Report No. 201 73-TUN Republic of Tunisia Private Sector Assessment Update Meeting the Challenge of Globalization (In Three Volumes) Volume l: Executive Summary and Proposed Reform Agenda December 14, 2000 Private and Financial Sector Development Department Middle East and North Africa Region Document of the World Bank Vice President: Jean-Louis Sarbib Country Director: Christian Delvoie Sector Director: Wafik Grais Task Team Leader: Hamid Alavi Republic of Tunisia - Private Sector Assessment Update Volume I - Executive Summary and Proposed Reform Agenda REPUBLIC OF TUNISIA PRIVATE SECTOR ASSESSMENT UPDATE PREFACE The purpose of this Private Sector Assessment (PSA) Update is to evaluate how conditions for private sector development in Tunisia have evolved since 1994, when the first PSA was carried out, and what are the remaining constraints to private investment. Because of the rapidly changing environment which is presenting Tunisia's private sector with significant competitive pressure, however, this PSA goes beyond simply assessing the progress in implementing the recommendations from 1994. Rather, it lays out a more elaborate framework for thinking about private sector developnment in Tunisia in the context of global economic integration and increasing competition from international competitors, especially in the European market. Tunisian exports to Europe have traditionally been strong, but are now under heightened competition from Asian and Central and Eastern European countries. They are also being hurt by the continued anti-export bias of the domestic economy, even as other countries are rapidly putting in place the legal and regulatory framework, infrastructure, and investment incentives for private sector activity that are enabling their firms take advantage of the opening of the European market. Hence, improved competitiveness of Tunisian enterprises, especially small and medium ones, is a major issue in this context. After analyzing the characteristics and performance of the private sector since 1994, the report describes the remaining constraints to private sector development, fromn the point of view of both Tunisian entrepreneurs and foreign investors. It then proposes reforms in incentives to encourage private sector-led growth and lays out a framework for modern governance; discusses the need and measures to expand access to finance for small and medium enterprises; and proposes options to lay the foundation of a long- term private sector growth strategy. The authors hope that the analysis in this report will provide some options to enable Tunisia to maintain its competitive position in a environment radically different from that which Tunisia's past success possible. The report was written by a team led by Hamid Alavi, and consisting of Denis Chaput, Christine Richaud, Lorenzo Savorelli (access to finance); Dominique Bichara and Eric Haythorne (legal and regulatory framework); Guillermo Hakim (skill development); Mohamed Lahouel (Competition policy); Fay,al Lakhoua (business survey); Michel Loir (transport); Leila Mokaddem and Pierre de Raet (privatization); Carlo Maria Rossotto (telecommunications); Manuel Schiffler (water and sanitation, power, industrial land); and Andrew Stone (design of the business survey ,questionnaire). Christine Richaud also contributed to the analysis of the investment code and SME support mechanisms. Araceli De Leon- Herlihy (IFC) contributed to the analysis of the private sector structure and performance. The team wishes to thank Christian Delvoie, Hassan Fazel, Fatma Felah, Olivier Fremond, Edward Gardner, Wafik Grais, Daniela Gressani, Auguste Tano Kouame, Benoit Millot, Jacques Morisset, John Nellis, and Andrew Stone, for their invaluable comments, and Liliane Vert for her contribution to the editing and production of the document. The team also benefited greatly from a QAG review of this report. The report could not have been completed without generous collaboration of Institut Arabe de Chefs d'Entreprises, which also financed and carried out the enterprise survey. REPUBLIC OF TUNISIA PRIVATE SECTOR ASSESSMENT UPDATE EXECUTIVE SUMMARY OVERVIEW 1. Since the World Bank prepared the Private Sector Assessment (PSA) on Tunisia in 1994, Tunisia has introduced important reforms in the areas of trade liberalization, investment incentives, legal and regulatory reform, privatization of state-owned enterprises, financial sector development, trade facilitation, and technical support to the private sector. And yet, private sector activity in the country has barely changed in terms of its share in total investment and its contribution to GDP. The private sector share in total investment reached just 51 percent in 1998, from 48 percent in 1995, while private sector contribution to GDP was 63 percent in 1997, the same as during 1992-95. This study examines the underlying causes for the persistently weak private sector investment, and proposes further policy and institutional measures which could boost the confidence of private investors. 2. Increased private investment, especially by small and rnedium-sized enterprises (SMEs) which constitute the majority of Tunisian enterprises, is vital to accelerate the growth of output and employment. In addition, to face competitive challenges posed by the adherence to the Association Agreement with the European Union (AAEU) and the World Trade Organization requirements, and the dismantling of the Multi-Fiber Agreements, Tunisian firms will need to undertake investments to find and develop markets, implement more efficient production processes, improve product quality, develop new products and services, and respond flexibly and rapidly to changing market demand. As to how to raise such investment, the country itself showed the way when, from the l1970s, it unshackled offshore enterprises from the cumbersome regulations imposed on most other private enterprises in the country. In the offshore sector, during 1975-94, the volume of private investment grew 15 percent per year; and employment grew 5 percent per year. 3. Could such performance be replicated throughout thLe economy? International experience suggests yes. For example, the implementation of deep structural reforms has been a key factor in the relative success of Portugal at the time of its association with the European Union (EU). Privatization in Portugal has been the most aggressive in the OECD (proceeds representing 9 percent of GDP during 1989-95, compared to less than one percent in Tunisia), and the number of private banks operating in Portugal has doubled. A combination of these reforms, with easing of labor market regulations and investment restrictions, contributed to a 10-fold increase in foreign direct investment (FDI) and to a 70 percent increase in private investment over the last decade. In Greece, on the other hand, the liberalization period was drawn out over two decades and was considered a weak episode with few tariff concessions or reductions in quantitative restriction coverage. Resistance to liberalization and reform also persisted after EU entry, as evidenced, for example, by Greece's non-participation in the Exchange Rate Mechanism (ERM), and its delay in achieving adequate progress on liberalization of capital markets and reform of labor and product markets. As a consequence, the private investment/GDP ratio decreased from 17 percent during its reform period (1962-82) to 13 percent in 1995. 4. A key factor affecting private sector investment is entrepreneurs' confidence and outlook for the future, as well as their perceptions of the constraints they face in starting up, operating and expanding their businesses. To solicit such perceptions in Tunisia, a survey of 397 private enterprises was conducted for this report. The results indicate that many Tunisian enterprises are apprehensive about market demand Republic of Tunisia - Private Sector Assessment Updat Page 2 Volume I - Executive Summary and Proposed Reform Agenda and competition (as a consequence of past protection). At the same time, they face a complex investment incentive regime, tax and other administrative issues, difficulties in access to finance by SMEs, insufficient supply of skilled workforce required to meet the challenges of globalization, high cost of telecommunications and marine transport, and insufficient supply of industrial land. To give private investors confidence, this report recommends that the Government be more aggressive in removing these bottlenecks and in reducing its own involvement in economic activity. 5. Accordingly, this report proposes the following actions to help improve the confidence and efficiency of the private sector and its contribution to the Tunisian economy: > Enhance market signals and competition by revising the schedule of tariff reductions in the context of the AAEU in a way to reduce effective protection, and by removing the remaining controls on retail prices. > Simplify the investment incentive regime to create more confidence on the part of private investors, and reduce the dualism within the industrial sector between offshore and onshore firms. > Accelerate privatization and streamline those administrative procedures that are still presenting a constraint for business start-up and operation. > Reshape the domestic regulatory framework to better facilitate business entry, operation and exit, and to increase the ability of private investors to conduct efficient transactions, through means such as more well-defined property rights, more effective and clear enforcement of contracts, and greater efficiency in the system for resolving disputes. > Facilitating access to formal sources of finance for private investors, especially SMEs. 6. The report also suggests the following actions towards laying the foundation for sustainable longer-term private sector development: > Build labor skills by reforming the vocational training system. > Modernize telecommunications and marine transport, to help connect the private sector to the global economy, and increase the supply of industrial land. > Re-orient private sector development programs more towards the needs of the private sector. CHARACTERISTICS AND PERFORMANCE OF THE PRIVATE SECTOR 7. Share in the Economy. The private sector accounts for 63 percent of Tunisia's GDP, representing only a slight increase since 1990 when this share was 60 percent. It dominates (in terms of value added and employment) the agricultural and fishing sectors, and the bulk of the manufacturing sector, but is barely involved in many infrastructure sectors. 8. Dominance of SMEs. Apart from a few dozen enterprises that can be considered as large (employing more than 500 workers) and belonging mostly to the public sector and the financial sector, the majority of Tunisian firms are very small private units. Out of about 87,000 formal sector firms, only 1,400 employ more than 100 workers. In the industrial sector, firms with fewer than 20 employees account for almost 60 percent of all active private companies, and companies with fewer than 250 employees account for more than 94 percent of all companies. In addition, about 45 percent of manufacturing enterprises have a sales volume below TD 0.5 million (approximately US$0.4 million), and 77 percent below TD 2 million (approximately US$1.6). The limited size of firms is due to two main factors: family ownership and the highly protectionist policies that have lasted over more than three Republic of Tunisia - Private Sector Assessment Updat Page 3 Volume I - Executive Summary and Proposed Reform Agenda decades. Tunisian entrepreneurs have so far been very reticent to opening ownership outside family ties. Given limited financial resources, this attitude has restricted their choice of investment to small projects. The existence of high barriers to entry of imports has made many of such projects artificially profitable. 9. High Concentration of Production by Large Firms. Despite their large number, SMEs and microenterprise account for only a fraction of production in the Tunisian economy. Market concentration, as measured by the shares of the four largest firms in total value added in a given sector, is very high due to the small size of the domestic market and to the legacy of investment licensing, which was not discontinued until 1987. Concentration ratios in manufacturing range from about 50 percent in textiles, clothing and leather sector to 88 percent in agro-industries; in non-manufacturing industries, as well as transport and telecommunications, the ratios reach almost 100 percent. 10. Dual Structure. An offshore sector was created through special incentives to counter the anti- export bias of the protected domestic economy in the 1970s and 1980s. While this policy fueled the country's strong export performance and facilitated Tunisia's entry into world markets, it has not given the domestic private sector the stimulus to competitiveness that normally results from external trade and competition. The main reason is that the offshore sector has developed very few linkages with the onshore economy, and takes from it virtually no tradable inputs. 11. Investment Performance. Even though Tunisia's overall investment ratio (the ratio of investment to GDP) has been higher than that of middle-income developing countries (outside of East Asia), the private sector's share of total investment is still too low in Share of private investbnent in total investment comparative terms-about 51 percent in Tunisia and major developing regions in 1998, against 48.4 percent in 1990. o Thus the public sector continues to play a much bigger role in physical capital formation than in most other emerging economies. D |f 12. While the private sector's share in GD and totalinvestment Tmisia 1992-1998 Europe &MENA East Asia 1990- Latin A. & Alldeveloprng saein GDP and total investment 1990-1995 1995 Cantrb 1990-1995 cointrts 1990- has remained low, its contribution to 1995 the growth of value-added of non- o Private veonnentto%oftotal investnent financial enterprises has increased steadily since the mid-1990s (Annex 2). This suggests that private investment may have been more efficient than public investment, and that measures to improve the business environment, accelerate privatization, and reduce transactions costs of doing business, are likely to go a long way toward promoting growth and employment generation. | ~~~~Forign lnveatme,da in Tuntiai (1992.1999)] 13. Tunisia has adopted important measures n to attract foreign investment, including the 800 establishment of the Foreign Investment 700 Promotion Agency and the adoption of a revised 50 Investment Code in 1994, which provides * 9 400 -r9ecto generous incentives, especially to the offshore sector of the economy. The level of FDI 200 - - H (excluding privatization) has been increasing '° - l steadily over the past five years, from TD 305 1992 1993 1994 199 1996 99 1998 1l9 million in 1995 to TD 437 million in 1999. l --- l Republic of Tunisia - Private Sector Assessment Updat Page 4 Volume I - Executive Summary and Proposed Reform Agenda Moreover, this increase is mainly due to a marked growth of FDI in the manufacturing sector, which accounted for 45 percent of FDI (excluding privatization) in 1999, compared to 8 percent in 1995. Nevertheless, the level of FDI in Tunisia remains marginal. The share of FDI in total private investment declined from about 30 percent in 1990 to 24 percent in 1998 (the 1998 ratio would be only 12 percent if the purchase of two privatized cement plants by foreign investors in 1998 is excluded). 14. Export Performance. The evolution of exports is normally an indicator of trends in competitiveness, and the export-oriented sector often acts as a vehicle to introduce technological advances in a small economy like Tunisia. Tunisia's exports are under tremendous pressure from ecological factors (tourism) and competition from other countries (offshore exports). The heavy concentration on textile and garments has created some risks because of the scheduled elimination of the Multi-Fiber Agreements (MFA) in 2005. Through the MFA, Tunisia expanded its share of the EU textile and garment market from 1.5 percent in 1980 to 4 percent today. After the MFA is eliminated, increased competition from countries with cheaper and/or better skilled labor will make it difficult for Tunisia to maintain its market share in Europe or to penetrate other OECD markets. In effect, the growth of manufactured exports has declined in real terms from about 12.8 percent per year during 1987-91 to 4.0 percent per year during 1992-98. Tunisia's share in certain key export products has also fallen in traditional export markets relative to that of new competitors. Share of EU Imports 1988 1990 1995 1996k 197 Men's and Boys' Clothing (knitwear) - SITC 843 Bangladesh 0.3 0.5 2.2 2.4 2.4 China 3.8 5.5 10.5 10.6 11.7 India 0.8 0.9 4.0 4.1 3.9 Tunisia 1.0 1.4 1.1 1.1 1.4 Turkey 3.2 4.1 8.7 7.7 8.2 Women's and Girls' Clothing (excluding knitwear) - SITC 844 Bangladesh 0.0 0.1 0.5 0.5 1.0 China 2.5 3.3 7.4 8.1 8.9 India 1.5 2.1 3.2 3.3 3.2 Tunisia 1.5 1.7 2.5 2.4 2.5 Turkey 7.3 10.7 14.5 12.4 12.9 Source: COMTRADE CONSTRAINTS TO PRIVATE INVESTMENT 15. Based on evidence from other countries, the needed changes to encourage private investment go beyond the EU requirements of simply reducing tariffs and meeting manufacturing standards. Portugal, for example, has fared better after EU accession because it has exceeded EU requirements in terms of rapidly creating the conditions for private sector growth (including privatization), while Greece, for example, has fared worse because it has done so more slowly. Evidence from other countries has also shown that performance under accession depends less on the degree of a country's adherence to EU trade requirements than on policies that create a conducive business environment and ensure the efficient allocation of resources through private sector development. Republic of Tunisia - Private Sector Assessment Updat Page 5 Volume I - Executive Summary and Proposed Reform Agenda 16. The perceptions of private enterprises of the business environment in which they operate, shed further light on what prevents them from investing, operating and expanding. Surveys of Tunisian enterprises, emerging exporters, and foreign investors confirm that reforms have not yet created the kind of operating environment they see as necessary to fully succeed under integration. Small, medium, and large firms alike are concerned with tax levels and administration, as well as some other administrative barriers for business start-up and operation; small firms are constrained by the high costs and lack of access to finance; and medium and large firms are hesitant to invest due to high telecom and marine transport costs, and the scarcity of industrial land. Emerging exporters (especially partial and indirect exporters) are, in addition, concerned about the complexity of trade procedures, weak overseas connections, and the lack of marketing assistance. Foreign investors are concerned about the relatively complex investment regime, and the administrative procedures involved in establishing and operating businesses. In addition, most private enterprises are hesitant about investing for fear of the competitive pressures expected from increased liberalization. These concerns are symptoms of the incentive regime that these enterprises have so far been exposed to. AN AGENDA To ENCOURAGE PRIVATE INVESTMENT 17. Creating the conditions for private sector growth in thle context of economic integration will require not only faster trade liberalizatioh, but a deeper transformation of the incentives and environment for private sector development than was envisioned in the 1994 l'SA. To that end, this report recommends the following measures: A. Re-orientini Policies for Private Sector Led Growth 18. Enhancing Market Signals. Efficient private investment is hampered by the lack of sufficient competition. Adequate competition will be key to maintaining an adequate private sector supply response during the adjustment period, and would encourage new investments by reducing the market power of incumbents. Opening to the EU presents a substantial challenge for Tunisian firms accustomed to operating under protective tariffs and quotas and special privileges (MFA). But the private sector will not respond efficiently if it receives conflicting policy signals. The lengthy schedule for tariff reductions in the context of the AAEU, combined with an initial increase in effective protection, reduces pressure on enterprises to enhance productivity and competitiveness, and discourages efficient private investment. The report proposes the following policy instruments to enhance competition: > Maintain appropriate macroeconomic incentives. Tunisia has pursued a prudent macroeconomic policy since 1986: the fiscal deficit and inflation have been reduced, monetary aggregates have been better controlled, and the exchange rate has been managed flexibly. While these reforms have created a stable macroeconomic environment conducive to private investment, there is a risk of crowding out of private investment through increased government borrowing due to reduced tariff revenues under AAEU. Therefore, improvements in fiscal stance, wage policy, and exchange rate policy can further enhance the macroeconomic incentives to private investment. > Strengthen competition by deepening trade liberalization to reduce effective protection, liberalizing retail margins to foster competition among merchants, and reducing anti-competitive practices. 19. Clarifying Tax Administration. Taxes and tax administration have been considered by enterprises as the two leading constraints to their operations. T!he analysis shows, however, that tax rates in Tunisia are in line with competitors. Instead, there are two explanations for this perception: (a) although not excessively high, the VAT base and rate have increased since 1996 to compensate Republic of Tunisia - Private Sector Assessment Updat Page 6 Volume I - Executive Summary and Proposed Reform Agenda progressively for the revenue losses of tariff reductions under the AAEU; (b) the relations between enterprises and tax administrators is unclear, calling for rapid adoption of the Code des Procedures Fiscales. 20. Improving Incentives for Private Investment. Local and foreign investors prefer a simple and transparent incentive regime and rules-of-the-game, than a generous but complex set of financial incentives. The incentives for domestic investment are still complex, selective, and inconsistent across industries, which undermines the efficiency of investment and constrains economic growth. International experience shows that tax incentives are effective mainly in attracting foot-loose investments, but are not significant in attracting the kind of investments that Tunisia needs today. A simplified and more predictable investment and regulatory regime would create more confidence on the part of private investors. Another bottleneck to private investment is the dualism between offshore and onshore firms. With deep trade liberalization and openness to the EU, the distinction between offshore and on-shore firms is becoming less tenable. As the AAEU approaches completion and protections are removed, the differential tax treatment in favor of offshore firms will lead to discrimination against partially exporting firms and firms producing for the local market. 21. The Tunisian investment incentives today represent significant progress since the first measures of liberalization in 1987, but need to be further improved to better attract competitive private investment. Reforming the Tunisian tax system is part of a broad effort, and defining options to improve the impact of investment incentives would require further research, which could be guided by the following considerations: > Simplifying tax incentive instruments. The Investment Code is still complex, providing differentiated levels of support across industries and sectors (38 categories of beneficiaries). Investors generally prefer a simple and stable tax system when they go through the investment decision process. A simple and transparent tax system will also reduce the burden on the tax inspectors and reduce the risks of fraud. For Tunisia, the simplification of tax incentives could become an easier task when import duties are abolished under the AAEU, rendering import duty exemption/reduction, which is one of the main incentives provided by the Investment Code, inconsequential. > Eliminating offshore-onshore dichotomy. There is a risk that onshore enterprises (including partial and indirect exporters) may be disadvantaged in the aftermath of the AAEU as offshore and most onshore firms will then both operate in a competitive, open market, but will not be granted the same facilities and incentives. A better approach would be a common regime applied to all exporters, either offshore or onshore. Linkages between offshore and onshore sectors would further be encouraged by: (a) giving partially exporting firms the same advantages as offshore enterprises, regarding procedures for business start-up, operation and exit, employment of expatriates, tax rebates on purchase of shares and reinvestments and exemption from VAT and sales taxes on imports according to export performance; and (b) eliminating customs duty on local sales of off-shore enterprises, in line with the elimination of duties on imports from the EU and the harmonization of incentives between offshore and partially exporting firms, thus stimulating domestic competition. > Gradually removing corporate income tax holidays. There is over-reliance on corporate income tax holidays in Tunisia; they are not the most cost effective instruments, and their impact in terms of increased competitive private investment is doubtful. On the one hand, they are likely to attract mainly short-term investment (e.g. footloose industries) with limited benefits for the host country. On the other hand, most investments are unlikely to make significant profits in the first few years of operations and, thus, not really influenced by tax holidays. In addition, tax holidays are ineffective for foreign investors from countries that tax foreign subsidiaries of their Republic of Tunisia - Private Sector Assessment Updat Page 7 Volume I - Executrve Summary and Proposed Reform Agenda home companies (such as the United States). Therefore, the impact of tax holidays in terms of attracting private investment has been mixed, while the fiscal costs have been high. Instead of tax holidays, it may be more appropriate to use some combination of international standards for cost deductibility and accounting in general, good loss-carry-forward provisions, and some kind of tax allowances or tax credits. These can be better targeted than tax holidays, for example, to promote fixed investment, labor training and technology transfer. They can be included in the tax code and operate automatically, and they give rewards only if and after the action is undertaken. In the medium term, the most effective way to promote non foot-loose foreign investment would be to provide adequate and affordable infrastructure, appropriate skills, and an adequate and transparent legal and regulatory framework. In addition, the removal of existing restrictions on foreign ownership in certain sectors (especially services) and activities would be highly beneficial for Tunisia. 22-- Accelerating Privatization. The Government still owns and operates a number of firms in the service (especially infrastructure) and industrial sectors, and still has minority ownership in some 200 private companies. Its approach to privatization has been cauatious, the result of an effort to build consensus among Government, business, and labor. Since the adoption of the Law 94-102, privatization program has accelerated, but there are some weaknesses in the process that may undermine the success and speed of the program in the future: > Incentive framework. Law 93-120 of December 27, 1993 (Investment Code) and Law 89-9 provide for specific incentives to buyers and workers of public enterprises (PEs). The Government also takes charge of financial restructuring of the enterprises to be privatized. These incentives could create distortions which would penalize existing private enterprises in the same sector. > Institutional framework. The Direction Generale de la Privatisation (DGP) of the Ministere du Developpement Economique (MDE) has insufficient resources to fulfill its mandate of monitoring privatized enterprises. This may become a critical issue if the Government is to embark on a policy of granting concessions in the infrastructure sector. Another key institutional bottleneck is the absence of a single database on Public Enterprises (PE), since information is dispersed among several ministries. In this light, the implementation of the Systeme Information Reseau Entreprises Publiques (SIREP), needs to be accelerated. Several other actions could be undertaken to help DGP step up the privatization program: (a) simplifying procedures for preparing dossiers sent to the Commission d'Assainissement et de Restructuration des Entreprises a Participation Publique (CAREPP); (b) defining the human and financial resources required to meet the new challenges; (c) resorting more to specialized external expertise; and (d) redefining the criteria for selecting purchasers, based on the purchasers' proposed investment program. :9 Information dissemination. The privatization operations realized recently have been much more transparent than those realized before 1996, and infolmation on the privatization program is made increasingly available to the public and potential investors. However, since the public still holds a relatively adverse view of the social impacts of privatization, broader dissemination of information are important to remove the remnants of distrust. > Redeployment of personnel. Another constraint to accelerating the privatization program arises from the difficulty of redeploying redundant personnel., Although Tunisia has several financing mechanisms for micro projects started by redundant personnel, there is no entity dedicated to addressing their needs. > Narrowness of the financial markets. The Government has taken steps to encourage share issues by privatized companies (reduced corporate taxes of 20 percent). However, of the 44 companies Republic of Tunisia - Private Sector Assessment Updat Page 8 Volume I - Executive Summary and Proposed Reform Agenda listed on the Tunis Stock Exchange, 16 are banks and insurance companies. IPOs represent only 6 percent of revenues from privatization during 1987-98, and only 5 transactions were IPOs during 1995-97. The 1999-2000 privatization program envisages only 10 such transactions. A more forceful privatization policy (for example by encouraging privatization by means of sale of equity and IPOs), could considerably broaden the financial markets. 23. Reshaping the Legal and Judicial Framework. With trade liberalization and the restructuring of the Tunisian economy, resource allocation and the expansion of investment are influenced by the degree of flexibility of the regulatory framework governing business entry, operation and exit, and establishing property rights. Uniform and transparent interpretation and application of laws are essential to facilitate private investment. In Tunisia, measures are needed to: > Facilitate company entry. operation and exit, for example by: (a) incorporating the concept of holding companies in the revised Company Law to regulate a number of corporate issues such as minqrity shareholders rights; (b) reinforcing creditor rights conceming collateral to facilitate access to finance; (c) removing limits on foreign direct investment in the offshore sector; (d) accelerating the revision of Bankruptcy Law and streamlining bankruptcy procedures; (e) introducing explicitly electronic data transfer and credit card transactions in the Commercial Code; and (f) regulating franchising and factoring contracts, and updating the Code des Obligations et des Contrats to reflect technological advances in communications. > Improve enforcement capacity and the iudicial system to handle business-related issues, for example by: (a) strengthening training of magistrates, judges, court registrars, and court reporters; (b) improving access to legal information; (c) completing the reform of commercial arbitration; and (d) strengthening independent competition authorities. > Secure property rights, by updating the law on commercial, industrial and intellectual property. 24. Reducing administrative barriers. Despite significant progress in reducing administrative barriers to private sector development, certain rigidities remain that increase transaction costs and discourage local and foreign private investment. For example, the startup process can take up to three months for an investor in agro-industry or tourism, and up to six months in manufacturing. Despite API's one-stop-shop (guichet unique), which has significantly reduced administrative procedures to business startups in the industrial and service sectors, there are still several ministries, many steps, and much documentation involved in the process of startup and application for incentives. To facilitate business activity, the present report recommends the following measures: > Prepare a negative list of activities that are not permitted to foreign investors. > Reduce or eliminate sectoral authorizations by: (a) extending the declaration system of one-stop shop to all sectors; (b) eliminating the carte de commer ant; (c) eliminating the prior authorization for foreign participation in onshore companies above the 50 percent limit; (d) imposing a deadline of 30 days to review an investment request; and (e) eliminating state monopoly in telecommunications, in line with the WTO/GATT agreement. > Reduce the number of forms and simplifying the information needed from investors. In this respect, the " Vis-ai-vis Unique" and "Document Unique" initiatives proposed by API could prove highly useful. > Streamline intellectual and industrial property registration procedures. 25. In addition, as far as business operation is concerned, there are still procedural problems, especially involving taxation (discussed above) and trade-related transactions. For example, it can take an enterprise an average of 22 days to conclude an import transaction. However, many of the administrative Republic of Tunisia - Private Sector Assessment Updat Page 9 Volume I - Executive Summary and Proposed Reform Agenda procedures for business operations are currently under review: A, Code des Procedures Fiscales is under preparation, and trade-related procedures are being significantly streamlined by the introduction of liasse unique, modernization of customs, and the creation of Tunisie Trade Net. Number of Days To Realize Operations Related to Imports (by size of enterprise) Average Number of Days Small Medium Large Total Letter of credit 9.2 5.0 5.2 5.7 Shipping 2.1 1.8 2.5 2.1 Unloading 3.5 2.3 4.5 3.3 Customs 8.1 4.7 4.1 4.9 Release of goods 5.7 2.5 2.5 3.0 Inspection 4.2 2.7 3.4 3.2 Total 32.8 19.0 22.2 22.2 Source: Enterprise Survey B. Improvinf Access to Finance 26. One of the constraints to increased private investment, especially for SMEs, is access to finance for investments and working capital. The primary source of investment financing in Tunisia is firms' own funds, imposing a significant limit on their investment and expansion. According to the LACE survey, 53 percent of firms finance more than 50 percent of investment out of own funds. The second major source of financing is local commercial banks: 51 percent of firms use commercial bank loans to finance investment, with 19 percent of firms financing more than 50 percent of their investments out of bank credit. The capital markets, as well as existing risk capital funds and leasing agencies, service a limited number of clients. Only 14 percent of firms get finance from issues of shares, which in 95 percent of cases provide less than 5 percent of the total investment cost. 27. Several Government-sponsored programs are designed to provide equity and credit to SMEs, but the quality, penetration, and size of these programs remain limited. In 1973, the government established the Fonds de Promotion et de Developpement Industriel (FOPRODI) to provide equity to SMEs. While successful in the first few years, FOPRODI has not been widely used subsequently. This poor performance has largely been due to the absence of an approlpriate credit guarantee scheme, and the general reluctance of banks to service the SME sector. 28. In addition, a Fonds National de Garantie (FNG) was created in 1983 to reduce credit risk (for investment financing) of banks lending to SMEs. The FNG wvas capitalized by the contributions of commercial banks. However, the banks have not easily been able to recover their loans in the case of default through FNG, therefore reducing the latter's credibility. 29. Bank credit. The results of the enterprise survey suggest that SMEs face a relatively higher constraint than larger firms regarding access to credit: only 48 percent of small and 69 percent of medium enterprises which did not borrow, did not actually want a loan, compared to 80 percent of large firms. In addition, this constraint is likely to be higher for access to start-up finance. Republic of Tunisia - Private Sector Assessment Updat Page 10 Volume I - Executive Summary and Proposed Reform Agenda Reasons for not borrowing from banks according to size of firms (Percent) Small ediwn arg oa Firm did not want a loan 48 69 80 69 Financing plan was rejected 19 10 0 8 Lack of collateral 14 5 0 5 Other reasons 19 1 5 20 1 8 Total 100 100 100 100 30. The report identifies three main constraints to bank financing of SMEs: > Collateral requirements. The value of collateral required by banks for the most recent lending operations is high for all borrowing frmns, regardless of sector and size: on average, it represents 182 percent of the loan amount. Nevertheless, large firms are more able to provide required collateral, whereas SMEs may lack appropriate collateral and therefore be unable to borrow from banks. > Accountingz standards. SMEs face constraints regarding access to bank credit because they may not be able to provide appropriate accounting information based on intemnational standards. >' Capitalization and Financing_plan. SMEs may also have difficulty to borrow from banks because of low capitalization. In addition, SMEs may face higher difficulties to elaborate and negotiate their financing plans. Substandard accounting information and level of capitalization are likely to impose a stronger constraint on SMEs, because banks rely mainly on financial structure when assessing borrowers' creditworthiness, rather than on less standardized criteria, which would require more time, skills and costs. 31. The following measures could therefore facilitate SMEs' access to bank credit: > Regulatory adjustments. The regulatory measures which could ease access to bank credit include: (a) broadening the definition of collateral to make SMEs eligible for credit; (b) implementing risk-based supervision of credit for bank lending to small customers; (c) adopting a system of tax deferrals and incentives for retained earnings of SMEs; (d) creating a credit reporting agency that would standardize procedures to classify creditors and keep a log of the credit history of corporate as well as household clients; and (e) promoting stricter accounting and disclosure standards for all enterprises. > Commercial bank procedures and skills. Commercial banks can realize the potential of SME lending by enhancing skills, procedures, and information technology, and developing marketing strategies. The recent experience of Eastern Europe and West Bank/Gaza, as well as some African countries, can be instructive. >- Guarantee schemes for SME Financing. The FNG has been reformed several times in recent years, without significant improvement in its impact. International experience shows that successful SME guarantee funds have to follow several major principles: (a) subsidized credit should be avoided; (b) the guarantee agency should be an independent body; (c) the guarantee scheme should be adequately capitalized and staffed with strong expertise in risk assessment (understanding the specific needs of SMEs in different sectors) and claim handling; (d) guarantee services should be complemented by strong marketing and communication activities focused on lenders and SMEs; (e) guarantees should be adequately sized and targeted to SMEs rather than micro-businesses only; and (g) there should be appropriate prudential guidelines such as upper exposure limit on individual guarantees, limit. on the amnount of eligible loans and adequate risk-sharing principles. Republic of Tunisia - Private Sector Assessment Updat Page 11 Volume I - Executive Summary and Proposed Reform Agenda 32. Capital markets. To reduce the crowding out effect of bank borrowing by large enterprises on SMEs, alternative sources of finance for large enterprises are required. In terms of share issues, the Tunis stock exchange, with a relatively small percentage of non-financial enterprises among the listed companies, remains a poor reflection of the country's economic activity (market capitalization is 12 percent of GDP). There are currently only 44 companies listed in Tunis exchange and daily trade volume is below $8 million. In the international markets, mutual and pension funds normally put between $1 and $5 million in a single emerging market stock; a daily volume of $8 million would not give them much maneuvering room. In Tunisia there are about 500 companies with more than $1 million in capital that would be candidates for the exchange, but like most large companies in other countries in the Region, they are family owned and so far have shown little interest in sharing ownership. 33. In addition, corporate bond issues by non-financial enterprises remain negligible in the overall financing of large enterprises in Tunisia. Between January 1998 and May 1999, 14 enterprises launched 23 bond issues totaling TD 230 million. About 85 percent of this amount was raised by credit institutions, mainly leasing companies, in addition to two development banks. 34. As AAEU goes into effect, competition from Europeaen imports is likely to push some private companies into the market in search of financing to enhance their competitiveness. But in parallel, measures are needed to facilitate large enterprises' recourse to alternative sources of funding to bank credit, by addressing constraints in both the supply of and demand for corporate securities: > The main supply-side constraints are: (a) insufficient flexibility in the Company Law, limiting the formation of joint stock companies and the attract:iveness of funding by issuing new shares; (b) absence of a legal framework for the creation of holding companies; (c) lack of incentives to issue stock as an alternative to bank credit; (d) low fee structure for investment banking services; and (e) stock listing requirements that inhibit market access by new companies. > The main demand-side constraints are: (a) insufficient liquidity in the secondary market for shares; (b) insufficient compliance with financial disclosure requirements on the part of listed companies, which weakens the reputation of the stock market; (c) little of transparency in the placement of corporate securities, which favors institutional investors and limits the participation of individual investors; (d) lack of institutional savings from insurance companies and pension funds; and (e) unfavorable taxation, which restricts the development of equity mutual funds. 35. The report recommends the following measures to address constraints on supply of and demand for corporate securities: > To address constraints in the supplv of corporate securities: (a) large bank borrowers can be encouraged to use alternative financial instruments by regulating bank exposure to large borrowers, (b) the Company Law can be amended to increase the range of admissible financial instruments, while not diluting control by company founders; (c) fees can be brought into line with the capital requirements of securities firms; (d) and listing requirements for new companies could be relaxed. > To address constraints in demand: (a) liquidity in the stock exchange can be increased by limiting off-floor transactions, and by facilitating stoc]k splits to make stocks more affordable to small investors; (b) small investors can be further encouraged by establishing a quota for small investors in the placement of new issues, and by extending to them the tax exemption on capital gains; (c) compliance can be increased by strengthening enforcement of securities regulations and by adopting international accounting standards; and (d) institutional investors can be encouraged through reforms of the insurance industry and pension funds. Republic of Tunisia - Private Sector Assessment Updat Page 12 Volume I - Executive Summary and Proposed Reform Agenda 36. Government-support programs. As shown by international experience, venture capital funds can play a crucial role to promote SMEs. Because of its past unsuccessful history, the FOPRODI has been redesigned to support industrial projects and job creation by providing venture capital. Under the new scheme, FOPRODI, through SICARs (Societes d'Investissement en Capital Risque), privately financed closed end risk funds, will participate in the equity of new companies. However, the entrepreneur's required contribution is low (3 percent of total project cost), which may lead to excessively risky investment choices. Moreover, banks may be reluctant to finance such projects, given the high level of indebtedness with respect to FOPRODI and repayable contributions. The United States experience with Small Business Investment Companies (SBIC) may provide useful insights on how to design and support effective venture capital funds for SMEs: > SBICs as profit-motivated businesses, provide venture capital, long-term loans, and expert management assistance to new and existing small businesses. SBIC financing is specifically tailored to the needs of each small business concern. > Venture capitalists participating in the SBIC program can supplement their own private investment capital through publicly selling stock, issuing debt securities, and obtaining loans. C Lavine Foundations for Sustained Lone-Run Private Sector Comwetitiveness 37. Developing Skills. Tunisian labor may be falling behind competitors in meeting the needs of private investors in an integrated world economy. The current skills levels - less than 10 percent of labor force reaches higher education - are not consistent with Tunisia's ambitions to diversify into new sectors and activities. Only one percent of labor force in the textiles and clothing sector - the main vehicle of manufactured exports - has higher education, and 70 percent only has primary education. The development of the offshore textiles and clothing sector has therefore been based on low wage and relatively unskilled labor. This advantage is being eroded by competition from lower labor-cost countries. To address labor skill constraint, the Government is increasing its formal and vocational training capacity, but there is still ample scope for fruitful cooperation between the private and public sectors, both in formal education and in vocational training. 38. The report recommends the following measures: ' Making planning for training more demand driven. Up to 1996, manpower projections have been used to forecast skill requirements and to determine the size and composition of vocational training programs. With the reduction of the role of the State as a job provider and the development of a market-oriented economy, the Government has embarked in a far reaching reform. In line with this approach, new investments in training capacity could be increasingly decided on the basis of economic analysis and on the basis of impact evaluation studies. > Reducina the segmentation of pre-employment training. In order to increase the relevance of training to private investor needs, the ongoing vocational training reform seeks to encourage private sector participation in the provision of industrial training: (a) new incentives are provided in the Investment Code for the education/training sector; and (b) focus has shifted from institution-based training to enterprise-based training. In this context, more public training centers could be managed by the private sector, with greater institutional flexibility and adjustment to changing skill needs. > Increasing external efficiency of pre-employment vocational training. Public industrial training programs have two shortcomings: (a) until very recently, they have been organized predominantly as institution-based training with weak links to enterprises, as the latter do not participate in the elaboration of training programs nor in the actual provision of training; and (b) Republic of Tunisia - Private Sector Assessment Updat Page 13 Volume I - Executive Summary and Proposed Reform Agenda they focused on dropouts from the general education s,ystem and minimal preparation for entry- level employment. In its efforts to address these shortcomings, the Government has opted to (i) involve enterprises in the elaboration and provision of training programs; and (ii) ensure higher quality at entry and exit for vocational training students, implying an increasing share of training at the technician level. As such, basic school dropouts will be redirected towards apprenticeship program, whose resources (number of tutors, curricula and course attendance) are inadequate. There is therefore a need to strengthen these programs in order to avoid turning them into receptacle of the dropouts from general education. Efforts to develop enterprise-based training need to be sustained with incentives to enterprises to offer training. > Enhancing financial and managerial autonomy of training centers. Public training centers (TCs) have only recently started to charge fees (10 percent of their budget allocations) for student registration and room and board, to complement their budgetary resources. The weak linkage between the TCs and enterprises also limits the contractual services that TCs can provide and thus limit the potential diversification of the TC revenue sources. Consequently the centers have limited autonomy vis-a-vis the Government (ATFP). Therefore, new funding mechanisms need to be developed, which would in turn increase the responsiveness of the TCs to the needs of businesses. Allocation of funds to training centers based on performance would be a step in the right direction. TCs could also market their services more actively to enterprises. > Increasing possibilities for in-service training. The Government is also responsible for in-service training which is financed by a vocational training tax levied on onshore firms. Qualifying firms receive a partial rebate if they conduct in-service traiining, but few (mostly public) Tunisians enterprises undertake in-service training for workers. Tax rebate is not a strong incentive for most enterprises, especially SMEs, since the training tax they pay (1 percent for manufacturing and 2 percent for non-manufacturing) is small and would only partially cover the costs of in- service training. PRONAFOC was introduced in 1996, to promote in-service training among SMEs employing less than 100 permanent workers, and is considered a valuable innovation by enterprises, but needs to become more demand-driven and improve its capacity to assess individual firms' training needs. An instrument under the FIAP (Fonds d'Insertion et d'Adaptation Professionnelle) also has for objective the development of in-service training for workers (for all enterprises). An evaluation of FIAP, as well as the PRONAFOC, is currently underway to identify further areas for improving these schemes 39. Modernizing Infrastructure. To meet the globalization challenges, telecommunications and transport services need to be improved. Despite recent tariff reductions, international and mobile calls, and internet services are expensive by international standards. Transport costs for a 20-foot container from Tunis to Germany and from China to Germany are about the same; and marine transport rates to Europe exceed those from Thailand to Europe. In addition, delays in port handling entail substantial indirect costs that often far exceed the direct costs reflected by port charges. These delays, and multiple procedures and steps involved in trade activity, translate into 7 to 8 days for customs and port clearance for a partial exporter, compared to a few hours for a competitor in France, supplying the same goods. As part of its policy to address the above issues, the Government encourages private participation in infrastructure (PPI), but its approach to PPI remains cautious and slow. 40. Telecommunications. In a globally integrated environment, demand for telecommunications services in Tunisia is likely to increase dramatically, giving rise to significant growth potential for the sector. Tunisia has achieved substantial progress in several areas of the telecommunications sector. In particular, the fixed line network has been considerably expanded and modernized and the penetration rate (number of fixed lines per 100 inhabitants), is now higher than in some countries of the region (Jordan and Morocco, for example). At the same time, the network reliability has improved, as witnessed Republic of Tunisia - Private Sector Assessment Updat Page 14 Volume I - Executive Summary and Proposed Reform Agenda by the number of faults per 100 lines per year, which is broadly in line with other competitors in the region. Telecom Fixed Line Faults Rate Mobile Cost of 360 Number of Revenues Penetration (number of Penetration minutes mobile Internet Hosts as a % of (main lines aults per (mobile communications per 100.004- GDP per 100 100 lines subscribers per as of 8/1/99 in inhabitants as inhabitants) per year) 100 inhabitants) YSS of January IJ/999 as of l1l/199 2000 Tunisia 1.51 8.3 About 40 0.32 85.58 1.06 Turkey 1.45 25.0 - 3.87 72.20 151.50 Lebanon 2.20 17.5 30 17.24 53.03 118.20 Morocco 1.90 5.5 45 0.27 50.00 3.55 Jordan 3.60 8.0 73 1.41 - 1.30 41. However, Tunisie Telecom remains the sole provider of basic services which remain expensive compared to some of the key competitors, despite recent tariff adjustments. In addition, there is a gap, compared to international competitors, in the internet and mobile telephony services. For example, internet hosts in Tunisia are 143 times lower than in Turkey and over 110 time smaller than in Lebanon. Moreover, the size of the cellular network is ten times smaller than in Turkey and over 50 times smaller than in Lebanon, two countries with similar stages of development as Tunisia. Concerning the Internet segment, the present underdevelopment is due to limited competition and excessive regulation. Although the two existing ISPs are offering services comparable to those in more competitive environments, their price is still higher than international best practice. The Government is currently planning to introduce competition by granting a second mobile phone license to a private operator by the end of the year 2000, in order to comply with the WTO telecommunications obligations. I Despite this effort, the gap in the development of internet and mobile ~ /. ~ services is reflected in the overall size of the telecommunications sector in percentage of GDP, which has substantial room for growth to meet the requirements of a globally integrated private sector. In some competitor countries, telecommunications has been an engine for growth, developing faster than other sectors and creating the conditions for future development (e.g., banking system in Chile). 42. International communications are expensive compared to some competitors and constitutes a competitive disadvantage for export-oriented firrns. However, compared with other regional operators, the price of international communications is not dramatically high. The gap widens when comparing Tunisia with European operators that have radically changed their tariff structure to face competitive challenges. Republic of Tunisia - Private Sector Assessment Updat Page 15 Volume I - Executive Summary and Proposed Reform Agenda Operator Tunisie Etisalat Telkom SA Itisslat-al- lnfostrada(Jtaly) Telecom (United Arab (South Maghreb Emirates) Africa) (Morocco) Call to USA (USD/min.) 0.87 1.25 0.82 0.90 0.16 Call to France (USD/min.) 0.72 1.25 0,82 0.63 0.16 Source: corporate information. 43. The quality of services has improved, but is still - sub-optimal. The fault rate (number of faults per 100 lines How many times do you have to dial a per year) improved over time, from 70 percent to 40 number to get a connection? percent between 1997 and 1999. In parallel, customer Local Long-distance assistance has improved as now over 85 percent of faults 1 71% 60% are repaired within 48 hours. Despite these improvements, 2 21% 22% the private sector is still only partially satisfied by the 3 6% 11% quality of service. The enterprise survey found that a > 3 times 2% 5% substantial share of commercial users need to dial several times before being connected. 44. The timely adoption of a new Tele-communications Code, including the establishment of an autonomous regulatory agency, is a prerequisite for issuing the GSM license, and should be a high priority for sector reform. The Government is not yet fully committed to privatize Tunisie Telecom, and is inclined towards the sale of minority stakes through the local stock exchange at a later stage. This would set Tunisia apart from many other developing countries that have successfully strengthened their incumbent operators in the wake of competition, through the sale of a significant stake to a strategic investor. 45. Ports and shipping. Delays in ports and relatively high costs of shipping impose a burden on the development of the private sector. 46. Streamlining the administrative procedures necessary to pass customs will be an important step to reduce the involuntary retention time for imports. The introduction of competition in port services as well as changing restrictive labor practices would have a positive impact of the retention time of imports and exports alike. The Government has already passed a new law facilitating the former. High freight rates in shipping are partly due to the comparatively low traffic volume to and from Tunisia, partly to an imbalance between incoming and outgoing containerized cargo volumes, but also to a lack of competition and to collusive practices by Tunisian as well as foreign shippers. Republic of Tunisia - Private Sector Assessment Updat Page 16 Volume I - Executive Summary and Proposed Reform Agenda TRANSPORTATON WCOMST Tunisia MorocMo PorT*galEgyptE Thailand Air Freight <45 kg minimum <45 kg $1.60 /kg Not available. <45 kg <45 kg $8.29 to Costs $34 $3.05/kg London, $7.62 to (US$/kg.) Amsterdam >45<250kg >45<250kg >45<500 kg >45kg. $6.23 to $0.95/kg $1.42/kg $2.28/kg London, $5.67 to Amsterdam >500 kg $0.74/kg >500kg $1.22/kg Sea Freight $1,633 Uden, $612 Marseilles Not applicable. Not $1,173 to Rotterdam Rates to Holland Truck transport available, Europe primarily used but truck Including $2,050 Milan, to Europe: $446 transport is a ground Italy by truck to prime transportation Rotterdam, method of and fees $2,393 Malmo, $1,326 by truck transport. (US$/20 ft. Sweden to Paris. container) " Source: Compiled by The Services Groupfrom various sources, 1997. Information regarding Tunisia provided by FIPA; and Maxwell Stamp PLC, Guide for Investors in Tunisia, February 1997. 1/ Figures for Tunisia represent an average cost as there is only a minimal variance in costs between ports in Tunis, Sousse, and Sfax. 47. Industrial land. Industrial land in the north-eastern part of Tunisia, the country's main growth pole, is scarce. One reason is the slow pace of construction of industrial estates by the public agency AFI, although cumbersome bidding procedures for engineering consultants, the shortage of land designated for industrial development, as well as complicated land registration procedures are contributing factors. The introduction of competition from private developers in 1994 has not significantly improved the situation, mainly because private developers have to buy land from private land owners at market prices, while AFI has access to Government land at discounted prices. This situation could be improved if private developers were granted access to Government land either through long-term leases or through sales at prices that are on a level playing field with API. 48. Other infrastructure sectors. Besides telecommunications, marine transport and industrial land, other infrastructure sectors do not pose a notable constraint to private sector activity. Nevertheless, the report proposes the following measures to address some of the remaining issues in these sectors: > In the power sector, occasional power shortages occur during peak demand in summer, partly due to capacity constraints, but their incidence is expected to decline when the large new independent power plant in Rades becomes operational in two years. There are also fluctuations in tension and micro-cuts that could affect unprotected sensitive electronic appliances. About half of all private enterprises, mostly larger industrial companies, own a generator, suggesting that power shortages have been a problem. A few large companies, mainly in the construction material industry, use gas, which is priced above cost. The surplus generated from gas sales cross-subsidizes electricity tariffs, including a social tariff for poorer households. It is estimated that the average electricity tariff would be at least 14 percent higher without the cross-subsidy, or slightly higher than the world average for industrial tariffs. The Government could study the Republic of Tunisia - Private Sector Assessment Updat Page 17 Volume I - Executive Summary and Proposed Reform Agenda options for contracting out more services to the private sector. With regard to elimination of the cross-subsidy, maintaining the social tariff would remove a potential political obstacle to separating STEG into separate gas and electricity utilities-although further breaking up these new utilities into separate, privatized, competitive companies for production, transmission, and distribution does not seem feasible at this stage, because of the small size of the Tunisian power market and the low degree of connection with the grids in neighboring countries. > In the water and sanitation sector, further private provision of ancillary services on a competitive basis can be encouraged, by undertaking BOT projects in the sector based on the experience of other utilities, and accelerating the planned BOT for Tunisie West. 49. Reorienting Government business support to private sector. Programs designed to improve private firms' capacity to produce and market good quality products and services could be made more effective by: > focusing on products rather than institutions in developing innovative service products tailored to different segments of the small enterprise population; > aiming to remove the key constraint: information! - recognizing that small enterprises need specific information leading to business transactions, as well as knowledge of the potential payoff from investing in business services; > forging partnerships with the private sector in building upon existing private sector initiatives and using private firms for more effective delivery of business services; and > emphasizing a performance-based approach to business services in developing comparable indicators of financial performance, business services market development, and impact. 50. Several Government programs are already being re-oriented or designed based on some of these principles. The Industrial Promotion Agency (API) is undergoing a restructuring program involving private sector in the governance, fee-based services, and substantial skill development. The Mise a Niveau Program has relied largely on private sector demand for industrial upgrading and has recently put more emphasis on the requirements of SMEs. The recently established Export Market Access Fund (FAMEX) is managed by an international management team, is highly demand driven (50 percent of the costs are financed by the private sector beneficiaries), and encourages investments in capacity building and skill development. Moreover, the re-direction of sectoral technical centers to industry needs through performance contracts aiming to commercialize the services of these centers, is a good example of successful re-orientation to the private sector support mechanisms. CONCLUSION 51. Tunisia's Ninth Development Plan objectives make it clear that the country is favorably inclined to rapid growth of the private sector. However, practical policies and practices thus far have not translated the broad objectives into actions fast enough to stimulate broad-based private sector growth. The time is opportune now to establish a strong foundation for such growth in industry as the country prepares to negotiate liberalization of the services sector starting this year. The attached matrix proposes certain measures that can provide a better business environment to promote private investment. Some of these measures can be implemented in the short run, while others would require a longer time span. The matrix also assigns indicative priority to measures that acldress constraints identified through various business surveys. Republic of Tunisia - Private Sector Assessment Update Page I of 14 Volume I - Executive Summary and Proposed Reform Agenda REPUBLIC OF TUNISIA PRIVATE SECTOR ASSESSMENT UPDATE Measures to Consrider Existing Initiaives 1:high A. ENIIWAICING._MAW Macro-economic Incentives' Fiscal stance Maintain fiscal deficit at around 3 4Broaden tax coverage and ontain percent of GDP, which may increase expenditures as a result of import duty reductions under AAEU, to avoid risk of crowding out the private sector Wage Policy Allow firms to introduce productivity- 4 Keep wage and salary adjustment Make collective bargaming more based wage incentives wi-thiln moderate imILts, and i ine flexible by allowing two with productivity improvements. components of wage adjustment: one sectoral-based as practiced up to the present and a second component, firm-specific, based on productivity Exchange Rate Ensure stability of the real exchange 4 Guide exchange rate policy Policy rate. developments in relative market shares and in relative unit labor costs, as well as inflation differentials. Although macroeconomic issues are extremely important for investment promotion and private sector development, they are rated "4" regarding their degree of priority: the reason is that measures aimed at improving the business environment and the incentive regime for the private sector, which are the focus of this report, require immediate action, whereas enhancing macroeconomic incentives calls for the pursuance of ongoing efforts. Republic of Tunisia - Private Sector Assessment Update Page 2 of 14 Volume I - Executive Summary and Proposed Reform Agenda Measures to Consider Existing Initiatives Category PSD Policy Objectives Short Term Medium Termt 0 :_ 0 0 _ 0 ; 0 ;ti $0; 00 00: t00 5:lo wv (2 ; 0 years)0 (5 years ____________________________0 00 0 ff 0;00 : Competition Licensing Eliminate the monopoly of State 3 Issue remaining cahiers des charges Several cahiers des charges have trading companies where it exists been issued but no timetable for the remaining products Tariffs Reduce effective protection I * Reduce MFN tariff rates to a Extend tariff bindings to all * A proposal in this direction of maximum of 25 percent. manufacturing reform is under study * Introduce more transparency in * Some options may be under setting the Valeur minimale en study douane (VMD) * Reduce base tariff rates for the fiscal year 2001 and keep the existing dismantling schedule under the Association Agreement with the EU * Accelerate the dismantling by reducing rates in larger proportions in the early years than in the later years of the transition period Domestic Complete price liberalization agenda 3 Liberalize retail margins Strengthen the Competition Competition Council Republic of Tunisia - Private Sector Assessment Update Page 3 of 14 Volume I - Executive Summary and Proposed Reform Agenda Measures to Consider Existing Initiatives I:bigh Category PSD Policy Objectives Short Term Medium Term Silow (2 years) (5 years) B. REDUCING FISCAL DISTORTIONS AND DISINCENTIVES Taxation Improve tax administration 3 * Accelerate VAT credit reimbursement procedures * Accelerate adoption of the Code des Procedures Fiscales to clarify enterprise-tax administrative relations Customs Law Reform Customs Code to make the 3 Incorporate in the Customs Code Detailed analysis has been Tunisian customs regime compatible the same terms and definitions as completed and recommendations with WTO requirements as well as those contained in the EU formulated by the Centre d'Etudes those in AAEU. Areas of particular customs code. Juridiques et Judiciaires (CEJJ) concern include the valuation of and local and foreign experts goods ad s ic nmnrttp retained by it as customs procedures and the resolution of customs disp ts Investment Code * Establish a level playing field I Revise investment incentives to * Integrate investment incentives An amendment of the investment among all investors (offshore and eliminate offshore-onshore in the tax laws code enacted in 1997 has simplified onshore, foreign and local) and dichotomy by: (a) integrating * Remove 49 percent limit on the levying of duties on these sales ensure automaticity and equity offshore firms into domestic tax foreign investment in the on- by assimilating the latter to imports * Encourage foreign direct base; (b) generalizing the fast- shore sector from foreign countries investment clearance of imports granted to * Eliminate tax holidays and use * Improve transparency and reduce offshore firms, to all firms; and (c) instead a combination of discretion removing restrictions on domestic international standards for cost sales by offshore firms, thus deductibility and accounting, stimulating competition good loss forward provisions, and tax allowances Republic of Tunisia - Private Sector Assessment Update Page 4 of 14 Volume I - Executive Summary and Proposed Reform Agenda Business entry Facilitate company entry, operation 3 * Include holding companies in and exit and exit Company Law * Reinforce creditor rights concerning collateral * Remove limits on foreign direct investment concerning onshore firms and services * Provide greater protection to creditors in the Bankruptcy Law * Streamline bankruptcy procedures * Introduce electronic data transfer and credit card transactions in the Commercial Code * Improve contract Law by incorporating franchising and factoring * Update the Code des Obligations et des Contrats to incorporate advances in telecommunications (fax, electronic mail, etc.) Republic of Tunisia - Private Sector Assessment Update Page 5 of 14 Volume I - Executive Summary and Proposed Reform Agenda Measures to Consider Existing Initiatives Cakegory P lObetlves Short Term Medium Term . : :: : - 5:o o(2 years) (5 years) . Judicial system Improve enforcement capacity and the 3 * Train magistrates, judges, judicial system to handle business- Government registrars, etc.. related conflicts * Streamline procedures to settle commercial disputes * Update Commercial Arbitration Code . *~~~ Strengthen independent competition authorities Property rights Secure property rights 3 * Update the Law on commercial, industrial and intellectual property D. ACCELERATING PRIVATIZATION Regulatory * Eliminate discrimination against 3 ExaIne legislat.ion wv- a view to IRevise legislation to eliminate issues and private enterprises already present harmonizing and eliminating distortions and budgetary costs incentives in a given sector or that wish to distortions enter the sector as a result of the preferential treatment granted to purchasers of privatized PEs * Reduce budgetary cost to the State, arising from the restructuring phase Institutiona .Strengthen DGP to implement 3 * Constitute a high skilled core of Enhance human and financial Insfmtutonal privatization transactions civil servants (think tank) assisted resources for GDP framework with external expertise. * Sub-contracting to specialized external experts for all modes of privatization and at each step of ___________________________________ .______ the_process. . . Republic of Tunisia - Private Sector Assessment Update Page 6 of 14 Volume I - Executive Summary and Proposed Reform Agenda Measures to Consider Existing Init e Category ~ j"piihPlcy owjede Shoirt Term Me IwTr Information Reduce the negative view of general 4 Launch a broad public information Infor nation on the privatization dnisfs°emination public about social impact of campaign. program is increasingly available to privatization general public Reduce adjustment costs of 3 acilitate financing the purchase of Create a specialized entity to personnel privatization ares by present and retired facilitate the redeployment of eployees redundant personnel Narrowness of Increase possibilities for the sale of 5 Encourage privatization by means of Narrownnessao PEs equity sales and IPOs the financial markets E. REDUCING ADMINISTRATIVE BARRIERS Start-up Facilitate business Start-up 2 * Prepare a negative list of The "vis-,-vis Unique" and "Document activities that are not Unique" initiatives proposed by API permitted to foreign investors could prove highly useful * Reduce or eliminate sectoral authorizations * Reduce the number of forms and simplify the information needed from investors * Extend the one-stop-shop facility to all investors, including outside the industrial sector Republic of Tunisia - Private Sector Assessment Update Page 7 of 14 Volume I - Executive Summary and Proposed Reform Agenda Measures to Consider Existing Initiatives Category PSD Policy Objectives Short Term Medium Termn 51aow (2 yea) (5 year F. ACCESS TO FINANCE Bank Credit Improve loan collatoral and I * Broaden the defnition of Preparation of a draft law on the procedures for loan recovery collateral to make SMEs revision of loan recovery eligible for credit procedures and quality of loan * Implement risk-based collateral under ECAL 11 supervision of credit for bank lending to small customers * Adopt a system of tax deferrals and incentives for retained earnings of SMEs * Create a credit reporting agency that would standardize procedures to classify creditors and keep a log of the credit history of corporate as well as household clients * Promote stricter accounting and disclosure standards for all enterprises Improve expertise on credit analysis 3 Upgrading of professional * Introduction of an online and selection, and on management of training programs on bank computerized data bank on bank credit risk management indebtedness (ongoing) * Introduction of a bank training program supported by the European Union (under negotiations) Increase availability of equity capital I Develop small business investment FOPRODI has been reformed to in small and medium enterprises companies facilitate equity financing of SMEs in conjunction with SICARs Republic of Tunisia - Private Sector Assessment Update Page 8 of 14 Volume I - Executive Summary and Proposed Reform Agenda 0 ~~~~~~~~~~~~~~~~~~~esrs to Coni :0;r 'der E xistin. ntaivXe0s _, __ ~~~~~~~~5:JoJw (2 yers (. years) 1 0. Capital Markets Encourage enterprises to issue I * Revise legal framnework for * Regulate bank exposure to Five-year reduction of corporate tax and Institutional securities on the market private industrial grdups to large borrowers (to reduce rate from 35 to 25 percent for Savings promote stock listings of large crowding out of smaller newly listed companies and listed Tunisian conglomerates borrowers) companies increasing their * Speed up privatization program * Amend Company Law to proportion of listed shares over the and promote privatization increase the range of next three years through public offerings of admissible financial securities instruments * Relax listing requirements for new companies Improve incentive by bank-owned 3 Promote the development of market intermediaries to promote independent market intermediaries initial public offerings by non- through transitory limits on the financial enterprises as a substitute for volume of stock market operations bank credit by bank-owned market intermediaries (see also next measure below) Increase market transparency arising 4 * Introduce regulation or guidelines Draft regulation on mutual funds from the placement and trading of on the operations of bank-owned (ongoing market consultation- securities by bank-owned market market intermediaries on public second tranche measure of ECAL intermediaries and bank-sponsored offerings of securities by corporate 11) mutual funds bank borrowers * Introduce regulation on non-arm's- length investments by bank- sponsored mutual funds Republic of Tunisia - Private Sector Assessment Update Page 9 of 14 Volume I - Executive Summary and Proposed Reform Agenda Measures to Consider Existing lnitiatives Categoy PSD Poliky Oijective. Short Term Medium term . . 5:r (. years) (3 Years) Increase institutional savings from 3 * Revise premiums on insurance Ongoing study of the insurance insurance companies and pension services industry funded by the African funds * Promote life insurance Development Bank products * Initiate financial restructuring of insurance companies * Ensure actuarial equilibrium and reform of the basic pension system * Introduce privately managed supplementary pension plans Increase market penetration by mutual 2 * Authorize introduction of equity funds mutual funds * Grant tax relief on tuhe taxation of equity capital gain by mutual funds in proportion of individual ownership of mutual funds shares Encourage market participation by 2 * Introduce individual stock savings Draft individual stock savings individual investors plans with fiscal incentives scheme under discussion * Introduce minimum ratios on placement of public offerings in favor of individual investors Update investment regulation for 2 Modernize prudential investment institutional investors to maximize regulation of mutual funds, insurance benefit of credit ratings on corporate companies and pension funds debt instruments Republic of Tunisia - Private Sector Assessment Update Page 10 of 14 Volume I - Executive Summary and Proposed Reform Agenda Measures to Consider Eitn ntaIe Ceo : ?00 0PSD Polcy Objectives Short Term Medium Term Improve insufficient market validation 2 * Improve perfornance standards Reform of the Treasury securities of yields to maturity on Treasury for primary dealers in the market (first and second tranche securities as benchmark rates for the secondary market for Govemment measures of ECAL II) pricing of tradable private debt securities instruments * Revise auction mechanism for Treasury securities and improve incentives for the participation of primary dealers G. INFRASTRUCTURE Telecom * Reduce waiting time for new 1 * Adopt a new telecommunications * Privatize Tunisie Til6com * Unbundling of the former PTT - connections to the fixed network law * Introduce competition in all a ministerial department - into a * Reduce long-distance and * increase independence for Tunisie segments of telephone operator, a international calls are still above Telecom telecommunications market. maintenance company, and a intemational benchmarks * Liberalize GSM, GMPCS and postal service in 1996 * Increase range of services offered VSAT services * Privatization of the maintenance (e.g. free calls to companies as a * Complete liberalization of Internet company (SOTUTEL) marketing instrument) services and private networks * Enactment of a new Tele- * Increase mobile teledensity * Deregulate and simplify existing communication Code compared to similar countries administrative procedures * Ambitious investment program * Increase Internet coverage * Introduce competition in by Tunisie Telecom during the compared to similar countries wholesale telecommunications. IXth plan * Liberalize the sector by allowing * Licensing of two private Intemet competition and attracting foreign Service Providers in March 1997 investment [an adequate regulatory * Signing of a framework is needed which is not Telecommunications Agreement yet in place] with the WTO in October 1996 specifying steps for further liberalization Republic of Tunisia - Private Sector Assessment Update Page 11 of 14 Volume I - Executive Summary and Proposed Reform Agenda Measures to Consider Existing Initiatives Category PSD Policy Objectives lhigb Short Term Medium Term 5:low (2 years) (5 years) Maritime * Reduce long retention times in 2 * Separate sector regulation by Expand the Rades container port * Establishment of the OMPP Transport ports, mainly due to practices of OMPP and service provision by terminal. under a proposed draft law that TranPort traders which are partly due to operators allows for a separation of port cumbersome customs procedures * Revise labor regulation for the regulation by the public and the * Increase competition in cargo sector provision of port services by handling in the country's three * Simplify customs procedures and private operators main ports in the area of streamlining of the procedures to * Expansion of the Radbs container Tunis(monopoly of STAM) which follow in the whole transport chain terminal is planned leads to low productivity * Simplification of customs * Reduce conflict of interest [the procedures and technical newly established OMPP can modernization of the customs provide port services while at the services are planned (with same time regulating these same assistance by the EU) services, possibly leading to * On-going efforts supported by conflicts of interest] the World Bank-under the * Reduce restrictive labor practices in Transport Sector Adjustment all ports, exacerbating low Project and the Export productivity Development Project * Reduce capacity constraints during peak demand time for the container port in Rades; Republic of Tunisia - Private Sector Assessment Update Page 12 of 14 Volume I - Executive Summary and Proposed Reform Agenda M,|*ures to aCOosider Existing |~~~~~~~~~~~~~o (2e ye-0< -iI-t2 ars) (3 y . ea.r- s); Power * Reduce the incidence of occasional 5 * Eliminate in a stepwise fashion the * Evaluate the costs of The completion of the power plant power shortages and fluctuations in cross-subsidy from gas to generating power through a in Rades and other follow-up tension during peak consumption in electricity; BOT approach after two years projects may reduce shortages. summer. * Conduct a feasibility study of operation and using the * Reduce prices for gas which is used identifying the objectives and results as a basis for the by some large industrial companies. constraints of the separation of the decision whether new base- gas and electricity activities of load power plants should be STEG; built under the BOT approach * Evaluate the experience with the or under classical bidding with contracting out of services and operation by the power identifying the possible supplier. advantages and disadvantages of * Separate the gas and electricity contracting out other services. activities of STEG * Evaluate the benefits of establishing an Energy Service Company (Esco) that would consult large electricity consumers with the objective to lower their electricity costs by undertaking investments in energy efficiency and by optimizing their power supply from various sources. Republic of Tunisia - Private Sector Assessment Update Page 13 of 14 Volume I - Executive Summary and Proposed Reform Agenda Measures to Consider Existing Initiatives I:high Category PSD Policy Objectives Short Term Medium Term 5:1ow ( years) (5 years) Encourage private provision of some 5 * Contract out of a number of non- * Some services have already been Watateon ancillary services on a competitive core services contracted out (such as cleaning Sanitation basis; * Undertake a first BOT project in of office buildings and leak the water sector taking into detection) account the experience of other * A World Bank-financed study on utilities the contracting out of more * Continue and accelerate the services has been completed planned program of contracting recently out as well as the BOT for Tunis * A range of services (maintenance West without further delays (see of parts of the sewerage network as well the proposals for cross- in Tunis; three wastewater cutting issues) treatment plants in the Hammametl Nabeul area) have been contracted out on a pilot basis * Further services will be contracted out (other parts of the sewerage network in Tunis and other wastewater treatment plants). * The World Bank finances the technical assistance for the Tunis West wastewater treatment plant BOT contract. * Streamline land outside industrial 2 Grant private developers access to Simplify land registration Industrial Land estates due to cumbersome land public land at the same conditions as procedures. registration procedures; AFI. * Introduce competition for AFI in the access to public lands to be developed as industrial estates. Republic of Tunisia - Private Sector Assessment Update Page 14 of 14 Volume I - Executive Summary and Proposed Reform Agenda Cross-Sectoral * Streamline selection procedures for 2 * Revise the procedures of the Pre-qualify all bidders, as soon as Issues consultants and contractors; [in part Commission Superieure de la cumbersome selection procedures concerning pre-qualification is often omitted, Passation des Marches; have been streamnlined. concerning so that some private enterprises are * Loosen the guarantee requirements tPiiateon Pn unable to fulfill their contractual for bidders; Infrastructure obligations in terms of quality of * Allow temporary leave for service] employees of public enterprises. * Reduce guarantee payments * Revise current labor legislation to allow employees of public companies (EPIC) to leave service on a temporary basis for the private sector; when private participation is extended this may lead to a lack of experienced Tunisian employees for the private operators.