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Document of The World Bank

FOR OFFICIAL USE ONLY

Report No. 74724-SL

INTERNATIONAL DEVELOPMENT ASSOCIATION

PROGRAM DOCUMENT

FOR A PROPOSED

DEVELOPMENT POLICY GRANT

IN THE AMOUNT OF SDR 16.3 MILLION

(US$25 MILLION EQUIVALENT)

TO THE

REPUBLIC OF SIERRA LEONE

FOR A

SIXTH GOVERNANCE REFORM AND GROWTH GRANT

November 27, 2013

Poverty Reduction and Economic Management 3 Africa Region

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CURRENCY EQUIVALENTS (Exchange Rate Effective as of November 27, 2013)

Currency Unit = Leone

US$1.00 = Le 4,328

FISCAL YEAR January 1 – December 31

ABBREVIATION AND ACRONYMS

AfDB African Development Bank BSL Bank of Sierra Leone DFID Department for International Development (United Kingdom) DPO Development EAP Energy Access Project ECF Extended Credit Facility ESURP Energy Sector Utility Reform Project FDI Foreign Direct Investment GBAA Government Budgeting and Accountability Act GDP Gross Domestic Product GRG GRGG-6

Governance Reform and Growth Sixth Governance Reform and Growth Grant

GST Goods and Services Tax HR Human Resource IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund IPFMRP Integrated Public Financial Management Reform Project JAS Joint Assistance Strategy MDAs Ministries, Departments and Agencies MDBS Multi-Donor Budget Support MOFED Ministry of Finance and Economic Development NPA National Power Authority NRA National Revenue Authority OMCs Oil Marketing Companies PBCUOM Performance Based Contract for Utility Operations and Maintenance PEFA Public Expenditure and Financial Accountability PFM Public Financial Management PRS Poverty Reduction Strategy PRSP Poverty Reduction Strategy Paper SDR Special Drawing Rights

Vice President: Country Director: Country Manager:

Sector Director: Sector Manager:

Task Team Leader:

Makhtar Diop Yusupha Crookes Francis Ato Brown Marcelo Giugale Mark Roland Thomas Cyrus Talati

The Sixth Governance Reform and Growth Grant for Sierra Leone was prepared by an IDA team comprising Cyrus Talati, Yusuf Foday, Gregory Smith, Daniel Weise, Ismaila Ceesay, Dora Harris, Elvira Morella, Viorel Velea, Nikolay Nikolov, Kristen Himelein, Waqar Haider, Christine Makori, and Luis Schwarz, under the overall guidance of Francis Ato Brown, Country Manager.

REPUBLIC OF SIERRA LEONE

SIXTH GOVERNANCE REFORM AND GROWTH GRANT

TABLE OF CONTENTS

1. INTRODUCTION AND COUNTRY CONTEXT .......................................................................... 2 2. MACROECONOMIC POLICY FRAMEWORK .......................................................................... 3

A. Recent Economic Developments .................................................................................... 3 B. Macroeconomic Outlook and Debt Sustainability .......................................................... 8 C. IMF Relations ............................................................................................................... 12

3. THE GOVERNMENT’s PROGRAM ............................................................................................ 13 4. THE PROPOSED OPERATION .................................................................................................... 14

A. Link to Government Program and Operation Description ............................................ 14 B. Prior Actions, Results and Analytical Underpinnings .................................................. 15 C. Link to CAS and Other Bank Operations ..................................................................... 23 D. Consultations and Collaboration with Development Partners ...................................... 24

5. OTHER DESIGN AND APPRAISAL ISSUES ............................................................................. 24 A. Poverty and Social Impact ............................................................................................ 24 B. Environmental Aspects ................................................................................................. 25 C. Public Financial Management, Disbursement and Auditing Aspects ........................... 26 D. Monitoring and Evaluation ........................................................................................... 28

6. SUMMARY OF RISKS AND MITIGATION ............................................................................... 28

ANNEXES Annex 1: Policy and Results Matrix ..............................................................................................31 Annex 2: Letter of Development Policy ........................................................................................35 Annex 3: Fund Relations Note .......................................................................................................37 TABLES

Table 2.1: Sierra Leone: Selected Economic Indicators, 2009-16...................................................4 Table 2.2: Sierra Leone: Central Government Budget, 2009-16 .....................................................6 Table 2.3: Sierra Leone: External Financing Sources and Uses, 2009-16 .....................................13 Table 4.1: Prior Actions and Analytical Underpinnings ................................................................23 TEXT BOXES

Box 2.1: Trends in the International Iron Ore Market and Impact on Government Revenues ........9 Box 2.2: Fuel Subsidies in Sierra Leone ........................................................................................11 FIGURES

Figure 1.1: Poverty by District, 2011...............................................................................................2

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GRANT AND PROGRAM SUMMARY

REPUBLIC OF SIERRA LEONE

SIXTH GOVERNANCE REFORM AND GROWTH GRANT

Borrower Republic of Sierra Leone.

Implementing Agency Ministry of Finance and Economic Development (MOFED).

Financing Data SDR 16.3 million (US$25 million equivalent) in IDA resources.

IDA Grant.

Standard IDA Grant terms.

Operation Type Programmatic (third of a series of three), Single tranche.

Pillars of the Operation and Program Development Objective(s)

The proposed grant will support the financing of the government program articulated in the PRSP-2 and the newly launched PRSP-3 which seeks to deepen growth and diversification, and is a key element of IDA’s program in the country as noted in the Country Assistance Strategy Progress Report presented to the Board on July 19, 2012.

Development objectives are to: (i) improve the allocation and efficiency of public spending to support poverty reduction; (ii) strengthen domestic resource mobilization and management; and (iii) increase provision of electricity.

Result Indicators 1. In 2014 expenditure of individual budget categories (sectors) are to be within 15 percent, of budgeted allocations.

2. By the end of 2014 public domestic debt is stabilized under 13 percent of non-iron ore GDP.

3. By the end of 2014 the fiscal overhang will be limited to the 5 percent of revenue statutory limit on the central bank overdraft facilities, and the combination of domestic expenditure arrears and un-presented cheques will not exceed 2 percent of total actual expenditure.

4. Cash Management Committee reports to be inclusive of information on the levels and age of arrears in 2014.

5. By the end of 2014 three-quarters of procurement transactions are conducted through open competition.

6. Over the remainder of 2013 and 2014 any expected or actual overspending outside of GBAA proscriptions will be followed by the submission of a supplementary budget to Parliament.

7. Ratio of no. of teachers with HR records to no. of teachers on payroll. 8. Proportion of large taxpayers filing tax returns on time. 9. Tax revenue as a percentage of non-iron ore GDP. 10. By the end of 2014, national electricity utility will be under a performance

based contract to a reputable operator on efficient and transparent terms. 11. Number of prepaid meters in Freetown and collection efficiency rate.

Overall Risk Rating Substantial

Operation ID P133107

PROGRAM DOCUMENT FOR A

PROPOSED SIXTH GOVERNANCE REFORM AND GROWTH GRANT

TO THE REPUBLIC OF SIERRA LEONE

1. INTRODUCTION AND COUNTRY CONTEXT

1.1 This program document proposes a third Poverty Reduction Support Operation in a series of three, the Sixth Governance Reform and Growth Grant (GRGG-6) in the amount of SDR 16.3 million (US$25 million equivalent) to the Republic of Sierra Leone. The proposed operation will support government efforts to implement the second Poverty Reduction Strategy Paper (PRSP-2), and its newly launched successor, An Agenda for Prosperity, the third Poverty Reduction Strategy Paper (PRSP-3). The PRSP-3 covers the period 2013-18 with the main aim to promote inclusive growth, economic diversification and value-addition.

Country context

1.2 Sierra Leone’s progress since the end of the civil war is commendable in most realms—economic, social and political. Economic growth has been sustained, averaging above 7 percent annually between 2009 and 2012. Infrastructure development has moved beyond the immediate needs of post-conflict reconstruction and been extended to tackle the country’s profound infrastructure deficit. Basic services have been restored, though there remains a long way to go in terms of coverage and quality. Public sector capacity and reform remains a key long term challenge, as is governance. Notable among these achievements is the recent successful and peaceful national, parliamentary and local elections in November 2012. This marked the third national election since the end of the conflict and was preceded some 18 months earlier by another important transition—out of fragile state status.

1.3 The Agenda for Prosperity covers the period 2013-18 and sets out Sierra Leone’s vision to be an inclusive, green, middle-income country by 2035. A central role is also assigned to natural resource management which has risen in importance due to the recent advent of large scale iron ore mining and the heightened potential for offshore oil, which has sparked an oil exploration rush and generated windfall revenues from exploration license fees. Iron ore production has led to rapid real GDP growth of 15 percent in 2012 following a 6 percent increase in 2011 (non-iron ore GDP growth was 5.3 percent in 2011).

1.4 These developments created spending pressures and led to fiscal slippage in 2011-12, which elicited a decisive and positive Government response in 2013 through a strong fiscal consolidation effort maintained through the year to date. This has comprised expenditure rationalization, revenue mobilization, debt management. Government has also made a recent decision and sought comprehensive support to strengthen revenue administration. Overall coordination between fiscal and monetary policies has also been improved. Addressing these pressing short-term issues has distracted from emerging medium-term priorities relating to

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the changing country context and the challenges they will bring but the Government has made the right choices in this regard.

Poverty Developments

1.5 Economic growth has generally translated into poverty alleviation in Sierra Leone. The poverty headcount has declined from 66.4 percent in 2003 to 52.9 percent in 2011.1 The overall reduction was led by strong growth in rural areas, where poverty declined from 78.7 percent in 2003 to 66.1 percent in 2011, yet this figure was overall still higher than urban poverty. Urban poverty declined from 46.9 percent in 2003 to 31.2 percent in 2011. Demographically, Sierra Leone remains a rural and extremely young country with the majority of the population below the age of 20 and more than 75 percent are below the age of 35.

1.6 Sierra Leone experienced an overall decline in inequality between 2003 and 2011 (Figure 1.1). While inequality declined within Freetown and within rural areas, increasing only in other urban areas, the overall drop was largely driven by stronger growth rates in areas with higher poverty rates in 2003. Thus it was higher growth rates in previously high poverty districts, and higher growth rates outside of Freetown that narrowed the overall inequality gap between urban and rural areas between 2003 and 2011.

1.7 Educational completion rates are low by international standards. According to the 2011 Sierra Leone Integrated Household Survey, 56 percent of adults over the age of 15 have never attended formal school. Current enrollment indicators show mixed results from 2003 to 2011. Both net and gross primary enrollment rates have declined, but higher level education indicators have improved, as greater numbers of students were attending junior, secondary, and post-secondary education. They were also attending at ages more closely appropriate to grade level expectations. In addition, gender parity has almost been reached in primary education, though gaps do open as female students approach child-bearing age. Substantial gaps remain across income groups and between urban and rural areas.

1.8 Agriculture remains the dominant livelihood throughout Sierra Leone. In 52.4 percent of all households, the head listed their main occupation as agriculture. In rural areas, this percentage was 78.3 percent. Households in which agriculture was the primary occupation of the household head were poorer than other occupations and their poverty levels are decreasing more slowly. The poverty headcount for agricultural households showed an 18.5 percent decrease to 60.8 percent in 2011, while other households experienced a 25.5 percent

1 ‘A Poverty Profile for Sierra Leone, June 2013, World Bank, Poverty Reduction & Economic Management Unit.

Figure 1.1: Poverty by District, 2011

Source: Calculations based on SLIHS, 2011.

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decrease to 30.7 percent. Rice was the most common crop grown by rural agricultural households, both poor and non-poor, though poor farmers have smaller plots.

1.9 Access to services was low overall, but particularly in rural areas. Less than one percent of households in rural areas list electricity as the main source of lighting, compared with 57.7 percent in Freetown and 12.7 percent in other urban areas. Access to a primary school was consistently high across the country, with most households being less than 30 minutes away. Access to a secondary school, however, was more limited in rural areas, as 57.4 percent of residents were more than one hour’s travel from a secondary school. Access to health facilities was also much better in urban areas. Of rural residents, 35.5 percent lived more than one hour from a clinic and 71.7 percent more than one hour from a hospital. Less than 5 percent in urban areas were more than one hour from a clinic.

2. MACROECONOMIC POLICY FRAMEWORK

A. RECENT ECONOMIC DEVELOPMENTS

2.1 Real GDP growth in 2012 increased by 15.2 percent after expanding by 6.0 percent in 2011. The sharp increase was largely due to the commencement of iron ore production that reached 6 million tons in 2012 while non-iron ore GDP growth remained relatively robust at 5.3 percent (down marginally from 5.8 percent in 2011) (Table 2.1). The latter was led by an expansion in agricultural production, services and construction, as spending, particularly on publicly financed roads and the two large iron ore projects, continued at increased levels. The overall 2012 result was significantly lower than previously forecast mainly due to operational problems at the large Tonkolili iron ore mine.

2.2 Inflation trended lower over the year to July 2013 to 10.6 percent (from 11.4 percent at the beginning of the year) after reaching a peak of over 20 percent in mid-2011. The slowing reflects a stable currency, stable retail fuel prices due to subsidies, low and stable government charges and fees, very low private sector credit growth and lower than expected GDP growth rates. The persistence of double digit inflation reflects the expansionary fiscal policies of the past three years and possibly structural/supply impediments.

2.3 A rising current account deficit averaging 40 percent of non-iron ore GDP in 2011-12 resulted from imports associated with the construction of two large iron ore mines and were financed by foreign direct investment (FDI) inflows. Solid increases in commodity exports—of diamonds, rutile and iron ore—were overwhelmed by a substantial increase in imports due to the development of the two new iron ore projects, the sharp increase in freight, insurance and port service charges due to iron ore shipments in 2012, export price discounts to the Chinese equity partner in the largest iron ore mine and Government spending on infrastructure. The current account deficit reached US$1,389 million in 2012, although the trade deficit declined to US$620 million from US$1,246 in 2011. The growth in iron ore export values was, however, significantly below official projections for 2012 reflecting a collapse in global iron ore prices by September 2012 (to below US$90/ton) and production problems at the Tonkilili mine operated by African Minerals Ltd. (AML). Prices recovered somewhat over the final quarter of 2012 to reach above US$140/ton, but have since traded lower to around US$130/ton by October 2013. Both the trade and current account deficits are expected to

4

improve by the end of 2013 due to increases in phase I ore production and exports toward nameplate capacity in both mines.

Table 2.1: Sierra Leone: Selected Economic Indicators, 2009-16

2.4 Fiscal performance over 2010-12 which was marked by slippage has experienced a sharp turnaround in 2013 to-date, the result of a concerted fiscal consolidation effort. Increased levels of domestically financed infrastructure spending within a weak public investment framework and loss of some control over recurrent expenditures, particularly the wage bill and election spending, coupled with weak revenue administration, all led to higher than budgeted fiscal deficits and domestic financing difficulties. With limited deficit financing and liquidity management instruments, this resulted in high treasury bill yields (driving up domestic

2009 2010 2011 2012 2013 2014 2015 2016Estimate -----------------Projected---------------------

------------Annual Percentage Change, unless otherwise indicated---------------National accounts and pricesGDP at constant prices 3.2 5.3 6.0 15.2 13.3 14.0 12.4 7.7GDP deflator (excl i ron ore) 8.6 17.2 17.3 14.3 8.8 10.6 9.5 6.7GDP at market prices (bi l l ion leone) 8,183 10,256 12,755 16,459 20,357 24,713 29,421 33,298Consumer prices (end-period) 10.8 18.4 16.9 12.0 9.0 7.5 6.0 5.4Consumer prices (average) 9.2 17.8 18.5 13.8 10.3 7.7 6.7 5.7External SectorTerms of Trade -2.6 6.8 -0.7 4.9 -1.6 -4.9 -0.6 -0.2Exports of goods (US$) -1.0 33.9 6.2 147.3 56.9 29.9 22.0 12.2Imports of goods (US$) -2.6 92.3 85.2 -3.6 18.6 5.8 3.5 4.5Average exchange rate (Le/US$) 3,410 3,978 4,349 4,344Nominal efferctive exchange rate -26.7 -8.2 -4.1 1.0Real effective exchange rate -0.7 11.5 8.7 14.7Gross International reserves (mths of imports ) 4.1 2.0 1.8 2.0 2.1 2.2 2.4 2.6Money and CreditDomestic credi t to the private sector 45.4 31.5 21.8 6.3 10.8 11.0 12.6 12.1Base money 19.7 34.6 13.0 18.5 14.2 17.1 15.2 13.8M2 28.3 21.8 20.0 23.1 14.8 18.8 16.5 15.091 day treasury bi l l yield (percent) 14.0 24.5 23.4 19.0

------------------------------Percent of non-i ron ore GDP-----------------------------------National AccountsGross capi ta l formation 9.3 31.1 42.2 28.6 18.2 19.1 19.3 19.3 Government 5.5 7.7 9.0 8.2 7.2 8.1 8.3 8.3 Private 3.8 23.4 33.1 20.3 11.0 11.0 11.0 11.0National savings 2.8 11.4 -2.8 -10.8 -0.8 8.6 11.7 12.2External SectorCurrent account ba lance (incl officia l grants ) -6.5 -19.7 -45.0 -39.4 -19.1 -10.5 -7.7 -7.2Current account ba lance (excl officia l grants ) -9.9 -26.0 -48.8 -41.2 -20.6 -11.9 -9.1 -8.6External publ ic debt (incl IMF) 28.9 30.4 32.6 27.8 27.3 27.4 27.3 27.6Central Government BudgetRevenue 9.0 9.9 11.5 12.2 12.4 12.4 13.1 13.4Grants 6.1 5.3 5.6 4.1 3.6 3.1 3.1 2.9Tota l expenditure and net lending 17.7 20.2 21.6 21.9 19.1 20.0 20.5 20.5Overa l l ba lance (before grants ) -8.6 -10.3 -10.1 -9.7 -6.6 -7.6 -7.4 -7.1Overa l l ba lance (incl grants ) -2.5 -5.0 -4.6 -5.6 -3.1 -4.5 -4.3 -4.2

Memorandum Items:GDP (US$million) 2,400 2,578 2,933 3,789 4,607 5,390 6,203 6,808Non-iron ore GDP (US$ million) 2,400 2,578 2,926 3,529 4,000 4,531 5,112 5,637Source: IMF Staff Report, 2013 and Bank staff estimates.

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interest costs) and the accumulation of domestic arrears and large cheque floats at year-end, all of which impacted adversely on financing costs to the budget and posed systemic risk for the financial and business sectors. The Auditor General’s disclaimer of opinion on the 2011 audit underscored the poor fiscal accountability centered on widespread payments without documentation, failure to collect withholding tax, failure to undertake bank reconciliations, failure to maintain fixed asset registers and ineffective or non-existent internal audit units.2

2.5 In 2012 the budget deficit (on a cash basis) reached Le943 billion (5.6 percent of GDP), nearly double the budgeted deficit of Le507 billion. While domestic revenue collections were Le267 billion higher than budget, this masked a structural deterioration in revenue collections. Most of the increase in revenue was from advanced mineral payments and fees, a large part of which may not continue into 2013. Other categories of revenue were well down on budget, including corporate income tax, import duties, domestic Goods and Services Tax (GST), mining royalties, parastatal revenues, departmental revenues and road user charges. Across the board over-expenditures totaling Le549 billion—comprising wages and salaries by Le138 billion, goods and services and transfers over by Le119 billion, (including grants to education Le53 billion), domestically financed capital expenditures by Le146 billion, foreign financed capital spending by Le116 billion, and interest payments Le31 billion. Election spending amounted to Le177.5 billion which was under budget (expected to be mostly financed from foreign sources, but ended up being largely financed from domestic sources to an amount of Le113 billion). Road maintenance spending on was lower by Le9 billion.

2.6 The 2013 budget was submitted to Parliament in late December 2012 following the election of the new government. The budget was hastily assembled being aimed at ensuring supply for the new fiscal year and was based on earlier estimates of the 2012 outturns which provided an unrealistic base for revenue and expenditure management in 2013. With the need to finance the large fiscal overhang being the dominant concern in early 2013 and with prescribed limits on central bank financing being invoked, the application of approved 2013 budget envelopes was abandoned and only essential services were financed.

2.7 Faced with the large fiscal overhang from 2012 the new Government and Minister of Finance moved decisively in early 2013 to restore budget control and accountability. The stock of outstanding obligations at end-2012 was established to be Le299 billion. This comprised Le59 billion in personnel obligations (mostly obligations to the national pension fund NASSIT), goods and services obligations of Le133 billion, domestic capital expenditure obligations of Le59 billion and central bank overdraft obligations of Le48 billion. The Government’s newly formed cash management committee met weekly and expenditures were approved only for essential categories, whilst additional revenue was mobilized. By July 2013, all the 2012 outstanding amounts were paid, without recourse to new debt issuance from the domestic capital market.

2.8 To comply with constitutional requirements, the Government introduced a Supplementary Budget for 2013 into Parliament which was approved on July 4, 2013. The supplementary took account of the fiscal overhang and the revised 2013 estimates and projected a lower fiscal deficit of Le563 billion (3.1 percent of GDP) (Table 2.2). The lower deficit results

2 Auditor General’s Report on the Public Accounts of Sierra Leone, Freetown, December 2012.

6

from expected higher revenue (up Le221 billion on 2012 outturns), whilst overall expenditure levels were held constant against the much higher 2012 outturns (but Le153 billion higher than the original 2013 budget). Within the expenditure categories, wages and salaries and interest payments are up 13-15 percent offset by a marked decline in election-related expenses. Both domestic and foreign financed capital expenditures have been held generally constant with targeted expenditures aligned to the Government’s new development plan goals (roads, power and water priorities). The projected revenue increases are from expected increases in excise duties and road user charges on petroleum products. The budget is projected to be financed from mainly foreign sources (Le563 billion), while domestic sources will contribute 38 percent (Le350 billion).

Table 2.2: Sierra Leone: Central Government Budget, 2009-16

2.9 Government has taken a number of measures to ensure that the fiscal consolidation effort in 2013 does not fall short of its objectives. These included stringent monitoring of tax compliance and efforts to reduce tax and duty waivers. On the expenditure side strict commitment controls and other expenditure control measures were complemented recently by a commitment cut-off timetable for 2013 that requires all commitments to be made in October and November. Overall there has been an improvement in coordination between fiscal and monetary policies.

2009 2010 2011 2012 2013 2014 2015 2016Estimate -----------------Projected---------------------

------------------------------Percent of non-i ron ore GDP---------------------------------Tota l revenue and grants 15.2 15.2 17.1 16.3 16.0 15.5 16.3 16.3 Revenue 9.0 9.9 11.5 12.2 12.4 12.4 13.1 13.4 Tax 6.8 9.0 10.9 11.5 11.4 11.4 12.1 12.4 Non-tax 2.2 0.9 0.6 0.7 1.0 1.1 1.0 1.0 Grants 6.1 5.3 5.6 4.1 3.6 3.1 3.1 2.9

Tota l Expenditure and Net Lending 17.7 20.2 21.6 21.9 19.1 20.0 20.5 20.5 Current expenditures 12.2 12.5 12.6 13.7 12.3 12.1 12.4 12.3 Wages and sa laries 4.9 5.4 6.1 6.0 5.9 6.0 6.0 6.0 Goods and services 4.3 4.2 3.1 3.0 2.8 2.7 2.8 2.8 Subs idies and transfers 1.8 1.6 2.2 2.6 1.7 1.8 2.0 1.9 Interest payments 1.3 1.6 2.0 1.9 1.9 1.6 1.7 1.6 Capi ta l expenditures 5.5 7.7 9.0 8.2 7.2 8.1 8.3 8.3 Foreign financed 4.2 4.2 6.2 5.2 4.6 5.1 5.1 5.0 Domestic financed 1.3 3.5 2.8 3.0 2.6 3.0 3.2 3.3 Net lending 0.0 0.0 0.0 0.0 -0.6 -0.2 -0.2 -0.2

Overa l l ba lance Before grants -8.6 -10.3 -10.1 -9.7 -6.6 -7.6 -7.4 -7.1 After grants -2.5 -5.0 -4.6 -5.6 -3.1 -4.5 -4.3 -4.2

Financing 2.5 5.1 4.6 6.0 3.1 2.8 2.8 3.3 External financing (net) 1.9 1.6 2.4 3.4 2.6 2.8 2.8 2.7 Domestic financing (net) 0.6 3.5 2.2 2.2 0.5 1.6 1.5 1.4 Bank 1.3 4.0 0.5 1.4 1.4 1.2 0.9 0.7 Non-bank -0.8 -0.5 1.6 0.8 -0.9 0.5 0.6 0.8 of which: change in arrears , float -0.6 -0.8 0.9 -0.1 -1.5 -0.1 0.0 0.0

Source: IMF Staff Report, 2013.

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2.10 Monetary policy remained relatively firm over 2012 supported by the legislative restrictions imposed on the Bank of Sierra Leone (BSL) relating to lending to Government, higher treasury bill yields in 2012 (25-30 percent) and little credit growth to the private sector. The issuance of large amounts of treasury bills to finance the 2012 fiscal deficit raised treasury bill yields markedly in 2012 which tended to crowd out credit to the private sector. Over the year to December 2012, net credit to Government from the banking system increased by 18 percent compared with 6 percent to the private sector and 21 percent for net foreign assets. Consequently, broad money increased by 23 percent over 2012. Holdings of treasury bills by domestic banks and the non-bank public increased by a substantial 60 percent from Le714 billion at end-2011 to Le1,143 billion at end-2012. The BSL overdraft to government (Ways and Means Advance) increased from Le27 billion at end-2011 to Le48 billion at end-2012, within the required ceiling. With the rigorous approach adopted by the new Minister of Finance in 2013 and improvements to debt management, there was no net issuance of treasury bills to the market over the first half of 2013 and with high levels of seasonal liquidity in the system and with the central bank having exhausted its supply of marketable securities, yields on government bills declined dramatically to historic lows (5-10 percent range) and low yields were maintained to end-September 2013. While government issued some new debt in July and August 2013, part of which was due to the conversion of non-interest bearing bonds on the central bank’s balance sheet, private sector credit growth remains stagnant. With credit to government from domestic banks now accounting for around 50 percent of domestic lending, negative real yields on treasury bills could pose a risk to the domestic banking system. Over 2013 banking sector returns on equity and assets have declined significantly to 6.0 and 1.3 percent respectively—one-third of the levels in 2011.

2.11 After depreciating 27 percent against the U.S. dollar in 2009, the market determined Leone remained relatively stable between 2010 and 2012, depreciating by 8 percent in 2010 and 4 percent in 2011, held steady in 2012 and up to September 2013. This reflected the flexible exchange rate policy, FDI inflows associated with the new iron ore projects, official inflows and, in 2012, the rise in iron ore export receipts. Gross international reserves stood at US$382 million at end 2011 (2.4 months of imports cover), US$420 million at end-2012 (3.1 months non-iron ore import cover) and are estimated to reach US$452 million at end-2013 (3.2 months non-iron ore import cover). With stability in the currency and maintenance of substantial international price index differentials, the real effective exchange rate has appreciated significantly over the past three years causing a deterioration in competitiveness. With iron ore exports picking up, the Government will need to be cognizant of Dutch disease issues.

2.12 Sierra Leone’s nominal public and publicly guaranteed external debt, including IMF and principal arrears, was estimated at US$981 million3 at end-2012 equivalent to 28 percent of non-iron ore GDP which compares favorably with 33 percent of GDP at end 2011. About 64 percent of this debt is owed to multilateral creditors, 13 percent to bilateral creditors, and 23 percent to commercial creditors. The largest multilateral creditors are the World Bank Group (US$225 million), the IMF (US$122 million), the African Development Bank (AfDB) (US$86 million) and the Islamic Development Bank (US$54 million). Debt to external commercial creditors consists of arrears accumulated before and during the civil war. A

3 All external loans contracted by state-owned enterprises are guaranteed by the government.

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debt reduction operation is under preparation, with World Bank assistance, to extinguish all eligible commercial debt.

2.13 Domestic debt (excluding accounts payable) amounted to US$409 million (11 percent of GDP) at end-2012, about 29 percent of total debt on issue. With the expansion of the fiscal deficit in 2012, public domestic debt increased significantly over 2012 by 24 percent. Most of the debt is held by commercial banks (69 percent of marketable securities) and the non-bank public (20 percent of marketable securities). To lessen rollover risk, the authorities have achieved an increase in the duration of the domestic debt portfolio from 6 months at end-2010 to 8.3 months at end-2012 and further lengthening has occurred over the first nine months of 2013. Even so, with a domestic portfolio duration of less than 1 year, significant rollover risk remains. Domestic interest payments increased from 1.4 percent of GDP in 2010 to 1.6 percent of GDP in 2012.

B. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

2.14 Real GDP growth is projected to average above 13 percent annually over the 2013-15 period fueled by increases in mining sector production, and then to slow to 8 percent in 2016 as full phase I production is achieved in both iron ore mines. Government projections no longer assume large second phase developments at the two iron ore mines, a caution reinforced by AML’s September 2013 announcement that it was shelving planned second phase expansion because of uncertainty in international iron ore markets (Box 2.1).

2.15 With uncertainty increasing in the iron ore sector, Government revenue projections have been reduced to take greater account of risk parameters over the forward years. Domestic revenues are expected to increase modestly from around the 12 percent of non-iron ore GDP achieved in 2012 to just under 13 percent over the forward estimates, reflecting expected increased tax and royalty receipts from the iron ore mines and significantly improved tax administration. Budgetary expenditures are to be focused on the priorities outlined in the new Poverty Reduction Strategy (PRS). In practical terms this is expected to entail a continued focus on the road, energy, water and transport sectors to provide the foundation for accelerated development, as well as health and education. The macroeconomic framework is anchored on a sustainable fiscal path where domestic financing is maintained around 1.5 percent of GDP.

2.16 Under these settings, the non-mineral economy is expected to grow at 6 percent in 2013, increasing to 6.5 percent on average per year over the 2014-16 period with growth coming from agriculture, construction and services, as well as a scaling up of infrastructure investments. For this to occur, it will be important that public investments in the transport, power and water sectors materialize and have significantly higher economic returns than presently. Overall, regardless of the prospects for phase II developments in iron ore and oil, the commencement of iron ore mining in 2012 is likely to be a game changer for the country, with GDP expected to increase from US$489 per capita in 2011 to US$998 per capita in 2016.

2.17 Monetary policy in 2013 and beyond is expected to remain relatively firm and target price stability to enhance policy credibility and anchor expectations. The prescribed limit on central bank finance to government and its compliance with the law provided an important stabilization anchor, forced necessary fiscal adjustment in 2013 and enhanced overall credibility

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in the financial sector. Monetary policy has been somewhat accommodative in 2013, reflecting the lack of marketable securities held by BSL and thus its inability to sterilize foreign exchange inflows. This issue will be addressed in 2014 with Government’s conversion of Le80 billion in

Box 2.1: Trends in the International Iron Ore Market and Impact on Government Revenues 1. Iron ore production and exports commenced in 2011 at the Tonkolili mine (operated by African Minerals Ltd.) and in 2012 at the Marampa mine (operated by London Mining). Iron ore production and exports are expected to be the dominant driver of real GDP growth and fiscal revenues over the foreseeable future in Sierra Leone as these two projects ramp up through various phases. Given the estimated low operating costs of iron ore production in Sierra Leone (under US$30/ton), variability in the volume of exports will very much depend on technical production issues, climatic conditions, financing for subsequent phases, the composition of off-take agreements and any political/social obstacles. Once mines are operating at design capacity, it should be possible to forecast production volumes with a reasonable degree of accuracy. 2. By contrast, revenue to Government will be highly sensitive to the vagaries of international iron ore prices which in 2012 experienced record volatility. The variability in government receipts is exacerbated by the tying of royalty payments to f.o.b. prices (that are then discounted further by off-take agreements which also impact income tax receipts adversely). This is particularly important given that the bulk of the estimated receipts to Government in the early years are expected to come from royalty payment streams, as various tax concessions under individual agreements limit significant early payments of income and indirect taxes. The sharp increase in income tax receipts after 2017 very much depends on the commensurate timing of second phase production at both mines. The experience of 2012 where iron ore royalty receipts were Le66 billion compared with budget expectations of Le179 billion highlights the significance of international iron ore price volatility and the application of the complex tax regime established for each iron ore company comprising a myriad of concessions.

3. Early preliminary modeling (FARI model) by the Government (with assistance from the IMF) shows that, using current World Economic Outlook price projections, the iron ore mining sector could generate an NPV of US$9 billion in government revenue over the next 20 years. While the revenue profile is highly sensitive to the assumptions about the phasing of capital expenditures at both projects, the outcome is also very sensitive to assumptions about iron ore prices. The model allows for a sensitivity analysis on prices and costs to establish a band of project outcomes. For example, in the event of a 30 percent iron ore price shock, the fiscal receipts from the two projects decline 35 percent (Figure 1). The very sharp decline in iron ore prices by the third quarter of 2012 (to below US$90/ton and then back again to US$150/ton by year end highlights the variability in price and consequent fiscal risks, particularly given the predominance of one variable, Chinese demand and especially the destocking/restocking cycle (Figure 2).

Figure 2: Iron Ore Prices, & World & Chinese Steel Production

Source: World Steel Association, Brussels.

Figure 1: Iron Ore Production and Government Revenues, alternative price scenarios

Source IMF Fari Model, Company production updates.

4. There is a widespread market view that, while restocking by Chinese mills could extend into 2013 and 2014, the expected increase in design capacity over 2013-14 (expected to add 425 million tons per annum) will outstrip world demand (expected to be 3.1 percent per annum), thereby limiting further trend increases in prices., but maintaining higher volatility.1 Under this scenario fiscal risk in Sierra Leone from iron ore receipts could be substantial with implications for fiscal planning and budget execution and financing. 1 Roskill, Iron ore: Market Outlook to 2020, November 2012.

non-interest bearing bonds on the BSL’s balance sheet to marketable securities in the second half of 2013. Reserve money growth is forecast to be on a declining trend to below 14 percent by

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2016 compared with 18.5 percent at end-2012. The challenge for Government and BSL is to maintain a prudent and well capitalized banking system and provide room for real private sector credit growth in an environment where Government, at least up to 2012, has been heavily reliant on the commercial banks for funding over-expenditure and where crowding out and bank capitalization could be important concerns.

2.18 The current account deficit in 2013 is expected to fall by about half to 21 percent of GDP and then to decline steadily to below 9 percent by 2016 as iron ore exports reach nameplate capacity. For the same reason the trade balance is expected to be negligible in 2014 and to turn positive from 2015 onwards. Gross international reserves are expected to trend modestly higher over the 2013-16 period from 2.0 months import cover in 2012 to 2.6 months in 2016. The external position would appear sustainable and, if anything, risks would be tilted towards greater inflows from potential mineral developments in which case, the challenge for Government will be management of the exchange rate whilst maintaining the competitiveness of the non-mineral sectors. Indeed, the real effective exchange rate appreciated by over 30 percent between 2010-12, and is likely to have appreciated further in 2013.4

2.19 The two main sources of risk to the outlook are from domestic economic management and the growth outlook in the world economy. The latter will be impacted by debt ceiling and monetary tapering decisions in the U.S. and the effect on capital markets, industrial production in China and its direct link to mineral commodity prices, Middle East conflicts and the impact on imported petroleum prices and regional stability, and European debt and growth developments. Iron ore prices have been particularly volatile in 2012 and 2013 rendering forecasts of production and government revenue receipts from mining particularly difficult (Box 2.1). The risk from domestic economic management relates to: (a) strong political pressures to increase recurrent and infrastructure spending without a robust public expenditure and investment process being established and without first ensuring adequate financing;5 (b) continued improvements to pay conditions and spread of individual contracts for the civil service; (c) continued subsidization of the retail price of fuel which has imposed a significant burden on the budget over the past three years with various unintended consequences such as sever under funding of road maintenance (Box 2.2); and (d) the potential for policy reversal critical areas. If expected mining revenues decline, financing the resultant unexpected fiscal deficits falls back on Treasury bill issuance to commercial banks and build up in domestic payments arrears, both of which increase risk premiums and budget costs and impact adversely on private sector development. Recourse to non-transparent and high cost public private partnerships and/or offshore commercial loans is also a risk, although improvements in MOFED’s public debt and investment management areas in 2013 will mitigate such risks.

2.20 In light of these risks and the Government’s fiscal track record, it may have been more prudent for the Government to have established a medium term fiscal consolidation plan. Given, however, the anticipated mineral revenues and the dire poverty and infrastructure

4 Friska Parulian, Sierra leone: Competitiveness and External Stability Assessment, Annex 1, IMF Staff Report for the 2013 Article IV Consultation, October 8, 2013. The report concludes that there is no strong evidence of real exchange rate misalignment in Sierra Leone that could lead to external instability in the medium term. Results show a small overvaluation of 3.5 percent under the external sustainability and 4.5 to 6.0 percent of undervaluation under macro balance and equilibrium exchange rate approaches. 5 Consistent with the optimistic scenario in the poverty reduction strategy.

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needs of the country, the Government’s preferred course was to formulate a substantial development plan and to focus efforts to mobilize the necessary fiscal resources to implement it. The objective of this operation and the IMF program is to support the Government’s objectives and to focus efforts on mitigating the inherent risks. These efforts have been directed at revenue raising policies, subjecting recurrent and capital spending plans to more rigorous scrutiny and enhancing transparency and accountability—all within a programmed sustainable macro-fiscal framework.

Box 2.2: Fuel Subsidies in Sierra Leone 1. The price fixing framework for domestic retail fuel was established after the oil refinery closed in 1992 with the objective of aligning the pump price with the full pass-through price whenever the landed cost in Leone changed by more than 5 percent. In late 2007 and 2008 landed costs increased significantly and the Government decided to subsidize the domestic prices of petroleum products through reductions in import and excise duties, the road maintenance charge and port, demurrage and strategic stock charges. With landed costs declining in late 2008 all taxes and charges were restored and a higher than pass-through cost was set to facilitate the payment of arrears to the oil marketing companies (OMCs). When landed costs began to increase again in 2009, the Government continued to hold the established fees and charges whilst domestic prices were fixed at lower than pass-through cost levels. The difference in price was then refunded to OMCs but with various lags resulting, at times, in the OMCs holding back tax payments. With increasing subsidies and arrears, in early 2011, the Government decided to resort to the earlier method of reducing various components of taxes, fees and charges such that the explicit subsidy was generally netted out. With further landed cost increases in the second half of 2012 and with import duties reduced to zero and other charges reduced significantly, however, the fixed low level of domestic prices (seen as necessary by the Government in the lead up to the November 2012 elections) resulted in a widening gap in costs and prices and build up in arrears to OMCs. In response to declining revenues the Government established a two tier system in September 2012 wherein commercial petroleum products would be charged the full tax and charges structure. 2. The amount of the effective subsidy varies from week to week with each change in the landed price and consequent tax recalculation, but has been on an increasing trend since 2008 (Figure 1). It is estimated to have exceeded Le100 billion in 2012 for gasoline alone, equivalent to over 5 percent of domestic fiscal revenues or just less than the sum of total corporate tax collections. The estimated figure would be much higher if diesel and kerosene subsidies are added (IMF estimates of the total fuel subsidy show it to be equivalent to 3.5 percent of GDP since 2008). It would be even higher again if the numerous firms and entities that are duty and excise exempt are included, particularly those supplying work on government contracts and mining sector operators.

Figure 1: Estimated Gasoline Implicit Price Subsidies, 2007-12

Source: Petroleum Monitoring Unit, Ministry of Trade and Industry, Sierra Leone, Weekly Data. 3. The current subsidy structure is highly cumbersome and inequitable with few benefits going to the poorest 40 percent of the population. The cost components and suppliers’ margins do not accurately reflect actual costs. Moreover there is apparently no legislative basis for the tax changes and, in fact, such ad hoc changes may be unconstitutional (as section 110 of the Constitution requires that any changes in rates of taxation be subjected to the approval of Parliament and be reflected in an act of Parliament). Importantly the arrangements are non-transparent and, with large arrears at times, budget accountability and execution are adversely affected. 4. The IMF and World Bank have consistently called on Government to address these concerns and to improve the pass-through of costs to domestic retail prices and accountability. The implementation of the fuel pricing mechanism as agreed with the IMF in 2011 proved challenging for the Government. The Government plans to reinstate the pricing formula in 2013. As part of the need for further fiscal effort, the IMF and World Bank once again have called on the Government to eliminate fuel subsidies through the resumption of the fuel pricing mechanism. In general, social assistance to the poor can be better targeted through other more efficient, direct and effective means rather than through non-transparent fuel subsidies. There may even be a strong case in favor of a regime of higher fuel taxes reflecting environmental considerations (externalities).

2.21 Preparations for the changing country context—characterized by expected mineral receipt volatility and potential over reliance on the domestic banking sector—are

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advancing with a number of policy and structural reforms under discussion and design. In this regard the establishment of a stabilization and investment fund, accompanied by a legislated fiscal rule, will facilitate both stabilization of revenues and capital spending and increased savings, as well as ameliorate the adverse impacts on the domestic securities market and real exchange rate. Parallel efforts are underway to establish a stronger basis for public investment management and to design and implement a capacity development program in this area. These efforts to prepare for the medium-term challenges have, understandably, had to take a back-seat in 2013 to the more immediate priority to re-establish fiscal and financial control, but this has been the right choice given limited capacity.

2.22 A debt sustainability analysis (DSA) conducted in October 2013 concluded that Sierra Leone’s risk of debt distress continues to remain moderate. The DSA updated the joint IMF-World Bank DSA of September 2012 and concludes that, despite an improved long term macroeconomic outlook, under the baseline scenario all debt indicators were below their respective policy dependent indicative thresholds throughout the projection period. Stress tests highlight Sierra Leone’s vulnerability to adverse shocks particularly affecting exports. The most extreme shock stemming from lower export growth shows a greater impact on debt indicators related to exports and government revenue. The recent assessment takes into account the onset of iron production and exports in 2012.

C. IMF RELATIONS

2.23 Government entered into a new three-year Extended Credit Facility (ECF) arrangement for SDR 62.22 million (US$95.9 million equivalent) with the IMF in October 2013, following cancelation of the previous ECF-supported arrangement earlier in 2013. Policies under the program are geared to creating fiscal space for improving basic infrastructure and social services while maintaining macroeconomic stability, strengthening revenue performance, improving public financial management systems, effectively managing the fiscal regime for extractive industries and supporting private sector development.

2.24 External financing requirements for Sierra Leone are reviewed on a regular basis as part of the IMF supported ECF arrangement. Financing requirements between 2013 and 2016 are projected to be US$2,566 million (Table 2.3). The US$1,226 million required for fiscal operations is fully identified with US$636 million coming from grants and the remaining US$591 million from loans.6 Financing for all other activities would be provided by a combination of FDI and loans.

2.25 The macroeconomic policy framework set out above provides an adequate basis for the proposed operation, although with a relatively high risk associated with it as noted above. Whilst there have been fiscal slippages in 2010-12, maintenance of prudent monetary and exchange rate policies over 2010-12 and corrective fiscal actions in 2013 have restored a robust macroeconomic framework and, if maintained as expected, the framework should be sustainable over the medium term. The IMF is conducting close program monitoring, particularly with respect to fiscal spending and financing limits and fiscal transparency and 6 These numbers are consistent with implementation of PRSP priorities under the macroeconomic framework agreed with the IMF on the basis of identified external financing. Implementation of the PRSP beyond core priorities will require additional financing.

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Government has re-affirmed its commitment to adhere closely to the agreed macro-fiscal program.

Table 2.3: Sierra Leone: External Financing Sources and Uses, 2009-16 (US$ million)

3. THE GOVERNMENT’S PROGRAM

3.1 The PRSP-3, the Agenda for Prosperity covers the period 2013-18 and sets out Sierra Leone’s vision to be an inclusive, green, middle-income country by 2035. This strategy follows the Agenda for Change the second PRSP that covered the period 2008-12. The proposed operation is fully consistent with the Agenda for Prosperity and the Government’s program. The Agenda for Prosperity is based on wide consultation, underpinned by an economic growth diagnostic analysis, and takes account of the lessons learned from implementation of the second PRSP. The strategy maintains the main thrust and areas of focus of the second PRSP and includes the following pillars: Diversified Economic Growth; Managing Natural Resources; Accelerating Human Development; International Competitiveness; Labor and Employment; Social Protection; Governance and Public Sector Reform; and Gender and Women’s Empowerment. Efforts have been made to improve implementation of PRSP-3, including targets that cascade down to the district level, where most of the collection and reporting of information takes place. The Strategy and Policy Unit in the Office of the President is tasked with managing quarterly reviews of the Performance Management Contracts of Ministries, Departments and Agencies (MDAs). 3.2 Recent positive developments in the mineral and hydrocarbon sectors have generated high expectations regarding economic opportunities. Implementation of PRSP-3 will need to address several key challenges facing Sierra Leone, but also prepare for managing extractives sector wealth (less of a factor during PRSP-2). Principal among these challenges are poverty reduction, further reducing the infrastructure deficit, improving public sector performance and governance; all consistent with the progress achieved during the Agenda for Change. Accordingly the PRSP-3 places emphasis on a re-prioritization of inclusive growth,

2009 2010 2011 2012 2013 2014 2015 2016 TotalEstimate -----------------Projected--------------------- 2013-16

Gross Financing Requirements 122.3 625.9 1,566.1 819.6 865.4 597.6 531.3 571.4 2,565.7A. Current account ba lance /a 234.2 621.1 1,591.3 830.3 806.7 520.2 445.0 468.4 2,240.3B. Debt service due /b 15.1 13.8 6.8 20.3 27.2 24.1 27.9 27.8 107.0C. Debt s tock reductions 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0D. Increase in reserves -127.0 -9.0 -32.0 -31.0 31.5 53.3 58.4 75.2 218.4

Financing Sources 122.3 625.9 1,566.1 819.6 865.4 597.6 531.3 571.4 2,565.7A. Government budget 197.8 186.4 231.1 227.8 261.2 295.0 328.5 341.5 1,226.2 1. Grants 139.5 130.7 148.7 107.0 136.2 134.8 162.1 202.5 635.6 a . Program support 85.0 61.2 50.5 61.7 41.8 42.7 52.9 60.2 197.6 b. Projects 54.5 69.5 98.2 45.3 94.4 92.1 109.2 117.7 413.4 2. Loans 58.3 55.7 82.4 120.8 125.0 160.2 166.4 139.0 590.6 a . Program support 11.4 16.8 0.0 24.0 32.5 14.0 10.0 10.0 66.5 b. Projects 46.9 38.9 82.4 96.8 92.5 146.2 156.4 169.1 564.2B. Net IMF Credi t to Bank of Sierra Leone 18.8 34.2 8.8 -0.3 6.6 14.8 12.1 9.4 42.9C. Al l Other -94.3 405.3 1,326.2 592.1 597.6 287.8 190.7 220.5 1,296.6/a Net of interest and officia l grants ./b Debt service i s shown before tradi tional rel ief and after MDRI rel ief.Source: IMF Staff Report, 2013 and Bank staff estimates.

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youth employment, natural resource management, gender empowerment and greater effort directed at poverty reduction. Ongoing World Bank operations in the country are in line with such pronouncements and aim at supporting Sierra Leone in identifying additional drivers of growth, especially in key sectors such as tourism, fisheries, trade facilitation and cash-crops. 3.3 PRSP-3 attaches high importance to maintaining macroeconomic stability through sound fiscal and monetary policies, expanding economic infrastructure including electricity supply and roads, and institutional requirements for managing mineral related inflows. Underpinning the maintenance of macro stability will be government efforts, supported by this operation, to (i) strengthen public expenditure management to ensure scarce resources are used as efficiently as possible; (ii) improve domestic revenue mobilization and management in order to preserve the fiscal space needed for implementation of the government’s program, and (iii) ensure effective poverty reduction strategy implementation is carried out by strengthening public sector reform. The increase in fiscal space should also support PRSP-3’s ambitious goals to further lift and sustain growth rates. Moreover the support to the mineral sector and to the power sector supports those specific PRSP-3 goals. IDA’s broader program of assistance, which is currently in transition between the completion of the Joint Assistance Strategy (JAS) and finalization of its successor Country Partnership Strategy is also fully consistent with PRSP-3 with operations directed to the energy sector, minerals sector, ICT, human development to support a development strategy based on the notion of growth poles centered on natural resource development sites.

4. THE PROPOSED OPERATION

A. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION

4.1 The policy actions in the proposed GRGG-6 are an integral part of the Government program as defined in the PRSP-3 and reflected in the Letter of Development Policy, directly supporting two of its pillars—Economic Diversification to Promote Inclusive Growth and Governance and Public Sector Reform—and remains fully consistent with the previous PRSPs and the two earlier supporting GRGCs. The previous two GRGCs sought to: strengthen public sector management, particularly covering public debt management, expenditure management, public procurement and teacher payroll integrity and costs; improve government revenues through legislative changes to curtail discretionary tax exemptions, issuance of tax identification numbers, improvement in enforcement and disclosure of mineral revenues; and achieve policy reforms in the power sector through institutional restructuring and legislative changes and submission to Parliament of public private partnership and freedom of information legislation.

4.2 The thematic focus of GRGG-6 maintains the themes of the previous two GRGCs and is directly concerned with the stated PRSP goals. It is also consistent with the economic diversification agenda of the PRSP-3, especially as it relates to the electricity sector which has been a primary focus through this series of operations. These themes go to the heart of the project development objective, to finance the Government’s development program articulated in the PRSP-2 and now the PRSP-3 with a focus on three specific purposes: (a) to improve the allocation and efficiency of public spending to support poverty reduction; (b) strengthen domestic resource mobilization and management; and (c) increase the provision of electricity.

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Strengthening public expenditure management should improve accountability and public service delivery, especially for the poor and vulnerable while domestic resource mobilization should facilitate Government’s plans to reduce the infrastructure deficit which will contribute to economic diversification as will support to power sector reform. The latter would also contribute directly to poverty reduction and provide a basis for shared prosperity. Finally support to the legal, regulatory and institutional framework for the minerals sector will be critical to ensure that the sector is well managed and contributes effectively to enable PRSP goals to be met.

4.3 The benefits of a programmatic approach to policy based operations in the still fragile post-conflict setting of Sierra Leone are likely to outweigh the risks, particularly because it provides the opportunity to re-evaluate progress before each successive operation. Additionally, the practice of embedding prior actions, in the Government’s own reform agenda as reflected in the PRS and fully harmonized with reforms supported by the Multi-Donor Budget Support (MDBS) partners through the common basis of the Progress Assessment Framework has helped to instill ownership of the reforms from the onset. The proposed operation follows a similar approach in this regard.

B. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS

4.4 The proposed GRGG-6 is the third operation in a programmatic series of three annual development policy operations launched in 2010 with a strong emphasis on strengthening the public finances and public sector performance more generally. The proposed program has built on a number of lessons learnt from the previous programs, in particular, the overarching need to dramatically reduce end–of-year fiscal slippages through greater expenditure control and management, reinforced by enhancements in accountability and transparency. The need to deter corporate approaches to government offering non transparent and costly remedies, especially in the energy sector, needed special attention. Further, the rapidly changing country context with the recent advent of large scale iron ore mining and prospects for petroleum development coupled with the fiscal and policy slippage in 2012 noted above, resulted in a delay to the timing of this operation both to provide the new government the opportunity to put appropriate measures in place and to provide comfort to the Bank about these. More importantly the hiatus also provided the Bank the opportunity to revisit a number of the agreed prior actions and to design others that are more timely and pertinent to the current challenges. Relevant background and the rationale for their selection are discussed below in terms of their importance to the program and expressed government commitment. Each theme is also consistent with the PRS and its stated priorities.

4.5 The operation is organized around three inter-linked themes: (a) Strengthening public expenditure management; (b) Improving domestic resource mobilization and management; and (c) Public sector reform. Strengthening governance is considered a key element in each of the thematic areas and is therefore considered to be a cross-cutting theme. This section summarizes proposed changes to previously agreed prior actions and highlights any other changes to prior actions.

4.6 Three prior actions concerned with strengthening public expenditure management have been replaced, as stale because they related to 2011 and are no longer relevant as noted above. These were for: (i) MOFED to tighten the systems-based expenditure commitment controls and

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appropriation checks, and take other actions as necessary to enforce budgetary discipline in order to ensure that the difference (variance) between total actual primary expenditures (outturn) and total originally budgeted primary expenditures in 2011 does not exceed 15 percent of total originally budgeted primary expenditures. (ii) MOFED to strengthen commitment controls and expenditure management practices, including improvements in budget-linked cash management practices, to ensure that the stock of accumulated expenditure arrears at end of FY 2011 does not exceed 7 percent of total actual expenditures for same year. (iii) National Public Procurement Authority to take compliance actions to ensure that the share of 2011 procurement transactions above the competitive threshold which are conducted through open competition, will improve by 5 percentage points over the benchmark of 68 percent established against the 2010 procurement transactions. The first two of these actions could not be met due to the fiscal slippage noted previously. Relatedly after a period of some improvement in public procurement the third action was also not met as slippage was experienced due to Government’s acceleration of its capital program. Moreover, the priority in the procurement area has also shifted to legislative issues which the Bank has been providing support to the government for and which need to be addressed in the immediate future. These prior actions have therefore been superseded by more relevant prior actions #1, #2 and #9 as detailed below.

PRIOR ACTIONS AND RESULTS

Strengthening Public Expenditure Management

GRGG-6 Prior Action #1: MOFED to prepare and execute a plan to fully account for unpaid financial obligations incurred in 2012 and to extinguish these in 2013.

4.7 Sierra Leone experienced a fiscal overhang in 2013 due to overspending in 2012, which represents non-transparent financing if it is not accounted for, and may have adverse consequences for the current year budget if it is not recognized. In Sierra Leone unbudgeted expenditures in each of 2010, 2011 and 2012 have resulted in significant unpaid obligations and a fiscal overhang in each subsequent year. Thus comprehensively accounting for the fiscal overhang and then building that into the budget of the subsequent year through a supplementary appropriation or supplementary budget, is important for measuring the fiscal position accurately and ensuring that budget execution and public service delivery are not subject to unnecessary disruption. In early 2013 Government prepared such a comprehensive accounting of the fiscal overhang from 2012, totaling Le299 billion (equivalent to 1.8 percent of GDP), together with a strategy for paying down these obligations before the year-end, which it subsequently implemented by July 2013.

GRGG-6 Prior Action #2: Submit a Supplementary Budget for 2013 to Parliament.

4.8 Budgetary over expenditure in one year that leads to a fiscal overhang in the following year, needs to be adequately accounted for and accommodated in the absence of which it will undermine budget execution in the subsequent year. In the Sierra Leone system such sanction to increase the appropriation is provided by Parliament, either through a supplemental appropriation or supplementary budget, consistent with the Constitution and the Government Budgeting and Accountability Act (GBAA). Moreover, this is also appropriate and required from an accountability perspective. On July 4, 2013, Government submitted a Supplementary Budget to

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Parliament for 2013, which sanctioned resources for the fiscal overhang from 2012 to be cleared and was also a realistic statement of revenues and spending needs over the remainder of the year. It is not expected that utilization of supplementary budgets will encourage persistent over-spending rather the increase in accountability and transparency within a rigorous IMF program should ensure the adherence of fiscal targets.

GRGG-6 Prior Action #3: Complete teacher verification exercise and update Human Resource records and teacher payroll accordingly.

4.9 The integrity of the Teacher Payroll has long been an issue of concern due to the deplorable state of Human Resource (HR) records for teachers and therefore a lack of confidence about the payroll. It has some 37,000 teachers, representing 53 percent of the 70,000 strong public service. This element of the reform program aims to establish HR records for teachers, physically verify their existence and cleanse the payroll accordingly. The exercise was launched in 2010 and through the first phase, unique files were established for each teacher based on both HR records data at the Ministry of Education, Science and Technology (MEST), payroll data with the Accountant General and other data from relevant sources.7 This was to serve as a benchmark for the next phase, by providing a metric on the number of teacher files that were incomplete, in terms of the underlying documentation. The second phase was a physical verification of all teachers in the field which included collection of biometric data, and collection of missing documentation for those whose HR files were incomplete. The end-result was to be completed, up to date teacher files and a correspondingly updated Teacher Payroll.

4.10 Under the first phase some 122,000 documents and electronic data files were assessed resulting in the establishment of about 35,505 new teacher files. Two-thirds of the total number of teachers on the payroll, or some 24,000 teachers were found to have no documents in their HR files. The second phase, to conduct a census and physical verification of teachers8 by visiting every school in the country commenced in late 2011 and was completed a year later. Government records indicated a total of 4,675 schools were to be visited but the field work revealed an additional 830 schools. Accordingly more teachers were interviewed—a total of 41,085. More than 200,000 supporting documents required to complete teacher files were obtained which overwhelmed the relatively small work force dedicated to the exercise.

4.11 The exercise generated a specific list of names of personnel on the payroll to be removed as they could not be verified (4,068) and an extensive list of employees due for retirement (940). Beginning in August 2013, the Government deleted those who could not be verified from the payroll, some of whom were subsequently restored as they came forward and it also notified the retirees, who remained on the payroll for a further period of one month. In net terms, the number of teachers on the payroll declined from 34,938 in July 2013 to 32,091 in October. The corresponding decline in the monthly wage bill was from Le28.4 billion to Le27.6 billion for an annual savings of Le10.2 billion. Importantly confidence in the Teacher Payroll has been restored. This action was completed in October 2013.

7These were the MEST (Records Office and Accounts Office), the Sierra Leone Teachers Union (SLTU) as well as electronic data from the Accountant General’s Office, SLTU and National Social Security and Insurance Trust. 8 This will allow for collection of missing HR records and biometric data for each teacher so that identified anomalies can be addressed.

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4.12 Results. The expected result of these measures will be to secure a much higher level of budget control, execution and accountability. Outstanding personnel, goods and services and domestic capital arrears at end-2013 to be no more than negligible levels. This will ensure a solid foundation for the 2014 budget and permit allocations to priority areas to be planned and implemented more efficiently and assist in reinforcing the planned improvements to the public investment management and public debt management processes. It will strengthen the ability of the Government to achieve the programmed stabilization of public domestic debt to under 13 percent of non-iron GDP over the medium term. Any overspending above prescribed limits will be followed by submission of a supplementary estimate to Parliament. The teacher payroll and HR reforms will result in a stabilization of teacher payroll costs in the annual budget, allowing greater allocations to education infrastructure, materials and training.

Improving Domestic Resource Mobilization and Management

GRGG-6 Prior Action #4: National Revenue Authority to take administrative and enforcement action to increase compliance with respect to timeliness of filing of Income Tax returns.

4.13 Income tax compliance has been historically low in Sierra Leone and there also appears to be a structural deterioration underway in revenues collected from the non-mineral economy in the past few years. This needs to be addressed as a matter of urgency because of the risk that an over dependence on mineral sector receipts will expose the public finances to all the attendant problems of uncertainty and volatility. This would also have an adverse effect on the long term prospects for citizen voice and government accountability, an important element in improving governance and performance. Thus domestic resource mobilization remains an important element of the reform agenda.

4.14 Compliance with filing tax returns is poor, although it is improving. In 2009 only 15 percent of tax returns due had been received by the filing deadline, and less than half of the expected returns were received by the National Revenue Authority (NRA). As well an estimated 80 percent of corporate returns and about half of individual returns remained outstanding at the year-end. The situation with respect to GST (introduced in early 2010) compliance is considerably better. A shift to self-assessments was made in 2009 but this has challenges of its own as it requires taxpayer capability to estimate own-liability and strict enforcement capacity by the tax authority.

4.15 Recent efforts have been made by the NRA to increase compliance with respect to timeliness of filing of tax returns. Administrative and enforcement efforts include: (i) media campaigns (television, radio and print media; (ii) street campaigns; (iii) public notices on bill boards; and (iv) telephone calls to tax payers (including all 150 large taxpayers and over 600 of the Medium and Small tax payers). In doing so the NRA has met the prior action with 88 percent of large tax payers filing their GST and PAYE Annual Returns on time in 2012 compared to 29 percent in 2010. Looking to the future these initial steps in improving compliance will need to be complemented by ongoing monitoring and continued enforcement to ensure filling percentages, deadlines and collections continue to improve.

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GRGG-6 Prior Action #5: National Revenue Authority to initiate recovery proceedings in all cases of income tax arrears and progressively recover tax arrears.

4.16 With weak tax compliance and weak enforcement capacity, tax arrears have been accumulating. A first important step was to begin to undertake a comprehensive accounting and consolidation to determine the extent of the arrears. In 2011 NRA began to tackle the issue of tax arrears which had been neglected for many years and estimated tax arrears to be Le20.6 billion. This served as considerable motivation for the NRA which then initiated recovery proceedings through issuance of demand letters in all cases of income tax arrears in order to reduce the stock of arrears thereby meeting the prior action. As a result of these actions an estimated Le10.8 billion of arrears were recovered from the private sector in 2012. The measures undertaken to recover tax arrears began with a demand letter and were followed up by enforcement measures including: sealing of taxpayer property, closure of business, naming and shaming of firms, prevention from travelling, and suspension of bank accounts.

GRGG-6 Prior Action #6: Disclose publicly in the first half of 2013, a statement of the revenue collected in 2012 from the top extractive industries covering at least 90 percent of the total collection, by revenue type, in accordance with §159 of the Mines and Minerals Act, 2009, and consistent with Government commitments under the Extractive Industries Transparency Initiative.9

4.17 Revenue transparency in the minerals sector through public disclosure. Under the Mines and Minerals Act, (2009) the Minister is required to annually disclose and disseminate detailed information on revenues from the sector to the public. Compliance has not been possible to date as compilation of this information is not yet possible due to its fragmentation across agencies and recording systems. This is being addressed through a pilot data integration project which aims to automate the process. In the interim Government committed to disclose publicly in 2013, a statement of the revenue collected in 2012 from the top extractive industries covering at least 90 percent of the total collection, by revenue type, in accordance with §159 of the Mines and Minerals Act, 2009, and consistent with Government commitments under the Extractive Industries Transparency Initiative. A statement of revenues collected was prepared by the NRA and disclosed on the MOFED website on June 4, 2013covering the 20 largest firms by turnover, which in turn accounted for 92 per cent of total revenues collected from the sector.10

4.18 Results. The expected result of these measures is for personal and corporate income tax collections to exceed the levels programmed in the 2013 supplementary budget and for steady subsequent annual increases in terms of non-iron ore GDP. Regular reports on revenue collected from the top extractive industries will show the tax revenue performance of the extractive sector and the non-mineral sector.

9 The prior action originally agreed to with Government was to publicly disclose relevant 2011 revenues in 2012, which was done. Subsequently, the Government made the public disclosure with respect to 2012 revenues which is a superior outcome. Given the issue of stale or dated prior actions noted above, the prior action was revised to refer to the most recent public disclosure. 10 http://www.mofed.gov.sl/index.php?option=com_frontpage&Itemid=1&limit=9&limitstart=27; accessed November 12, 2013.

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GRGG-6 Prior Action #7: Submit to Parliament the National Minerals Agency Bill. .11

4.19 The rapidly expanding and future needs of the mining sector will clearly require a strong and sustained institutional response. Responding to this challenge government decided to establish a National Minerals Agency as the principal regulator for the sector. This semi-autonomous entity is to be professionally staffed with the relevant range of technical skills required to oversee the sector. In this regard, the Government submitted the National Minerals Agency Bill to Parliament in March 2012 and following its passage the Act was gazetted in May 2012. Development partners including the U.K. Department for International Development (DFID) and the Bank are providing policy advice and Technical Assistance for the Minerals Agency.

4.20 Results. The expected result is the progressive establishment of the minerals sector regulator.

GRGG-6 Prior Action #8: National electricity distribution utility to implement operational loss reduction plan.12

4.21 Electricity access and consumption in Sierra Leone are among the lowest in Africa exacerbating poverty conditions and frustrating economic growth in the country. Sierra Leone’s limited and dilapidated power infrastructure base in generation, transmission and distribution is a major constraint to expanding electricity access, which remains below 10 percent. Electricity supply is largely inadequate to meet fast growing demand and cannot be realistically expanded until transmission and distribution bottlenecks are adequately addressed. Both transmission and distribution capacity is constrained due to high losses, including both technical and non-technical losses, which exceed 38 percent combined. Lack of adequate technical, operational and financial management capacity at utility level severely affects sector performance. In particular, inadequate metering, billing and revenue collection systems and poor accounting have led to low levels of commercial efficiency and continued financial fragility at utility and sector level. Improving energy sector performance—through sector restructuring, a substantial increase in generation capacity, and upgrade and expansion of the transmission and distribution network—is a central element of the PRSP-3.

4.22 A credible loss reduction program can help address some of the major power sector challenges. While reducing technical losses requires extensive investments on network rehabilitation spanning the medium- and long-term, non-technical losses can be brought to an acceptable level within 18-24 months. Government identified that reduction of non-technical losses through installation of prepaid meters as an effective action to increase collection efficiency and immediately boost the commercial performance of the sector. This consideration is the basis of the related prior action, which entails the implementation of a loss reduction plan with a clear focus on non-technical losses by the end of 2012. Government initiated a re-metering program in 2011 and increased installation of prepaid meters in Freetown by 40 percent

11 At the time of preparation this Bill was initially titled, the “The National Minerals Authority” Bill and hence the original formulation of the prior action had referred to the “Authority”, now revised to “Agency” consistent with the final legislation. 12 Prior action originally formulated to state, “National Power Authority to implement operational loss reduction plan”. Now revised to reflect that NPA no longer a legal entity following sectoral reforms.

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in 2012, to reach a total of 41,609. Collection efficiency, as measured by the ratio of actual collections to amounts billed, also rose in 2012 to 78 percent, from 67 percent in 2011.

Results. The expected results are a sustained improvement in the collection ratio.

GRGG-6 Prior Action #9: Government to issue a Letter of Government Policy in Utility Reform for the Electricity Sector, committing to a performance based contract for utility operation and management to be awarded to a competitively selected specialized firm.

4.23 The electricity sector is in a state of transition due to the recent approval of the unbundling reform. Institutional and regulatory frameworks of the sector are at an early stage of development. Oversight of the sector falls under the Ministry of Energy, which is understaffed and lacks the resources needed to efficiently run the sector, and there is no regulatory authority. Objectives and principles for setting electricity tariffs have been approved by Cabinet and should constitute the basis for a new tariff scheme soon to be adopted. The 2011 Electricity Act established unbundling of the sector through the separation of the National Power Authority (NPA)—the single, vertically integrated utility—into two state owned enterprises: (i) the Electricity Generation and Transmission Company; and (ii) the Electricity Distribution and Supply Authority. The Electricity Act requires that employees, as well as all rights, liabilities, assets, obligations and privileges of the NPA be transferred to or imposed on the new utilities. None of these has been put into effect to date and over the past two years, despite its lack of legal status, NPA has continued business as usual.

4.24 Prospects for recovery and reform in the electricity sector hinge upon the establishment of an effective national electricity distribution utility. The distribution utility is the key agency of the power sector, the one that ultimately brings light to people and power to firms. The national distribution utility will be allocated staff and competencies from NPA, whose weak managerial capacity and endemic operational issues have been at the heart of Sierra Leone’s power sector challenges in the past years. The establishment of a national electricity distribution utility with adequate management and operational capacity as part of the unbundling reform is critical to leverage investments by multiple private and development partners and transform the power sector into an engine of economic and social growth. The investment climate and prospects for private sector participation in the unbundled sector will depend on the utility being perceived as a credible off-taker of privately produced power.

4.25 Government has decided that a performance based contract for utility operation and management (PBCUOM) would constitute an appropriate framework to help build the national distribution utility. The Letter of Government Policy in Utility Reform in the Electricity Sector dated October 2, 2013 confirms the Government’s commitment to the unbundling reform as well as the choice to place the national distribution utility under a performance based contract for utility operation and management. Under the PBCUOM, a specialized firm (Contractor) will be competitively selected to manage and operate the utility with fully delegated authority and clearly identified result targets. The main deliverable under the PBCUOM will be the implementation of a comprehensive Business Plan for the utility, geared towards strengthening its staff competencies, management and operational skills, build effective approaches and practices, and ensure adequate performance on a permanent basis. Overall, with the appropriate results and other contract obligations in place, the PBCUOM is

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expected to help establish efficient utility management and operations, leading to improved technical performance, better service delivery and financial viability at both utility and sector level.

Results. The expected result of these measures is the issue of a performance based contract for utility operation and management between the national electricity distribution utility and a competitively selected, reputable operator. The Contract will include clearly identified Key Performance Indicators to assess Contractor’s performance.

ANALYTICAL UNDERPINNINGS

4.26 The Bank has undertaken analytical work complemented by a policy dialogue in the policy areas relating to the prior actions supported under the proposed operation. These cover the period 2010-12 and are summarized below (Table 4.1).

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Table 4.1: Prior Actions and Analytical Underpinnings

Prior Actions Analytical Underpinnings

Strengthening Public Expenditure Management

MOFED to prepare and execute a plan to fully account for unpaid financial obligations incurred in 2012 and to extinguish these in 2013.

(a) Public Expenditure Review (2010); (b) PEFA Review, various years; (c) Integrated Public Financial Management Reform Program, Implementation Support Reports, various years.

Submit a Supplementary Budget for 2013 to Parliament. (a) Public Expenditure Review (2010); (b)Auditor General’s Report on the Public Accounts (2012).

Complete teacher verification exercise and update human resource records and teacher payroll accordingly.

(a) Public Expenditure Review (2010); (b) AfDB TA on teacher payroll.

Improving Domestic Resource Mobilization and Management

National Revenue Authority to take administrative and enforcement action to increase compliance with respect to timeliness of filing of Income Tax returns.

(a) Public Expenditure Review (2010); (b) TA provided by FIAS/IFC; (b) DFID TA.

National Revenue Authority to initiate recovery proceedings in all cases of income tax arrears and progressively recover tax arrears.

(a) Public Expenditure Review (2010); (b) TA provided by FIAS/IFC; (b) DFID TA.

Disclose publicly in the first half of 2013, a statement of the revenue collected in 2012 from the top extractive industries covering at least 90 percent of the total collection, by revenue type, in accordance with §159 of the Mines and Minerals Act, 2009, and consistent with Government commitments under the Extractive Industries Transparency Initiative.

Mines and Minerals Act (2009).

Public Sector Reform

Submit to Parliament the National Minerals Agency Bill Mining sector TA

National electricity distribution utility to implement loss reduction plan. (a) Sierra Leone Power Tariff Methodology (2011);(b) Sierra Leone Energy Sector Utility Reform Project (2013).

Government to issue a Letter of Government Policy in Utility Reform for the Electricity Sector, committing to a performance based contract for utility operation and management to be awarded to a competitively selected specialized firm.

(a) Sierra Leone Power Tariff Methodology (2011); (b) Sierra Leone Energy Sector Utility Reform Project (2013).

C. LINK TO CAS AND OTHER BANK OPERATIONS

4.27 The proposed GRGG-6 is fully consistent with the JAS prepared in collaboration with the AfDB and the International Finance Corporation, discussed by the Board on April 6, 2010. The JAS established the Bank’s support to the PRSP-2 covering the period FY10-13 through its two pillars on Human Development and Promoting Inclusive Growth. A successor Country Partnership Strategy is under preparation to support the newly launched PRSP-3. A CAS Progress Report prepared in 2012 emphasizes the centrality of Development Policy Operations (DPOs) to the Bank’s continued engagement in Sierra Leone and introduces a third pillar on

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Managing the Extractives Boom in recognition of the changing country context. Other Bank operations in public financial management, the minerals sector and the energy sector are linked to the proposed operation and also provide valuable support through Technical Assistance.

4.28 In the energy sector, the ongoing Energy Access Project (EAP) and the proposed Energy Sector Utility Reform Project (ESURP) will provide critical support to continue and extend the loss reduction plan to also cover technical losses. In particular, the EAP is financing the installation of an additional 20,000 prepaid meters and urgent rehabilitation of some of the weakest components of the distribution network in Freetown. The ESURP is focused on improving the technical, operational and commercial performance of the national electricity distribution utility. The associated investment program targets the extensive rehabilitation and upgrade of the national distribution network, contributing to increasing the transmission capacity of the system, as well as to improving service quality and reducing technical losses.

D. CONSULTATIONS AND COLLABORATION WITH DEVELOPMENT PARTNERS

4.29 Sierra Leone has an established system of undertaking consultations with relevant stakeholders where legislative reforms are to be undertaken. These are largely confined to the government sphere but are nevertheless important in ensuring consistency and ownership. Consultation on the reforms supported under DPOs has been uneven and more limited.

4.30 The Bank collaborates closely with the IMF and the MDBS partners comprising the AfDB, DFID, and the European Union. This extends to a close discussion and collaboration on macro-fiscal and financial sector issues and structural reforms with the IMF. Close collaboration with the MDBS partners encompasses program design and implementation. The IMF and MDBS partners have been providing financial support to Sierra Leone since the end of the civil war in 2002.

5. OTHER DESIGN AND APPRAISAL ISSUES

A. POVERTY AND SOCIAL IMPACT

5.1 Measures supported by the proposed GRGG-6 are expected to have a positive and direct impact on poverty reduction. Provisional results indicate that—whilst being supported by similar operations—the poverty headcount declined in Sierra Leone between 2003 and 2011, with the incidence of poverty declining from 66 percent to 53 percent. Other measures of poverty also declined over the same period. Furthermore, the Government’s 2012 program appears to have had the expected impact of stimulating growth, generating additional employment opportunities, and extending the reach of critical health services, guided by PRSP-2.

5.2 No significant adverse social or poverty impacts are expected from the prior actions supported by the operation. Measures supported through this operation could have a minor impact on the poor in two areas, namely from efforts to increase compliance with the filing of income tax returns and from efforts to improve the provision of electricity. The reasoning for drawing the conclusion noted above is detailed further below.

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5.3 Increasing compliance with filing income tax returns would likely have positive distributional consequences. Clearly there would be social costs associated with increased compliance and therefore welfare consequences. But these would depend to a large extent on where in the income distribution the burden of increased compliance fell. Increased tax compliance efforts would fall on those working in formal jobs in the private sector and having higher incomes. According to the data from the 2011 Sierra Leone Integrated Household Survey, there would be almost no direct impact on poverty. Only a very small percentage of the poor population is engaged in wage labor, which overall accounts for less than seven percent of the total labor force. Of those poor individuals in wage labor, nearly all those working in the formal sector (which constitutes the taxable population) are in public sector employment, and therefore already paying taxes through payroll deduction. It is more likely that the burden of increased compliance efforts would fall on relatively high income individuals as that is the basis for targeting compliance programs. To the extent that the additional revenue raised can be spent efficiently to extend and improve public services, the direct effects would be offset and the overall impact on the poor may be positive.

5.4 Electricity sector reforms in Sierra Leone are unlikely to lead to tariff increases with any direct effects on the poor in the foreseeable future. The 2011 Sierra Leone Household Income and Expenditure Survey found that by and large the poor have little or no access to electricity. For example, cumulatively across the first seven deciles of the income distribution less than 1 percent of monthly household expenditures are for electricity, and for the poor less than 0.3 percent of their total monthly household consumption expenditures were on electricity. In Sierra Leone electricity tariffs are already among the highest in Africa and the thrust and intent of tariff reforms should be to effect a reduction in the tariff thus giving rise to a positive poverty and social impact. Nevertheless, to encourage lower tariffs, it will be important to design an efficient and equitable tariff structure.

B. ENVIRONMENTAL ASPECTS

5.5 The reforms supported by the proposed GRGG-6 are not likely to have any positive or negative effects on the environment, natural resources and forests as they do not entail any environmental effect. The Government’s 2013 budget does, however, include investments in basic infrastructure and agriculture that may have some environmental effects. Many of these additional investments, should they materialize, would be financed by development partners, each with their own environmental requirements. In the long-run improvements in sector planning and public financial management may have positive environmental impacts through more reliable and predictable financing for the MDAs in charge of managing natural resources and the environment.

5.6 Potential positive environmental effects may arise from improved access to electricity generated mainly by hydro power as poor households switch from fossil fuels (wood and kerosene) and given the extremely limited access rates currently prevailing this is likely to be in the medium term. Household survey data show that the vast majority of the population does not use electricity for lighting or cooking. Only 2.7 percent of households use public electricity for lighting and 91 percent of households use kerosene for lighting. Similarly, 85 percent of households use firewood for cooking, 14 percent use charcoal, and almost none use

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public electricity.13 In view of these data, any short-run changes in lighting or cooking patterns that might result from a temporarily higher electricity tariff would be quite small and would not result in any significant environmental impacts. The sustained provision of affordable hydroelectricity should, over the long-run, induce a shift in lighting and cooking preferences towards electrical appliances that would have a substantially lower carbon-footprint than kerosene or charcoal.

5.7 Sierra Leone, located in the Upper Guinean Forest Ecosystem, hosts abundant richness of biodiversity and biological uniqueness. The country has five main ecosystem types including: (i) lowland rainforests; (ii) montane forests; (iii) savanna woodlands; (iv) freshwater and wetlands; and (v) coastal and marine systems. While biodiversity conservation and environmental protection are major objectives, increasing economic activity and infrastructure development are also imperative for the well-being of the population. The advent of large-scale mining in some of the remote regions of the country has highlighted the delicate balance between environmental/social management measures and exploitation of the country’s mineral reserves. Recognition of environmental and social consequences, and enforcement of appropriate mitigation actions, is of utmost importance if Sierra Leone is to undertake a sound and sustainable development path. The Government is conscious of the importance of environmentally benign and socially-responsive economic development, and has established a number of relevant institutions—namely the Environmental Protection Agency, the Bumbuna Watershed Management Authority, the National Protected Areas Authority and others. These institutions are in their early stages, and enforcement capacity is generally weak. The Bank and other development partners are, through their ongoing programs and projects, actively involved in institutional development and capacity-building activities to manage the environmental and social impacts of infrastructure development.

C. PUBLIC FINANCIAL MANAGEMENT, DISBURSEMENT AND AUDITING ASPECTS

Public Financial Management Systems

5.8 Although the Public Financial Management (PFM) environment in Sierra Leone continues to suffer from weaknesses, it has improved since the emergence of the last series of governance reform and growth (GRG) operations to warrant the continuation of a new series of GRG operations. Weaknesses remain due to inconsistencies in the enabling legal framework, as well as inherent capacity constraints of PFM actors, as a result of over-spills from the country’s historical fragility. Measurable progress has been achieved in critical areas of reform, partly due to the concerted efforts of development partners in support of the Government program of reforms, and partly as a result of government’s own demonstrated commitment to raise the profile of PFM within its menu of governance reforms. In its third year of implementation, the joint donor-supported project, the Integrated Public Financial Management Reform Project (IPFMRP), which currently serves as the vehicle and the essential thrust for implementing PFM reforms, has continued to show good intermediate outcomes supportive of addressing a number of key and more holistic PFM reforms that together will further strengthen accountability and financial management systems in the country.

13 Agenda for Change, Freetown, Sierra Leone, 2008.

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5.9 Considerable analytical work in the area of PFM has been conducted with the support of development partners in Sierra Leone during the past several years. Key amongst these were Public Expenditure and Financial Accountability (PEFA) assessments in 2007 and 2010, a Country Procurement Assessment Review (using the Organization for Economic Cooperation and Development bench-marking tool) in 2011, and an IMF Fiscal Affairs Department PFM Review in March 2008. A new PEFA assessment is planned for late-2013/early-2014. On the revenue side studies include ‘Tax Administration Reforms for Successful VAT Implementation’ published March 2008 and a 2010 Review of the GBAA and Financial Administration Regulations. The 2010 PEFA assessment indicates notable improvements in the PFM systems and processes in Sierra Leone (at both central and local government levels).

5.10 The PEFA assessments reported concrete PFM improvements in many important areas. These include: (a) strengthened strategic planning and budgeting; (b) annual budgets are published and publicly available; (c) budget execution and in-year financial reporting has been improved and all Ministries’ expenditures are transacted through the Integrated Financial Management Information System (IFMIS); (d) annual financial statements are drafted and submitted for audit within the legal timeframe of three months after the end of the fiscal year; (f) financial statements are prepared on a cash basis consistent with International Public Sector Accounting Standards, barring conformance deficiencies with the requirements for ‘consolidation’ and inclusion of ‘third party transactions’; and (g) despite their current weak capacities, internal audit functions have been established in 37 MDAs to support the systemic checks and controls across government entities.

5.11 The IMF conducted safeguards assessments of the Bank of Sierra Leone in 2002 and 2006, an update in 2010 and one is planned for 2014. The 2006 assessment concluded that significant progress had been made on the priority recommendations of the 2002 assessment. A follow-up report from 2009 indicates continued progress: International Financial Reporting Standards were introduced and implemented in 2007; the internal audit function is being strengthened; and the Government issued Le50 billion in 2008 as its capital subscription to the BSL per a Memorandum of Understanding established with MOFED in 2006 regarding BSL capitalization. Following completion of the 2010 safeguards assessment BSL has been addressing identified weaknesses in internal audit through training and recruitment.

Disbursement and auditing issues

5.12 Recipient and Financing Agreement: The proposed operation is a one-tranche IDA grant of SDR 16.3 million (US$25 million equivalent). The grant disbursement will follow the standard Bank procedures for Development Policy Lending. The administration of this grant will be the responsibility of the MOFED.

5.13 Funds flow arrangements: The Government of Sierra Leone shall identify a Foreign Exchange Account with the BSL, and which forms part of the country’s official foreign exchange reserves, into which the proceeds of the grant will be disbursed upon grant effectiveness subject to meeting the agreed prior actions. The Sierra Leone ‘Leones’ equivalent of the funds in the Account will, within two working days, be transferred into the Consolidated

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Fund of the Government of Sierra Leone, and the amount recorded appropriately in the financial management system of the Government.

5.14 Disbursements from the Consolidated Fund by the Government of Sierra Leone shall not be tied to any specific purchases and no special procurement requirement shall be needed. The proceeds of the grant shall, however, not be applied to finance expenditures on the negative list as defined in Schedule 1 of the Financing Agreement. If any portion of the grant is used to finance excluded expenditures as so defined in Schedule 1 of the Financing Agreement, IDA shall require the Government to promptly, upon notice from IDA, refund an amount equal to the amount of the said payment to IDA. Amounts refunded to IDA upon such request shall be cancelled from the grant.

5.15 Assurance Requirements. Based on the moderate fiduciary risk associated with the operation, there will be no special or additional fiduciary arrangements established for the grant in terms of a requirement for an audit in as much as an audit remains an option. Within 30 days of the disbursement of the grant by IDA, however, the Financial Secretary of the MOFED of Sierra Leone shall provide written confirmation to IDA, certifying the receipt of the ‘Leones’ equivalent of the grant into the Consolidated Fund Account of the Government of Sierra Leone, the number of the account, the date of the receipt, and the exchange rate applied to translate the grant currency into Leones. In addition, as the Auditor General is required by law to submit its annual report and the audited accounts on the public consolidated fund to Parliament within 12 months of the end of the fiscal year, a copy of the said reports and accounts shall be provided to IDA within one month after the lapse of the 12-month period. The Government shall equally ensure that the annual entity financial statements of the BSL, audited in accordance with international standards on auditing as promulgated by the International Federation of Accountants, are publicly available.

D. MONITORING AND EVALUATION

5.16 Monitoring and evaluation of the operation will be the responsibility of the MOFED. To facilitate program implementation and the coordination of activities, the Government will appoint an Inter-ministerial Steering Committee chaired by the MOFED and comprising key Ministers and the Governor of the BSL. The Steering Committee will be assisted by a Technical Secretariat chaired by the Financial Secretary and composed of high level staff from relevant line ministries and the BSL. The Secretariat will be responsible for coordinating the activities of all government agencies involved in program implementation. In addition, as mentioned above, a PRS monitoring function has been established within MOFED. The Central Planning, Monitoring and Evaluation unit within MOFED is expected to coordinate with the planning, monitoring and evaluation units within each ministry to produce annual PRSP progress reports. The Results Framework in Annex 1 provides the list of result indicators that will monitor the progress over the proposed operation.

6. SUMMARY OF RISKS AND MITIGATION

6.1 The overall risk rating for the operation is ‘substantial’, with four main sources of risk that could potentially jeopardize the expected outcomes and benefits of this operation. These are: (i) Domestic policy risks; (ii) Risks from exogenous shocks; (iii) Fiduciary risk; and

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(iv) Political Risks. Measures to mitigate these risks in the event they materialize are being taken as outlined further below. The potential benefits of the proposed operation, however, outweigh the residual risks and warrant IDA’s assistance for implementing critical reforms and policy actions in coordination with other development partners. Efforts will be made to support risk mitigation actions across the operation to maximize the sustainability of the reform agenda.

6.2 Domestic policy risks emanate from weak domestic revenue collection efforts and continued fiscal slippage which could materialize through excessive recurrent and infrastructure spending or through policy reversals that have adverse consequences for private investment and private sector development. These risks could in turn destabilize the reform program supported by this operation. Recent fiscal slippages heightened by the 2012 elections and expectations of future resource windfalls have raised the prospect that such profligacy may continue. Concern about these risks is heightened by recent and sizable public sector pay increases plus a surge in spending on domestically financed capital projects. The proposed expansion of infrastructure spending under the new PRS is likely to continue to place pressure on the expenditure side of the budget. Recent policy reversals on the economic diversification agenda—apparently the result of vested interests exerting political pressure—are an equally important concern particularly as they relate to summary abrogation of legal contracts and entrenchment of monopoly positions with potentially adverse long term investment and growth consequences for the country. Much greater and broader stakeholder involvement prior to adoption of policies or arrangements that eventually leads to monitoring by Sierra Leone community interests is the ideal long term solution to mitigate such risks. To some extent these risks are mitigated by: (i) potentially very high economic rates of return from public investments that could spur higher growth rates; (ii) greater discipline, transparency and accountability from the focus of the Bank and IMF programs; and (iii) financing constraints that will limit both domestic and non-concessional offshore financing including from the central bank. These domestic policy risks are also partially mitigated by the Government’s intensive engagement by, and close monitoring of the program by other development partners.

6.3 External macroeconomic risks spread from a slowdown in the global economy. This includes slower growth in China, a key source of demand for Sierra Leone’s natural resources exports. These risks are combined with the possibility of external shocks from higher international commodity prices for food or fuel and unavoidable expenditure obligations resulting from a natural disaster.14 Such events could trigger a further deterioration in the terms of trade, depress growth, reduce remittances from abroad, and jeopardize macroeconomic stability and implementation of the PRS. To help mitigate these risks is the Government’s intention to maintain a satisfactory macroeconomic framework, bolstered by continuous dialogue with a community of multilateral and bilateral development partners (including the IMF, World Bank and the MDBS partners). The Bank also continues to monitor the impact of global conditions on Sierra Leone.

6.4 Fiduciary Risk due to weak institutional capacity and poor governance. Weak institutional capacity and corruption hampers the implementation of the reforms supported by the

14 Sierra Leone has faced natural disasters of various kinds, mainly in the form of recurrent floods (2009, 2007, and 2005) drought or landslides. The country is thus considered to be at relatively high mortality risk from multiple hazards with 13 percent of its area at risk and more than 35 percent of the population at risk.

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proposed operation and the broader PRS. On the institutional side, weaknesses include: (i) a lack of skills and training with respect to procurement procedures (which could slow procurement reform) and limited accounting skills, especially at the sub-national level. These risks are mitigated by the choice and design of the supported measures —calibrated to existing capacity—that include: the provision of extensive technical assistance and capacity building through ongoing or planned projects, the IPFMRP and the growing involvement of civil society in oversight activities. IDA and other development partners remain committed to building capacity and strengthening the fiduciary environment.

6.5 Political risks relate to the potential for cabinet reshuffles and related changes to personnel as well as to the potential for changing Government priorities. The former could result in the loss of reform champions or otherwise destabilize the reform program. These risks are partially mitigated by the close monitoring and engagement under the Bank and IMF programs as well as the MDBS partners.

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Annex 1: Policy and Results Matrix

Prior Actions under GRGC-4

Prior Actions under GRGC-5

Prior Actions under GRGG-6

Results Indicator Baseline Description/ Remarks

Strengthening Public Expenditure Management Objective: Helping to achieve much greater budget control and accountability, creating space for improved public investment spending Submission to Parliament of a bill that will govern public debt management including the accumulation and management of contingent liabilities

MOFED to prepare and execute a plan to fully account for unpaid financial obligations incurred in 2012 and to extinguish these in 2013.

RI-1: In 2014 expenditure of individual budget categories (sectors) are to be within 15 percent, of budgeted allocations. RI-2: By the end of 2014 public domestic debt is stabilized under 13 percent of non-iron ore GDP. RI-3: By the end of 2014 the fiscal overhang will be limited to the 5 percent of revenue statutory limit on the central bank overdraft facilities, and the combination of the change in domestic expenditure arrears and un-presented cheques (float) will not exceed 2 percent of total actual expenditure. RI-4: Cash Management Committee reports to be inclusive of information on the levels and age of arrears in 2014.

2009=3.3% 2010 = 15% Fiscal overhang 2010 = -204 2011 = 163 2012 = 215 Ways & Means 5% 2010 = 38 2011 = 50 2012 = 73 2% of Expenditure 2010 = 42 2011 = 55 2012 = 67 2013 = no timely reports provided.

Verified using data from MOFED. Verified using data from MOFED. Verified using data from MOFED. Verified from Cash Management Committee Reports.

Submission to Parliament of amendments to the Government Budgeting and Accountability Act (2005).

Submit a Supplementary Budget for 2013 to Parliament.

(a) The variance in expenditure composition in 2009 for the 20 largest budget heads will not exceed the overall deviation in domestic primary expenditures by more than 10 percentage points; and (b) the portions of budget head 501 assigned to the Office of the Vice-President and to Miscellaneous Services General will be reassigned to other appropriate budget heads; (c) starting from January 2010, all remaining expenditures from budget head 501, or any other budget head for unallocated expenditures, will be made in full conformity with sections 25(4) and 25(5) of the Government Budgeting and Accountability Act (2005).

The variance in expenditure composition in fiscal year 2010 for the 20 largest budget heads will not exceed overall deviation in domestic primary expenditure by more than 9 percentage points.

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Prior Actions under GRGC-4

Prior Actions under GRGC-5

Prior Actions under GRGG-6

Results Indicator Baseline Description/ Remarks

The government will have met, the following procurement benchmarks: (i) At least 50 public entities will have prepared procurement plans for 2010 that are approved by MOFED or other applicable oversight institutions, including each of the 45 that produced plans in 2009. (ii) The share of 20 randomly selected 2010 procurement plans41that meet agreed criteria for good quality will increase by 5 percentage points over the benchmark of 42 percent established against 2009 procurement plans. In addition at least 10 plans will be completed and approved by MOFED before January 1, 2010. (iii) MOFED will have established a procurement unit and a procurement committee in compliance with the applicable procurement law and regulations.

The share of 2010 procurement transactions above the competitive threshold which is conducted through open competition, will improve by 5 percentage points over the benchmark of 58 percent established against the 2009 procurement transactions

RI-5: By the end of 2014 three-quarters of procurement transactions are conducted through open competition. RI-6: Over the remainder of 2013 and 2014 any expected or actual overspending outside of GBAA proscriptions will be followed by the submission of a supplementary budget to Parliament.

Percentage of eligible procurement conducted through open competition. 2010 = 59% 2010, 2011, 2012 No supplementary budget prepared.

Verified using data from MOFED. Verified using MOFED data and Parliamentary records..

Commence national verification of all teachers on the payroll).

Complete teacher verification exercise and update HR records and teacher payroll accordingly

RI-7: Ratio of no. of teachers with HR records to no. of teachers on payroll will be at least 98% at end-2014.

2010 HR records=13,000 Verified=0 Payroll=37,000 Ratio HR records: Payroll=35%

Data from Accountant Genera (Payroll), and Ministry of Education, Sports and Technology

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Prior Actions under GRGC-4

Prior Actions under GRGC-5

Prior Actions under GRGG-6

Results Indicator Baseline Description/ Remarks

Improving Domestic Resource Mobilization and Management Objective: Strengthening the NRA’s ability to collect tax, enforce compliance of the tax laws and enhance accountability Submission to Parliament of a law or amendments to the laws governing taxation of income and external trade that will reduce the opportunities for discretionary tax exemptions and increase the transparency and accountability of exemption decisions.

RI-8 Proportion of large taxpayers filing tax returns on time will be 90% or higher in 2014. RI-9:Tax revenue as a percentage of non-iron ore GDP will exceed 12% in 2014.

2010=45% 2010 = 9%

Data from NRA. Data from NRA.

National Revenue Authority to issue Tax Identification Numbers (TIN) to cover all current tax filers (Income Tax and GST) and expand TINs to cover potential taxpayers with the aim of improving compliance.

National Revenue Authority to take administrative and enforcement action to increase compliance with respect to timeliness of filing of Income Tax returns.

National Revenue Authority to take enforcement action to increase compliance with respect to timeliness of filing of Income Tax returns (for companies and non-companies).

National Revenue Authority to initiate recovery proceedings in all cases of income tax arrears and progressively recover tax arrears.

Disclose publicly in the first half of 2011, a statement on mining revenues collected in 2010 (licences, royalties, income tax, PAYE, GST, etc.) from the 10 largest mining enterprises by turnover, in accordance with §159 of the Mines and Minerals Act, 2009, and consistent with Government commitments under the Extractive Industries Transparency Initiative.

Disclose publicly in the first quarter of 2013, a statement of the revenue collected in 2012 from the top extractive industries covering at least 90 percent of the total collection, by revenue type, in accordance with §159 of the Mines and Minerals Act, 2009, and consistent with Government commitments under the Extractive Industries Transparency Initiative.

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Prior Actions under GRGC-4

Prior Actions under GRGC-5

Prior Actions under GRGG-6

Results Indicator Baseline Description/ Remarks

Public Sector Reform Objective: Helping to achieve legislative and policy reforms in the energy sector and accountability generally Submission to Parliament of a Freedom of Information Act.

RI-10: By the end of 2014, national electricity utility will be under a performance based contract to a reputable operator on efficient and transparent terms. RI-11: Number of prepaid meters in Freetown to exceed 50,000 at end-2014 and collection efficiency rate to exceed 83% in 2014.

2013 = management contract without efficient or transparent terms. For 2011: Prepaid meters=29K Collection efficiency=67%

Verified by a publicly available performance based contract. Data from national utility and Ministry of Energy.

Approval of the proposed restructuring of the power sector including the policy commitment to reform the NPA.

Cabinet approval of the key principles that will guide the tariff methodology as laid out in the tariff study.

Submit to Parliament the National Minerals Agency Bill

Formalize power sales from Bumbuna to the National Power Authority through a power purchase agreement.

National electricity distribution utility to implement operational loss reduction plan.

Submit to Parliament a Bill for an Electricity and Water Regulatory Commission Act.

Government to issue a Letter of Government Policy in Utility Reform for the Electricity Sector, committing to a performance based contract for utility operation and management to be awarded to a competitively selected specialized firm.

Submit to Parliament a Bill for a National Electricity Act.

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Annex 2: Letter of Development Policy

Tel:+(232-22) 222211 Fax:+(232-22) 228472 Email: info@mofed.gov.sl

Dr. Jim Yong Kim President The World Bank Washington D.C. U.S.A.

Ministry of Finance & Economic Development Treasury Building George Street FREETOWN

November 26,2013

SIXTH GOVERNANCE REFORM AND GROWTH CREDIT

LETTER OF DEVELOPMENT POLICY

I am writing on behalf of the Government of Sierra Leone to request the approval of the Sixth Governance Reform and Growth Credit (GRGC VI) in the sum of US$25 million equivalent to support the financing of Government's development agenda articulated in the Agenda for Prosperity, which will be implemented over the period 2013-18. The proposed credit will support the: (i) improvement in the allocation and efficiency of public expenditure to support poverty reduction; (b) strengthening domestic resource mobilization and management; and (c) increase in the provision of electricity in the country.

2. Mr. President, Government achieved tremendous progress under the second Poverty Reduction Strategy, the Agenda for Change (2008-12). During the period, Sierra Le·one recorded strong economic growth, maintained relatively stable macroeconomic environment, achieved significant improvement in infrastructure (roads, electricity and water supply), increased agricultural production and improved delivery of social services underpinned by good governance and political stability.

3. To consolidate these gains and address the remaining challenges, Government prepared the third poverty reduction strategy-the Agenda for Prosperity (AjP). The overarcbing objective of the AfP is to promote sustainable inclusive green growth and poverty reduction. The AfP has eight sectoral pillars: (i) economic diversification to promote inclusive growth; (ii) managing natural resources; (iii) accelerating human development; (iv) international competitiveness; (v) labour and employment; (vi) strengthening social protection systems; (vii) governance and public sector reforms; and (viii) gender equality and women's empowerment.

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I. RECENT ECONOMIC DEVELOPMENTS- 2010-2012 FISCAL YEARS

4. The economy recorded impressive growth rates averaging 5.7 percent per armum during 201 0-11 driven by increased activities in agriculture, construction, manufacturing and the services sectors. The economy grew by an impressive 15.2 percent in 2012, following the commencement of iron ore mining and exports by two large mining projects. Excluding iron ore, the economy grew by a healthy 5.3 percent in 2012.

5. Inflationary pressures, which surged during 2010 - 201ldue to the food, fuel and financial crises, and the one-off effect of the introduction of the Goods and Services Tax in 2010 started to decline in 2012reflecting the stability of exchange rates, increased domestic food supply and proactive monetary policy. Inflation declined from 16.9 percent at end 2011 to 12.0 percent at end 2012.

6. The external position of the economy also improved following the surge in exports in 2012. Exports recovered from a decline of 3 percent in 2008 to grow by 147 percent in 2012 supported largely by export of minerals especially iron ore. Hence, notwithstanding the high level of mining and construction related imports, the current account deficit narrowed from 45 percent of GDP in 2011 to 39.5 percent of GDP in 2012. The external current account deficit was financed largely by FDI inflows. The overall balance of payments recorded a surplus in 2012, thereby contributing to the accumulation of foreign reserves to about three months of imports. This trend continued into the first half of 2013, with the value of exports almost doubling relative to the corresponding period in 2012.

7. Despite the increase in external borrowing to finance key infTastructure projects, Sierra Leone's external debt remains sustainable at 27.8 percent of GDP in 2012. The 2012 Debt Sustainability Analysis carried out jointly by the IMF and World Bank confirmed that Sierra Leone's risk of debt distress remains moderate.

8. The local currency, the Leone, which depreciated massively in 2009 triggered by the negative impact of the global fmancial crisis on mineral exports regained its strength in 2010 and has remained stable since then on account of the increase in FDI inflows, increased exports and inward remittances.

9. Domestic revenue collection also gradually improved from 9.9 percent ofGDP in 2010 to 12.2 percent of GDP in 2012 following the implementation of reforms to strengthen tax administration including the installation of the Automated System of Customs Data (ASYCUDA ++);establishment of the Domestic Tax Department (DID); introduction of the Tax Payer Identification numbers (TIN) to tackle tax evasion and tax avoidance; and broadening the tax base with the introduction of the Goods and Services Tax.

10. Government expenditures have been shifted in favour of capital spending as Government scaled up investment in roads, electricity and water supply as part of an overall strategy to support sustainable economic growth and poverty reduction. Accordingly, capital expenditure increased from 7.7 percent of GDP in 2010 to 8.2

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percent of GDP in 2012 while efforts continue to rationalize recurrent spending. Domestically funded capital expenditure increased from less than 1.0 percent of GDP in 2007 to average 3.1 percent during 2010-12.

Economic and Budgetary Performance- January to September 2013

11. Available data indicate that macroeconomic developments were positive in the first half of 2013. Economic activity was strong; hence the projected growth rate of 13.3 percent in 2013 is likely to be achieved as indicated by the higher than anticipated output from the mining sector in the first half of the year.

12. Inflationary pressures continued to decline in 2013supported by stable exchange rate, increased domestic food supply and proactive monetary policy. Inflation as measured by the Freetown Consumer Price Index fell to single digit of 9.5 percent in July for the first time in four years and continued to decline to 9.1 percent in September. The national inflation also fell to single digit of 9.9 percent in September from 11.4 percent in December 2012.

13. Domestic revenue collection continued to improve in 2013, exceeding the half-yearly target, reflecting strict monitoring of tax compliance and efforts to reduce tax and duty waivers. Domestic revenue increased to 6.4 percent of GDP during the first half of the year from 5.5 percent of GDP for the same period in 2012. Government expenditures were rationalized and remained within budgeted allocations during the first half of the year. This was made possible by the strengthening of expenditure control measures, improved cash management and better coordination of monetary and fiscal policies

14. The exchange rate, which is market-determined, remained stable reflecting the increase in exports, remittances, and increases in Foreign Direct Investments inflows.

15. Recognizing the high domestic debt burden and the associated huge debt service payments, Government adopted a policy stance of zero borrowing from the domestic securities market in 2013. As a result, interest rates on Government securities, which had remained sticky during the past few years declined sharply in 2013. The interest rate on the 91-day Treasury bills dropped from 19.0 percent in December 2012 to 3.5 percent in September 2013.

16. The improved performance of the economy combined with implementation of structural reforms and sectoral projects and programmes resulted in significant reduction in poverty. The Sierra Leone Integrated Household Survey (2011) estimated that the incidence of poverty declined to 52.9 percent of the population compared to 66.4 percent in 2003. Poverty in the rural areas also decreased to 66.1 percent compared to 78.7 percent in 2003. Similarly urban poverty declined from 46.9 percent in 2003 to 31.2 percent in 2011. However, poverty in the capital, Freetown increased from 13.6 percent in 2003 to 20.7 in 2011.

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II. MEDIUM-TERM MACROECONOMIC OBJECTIVES AND POLICIES

17. The outlook of the Sierra Leone economy is favourable with sustained economic growth, low inflation and improved fiscal and external positions. The key objectives of Government's medium term policy framework are to reduce poverty and create job opportunities through sustained and inclusive growth.

18. The medium-term objectives are: (i) to achieve real GDP growth (excluding iron ore) of 7.0 percent by 2017; Including iron ore, GDP is expected to grow by 14 percent in 2014, 12.4 percent in 2015 before moderating to 7.7 percent in 2016.; (ii) reduce inflation from 12 percent in 2012 to 5.4 percent by 20 17; and (iii) improve gross reserves coverage to about four months of non-iron ore imports.

19. Economic growth will be supported by the continued increase in iron ore production and export, increased productivity in agriculture, continued public investment especially in infrastructure and expansion in activities in the services and construction sectors.

20. Monetary policy will continue to target price stability over the medium term. The expected decline in inflation will be supported by proactive monetary policy, stable exchange rate and an increase of domestic supply of food items.

21. The exchange rate will remain market determined and foreign currency reserves are programmed to increase in light of the economy's vulnerability to external shocks.

20. The medium-term fiscal strategy aims to strengthen revenue collection, improve expenditure management, and reduce domestic debt. Domestic revenue will increase from 12.4 percent ofGDP in 2014 to 13.4 percent ofGDP in 2016.Revenue performance will be supported by continued sustained economic activity in the non-iron ore economy and the projected increase in royalties from the mineral sector. Government expenditures will continue to be rationalised and re-oriented towards capital investments. Total expenditures will average around 20.3 percent of GDP as capital expenditures increase from 8.1 percent ofGDP to 8.3 percent ofGDP over 2014-16.

22. The current account deficit (including official transfers) will narrow down to 7.2 percent of GDP in 2016 from 10.5 percent of GDP in 2014 as exports surge and mining related imports moderate.

23. Public Debt policy in the medium term prioritises grants and highly concessional loans to ensure debt sustainability in the medium to long term.

III. PROGRES IN THE IMPLEMENTATION OF THE AGENDA FOR CHANGE

24. Mr. President, as mentioned earlier, Government made considerable progress in the implementation of the Agenda for Change, which contributed to the strong economic growth and reduction in the incidence of poverty. The Agenda for Change focused on

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five strategic priorities: (i) Roads; (ii) Electricity; (iii) Agriculture; (iv) Health; and (v) Education. Below are highlights of achievements made in each of the strategic priorities.

25. Roads:- During the period of the Agenda for Change, several kilometres of trunk, feeder and township streets were constructed, reconstructed and or rehabilitated. The Freetown-Conakry Highway (86Km), the Makeni - Matotoka Highway (35 Km) and the Bo-Kenema Highway (65Km) were reconstructed with support from the development partners including the European Union and the World Bank. Rehabilitation work involving the reconstruction of total length of 175Km of pavement and drainage works on streets in Freetown and in the district headquarter towns is almost complete. The construction of the Hillside By-pass Road and the Lumley-Tokeh Road is in progress. With support from the Chinese Government, work on the Jui-Regent road is progressing well. As of June 2013, a total of 1,350 Km of feeder roads throughout the country was upgraded.

26. Electricity:- In September 2007, the total electricity generation in the country was under 10 megawatts. By end 2012, total national electricity generation capacity increased to over 75 MW following the completion of phase I of the 50MW Bumbuna Hydro Power Project, and installation of two (8.5 MW each) thermal plants at Black Hall Road as well as the installation of a l OMw thermal plant at Kingtom with support from the Japanese Government. Solar Street lights have also been erected in some parts in Freetown and in the district headquarter towns.

27. Agriculture:- Agricultural productivity significantly increased through the implementation of the Smallholder Commercialisation Programme (SCP). Nearly 500 farmer-based organizations and nearly 300 Agricultural Business Centres (ABCs) were established. Over four thousand hectares of inland valley swamps were rehabilitated during 2008-12. Thousands of kilometers of feeder roads linking ABCs to production centres and markets were constructed. About 60 Financial Services Associations and 20 Community Banks have been established throughout the country to improve rural financial intermediation.

28. Health:- Government introduced the Free Health Care Initiative in April 2010 to improve access to health services to vulnerable groups (pregnant women, lactating mothers and children under five years of age) and make progress towards achieving Millennium Development Goals (MDGs). Implementation of the Free Healthcare Initiative sharply improved access (by over 250%) to basic health care for these vulnerable groups. The percentage of deliveries taking place in public health facilities increased from 17.8 percent of total deliveries in 2008 to 54 percent in 201 1 and further to 60.9 percent in 2012. Similarly, the proportion of children immunised against diphtheria, pertusis and tetanus (penta 3) increased from 54.6 percent of total number of children to 83.8 percent in 2011 and further to 87.3 percent in 2012. The percentage of children sleeping under insecticide treated bed nets increased three-fold following the distribution of insecticide treated bed nets by Government and development partners. The conditions of service of health sector workers were also improved.

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29. Education:· During 2008-12, Government took measures to improve the working conditions of teachers and increased its support to tertiary education in order to improve the quality of education. The salaries of teachers were increased, ranging from 200 to 400 percent, depending on the grade of the teachers. Government subvention to the University of Sierra Leone and Njala University has been increased five-fold. Over 4,000 additional teachers were recruited based on the new National Policy on Teacher Training and Development. A teacher biometric verification exercise was completed in 2012 with aim of cleaning the teacher payroll. Government is taking action to update the teacher payroll by removing the names of the unverified and retired teachers from the payroll. A total of 35,305 Personnel Files have been created, which are being updated regularly. Government continues to pay for public examinations at the primary, junior and secondary schools levels; and also supporting the Girl-Child Education program.

Structural Reforms

30. In addition to macroeconomic and sectoral policies and programmes, Government implemented wide-ranging structural reforms including public financial management, financial sector, business regulatory, governance and public sector reforms.With the support of development partners, Government undertook several public fmancial management (PFM) reforms at both the central Government and Local Councils to ensure efficiency, transparency and accountability in the use of public resources. These include the installation of an Integrated Financial Management Information System (IFMIS) and its roll-out to high spending Ministries, Agencies and Departments; the establishment of internal audit units in MDAs and the Local Councils, improvement of the procurement function of Government, strengthening budget planning and execution, as well as Government accounting and reporting.

IV. THE SIXTH GOVERNANCE REFORM AND GROWTH CREDIT

31. Mr. President, the sixth Governance Reform and Growth Credit wiii support the strategic priorities of Government articulated in the Agenda for Prosperity. The proposed operations will focus on: (i) improving the allocation and efficiency of public spending to support the overall objective of poverty reduction; (ii) strengthening domestic resource mobilization and management; and (iii) increasing the provision of electricity in the country.

(i) Improving the Allocation and Efficiency of Public Expenditure

32. In recent years, extra-budgetary expenditures resulted in the accumulation of huge un­paid bills. To address these slippages; Government introduced measures to re-assert fiscal discipline in 2013 to clear these outstanding arrears. As a first step, Government prepared a strategy and an accounting framework for the clearance of these unpaid obligations. Secondly, to ensure that the clearance of these arrears does not displace the planned 2013 expenditures, Government submitted a supplementary budget in Parliament in July 2013 consistent with the provisions of the 1991 Constitution and the Government Budgeting

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and Accountability Act, 2005. The supplementary budget made provision for the clearance of the outstanding bills.

33. The instability and unpredictability of the teacher payroll have also been of concern to Government and development partners. In this regard, Government designed a programme to clean up the teacher payroll. These include the creation of a file for every teacher updated with the relevant supporting documents and the physical verification of teachers to determine genuine teachers on the payroll. A total of 35,505 teacher files were created in 2010. The biometric verification of teachers, which,was completed in 2012,revealed that 4,068 teachers whose names appeared in the teacher payroll could not be verified.

34. In August 2013, Government took action to remove the names of the 4,068 unverified teachers from the payroll as well 939 teachers whose retirement was long overdue. However, following subsequent re-verification, 772 were reinstated in September and another 1,362 in October 2013.ln tandem, Government took the actions to terminate the services of the teachers who were due for retirement. The Ministry of Education, Science and Technology issued out letters of retirement to the affected 939 teachers in August 2013. The payment of salaries to these teachers was subsequently stopped in September 2013.

35. As at October 2013, 32,091 teachers were on the payroll with a corresponding wage bill of Le27.6 billion, resulting in a saving of Le851.3 million. This number took into consideration new recruitments of 31 teachers, 3 teachers that left the teaching service to become civil servants and 1 teacher that retired in September 2013.

(ii) Strengthening Domestic Resource Mobilization and Management

36. Domestic resource mobilization remains an important element in Government's reform programme. In particular, there is an urgent need to improve the collection of revenues from the non-mining sector given the uncertainty and volatility associated with mineral revenues and the attendant effect on budget planning and execution. One of the factors attributed to the weak revenue performance especially from the non-mining sector is the low compliance rate by tax payers. An estimated 80 percent of corporate tax returns and 50 percent of individual tax returns remained outstanding at the end of the year. Moreover, tax payers file income tax returns late. To overcome this challenge, and in addition, to the introduction of self-assessment in 2009, the National Revenue Authority took administrative and enforcement action to enhance compliance with respect to the timeliness of filing of Income Tax returns. These actions include press releases, bill board notices, warning letters and attempts to seal off the premises of tax defaulters.

37. Another factor undermining domestic revenue collection is the non-collection of accumulated tax arrears. As a first step, NRA ascertained the stock of tax arrears estimated at between LelO to Le 20 billion. Subsequently, NRA initiated recovery proceedings in all cases of tax arrears.

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Mineral revenues will constitute a significant proportion of domestic revenues in the medium-term. Hence, it is important to monitor the performance of revenues from the mining sector. To this end, Government is committed to disclosing publicly revenue collected from the top extractive industries covering at least 90 percent of total collections. As a demonstration of this commitment, and consistent with the requirements under the Extractive Industry Transparency Initiative (EITI), Government published in the first quarter 2012 and the first quarter of2013, revenues collected from the 10 top and 20 top extractive industries in 2011 and 2012, respectively.

38. The growing importance of the mining sector in the economy of Sierra Leone calls for the establishment of effective and efficient institutional arrangements to oversee and coordinate and supervise activities in the sector. To this end, Government submitted the National Minerals Agency Bill to Parliament in March 2012. The National Minerals Agency (NMA) was subsequently established and made operational in early 2013. Among other activities, the NMA collaborates with the NRA in the assessment of revenues due from the mining sector.

(iii) Increasing the Provision of Electricity in the Country

39. Access to electricity remains limited in Sierra Leone, estimated at around 5-6 percent of the population. Therefore, the provision of increased, reliable and efficient electricity supply under the Agenda for Change as well as the Agenda for Prosperity remains a top priority of Government. The Ministry of Energy, in collaboration with the defunct National Power Authority, which is responsible for the generation, transmission and distribution of electricity, is not financially and operationally viable due to high operating cost and weak governance. Government remains committed to reform the energy sector in general and improving the performance of the electricity generating agency in particular. To this end, Government enacted the National Electricity Act, 2011, the implementation of which is expected to commence soon. In the Interim, the Ministry of Energy has prepared an operational loss reduction plan to improve the efficiency of revenue collection and the reduction of non-technical losses. This plan focused mainly on the installation of pre-paid meters. As at end 2012, over 40,000 pre-paid meters had been installed.

40. Government has also reached full internal consensus on the objectives and actions required to fund the Ministry of Energy in line with the National Electricity Act 2011. The National Electricity Act establishes the unbundling of the electricity sector through the creation of the Electricity Generation and Transmission Company (EGTC) and the Electricity Distribution and Supply Authority (EDSA). Government is also determined to encourage privately financed generation in the form of Independent Power Producers (IPP) and sell their output to Electricity Distribution and Supply Authority.

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. . .

V. CONCLUSION

42. Mr. President, Government is determined to implement the programmes and policies articulated in the Afp to achieve inclusive green economic growth for poverty reduction and greater income equality. This would require the provision of continued financial and technical assistance by our development partners including the World Bank.

43. Your approval, therefore, of this credit will facilitate the implementation of programmes, projects and policies aimed at addressing the challenges of low domestic revenues, weak infrastructure, high incidence of poverty and high unemployment in the country.

Yours Sincerely,

c-~l!~ Kaifala Marah (Dr.)

Minister of Finance and Economic Development

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Annex 3: Fund Relations Note IMF Executive Board Approves Three-Year, US$95.9 Million ECF Arrangement for Sierra-Leone Press Release No. 13/410 October 21, 2013 The Executive Board of the International Monetary Fund (IMF) today approved a three-year arrangement under the Extended Credit Facility (ECF) for Sierra Leone in an amount equivalent to SDR 62.22 million (about US$95.9 million). The overall amount of the program represents 60 percent of Sierra Leone’s quota in the IMF and enables the immediate disbursement of SDR 8.89 million (about US$13.7 million). The ECF-supported program seeks to underpin the government’s economic program and aims to facilitate high-quality public investment and growth enhancing reforms in the context of macroeconomic stability. The Executive Board also concluded the 2013 Article IV consultations with Sierra Leone, which will be detailed in a separate press release in due course. Following the Executive Board’s discussion, Mr. Min Zhu, Deputy Managing Director and Acting Chair, made the following statement. “Sierra Leone has achieved strong macroeconomic gains in recent years. Bolstered by iron production, economic growth has been robust, while inflation has been falling on the back of a tight monetary stance, a stable exchange rate, and lower food prices. The medium-term outlook is favorable, with policy focused on achieving strong broad-based growth, further disinflation, and an improved external position. “Continued efforts will be needed to strengthen policy implementation, particularly in the fiscal area. The authorities’ plans to strengthen public financial management appropriately aim to enhance revenue mobilization, improve spending controls, and reduce domestic debt. Key revenue components in their fiscal strategy include improvements in tax administration, reductions in tax exemptions, and the adoption of a comprehensive fiscal regime for the natural resources sector. Timely implementation of these reforms will be critical to buttress macroeconomic stability and the credibility of fiscal policy. “The new Fund-supported program aims to underpin the authorities’ development and poverty-reduction strategy. This strategy aims at entrenching macroeconomic stability and promoting inclusive growth through further infrastructure investments and economic diversification. The program calls for continued fiscal consolidation, strong monetary and exchange rate policies to support the single-digit inflation target, prudent borrowing policies, and growth-enhancing structural reforms.” ANNEX Recent economic developments Sierra Leone has made significant progress in the implementation of the ECF-supported program that was cancelled prior to its expiration at end-June. Reform measures and policies put in place have helped improve macroeconomic stability, advance social policies, and enhance prospects for broad and inclusive growth. Economic growth accelerated and inflation declined in 2012. Real GDP growth is estimated at 15.2 percent, reflecting increased iron ore production, from 137,000 tons in 2011 to 6.6 million tons in 2012. Non-iron ore growth is estimated at 5.3 percent (5.8 percent in 2011), driven by output expansion in agriculture, manufacturing, construction, and services. In agriculture growth has been sustained since 2010 with the introduction of the government and donor-supported Small Holder Commercialization Program (SHCP). Good progress has been made in containing consumer price inflation, and price pressures have eased. Inflation declined from 16.9 percent at end-2011 to 12 percent at end-2012, and 9.1 percent at end-September 2013. A significant increase in foreign direct investment flows during 2011 and 2012 has led to a surge in investment-driven imports, and helped finance the resultant external current account deficit. Revenue collection reached 12.2 percent of non-iron ore GDP compared with 11.5 percent in 2011 reflecting higher than anticipated taxes from the extractive sector that helped compensate for weak performance in other tax categories.

In spite of the progress noted, the country faces important challenges. Poverty, and unemployment are still high, and access to public and social services is limited. In addition, growth prospects are hindered by numerous obstacles, including insufficient power supply and road networks, and limited access to financial services, particularly for the small and medium-sized enterprises (SME). Program and key medium term policy objectives Although significant progress has been made since the end of the civil conflict toward social stability and a sustainable macroeconomic position, Sierra Leone needs more durable poverty reduction and growth efforts. The government intends to address remaining challenges and accelerate Sierra Leone’s development through steadfast implementation of the new Poverty Reduction Strategy, the Agenda for Prosperity (AfP). The ECF-supported program seeks to underpin this effort by facilitating high quality public investment and growth enhancing reforms in a stable macroeconomic environment. The medium-term objectives are to: (i) achieve a real GDP growth (excluding iron ore) of 7 percent by 2017; (ii) reduce inflation from 12 percent in 2012 to about 5.4 percent by 2017; and (iii) improve gross reserve coverage to about 4 months of non iron-ore related imports by the end of the program period. Economic growth will be driven by continued public investment scaling up, increased productivity, notably in agriculture, and sustained activity in construction and services. Non-iron ore activity will also benefit from upstream activity in iron ore mining where production (under phase I of the largest mine) is expected to increase through 2015, and level off starting in 2016. Inflation is projected to decline from 9 percent in 2013 to 5.4 percent in 2017, on account of continued prudent monetary and exchange rate policies. In addition, monetary policy would be adequately calibrated to contain inflationary pressures, and macro-prudential measures would be geared towards a healthy expansion of private credit. The government’s medium-term fiscal strategy aims to strengthen revenue collection, improve expenditure management, and reduce domestic debt. Revenue performance will be supported by continuing sustained economic activity in the non-iron ore economy, and the projected increase in royalties from the mineral sector. The government will continue implementing measures needed to improve public financial management, notably to enhance expenditure commitment monitoring and capital expenditure management. Monetary policy will continue to target price stability over the medium term. The Bank of Sierra Leone recognizes the need to build up foreign exchange reserves in light of the economy’s vulnerability to external shocks. It will also actively pursue initiatives aimed at strengthening the financial system. The government intends to accelerate implementation of structural reforms to support private sector development and enhance growth prospects in the non-mineral economy. In this regard, the government plans to rehabilitate the Bumbuna hydroelectric power plant and thermal power generators to increase energy supply; complete the teacher biometric verification exercise and the civil service remuneration survey; and implement measures to strengthen the Public Service Commission. It also intends to establish an SME Fund to finance new centers for training and skills development, including business management, accounting, and project design and introduce a one-stop window for imports clearance.

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