's investment climate by means ofimprovement to its basic infrastructure.

B. Private sector development

In the last few years the Government has made important strides to enhance competition, althoughhigh barriers persist. It lifted all quantitative import and export restrictions, and has also abolished thelegal import monopolies of EMPA, the state commodity trading company. The dominant sector inCape Verde is services (approximately 72 percent of GDP in 2000). The development of tourism hassupported gradual growth of the sector in absolute terms and as a share of GDP. Industry representsslightly less than 20 percent; its growth prospects are limited by high factor costs and the absence ofeconomies of scale, but encouraged by the availability of qualified labor and a steady improvinginvestment climate.

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The Government is aware that growth is not sustainable unless critical issues such as factor costs andavailability of service infrastructure sectors are addressed. While standards in terms oftelecommunications are high, access to water and electricity are relative low. However, the price ofutilities are high and have an impact on the viability and profitability of business. Reforms in theutility sector are underway, including: (i) the adoption of a modernized legal and regulatoryframework with the view of increasinge competition wherever possible; (ii) privatization and privateparticipation in infrastructure sector policies; and (iii) creation of a multi-sector regulatory agency.

With support of the recently closed World Bank (Capacity Building Project for Private SectorPromotion), the private sector has taken strides to become more vibrant and organized. There are twoChambers of Commerce; one for each group of islands (Sotavento and Barlavento) which werecreated to represent private enterprises' interests in trade, manufacturing, construction, civilengineering, transport and fisheries. While the chambers do not cover all of the private sector,membership is growing.

The chambers are responsible for building private/public partnerships and under this mandate,organize, at least twice a year, a forum for private enterprises to further the dialogue between theGovernment and the private sector. The forums provide the opportunity to Government agenciesdealing with private sector and private enterprises to meet and discuss issues concerning the privatesector. It is the Government's intention to follow-up on the agreements made at the forum. In aneffort to systematize and strengthen the dialogue between Government and the private sector,Government will work with the leaders of the private sector, as well as representatives of theassociations on a regular basis to exchange ideas on pending economic and social issues.

The Chambers also play an important role in providing private enterprises with resources for training,studies and technical assistance. The operating funds are obtained through their import licensingoperations. However, while the funds help, they are insufficient to meet all of the demands by agrowing private sector for training opportunities and technical support. Government recognizes thatthe environment for technical learning and assistance in Cape Verde continues to be underdevelopedand that the mechanisms by which private firms transfer technology and raise their technicalcapabilities are weak. While foreign investment in the country is increasing, technology transfer viathis channel remains limited. In this spirit, Government will support the Chambers' efforts through amatching grant facility. This facility will enable the Chamber to expand its efforts to support localbusinesses on a cost sharing (50:50) basis. The grant would be available to all Cape Verdean firmsand informal enterprises, working through their associations. In addition, the Chambers, as managersof the facility will also be able to access the funds to strengthen its capabilities.

Private sector led economic growth is crucial to Cape Verde's poverty reduction strategy and externalviability. It is the Government's objective to promote exports, especially manufactured goods,tourism and transportation services and to attract a higher level of foreign direct investment and otherprivate sector capital inflows. This strategy will require a dynamic private sector that is able tocompete effectively in world markets and structural reforms, human development, legal reforms andinvestment promotion will all be necessary to achieve these objectives.

The Government's public investment program will continue to focus on improving the basicinfrastructure (roads, water, power and telecommunications) toward this end. Additionally,Government is currently reviewing the country's labor laws with a view to remove barriers toemployment and is working to eliminate administrative barriers to foreign and domestic investment.

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To promote domestic investment the Government intends to support SMEs. Government's strategyvis-a-vis SME development is at a crossroads. While it has articulated a vision of efficient businessdevelopment services provision, the private sector forum for public/private dialogue, and facilitating afavorable business enabling environment, the institutions serving SME's do not meet this challenge.The Government is currently re-examining its role in SME development and its core activities.

Rationalization of agencies which interface with SME's is currently under way, as part of a broadereffort to evaluate autonomous public institutions. A multi-disciplinary Task Force has been recentlyset up and is scheduled to submit to the Government a full report by September 30, 2003 outlining thefindings and making recommendations for improving Government strategy towards these institutionsand the areas they target. Government will take steps to build technical capacity in those selectedGovernment ministries and agencies which interact most intensively with private firms. This will bedone in a manner to address two key objectives: (a) enhancing the capabilities of private and publicinstitutions to deliver business support services; and (b) support Government agencies in their effortsto provide business facilitation and promotion services, including improving their capability toidentify and ease bureaucratic rigidities.

C. Tax reform

In 2001, the Council of Ministers approved the legislative framework for introducing a value-addedtax (VAT) and the liberalization of the external tariff regime. Tax reform has two complementaryobjectives related to fiscal equilibrium and the improvement of the business environment. The taxreform strategy consists of three categories of measures: (a) the introduction of a VAT; (b) reform ofexternal tariffs; and (c) reform of the income tax structure. Government will focus its efforts onensuring that the VAT and new customs tariff structure are fully implemented by June 2003.

Government recognizes that the large number of customs and tax exemptions undermine its objectivesof fiscal policy and could provide more resources for its anti-poverty programs. In this spirit, theGovernment recently took important steps to rationalize private sector taxation.

We first tackled "indirect" taxation. The Lei de Tributaqdo das Despesas, passed in June 2002,significantly simplifies international indirect taxation. There are now only seven (7) rates of customsduties (from 0% to 50%). All other taxes formerly due on imports, such as the 8% "emolumentosgerais " (EGA), were suppressed. As a result, capital goods and raw materials now carry total customsduties of either 0% or 5%, down from a level of about 20%, a clear sign of encouragement to theproductive sectors. This was the first step. By end 2007, Government intends to reduce spreads andrates further, in line with international best practices. This will be done, however, prudently in ordernot to jeopardize the sustainability of public finance.

The same law addresses domestic indirect taxation, with the introduction of a single-rate VAT of15%, and the corresponding suppression of the Imposto sobre o Consumo (consumer tax).

Subsequently Government sought to improve "direct" taxation. Key measures included: (i) thereduction in the 2003 budget/appropriate law of the Imposto Unico sobre o Rendimento (IUR-corporate tax) at 30% of net profits, down from a rate of 35%; (ii) the increase of the tax creditpursuant to the taxation of dividends paid out to corporate shareholders of 40%, up from a rate of20%. This contributes to bridging the gap between the taxation of dividends to corporate bodies (noweffectively at 21%) and dividends paid to individuals (still at 15%); and (iii) the suppression of all"estampilhas fiscais" (fiscal stamps). The reforms should have a positive effect on the supply

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response of the business community.

Although these measures have had a positive impact, the Government recognizes the need for furthertax reform, along the following lines: (i) a further reduction of the [UR down to a level of 25% and thesuppression of the stamps in the collection of the Imposto de Selo of 0.7% on sales; (ii) thesimplification of the overly complex fiscal incentive mechanisms. This simplification will beimplemented by streamlining the existing incentive schemes, respectively pertaining to industry,fisheries, exporters, external investors and tourism. In particular, the Export Processing Zone (EPZ)instrument will be subject to a specific study.

Additional tax reform initiatives currently in the pipeline include a review of taxes on dividends inorder to eliminate the current unfair double taxation of dividends, which penalizes investors as well ascompanies. Taxation of independent workers (traders, consultants, etc) will also be reviewed, specificgoals being more equitable fiscal treatment of these workers as well as alleviation of their tax burden.

D. Financial sector development

Despite the major improvements introduced in the financial system in the past few years, financialintermediation is still challenged by the absence of a sufficient supply of long-term funds to meet thegrowing demand.

In that context, studies about how to access international capital markets, as well as proposals for thecreation of new financial instruments (e.g. leasing, venture capital), and the establishment ofsustainable long-term financial resources are key for the future of the country's financial sector.

Efforts have been made to improve regulations governing financial institutions, and the BCV hasstrengthened its supervisory function. These efforts will continue. The BCV is implementing anumber of projects to strengthen its operational and oversight responsibilities. It will continue tostrengthen banking supervision through the training of staff in cooperation with partners in othercountries, increasing the number of on-site examinations, modernizing the off-site reporting systemand strengthening supervision of its offshore financial institutions.

In its efforts to continue improving the credit culture, the central bank, with support from commercialbanks, will implement a real time credit risk system. With this system, commercial banks anticipate areduction in non-performing loans (NPL) portfolio from 9% to 7% in the next few years.

In late 2002 the National Assembly approved a new anti-money laundering law. Appropriateregulation, which accompanies the legislation will be prepared and information and training will beprovided to Government, as well as commercial banks and private sector.

With respect to insurance, Government recognizes that life insurance can be a source of long-termresources, which is vital for the development of investment opportunities. In this context regulationswill be updatedimproved and supervisory capacity will be strengthened. In addition, in an effort tofurther diversify the financial sector, other alternative non-bank financial instruments, such as leasingwill be reviewed and the legislation updated accordingly.

In its continued efforts to deepen the financial system, the Government will support SISP's initiative,currently in the works with VISA INTERNATIONAL, to extend the electronic VISA services (onecan currently obtain cash using a VISA card by going to the commercial banks), which will betremendous boost for tourism as well as business opportunities.

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Pensions represent an important element of the social safety net as well as an important potentialsource for longer-term resources that could fuel investments. The Government is concerned about thesustainability and fiscal effect of the present system and the impact of pension liabilities on the budgetand will tackle the following issues facing the pension system in Cape Verde:

(a) Civil service pension liabilities. The target benefit is high both by international standards andrelative to the private sector system (run by INPS), and has resulted in a large and increasing burdenon the budget. The Government will gradually phase in parametric reforms, and changes to eligibilityrequirements and target benefits.

(b) Government arrears to the INPS. Until recently the Government owed over 2 billion escudos(approximately US$ 20 million) to INPS including interest and penalties, resulting from (i) earlyretirement programs used during the privatization process to shed excess labor; (ii) contributions forapproximately 1,000 employees at institutes and decentralized public services not paid to the INPS;and (iii) civil servants who move to the private sector, without the correspondent compensation fromthe Government to 1NPS. The arrears problem has been resolved using Treasury securities but furtherefforts need to be made to avoid recurrence of the problem. The Government will take the necessarysteps in this regard, including, namely, appropriate budget allocations to ensure timely payment ofthese contributions.

(c) INPS investment polica and partial funding. While INPS continues to run surpluses in its pensionscheme, previous governments have effectively forced the MPS to purchase government bonds inorder to finance central budget deficits. As a result, the INPS portfolio is heavily weighted towardsnon-tradeable government bonds. This has a direct effect on the long-term finances of the schemesince it reduces risk-adjusted returns relative to a diversified portfolio.

The Government will take progressive steps to manage this problem through a combination ofmacro-economic stability measures and capital market development initiatives, therefore reducing theGovernment financing needs on one hand, while on the other hand promoting suitable alternatives forapplication of surpluses.

Further, the Government will promote the development of an investment policy for INPS whichreflects relevant best practices, such as portfolio diversification.

(d) Governance. The use of pension reserves as way to finance deficits is one example of the conflictof interest that governments face when they run public pension funds. In order to avoid conflict ofinterest problems in Cape Verde, reforms to the current governance structure will be considered and anumber of measures designed to remove political discretion implemented.

(e) Financial deterioration in other programs administered by the INPS. In addition to pensions, theINPS administers programs for sickness and maternity, family allowances and other benefits.Currently, the INPS faces financial problems related to a rapid increase in health related spending,especially pharmaceuticals where fraud is known to be a serious problem. This indirectly affectspension system finances because pension reserves may be used to cover health system deficits in thefuture. Also, given that pensioners are major consumers of health services, as their number growsdramatically in the coming years, so too will health expenditures.

The Government recognizes the importance of strengthening the pension system and will implement aseries of reforms designed to improve financial equilibrium and institute fundamental changes to

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governance and management aimed at establishing a sustainable pension system. The Government'sfirst step towards a sustainable pension system includes a parametric reform of the current system,designed to raise the retirement age, standardize the eligibility requirements and increase collectionefficiency.

The Government wants to undertake a comprehensive reform process and a framework law waspassed in January 2001, which establishes the broad parameters of the pension system. This law takesin account the need for a safety net for the elderly poor as the first tier of the system, a mandatory,contribution based scheme as the second, and a third tier comprising voluntary, private pensionprovision. The two formal pension schemes operating in Cape Verde form the second tier at present.They have the same public policy objective, namely to ensure that income is available during old ageand prevent a sharp decline in living standards over the life cycle.

The merger of the two schemes is being considered to ensure efficiency and equity, includingeconomies of scale in administration, labor mobility and equity. Despite more generous pensions intheir present scheme, civil servants appear to favor such a change because of the health and otherbenefits that would come through the INPS. Particular care will be exercised to avoid transfer ofliability without due compensation.

Overall, the initiatives envisaged by the Government with regards to financial sector developmentinvolve its deepening, aiming at the goals of facilitating credit access to small companies as well as toincrease the availability of long term capital.

With this in mind, the Government will help mobilize resources to broaden SDEs resource base, aswell as create and/or improve the conditions for establishment and operation of specialized financialinstitutions, such as mutual funds, and leasing, and factoring institutions.

E. External investment and export promotion

Cape Verde offers various investment opportunities in sectors like tourism, light manufacturing andservices. Therefore one of the priorities of the Government will be to promote the country's imageabroad as well as to encourage a stronger internationalization of Cape Verde's economy.

Specific Government initiatives in this area will include a marketing and communication program todisseminate information on Cape Verde as an investmnent location, export base and tourismdestination, and a program to attract increased levels of foreign direct investments, not least inexport-oriented industries and in the tourism sector.

These substantial priorities will be supported by an institutional development program for PROMEX,the country's tourism, external investment and exports promotion agency, through which the agencywill update staff skills and internal processes and systems. Specifically, the Government will focus on(i) the development of a strategically focused investment promotion strategy, including thedevelopment of 4 master plans; (ii) an institutional capacity/skills building for PROMEX staff; (iii)the preparation of up-to-date marketing materials, including revamping the PROMEX website; (iv)introduction and upgrading of necessary systems and processes (investor tracking system, Intranet);and (v) upgrading institutional capacity.

As a result of interventions in this area it is expected that within two years the amount of total foreigndirect investment in the country will increase by US$100 million with total 2,000 jobs created andwithin four years a total US$225 million with 5,000 jobs will be created.

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Policy management

In the context of a broader agenda for economic management, implementation of the above mentionedpolicies will be monitored by the Ministry of Finance, Planning and Regional Development. TheMinistry will coordinate with the various line Ministries, public agencies and private sector entitiesinvolved in its execution, thus ensuring the integration of efforts of the various stakeholders.

Further, to ensure stakeholder ownership of the various interventions, Steering Committees will be setup as needed to oversee further definition, implementation and monitoring of the various initiatives.

One of the main operational instruments to be used in achieving the objectives envisaged with thesepolicies is the Growth and Competitiveness Project, a US$ 13.5 million project financed mainly bythe International Development Association (IDA).

The overall Project objective is to broaden the base of private participation in Cape Verde's economicgrowth and enhance private sector competitiveness, as well as further develop its financial sector insupport of private sector development. This would be achieved through a series of actions supportedby the project, notably (a) financial sector reform, including pension reform; (b) investment climatereform and improved supply chains, and (c) private sector and institutional capacity building. Afourth component is to support post privatization and divestiture efforts that may not be completedunder the ongoing Privatization and Regulatory Capacity Building Project, prior to its closing inDecember 2003.

Further, various other projects included in the Public Investment Program will be contributing to theachievement of these objectives in the coming four years. As said before, real sector growth will bethe thrust of economic policy in the coming years in Cape Verde.

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