Dar es Salaam, July 13, 1999

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431
U.S.A.

Dear Mr. Camdessus,

1.  Tanzania's program for 1998/99 is being supported by the third annual ESAF arrangement that was approved by the IMF's Executive Board on February 8, 1999. The program, which was described in the memorandum of economic and financial policies that was attached to my letter to you of January 18, 1999, was formulated in conformity with the updated policy framework paper of January 19, 1999. The present letter discusses progress in implementing the program to date and policy plans for the remaining period of the third annual arrangement, and also requests disbursement of the second loan under the arrangement. The attached Tables 1-3 report on developments with regard to performance criteria and benchmarks through March 1999, reflect some revisions through June 1999, and set out certain indicative targets that represent our key policy intentions for the remaining period of the third annual ESAF arrangement.

Developments through March 1999

2.  During the first nine months of the fiscal year, progress on our main macroeconomic objectives was in line with the program, apart from the impact of adverse climatic conditions. The 12-month inflation rate declined to less than 9 percent in the first quarter of 1999, the lowest rate in two decades, despite the impact of the introduction of the (VAT) in July 1998 and pressures on food prices from the partial failure of seasonal rains at the end of 1998. The adverse weather is affecting growth, but real GDP is still expected to grow by almost 4 percent. On the external side, the recent adverse weather, and the continuing effects of last year's floods, have increased the trade deficit. We nevertheless met our target for increasing international reserves; gross reserves at the end of March reached the equivalent of 3.4 months of imports.

3.  These accomplishments reflect the strength of our macroeconomic policies. The fiscal stance permitted the target for net repayment of domestic financing to be attained with a considerable margin. The introduction of the VAT in July 1998 has been largely successful in increasing the revenue base, especially with regard to imports. However, revenues were slightly lower than projected (albeit 14 percent higher than in the corresponding period of 1997/98), mainly because of shortfalls in revenues from the petroleum sector.

4.  Recurrent expenditures were somewhat higher than projected, mainly on account of large allocations to the social sectors and infrastructure and an underestimate of the funding needed by noncommercial parastatal, but also because of one-time expenditures, such as the acquisition of a police helicopter to strengthen Tanzania's ability to respond to national disasters, and the acquisition of parliamentary facilities in Dodoma. These more than offset savings on debt service and wages, the latter because of a cautious approach to salaries in 1998/99, particularly the absence of a general wage increase. Improved budgeting reduced the need for arbitrary expenditure adjustments under the cash management system. There was some progress in reducing suppliers' arrears outstanding from previous years, but not as much as projected because of delays in verifying the outstanding amounts.

5.  The Bank of Tanzania (BoT) continued its prudent monetary policy stance, keeping its net domestic assets well within program limits, while reserve money and broad money were also somewhat below the original targets. Nonetheless, with the strong fiscal stance, credit to the private sector was able to grow by 58 percent in the year ending March 1999, continuing the recovery of credit from the stagnation occasioned by the restructuring of the state-owned banks in 1995-97. Treasury bill rates declined in line with the improved inflation outlook; commercial bank lending rates, and the margin between lending and deposit rates, also continued to decline.

6.  Bilateral donor support for the Multilateral Debt Fund amounted to US$85.4 million, covering about three quarters of multilateral debt service for the year as a whole. All details of the bilateral agreements with Italy and Japan under the 1997 Paris Club rescheduling have been settled, and signature is to take place as soon as those creditors complete the necessary paperwork. At the request of Russia, finalization of its bilateral agreement with Tanzania was postponed to an undetermined date. The government continued to seek rescheduling agreements with its non-Paris Club bilateral creditors on terms comparable to those of the Paris Club. Preparation for an IDA-financed commercial debt buyback operation was completed, with World Bank approval of the operation scheduled to take place in June 1999.

Recent policy adaptations

7.  In consultation with a Fund staff mission, at the end of April we undertook a comprehensive review of the 1998/99 program. We revisited our macroeconomic policy stance through the end of the fiscal year, particularly in light of the deterioration in the trade balance. Revised policy targets for the end of June are included in Table 1. Structural policy implementation had fallen behind schedule in a number of respects (Table 2), and we developed new timetables, key aspects of which are set out in Table 3.

8.  Developments in the first nine months of 1998/99 suggested that the trade deficit for the year might be US$75 million higher than originally projected. Strength in services and private capital was expected to offset this deterioration to a substantial extent, but we nonetheless decided that our target for the accumulation of net international reserves needed to be reduced by US$15 million. As the exchange rate continues to be determined by market forces, we are confident that the revised target will be achieved. The BoT's monetary policy targets have been adjusted in line with the new reserve target.

9.  A review of the prospects for government revenues suggested that the small shortfall in the first nine months might deepen by the end of 1998/99. As most of the shortfall was attributable to the petroleum sector, it was decided that corrective measures would mainly focus on that sector. The new windfall tax levy, which was designed to ensure that windfall tax revenues reflected the international petroleum prices prevailing before the recent sharp increase in international prices, was introduced at the time of the liberalization of petroleum prices on June 2, 1999. Moreover, the Tanzania Revenue Authority (TRA) stepped up its efforts to reduce evasion of petroleum taxes, one aspect of which was intensified cooperation with other revenue authorities in the subregion. Despite these measures, it was decided that the program benchmark for revenues for 1998/99 as a whole would need to be revised downward by T Sh 20 billion.

10.  Reflecting the trend in the first nine months of the year, expenditure on other goods, services, and transfers was expected to be higher than budgeted. The wage bill was expected to remain below budget, however, and debt service was also expected to remain well below budget, mainly reflecting the delay in the agreement with Russia. With assistance from the European Union, all verified suppliers arrears were programmed to be cleared by the end of 1998/99. The government expects to meet the program benchmark for repayment of net domestic financing during 1998/99.

11.  Progress continues with the structural reform agenda, but delays have occurred. In some cases the delays reflected a need to reconsider strategies, and in others technical difficulties were encountered, but in some instances the delays have been inadvertent. To accelerate progress, in May a follow-up working group was established under the chairmanship of a Deputy Permanent Secretary in the Ministry of Finance (MoF) and consisting of representatives of the MoF, the BoT, the Planning Commission, and, given the importance of petroleum sector reforms in this year's program, the Ministry of Energy and Minerals. The working group has been charged with following up on the implementation of the structural reform measures on the basis of detailed time frames; it will be in continuous contact with all concerned government bodies, and will report on a monthly basis (and more often if necessary) to the Permanent Secretary of the MoF and the Governor of the BoT. In the coming months, the committee will focus particularly on the indicative targets included in Table 3.

12.  The privatization of the large utilities is a complex process, requiring full audits, legislative changes, and the preparation of regulatory frameworks. Despite well-planned time frames, delays have occurred. For example, the invitation to bid for Tanzania Telecommunications Corporation Ltd. (TTCL) had been scheduled for issuance by February 1999, but had to be postponed because a further audit, which had become necessary following the first international audit of the company's financial situation in the third quarter of 1998, was completed only in May 1999. The invitation to bid was issued on June 29 and the information memorandum will be made available to interested bidders shortly. This will be followed by prequalification of bidders, and final agreement with the successful bidder is expected to be reached by the end of 1999.

13.  The start of final negotiations on the privatization of the Dar es Salaam Water and Sewerage Authority (DAWASA) was postponed from February as the DAWASA Act needed to be amended to provide for a new regulatory framework. Consultations with potential bidders are now planned to be completed by July 1999; the bidding documents will then be sent out and the agreement with the successful bidder is expected to be finalized by November 1999. Meanwhile, preparations for the divestiture of other key parastatals continue. A draft policy paper on the restructuring and divestiture strategy for the electricity sector will be submitted to Cabinet in July, and a decision is expected by end-August.

14.  In aggregate, during July-December 1998, 23 parastatal entities were removed from government control, against the benchmark of 25, and the total number for the fiscal year as a whole was 36, compared with the benchmark of 50. The shortfall is expected to be made up early in the new financial year, however, as preparations for the divestiture of a substantial number of tea estates and milling units have reached an advanced stage. In 1998, the PSRC was requested by the government to further assess the situation of 16 entities that had been sent to the Loans and Advances Realization Trust for liquidation. A thorough review of the situation of each company indicated that indeed liquidation was the only option, and in June 1999 the government authorized liquidation to proceed. Since early 1999, the PSRC has also undertaken an intensive effort to complete sales agreements for some 32 companies for which memoranda of understanding had been signed before the end of 1998. By end-June, six agreements had been signed, and another six are expected to be signed in July 1999. The rest will either have agreements signed or be returned to the privatization pipeline before the end of the year.

15.  Studies on parastatal retrenchment, the regulatory framework for the utilities and infrastructure sectors, and the strategy regarding the resolution of parastatal debt were completed in May and June 1999. The PSRC expects to submit policy papers on parastatal retrenchment, parastatal debt, and the regulatory framework to the government by October 1999.

16.  Late in 1998 certain private investors expressed a wish to submit proposals for continued operation of the Tanzanian and Italian Petroleum Refining Company Ltd. (TIPER) as a refinery of crude oil. A draft cabinet paper regarding the divestiture strategy for the refinery, which had been prepared for cabinet decision, was therefore withdrawn, and March 31 was established as the deadline for submitting proposals. No responses were received by the deadline, but in early April, a private company submitted a proposal to purchase the government's shares in the refinery. In early June, the government decided that with effect from January 1, 2000, the refinery would no longer be subsidized, either through the pricing system or from the budget. A three-option strategy was adopted: by that date, TIPER would either be privatized as a refinery without government subsidies or privatized as a storage depot or, if neither proved feasible, would be closed. The Ministry of Energy and Minerals was asked to evaluate all three options, including a private sector proposal, to permit a final decision to be taken by end-September 1999.

17.  With the completion of the upgrading of the harbor facilities in December 1999, Tanzania will be able to meet all of its needs for refined petroleum products through imports. Accordingly, in June 1999 the government informed the Tanzania Petroleum Development Corporation (TPDC) and the private oil marketing companies that all imports of petroleum products will be fully liberalized-subject to interim regulations to be adopted by September 1999-as of January 1, 2000. The government has also decided that as of January 1, 2000, all revenue from taxes and other levies on petroleum products, except for the charges for the TPDC overhead cost and the TPDC margin, would accrue to the budget, and that the latter would accrue to the budget from July 1, 2000. From the latter date, TPDC will not receive any payments from the budget, except for tasks it performs on behalf of the government, such as acquisition and management of data and information on Tanzania's petroleum potential. As for the removal of controls on petroleum product prices, the need to obtain parliamentary approval for the associated change in the windfall tax delayed implementation until June 2, 1999. Amid this complex set of activities, plans to increase the controlled retail prices in line with the rise in world prices that began in February were not carried out. A draft regulatory framework for the petroleum sector was submitted by consultants in March, 1999, slightly behind schedule. Interim regulations covering key issues such as safety, environmental protection, quality standards, and competition are scheduled to be promulgated in September 1999, under the provisions of current legislation. Over the next two years, the government intends to revamp the 1981 Petroleum Conservation Act to provide a comprehensive modern regulatory framework for the sector.

18.  In the financial sector, progress continued with the divestiture of the National Bank of Commerce (NBC (1997)) and the National Microfinance Bank (NMB). Negotiations with the Amalgamated Banks of South Africa (ABSA) regarding the privatization of NBC (1997) were concluded successfully in April, but signature of the memorandum of understanding (MOU), and assumption by ABSA of the management of the bank could not take place immediately because of a court injunction obtained by the bank's employees. In late June, the court ruled in favor of the government and the MOU is now expected to be signed in July. Negotiations on the management contract for NMB have now been concluded, and the bank will be put under private sector management in July. An investors' conference to discuss participation in the NMB is planned for October 1999. Pending the private sector takeover of their management, the operations of the NBC (1997) and the NMB remained subject to their memoranda of understanding with the MoF and the BoT, which were monitored by the latter on the basis of monthly returns and quarterly management reports. The BoT has stepped up its scrutiny of these returns, and has requested remedial action in a number of areas; in this regard, task forces were established early in 1999 to reconcile the NBC (1997)'s inter-branch accounts and to facilitate its recovery of nonperforming loans. A restructuring plan for the People's Bank of Zanzibar will be developed in the coming months with the assistance of a World Bank financial institutions development project.

19.  A book-entry system for government securities was instituted on schedule in December 1998. The BoT is preparing a number of revisions to prudential guidelines. Several have been finished and are expected to come into effect shortly; the remainder will be issued as they are completed in the course of 1999/2000. The BoT will review the Banking and Financial Institutions Act to determine whether there is a need to update it. At the same time, the BoT will complete the development of a microfinance policy framework, which is expected to be in place by September 1999. The completion of suitable own premises for the commercial court has taken longer than expected because of donor financing delays. However, judges have been appointed and the court rules have now been finalized and submitted for gazetting, and the court will start operations in temporary offices by October 1, 1999. Following the completion in February 1999 of a BoT-sponsored feasibility study on the establishment of a credit information bureau, the BoT is encouraging the Tanzania Bankers Association to develop a credit information bureau during the next financial year. Efforts to broaden and deepen the stock market will be complemented by technical assistance from the IMF, which will help to develop options for the further opening of the capital account, drawing on the experience of other countries.

20.  In spite of occasionally inadequate funding, the National Bureau of Statistics (NBS) has generally fulfilled its core responsibilities. The NBS was converted into an executive agency in March 1999, increasing its flexibility in managing and improving the quality of its staff. We have reached a formal agreement with the NBS for 1999/2000 on the compilation and publication of part of a core set of statistical data, including a monthly consumer price index and annual and semiannual national accounts. The government will ensure that these activities are fully funded on a timely basis. The NBS is expected to generate additional resources from the sale of statistical services to the BOT, other organizations, and to the general public. The first publication of semiannual national accounts was delayed from the target date of January, 1999, partly due to the reorganization, but is now scheduled to appear in July. Preliminary estimates for the 1998 national accounts were completed in May. The BoT, together with bilateral donors, intends to contract with the NBS for a household budget survey in 1999/2000, one objective of which will be a revision of the consumer price index weights and basket. The BoT is also developing surveys of capital flows, and has asked commercial banks to provide it with information on average interest rates on loans, as opposed to the posted rates that have been provided heretofore.

Macroeconomic policies for 1999/2000

22.  The revenue projections for the 1999/2000 budget are formulated taking into account the tax reforms discussed below. Including all petroleum sector revenues, on a comparable basis the ratio of revenue to GDP is projected to rise by 0.4 percentage points to 13.2 percent. The reform of the import tariff system is expected to result in a revenue loss, but this will be approximately offset by higher revenues from excises, due to the harmonization of the rates on domestic and import goods at a higher average rate, and higher net revenues from the petroleum sector from the fixing of the windfall profits tax and the termination of subsidies at the end of 1999, as well as higher dividends. Other aspects of the tax reforms we are implementing with this budget are also expected to be broadly revenue neutral in 1999/2000.

23.  Following a recent Consultative Group meeting, disbursements of foreign financing for the budget are projected to rise from their levels in 1998/99. The aid and revenue outlook, together with declining repayments of domestic financing, will free resources for other uses. Expenditures are thus projected to rise from 16.9 percent of GDP in 1998/99 to 18.3 percent in 1999/2000. The budget provides for an increase of 29 percent in expenditure on other goods and services in the priority sectors, an increase that has been decided in the context of a medium-term expenditure framework formulated with the assistance of the World Bank and bilateral donors. We also intend to make progress with civil service pay reform, the principles of which were approved by Cabinet in January 1999. In order to improve the ability to attract and retain qualified professional staff, over a period of five years pay levels for such staff will be raised to bring them into line with the private sector, while pay levels at the lower end of the pay scale will be raised as needed to keep them in line with the market. This program is reflected in an increase in the wage bill by 24 percent in 1999/2000, which will include increases for middle and upper level civil servants in the range of 40 percent to 80 percent. Over the medium term, additional salary increases will be facilitated by further rationalization of the structure and functions of the government, as well as performance improvement measures in the public service. Among other items in the budget, one requirement will be to provide T Sh 16 billion for preparations for the elections scheduled for October 2000, mainly for voter registration. The overall deficit, excluding foreign financed development expenditure, is projected at 0.8 percent of GDP. During 1999/2000, the government will also eliminate all its domestic financial arrears through renegotiations or issuance of new securities; in this context, the financial relations between the government and the BoT will be restructured and regularized in July 1999.

24.  The new computerized financial information management system (FIMS) will be extended to all ministries and spending units as of July 1, 1999. The system is expected to become fully operational in the course of 1999/2000 and will greatly improve expenditure control and the availability of budget management information. In support of the FIMS, a Finance Act has been drafted and is expected to be presented to Parliament in February 2000. Work is continuing on the further integration of donor-financed development spending in the budget, while the capacity of the MoF to conduct macro-fiscal policy analysis is also being enhanced.

Tax Reform

25.  Reform of the tax system has been a major element of the government's structural adjustment program in recent years, and further reforms in import duties, excise duties, and income taxes have been announced with the 1999/2000 budget. The customs tariff system has been further rationalized and the top rate has been lowered from 30 percent to 25 percent, with three other nonzero rates of 20, 10, and 5 percent. The 5 percent rate will apply to raw materials and capital goods, and spare parts will move to 10 percent. Moreover, statutory exemptions from customs duty payment are being reviewed. From July 1, 1999 import tax liabilities on public sector imports are being recorded on a proforma basis, in preparation for the elimination of the exemption of such imports in future. As part of its ongoing work on strengthening control of exemptions, over the coming year the TRA will study the merits of introducing mechanisms for improving coordination of exemption control among the departments of the TRA and of introducing a refund system under which duties are payable upon importation, but refundable to exempt parties. In addition, the Import Duty Act is being amended to centralize in the Income Tax Department of the TRA the certification of the status of nongovernmental organizations eligible for exemptions. A current step to strengthen customs administration is the application of the standard preshipment inspection (PSI) fee to imports coming in through Zanzibar, in view of the latter's failure to extend PSI to private sector imports.

26.  To improve the tax refund mechanism, the TRA established a special committee to accelerate the administrative process early in 1998/99. The TRA will develop a revised duty drawback system. The new system will be put in place within three months following the provision of technical assistance by the IMF. In the meantime, the former system administered by the Board of External Trade has been reestablished in the TRA to permit timely processing of duty drawback claims.

27.  The corporate income tax (CIT) has been amended to extend to all corporate taxpayers many of the benefits currently available to holders of certificates of incentives from the Tanzania Investment Center (TIC). The principal reform is to apply to all taxpayers, including future holders of TIC certificates, a cash-flow tax with full capital expensing but no deduction for interest, with loss carry-forward of five years. As issuance of TIC certificates no longer gives access to reduced import duties on capital goods, they will not confer tax advantages beyond the incentives available to other taxpayers under the general tax regime with the exception of withholding taxes on interest and dividends. The process of rationalization and harmonization will be completed next fiscal year. This reform is important not only because it creates a level playing field for investors, but also because it is essential to Tanzania's fiscal viability. Nonetheless, existing certificate holders will continue to enjoy the full benefits offered by their certificates, although their certificates can no longer be amended.

28.  The government has also introduced a comprehensive reform of the personal income tax system. The monthly income threshold has been raised to T Sh 45,000, the top marginal rate has been reduced to the same level as for the corporate income tax (30 percent), and the number of tax bands has been reduced from 12 to 5. All cash allowances have been subjected to income tax. The housing levy will be integrated into the personal income tax within the next two years. The taxation of small businesses is being simplified.

29.  As part of the overall reform of the petroleum refining and distribution sector, the tax regime for the sector will be rationalized. The exemption of petroleum products from the VAT will be abolished at the beginning of 2000/01, and the complex system of taxes, levies, and charges will be rationalized. By September 1999, the TRA will simplify collection procedures to help in its campaign against evasion. Under the rationalized system, excise tax rates will be adjusted to broadly maintain the average tax rate on petroleum products, including the new windfall levy that now prevails. As exporters will be able to claim VAT refunds on their consumption of petroleum products, their competitiveness will increase. The loss of revenue will be offset by the fact that the subsidy to the refinery will no longer be needed once the refinery is closed at the end of 1999. In the meantime, the subsidy will continue to be provided through the transfer of certain fees and charges, which thereafter will accrue directly to the government as part of petroleum taxes.

30.  As mentioned above, the introduction of the VAT in July 1998 has been largely successful, but the VAT base has been somewhat eroded by statutory exemptions, and further exemptions with respect to certain medical products, aircraft engines and parts, and air charter services have recently been granted for humanitarian reasons or because of the need to take account of favorable VAT treatment offered in neighbouring countries. Conscious of the need to preserve the integrity of the VAT, however, from now on the government will refrain from allowing any further exemptions, zero-rating, or special relief. Moreover, the zero-rating of export-related transport services has now been limited to transit trade only, as exporters would be able in any case to claim refunds of any VAT paid on export-related transport services. As with customs duties, explained above, potential VAT liabilities on government purchases will be tracked on a proforma basis in preparation for the elimination of the exemption on VAT for the public sector in future. The administration of other VAT exemptions will be strengthened through the same mechanisms as are being developed in the customs area.

31.  With these measures, the reform of the central government's tax system is largely complete, although some work remains on the rationalization of local government taxes. The number of taxes has been reduced substantially, a modern, efficient, and buoyant tax system has been put in place, and an independent and professional tax administration has been established. Under the Tax Administration Project, financed by the World Bank and bilateral donors, the TRA is working on further improving tax administration, and the government will ensure that this effort receives adequate support from the budget. One important step will be the issuance of uniform Tax Identification Numbers, which is expected to be substantially complete by the beginning of 2000/01. This will facilitate eventual abolition of the withholding tax on goods and services. Some legislative difficulties were encountered in setting up a unified tax appeals system; however, following a broad-based discussion with stakeholders, a new proposal is expected to be approved by the government by September 1999, and a unified system is expected to be put in place by March 2000.

32.  In consultation with the governments of neighbouring countries, the government will keep import duty and VAT rates under review, with a view to achieving greater harmonization. Efforts will also be made to achieve a harmonized elimination of special VAT treatments. Suspended duties, applied to some of Tanzania's imports from its partners in COMESA, will be phased out over time. In view of the difficult situation of domestic sugar producers occasioned by dumping of imported sugar, since October 1998 suspended duties have also been applied to sugar imports from other countries and, together with an assumed dutiable value that is higher than the world price, result in an effective customs duty rate in excess of 50 percent. This regime is however temporary and will also be phased out over time.

Concluding remarks

33.  The government of Tanzania will continue to provide the Fund with such information as the Fund requires to assess Tanzania's progress in implementing the policies described in this letter, and in the policy framework paper and memorandum on economic and financial policies indicated in paragraph 1. Moreover, Tanzania will continue to consult with the Fund on Tanzania's economic and financial policies in accordance with the Fund's policies on such consultations.

34.  The structural performance criteria for February 1999 regarding the invitation to bid for TTCL, the Cabinet decision on the TIPER divestiture strategy, and the removal of controls on petroleum prices, as well as the continuous performance criterion on the adjustment of petroleum prices in line with an increase in import costs pending the liberalization of prices, were not observed. However, as indicated in paragraphs 12, 16, and 17 above, these or related corrective actions will have been implemented by the end of June 1999; moreover, most of the measures that constituted structural benchmarks under the program will have been implemented by the end of June (Table 2), and further progress on the remainder as well as on other structural reforms is envisaged for the remaining period of the third annual ESAF arrangement (Table 3). The government therefore requests that the Fund grant the necessary waivers for the nonobservance of the four performance criteria. The government of Tanzania remains fully committed to the implementation of the economic and financial program supported by the ESAF arrangement.

35.  The government has agreed with the staffs of the World Bank and the Fund on a debt sustainability analysis that will provide the basis for a preliminary HIPC document, and in due course the government expects to request debt relief under the HIPC Initiative. The government also intends to request a new three-year ESAF arrangement, discussions on which could start later this year, and trust that we can count on the continued support of the Fund.