eotN.336M Muiai ManagingNatural Resources: ChallengesandOptions Report No.36386-MR Report No. 36386-MR Mauritania Managing Natural Resources:

ChallengesPublic Disclosure AuthorizedPublic Disclosure Authorized and Options Country Economic Memorandum Update

December 2006

PREM 4 Africa Region Public Disclosure AuthorizedPublic Disclosure Authorized Public Disclosure AuthorizedPublic Disclosure Authorized

Document of the Public Disclosure AuthorizedPublic Disclosure Authorized

... 111

LDF Loi des Finances; Budget ofthe State LDR Loi de RBglement; Budget Execution Law LNG Liquefied Natural Gas MAED MinistBre des Affaires Economiques et du De'veloppement; Ministry ofEconomic Affairs and Development MC Cadastre MDRI Multilateral Debt Relief Initiative MGDs Millennium Development Goals MDRE Ministtre du Ddveloppement Rurale et de 1'Environnement; Ministry ofRural Development and Environment MEP Ministry ofEnergy and ; Ministere de I'Energie et du Petrole MEN MinistBre de L 'Education National ; Ministry ofEducation MIFERMA Mauritanian Mines ; Mines de Fer de Mauritanie MMI Ministdre de Mines et Industrie; Ministry ofMining and Industry MOF MinistBre de Finance; Ministry of Finance MPEM MinistBre de la P6che et de I'Economie Maritime; Ministry ofFisheries MOHSA MinistBre de la Sante' et 1 'Action Sociale; Ministry ofHealth and Social Action NORAD Norwegian Development Agency MTEF Medium-term Expenditure Framework ONS Office National de la Statistique; National Statistics Office OPEX Operating Expenditure PER Public Expenditure Review PI Permanent Income PIP Public Investment Program PPP PRGF Poverty Reduction and Growth Facility PRISM2 Second Mining Sector Capacity Building Project PRSC Poverty Reduction Support Credit PRSP Poverty Reduction Strategy Paper PSA Production Sharing Agreement PSIA Poverty and Social Impact Analysis FEER Real Effective Exchange Rate ROSC Report on Observance of Standard Codes SAVF Saving Fund SESA Strategic Environmental and Social Assessment SIGM Geographical Information System SIGE Environmental management Information System SMH Socie'te' Mauritanienne des Hydrocarbures ; National Oil Company SNDE Socie'te' Nationale d'Eau; National Water Company SNIM Socie'te' Nationale Industrielle et Minitre; National Industrial and Mining Company SOMELEC Socie'te' Mauritanienne d 'Electricitd ; National Electricity Company SONELEC Socie'te' Nationale d 'Eau et d 'Electricitd ; National Electricity and Water Company SSA Sub-Saharan Africa STABF Stabilization Fund TOFE Tableau d'ope'rations FinanciPres de I'Etat; Monthly government financial and economic accounts WE0 World Economic Outlook

Vice President: Gobind Nankani Country Director: James Bond Sector Director: Sudhir Shetty Sector Manager: Robert R. Blake Task Team Leader: Nicola Pontara

iv

TABLE OF CONTENTS

ACKNOWLEDGMENTS ...... VI1 EXECUTIVE SUMMARY ...... VI11 1. THE POLITICAL ECONOMY OF NATURAL RESOURCE WEALTH: LESSONS FROM INTERNATIONAL EXPERIENCE ...... 1 1.1 INTRODUCTION...... 1 1.2 THEORETICALAP HES TO THE ANALYSIS 1.2.I Volatile and Declining Terms of Trade...... 3 1.2.2 The Dutch Disease Effects of Over-rapid Domestic Revenue Absorption .. 1.2.3 Adverse Nature of Point Source Commodi I .2.4 Political Economy of Rent-Driven Development 1.3 DEPLOYMENTOF MINERAL RENTS: GLOBAL EXPERIENCE AND POLICY OPTIONS ...... I .3.I Unsuccessful Mineral Economies: The Nigeria I .3.2 Successful Mineral Economies: Indonesia and ...... 12 1.4 MAINCONCLUSIONS AND RECOMMENDATIONS ...... 2. THE MAURITANIAN CASE: INITIAL CONDITIONS AND NATURAL RESOURCE POTENTIAL ...... 15 2.1 INTRODUCTION...... 15 2.2 MAURITANIA’SINITIAL CONDITIONS ...... 16 2.2.1 Does Mauritania Already Suffer fro utch Disease Effects? ...... 16 2.2.2 The Political Economy of the Mauritanian State: A Snapshot...... 2.3 MAURITANIANATURAL RESOURCE POTENTIAL ...... 2.3.I The Oil Sector...... 20 2.3.2 The Mining Sector ...... 26 2.4 MAINCONCLUSIONS AND RECOMMENDATIONS ...... 29 3. MANAGING NATURAL RESOURCE WEALTH IN MAURITANIA: CHALLENGES AND GOVERNMENT RESPONSE...... 30 3.1 INTRODUCTION...... 30 3.2 KEYCHALLENGES IN THE MANAGEMENTOF NATURAL RESOURCE WEALTH ...... 31 3.2.1 Coordinating Policy Response to Oil Booms, Fiscal Policy Options, and Sustainability 3.2.2 Establishing Appropriate Mechanisms for the Management of Oil Revenues...... 3.3 OIL REVENUEMANAGEMENT: THE GOVERNMENT RESPONSE TO DATEAND REMAINING CHALLENGES...... 36 3.3.I The Oil Sector Institutional Framework 3.3.2 TheEITI...... 3.3.3 Capaciq Building 3.4 MAINCONCLUSIONS AND RECOMMENDATIONS ...... 43 4. THE IMPACT OF NATURAL RESOURCE WEALTH ON THE MAURITANIAN ECONOMY...... 45 4.1 INTRODUCTION...... 4.2 RECENTECONO ...... 46 4.2.I Deterioration in Macro-budgetary Discipline and Recovery 4.2.2 The Economic Outlook (2006-2010) and Debt Sustainability Analysis ...... 47 4.3 OPTIONS FOR ABSORBINGTHE OIL RENT INTO THE MAURITANIANECONO 4.3.I Strategic Options for the Use of Hydrocarbon Financial Resources 4.3.2 Option A: Boosting Public Investment in Infrastructures ...... 4.3.3 Option B: Transferring Oil Revenues to Households ...... 53 4.3.4 Option C: Saving Part of the Windfall for the Future...... V

4.5 MAIN CONCLUSIONS AND RECOMMENDATIONS ...... 57 5. IMPLEMENTING CROSS-SECTORAL REFORMS AND BUILDING A DYNAMIC MARKET SECTOR...... 58 5.1 INTRODUCTION...... 5.2 THE CROSS-SECTORALREFORM 5.2.I Creating an Enabling Environment for the Private Sector ...... 59 5.2.2 Improving Public Sector G 5.2.3 Building Capacity in the Public Administration 5.3 DUALSECTOR RENTABSORPTION STRATEGY ...... 64 5.3.1 Track 1: Boosting Income and Employment in Rural Areas ...... 64 5.3.2 Expanding Niche Tourism in Rura 5.3.3 Encouraging Manufacturing Growth 5.3.4 Boost the Emergence of a National ...... 70 5.3.5 Track 2: Reforming the Rent-Drive 5.4 MAIN CONCLUSIONS AND RECOMMENDATIONS ...... 72

List of Tables Table 1: Summary of Policy Recommendations...... 1 Table 2: Rent Share in GDP 1994 and GDP Growth 1985-97, Natural Resource Endowment ...... Table 3: Index of Institutional Quality 2005, and (2003), Selected Countr Table 4: Evolution of Political Accountability under Political States with Differing Autonomy and Rent ....8 Table 5: Windfalls 1974-81, Selected Countries (% non-mining GDP/annum) ...... 10 Table 6: Real Effective Exchange Rate Movements, Selected Countries 1970-84 ...... 11 Table 7: Changing Export Structure, Indonesia and Malaysia 1970-2000...... Table 8: Aid Flow, Selected African Countries 1960-2003 (% of GNI) ...... 17 Table 9: Proven Crude Oil Reserves and Average Daily Production in Selected Countries ...... 23 Table 10: Oil Price Scenarios ...... Table 11 : Projections on Government Take (US$ million, d real) 2006-2024 ...... Table 12: Shares in World Production, 1990-2000...... 27 Table 13: SNIM Production and Exports (2000-2005) ...... 27 Table 14: Selected Economic Indicators (2001-2006) ...... 47 Table 15: Mauritania Macroeconomic Framework (2001-2010) ...... 49 Table 16: Expenditure and Net lending (2005-2010, % of Non-oil GDP) ...... 51 Table 17: Governance Fundamentals - Based on Political Arena and Key Principles ...... Table 18: Development and Exploration Costs: Base and High Case Scenarios ...... Table 19: Production Sharing Agreement...... Table 20: Social Indicators and MDGSiPRSP Targets ...... 80 Table 21: Mauritania Oil Blocks: Shares and Oper ...... 81

List of Boxes Box 1: GIRMA Activities to Promote Mining in Mauritania...... Box 2: Variety of Oil Funds ...... 34 Box 3: Characteristics of the EITI...... Box 4: The Oil Circuit in Mauritania ...... Box 5: Key Elements for Consideration on Absorptive Capacity Box 6: Preliminary Findings of the FSAP Mission ...... 60

List of Figures Figure 1: Low Rent and the Competitive Industrialization Model ...... ,7 Figure 2: High Rent and the Staple Trap Model ...... Figure 3: Composition of Exports (2003-2006, %) ...... 15 Figure 4: Evolution of by Sector (1970-2004) ...... 16 Figure 5: Mauritania: Evolution of the Real Effective Exchange Rate (1990-2005) ...... 18 vi

Figure 6: Oil Production Profile - Base and High Cases (2006-2024): bbVday ...... Figure 7: Mauritania Key Oil Ratios: Base and High Case Scenarios ...... 25 Figure 8: Export Value (in US$ million) of and Copper (2006-2018) ...... 28 Figure 9: Holistic Approach to Petroleum Sector Management...... 41 Figure 10: Size of the Permanent Fund and Spending Patterns (2006-2024 ...... 55 Figure 11 : Income Available for Spending from both Fund Revenues and Oil under “Permanent income”

Approach ...... , , , , ...... , , .. . . . , ...... ~ ...... 55 Figure 12: Corruption as a Constraint (YOof ent) and Cost of Corruption (“h of Yearly Turnover Spent on Informal Payments) ,...... 61 Figure 13: Selected Governance Indicators for Mauritania (200 ...... 62 Figure 14: Sectoral Contribution to GDP Growth (1999-2007)...... *... Figure 15: Understanding the Effects of Dutch Disease ......

List of Annexes Annex 1: Explaining Dutch Disease Effects ...... ,...... 74 Annex 2: Political Economy Classification of Oil Exporters ...... 76 Annex 3: Field’s Costs and Fiscal Regime...... 77 Annex 4: Social Indicators and MDGSiPRSP Targets...... 80 Annex 5: Maps of Oil and Mining Fields ...... ,...... 81

REFERENCES...... 82

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ACKNOWLEDGMENTS

This report was prepared by a multi-sectoral team, led by Nicola Pontara (World Bank, Senior Economist, AFTP4). The core team was composed of: Professor Richard Auty (University of Lancaster UK), Eleodoro Mayorga-Alba (World Bank, Lead Economist, COPCO), Arjan Berkelaar (World Bank, Principal Investment Officer, QRA), Jennifer Johnson-Calari (World Bank, Head of Reserves Advisory Management, BFC), Couro Kane-Janus (World Bank, Investment Officer, QRA), Michael Lewin (Senior Economist, DECDG), Alexandra Pugachevsky (World Bank, Operations Analyst, COPCO), Thilakaratna Ranaweera (Consultant, AFTP2), Boris Samuel (Technical Advisor to the Minister of Finance, French Cooperation), Hawa CissC WaguC (World Bank, Economist, AFTP4), and Gotthard Walser (World Bank, Senior Mining Specialist, COCPO).

The Mauritania CEM counterpart team was led by Isselmou Ould Sidi El Moctar, Deputy Director of the Directorate for Planning and Studies (Ministry of Economic Affairs and Development - MAED), Mohamed Abdellahi Ould Didi, Technical Advisor (Ministry of Finance, MOF), Mohamed Ould Abba, Advisor on Development Policy (MAED), Sidna Ould Cheikhna, Technical Advisor (Ministry of Petroleum and Energy, MEP), Dia Souleye Aly, Technical Advisor (Ministry of Mimes and Industry, MMI), Abba Ould Ahmed-Tolba, Director for Planning and Studies (MAED), Baba Ould Boumeiss, Director of the National Statistics Office (ONS), Hacen Ould Zein, Director ofthe Mauritanian Centre for Policy Analysis (CMAP and MAED), Mohamed Ould Brahim, Deputy Director for Planning and Studies, Poverty Commissariat (CDHLCPI), Boumedienne Ould Mohamed Ould Taya, Interim Director form Studies, Central Bank (BCM), Ahmed Salem Ould Beidah, Economist at the Chinguetti Project, and Abderrahmane Ould Dadah, Deputy Director, PRISM Project (MMI).

The report has benefited from the overall guidance of Robert Blake (World Bank, Sector Manager, AFTP4) and comments made by the peer reviewers, Alan Gelb (World Bank, Director of Development Policy, DECVP) and Charles McPhersons (World Bank, Senior Adviser, COPCO). The IMF Mauritania Country Team (MED) also provided comments at various stages. The team is also grateful to Francois Rantrua (World Bank, Country Manager, AFMMR) for comments and support. Logistical support was provided by Pierre Lenaud (World Bank, AFTP4).

In canying out this task, the team drew upon economic reports and operations prepared by the Bank on Mauritania in the last few years, the contribution prepared by the Mauritanian authorities to this report, and on the analytical work conducted by the IMF team working on Mauritania. The available literature on natural resources was also systematically utilized. Synergy was sought with the update ofthe 2006 PER Update for Mauritania.

... Vlll

EXECUTIVE SUMMARY

(i) The key challenge of Mauritania is to make full use of its physical and human assets to accelerate growth and improve the living standards of the population. However, the risks facing Mauritania on the eve ofthe oil boom are substantial. Empirical research suggests that many countries with large non-renewable natural resource wealth tend to lag behind comparable countries in terms of real GDP growth, social indicators and political stability. Moreover, the easing of resource constraints - as the exploitation of oil and other natural resources gets underway - might reduce the authorities’ commitment to the ambitious program presented in the second PRSP (2006-10). (ii) The CEM Update seeks to help the authorities in the formulation of their long-term strategy to accelerate growth and improve the living standards of the population by focusing the attention on the management of the country’s natural resource wealth. The CEM Update also aims at filling the analytical gap on petroleum issues, which were only marginally covered in the 2004 CEM. A companion PER Update examines public expenditure trends in recent years and reviews the institutional framework for public financial management (PFM). What follows summarizes the main findings of the report, concentrating on six key domains ofintervention. Policy recommendations are presented in Table 1.

1. Mauritania’s Natural Resource Potential

(iii) Mauritania’s proven and probable crude oil reserves are estimated at around 310 million barrels - yielding an average daily production of 75,000 thousands barrels - and could last for about 20 years (2006-2025). Cumulative oil wealth in nominal terms oscillates between US$3.0 billion (Le. base production case, low oil price) and US$10 billion (high production case, high price). In the former case, oil production peaks in 2015 and the Government’s take in that year would constitute around 20 percent of total government revenue and around 6 percent of non-oil GDP. In the latter, the government’s take would constitute around 22 percent of non-oil GDP and almost the totality of Government revenue in 2015. (iv) Besides the traditional iron ore, production of copper and gold also started in 2006. In terms ofrevenue, given the promotional terms ofthe concessions under development, mining will make a much smaller contribution than oil to the national budget. The National Mining Company, SNIM, pays around US$20 million annually to the government, which is about 10 percent of its total revenue. The combined fiscal contribution from the new projects in gold and copper through to 2010 will also be modest and driven mainly by the royalties, running at US$4-5.5 million annually combined (i.e. around 2.2 percent of export earnings).

2. Mauritania’s Initial Conditions

(v) Mauritania has undergone significant structural changes in the last 50 years. Today, the tertiary sector dominates the productive sector of the economy, while the share of and livestock account for around one-fifth of GDP, much lower than in the comparator country group. At the same time, overseas assistance increased substantially over the years, from an average of 6.5 percent during 1970-73 to an average of25.4 percent during 2000-2003. Although the real effective exchange rate did not begin to appreciate until ix recently, the initial conditions of the economy on the eve of the oil boom are not propitious, raising the risks ofDutch disease with the inflow. (vi) The political economy of Mauritania on the eve of the oil boom reflects four decades of rent-driven development since independence, beginning with the expansion of an iron ore mine in the 1950s; followed by foreign aid from 1974 that has averaged over one-fifth of GNI annually; and more recently from fisheries. The legacy of rent-driven growth is not propitious for effective use of the oil windfall: the economy already exhibits rent seeking behavior (as shown by the management of the enclave mining and fisheries sectors in the last half century) together with a political system characterized by clientelism and patronage, a dependent form of social capital, and some early signs of Dutch disease.

3. Looking Forward: Economic Management during the Oil Era

(vii) On the eve of the oil era, Mauritania already displays a distorted economy and dependent polity that tends to prioritize rent redistribution over wealth creation. These factors combined together increase the risks of not making effective use of the projected increase in mineral rents. What choices really matter now? The recommendations of the CEM Update focus selectively on six domains ofintervention.

3.1 Get the Macroeconomic Basics Right

(viii) Countries rich in non-renewable resources face two key problems: (a) the uncertainty and volatility of the resource stream; and (b) the exhaustible nature of the resource. These problems raise important challenges for economic policy in general and fiscal policy in particular. One of the challenges consists of simultaneously targeting realistic spending objectives (in line with the PRSP 2 priorities, as well as public absorption capacities), while limiting volatility and, together with monetary and exchange rate policies, coping with Dutch Disease pressures. (ix) In the short run, the challenge is to minimize the correlation between government spending and the volatility of oil prices, by smoothing fiscal expenditure and avoiding abrupt changes in Government spending and non-oil deficits. This would imply eliminating expansionary fiscal policy biases during oil booms and targeting prudent non-oil fiscal balances to reduce the non-oil fiscal deficit overtime, (x) In the medium term, the Government should aim for an (overall) fiscal surplus, especially given that sound systems to spend public money are not yet in place. In addition, it should establish a medium-term smoothing rule for oil revenue utilization, to stabilize expenditure over time. From a long-run perspective, the authorities should pay particular attention to a sustainable non-oil primary deficit, which sets a simple and transparent rule for the level of expenditures financed from oil revenue, consistent with long-term savings objectives.

3.2 Strengthen the Framework to Manage Natural Resource Revenues

(xi) Good progress has been made to set up an institutional framework for the transparent management of oil revenues, which are treated transparently in the 2006 and 2007 budgets. The authorities have engaged in prudent fiscal and monetary policies and set up the National Hydrocarbon Revenue Fund (FNRH). The government has also created a National Oil Company (SMH), adhered to the EITI and agreed to implement all its steps; and sought X support and technical assistance in the oil sector and in the management of oil revenues from the World Bank and International Monetary Fund. (xii) The overall legal framework and procedures, however, need strengthening. The links between the FNRH and the annual budgets and the medium-term expenditure framework (MTEF) need to be clearly defined. The surveillance role of Parliament (after the November 2006 elections) over the use of the resources of the oil fund is to be stressed. Also, clear guidelines, based on a long-term fiscal strategy, need to be established on the transfer of resources from the FNRH to the budget. The authorities should formulate an Oil Sector Policy Letter and elaborate and adopt a Hydrocarbon Law. (xiii) In addition, the role of the newly formed state oil corporation, SMH, should be clarified and its commercial mandate safeguarded and made paramount, to prevent leakages of funds from the commercial enterprise into the political patronage system. The Parliament should approve the budget of SMH in conjunction with the state budget on a yearly basis. Moreover, the audited accounts ofthe contracts to which SMH is party, on behalf ofthe state, should be published to make the SMH assets and liabilities transparent. (xiv) On the EITI front, priorities for action in the near future include: (i)facilitating the task ofthe international auditor to launch the process ofreconciliation ofrevenue figures; (ii) training the representatives of civil society on basic oil industry and macroeconomics concepts; (iii)preparing the 2005 audit report on SNIM and the 2006 report on oil and mining companies; and (iv) launching the communication campaign to manage the expectations ofthe general public. The EITI reports should be publicly disclosed.

3.3 Invest Judiciously in Priority Areas

(xv) Mauritania faces considerable pressure to use the oil revenue to boost social expenditures rapidly, given the need to reduce the country’s 46.7 percent poverty headcount. However, the over-rapid absorption ofa natural resource rent stream that will emerge quickly but be relatively short-lived poses severe risks to the political economy. The Mauritanian government can learn from successful resource-rich countries like Malaysia, which matched the rent flow to domestic absorptive capacity. (xvi) Yet, public spending could increase quite dramatically, propelled by political decisions. Policy makers have a number of options: (i)Using accumulated oil revenues to expand public investment in infrastructure as a means to directly propel non-oil sector growth; (ii)Distributing oil windfalls to households, as a means of bolstering incomes and domestic demand growth, while possibly ensuring a better stabilization mechanism against oil revenue volatility; and (iii)Saving part of the oil windfalls for the future. A mix ofoptions 1 and 3 seems to be the most appropriate in the Mauritanian context.

(xvii) Mauritania needs infrastructures but the territory is vast and the population dispersed. Policy makers should develop a long-term priority investment plan. A public sector investment evaluation unit can compare the prospective returns to alternative applications of the rent, while an audit unit can hunt out corruption in the award of contracts and during construction. A two-hurdle system can be set up to evaluate investment projects to: (i)assess the economic rate of return of a project and (ii)assess the honesty of the procurement process. The MTEF should guide the investment decisions of the authorities in the medium-term. xi

3.4 Focus on the Political Economy and Prevent Rent Seeking Activities

(xviii) The current Government of Mauritania took power in August 2005 through a bloodless coup d’etat. Early on, the new Government indicated its intention to restore democracy and has set out an ambitious timetable, culminating in new presidential elections in March 2007. During this period of transition to democratic politics, the new authorities managed to improve the social consensus toward development by being more transparent on both the political and economic fronts. It is important that this positive trend be maintained in the future, to cement the progress achieved in recent times. (xix) The transition authorities should deliver on the policies endorsed in the Road Map, namely: (i)Combating corruption, following through on the Government’s open recognition of this problem and its plans to elaborate a national Anti-corruption Strategy before the end of the transition period; (ii)Strengthening the judicial system, to establish a fairer system for individuals and an attractive investment climate for businesses; (iii)Fostering public sector governance, by reviewing the regulatory framework affecting civil servants’ behavior and deepening public financial management reforms (especially procurement); and (iv) Improving the social consensus on the utilization ofoil revenues. (xx) The transition to a democratic rule can paradoxically intensify rent-seeking activities as politicians compete with each other through rival patronage networks. Patronage can be limited by: (i)Setting up checks and balances on how public revenues are used, including informal institutional arrangements, such as a free and informed media, and engaged groups from civil society; (ii)Limiting the extent to which political campaigns are financed with the oil revenues; and (iii)Improving citizens’ information, notably about the potential of oil revenues to improve public provision, as patronage thrives on the ignorance of citizens.

3.5 Build Capacity to Manage the Petroleum Sector Appropriately

(xxi) Building national capacity includes training of local personnel who will be progressively able to elaborate and put in place a clear legal, regulatory and contractual framework. Such a framework should: (i)Emphasize the government’s objective in maximizing the positive impact that the oil and gas sectors have on overall economic development; and (ii)Translate into petroleum laws, regulations, contracts and institutions that promote foreign and domestic direct investment and competition. Proper attention will need to be paid to environmental management, especially since offshore fishing represents a sizeable share of exports for the country. (xxii) At the same time, the authorities will need to gradually build up the institutions responsible for sector management in accordance with the oil sector policy, when it is adopted. Oil exploration and production generates a large number of seismic, economic, financial, and environmental data. The near-term agenda includes: (i)Setting up the reporting system, and training staff who will be responsible for preparing monthly reports on hydrocarbon production and sales; (ii)Updating oil production and revenue projections; and (iii)Continuing the implementation ofthe EITI recommendations. xii

3.6Revive the Non-oil Economy

(xxiii) Realistically, over the medium term, Mauritania will continue to depend primarily on mining and fishing as the two main (non-oil) sources of growth. Without massive investment in important infrastructures and services, there is little chance that the country would be able to diversify its economic and export base in a meaningful way. The experience of the formerly centrally planned low-income economies suggests dual track reform offers a politically practical way ofreorienting the distribution ofrent towards sustainable growth that is pro-poor than does either rapid or gradual economic reform on its own.

(xxiv) The dual track strategy creates a dynamic market economy within the neglected rural economy (track one), and incrementally promotes politically sensitive reform of the largely rent-driven urban economy (track two). However, the dual track strategy - and the economic restructuring and political realignment that it entails - requires a favorable environment for private sector growth and sound institutions to manage public resources. This could be achieved by: (i)Creating an enabling environment for the private sector, also by restructuring the financial sector; (ii)Improving public sector governance; (iii)Building capacity in the public administration; and (iv) Improving the management ofpublic expenditure.

(xxv) At the sectoral level, the CEM suggests that the growth agenda could be boosted if the authorities could focus on the following priorities: (i)Intensifying cropping activity and raising commercial returns to livestock herding, which are shown to have substantial potential; (ii)Expanding niche tourism in rural centers; (iii)Encouraging manufacturing growth, in agro-processing and fisheries; (iv) Boosting the rise of a national fisheries industry; and (v) Reforming the rent-driven urban sector. In so doing, substantial inroads could be made in implementing the dual track strategy.

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1. THE POLITICAL ECONOMY OF NATURAL RESOURCE WEALTH: LESSONS FROM INTERNATIONAL EXPERIENCE

1.1 INTRODUCTION

1. Empirical research suggests that a majority of countries with large natural resource wealth tend to lag behind comparable countries in terms of real GDP growth (Sachs and Warner 200 l),quality of institutions and governance (Sala-i-Martin and Subramanian 2003), and social indicators. Also, these countries are more prone to develop civil conflicts (Collier and Hoffler 2002). In terms of per capita GDP growth, large, resource poor countries have outperformed resource rich (whether large or small) and especially small, oil-exporter countries (Table 2).’ Ifmeasured through an index of institutional quality, most oil-producing countries perform worse than non-natural resource dependent countries (the exceptions being Trinidad and Tobago and Botswana - Table 3).

2. One finds that the performance of social indicators is disappointing in oil-producing countries, notably in Sub-Saharan Africa (SSA). For instance, the Human Development Index (HDI) reached by big oil-exporting countries (Angola, Nigeria) is below the African average (Table 3). The coincidence of oil and natural gas with civil conflict is also striking (e.g. Sudan, Angola, Yemen, Iraq, Colombia, Indonesia, Algeria, etc.). In some cases, it is found that dependence ofprimary commodity exports has an explanatory power in predicting the occurrence of civil strife.2 Reasons for the poor performance of natural resource rich countries also include the pro-cyclicality of government expenditure, the postponement of politically unpopular (but growth-enhancing) reforms and the adverse effects associated to Dutch disease (Barnett and Ossowski 2002, see footnote 5 and Annex 1).

3. The “natural resource curse” is not a fatality, however. There are some success stories: Indonesia, Chile, Botswana, , and Malaysia - to different extents - have managed to build sound institutions and sustain growth while decreasing their dependency on natural resource rents. The objective ofthis chapter is to examine some ofthe success stories (Indonesia, Malaysia, and Botswana) and some of the less successful examples (Nigeria) in the literature on natural resources. Against this background, the Mauritanian case will be closely examined in Chapters 2 to 5. Section 1.2 deals reviews the theoretical approaches to the analysis of natural resource windfalls. Section 1.3 concentrates on the global experience in the deployment of natural resource wealth, highlighting policy options that led to failure as well as success. Section 1.4 provides some conclusion and recommendations drawing on the international experience.

By way of example, it is estimated that Venezuela gained nearly US$600 million in oil exports since the early 1970s, but its real per capita income fell by 15 percent between 1973 and 1985; since then, per capita GDP fell on average by 2.2 percent per year during 1985-2000 (Eifert et al., 2003). At most dangerous levels of dependence - that is, with a share of GDP deriving from the export of primary commodities of 32 percent or above - the risk ofcivil conflict rises to 22 percent. By contrast, zero dependence on primary commodity exports reduces the risk to 1 percent. (Collier and Hoffler 2002). * E a2 E

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4. There are four leading theories that seek to explain the disappointing impact of natural resource windfalls. They focus upon: (i)volatile and declining terms of trade, (ii)currency appreciation and the contraction ofnon-boom tradable activity (the Dutch disease effect), (iii) the skewed linkages generated by commodities with capital-intensive production functions; and (iv) the impact ofrents on political incentives.

1.2.1 Volatile and Declining Terms of Trade

5. Commodity price volatility is bad for economic growth because booms lead to rising expenditure. In the public sector, this phenomenon tends to result in increased consumption entitlements along with hastily expanded investments that exhibit low efficiency. Unfortunately, such increased public expenditure acquires a momentum that renders it difficult to cut back during downswings leading to the accumulation of debt, which merely postpones the necessary macroeconomic adjustment. The result is that cutbacks are much more severe when they become ~navoidable.~

6. A long-standing explanation for the disappointing performance of the resource-rich countries is the long-term decline in the terms of trade of primary product exporters (that is, the price of exports rose more slowly than the price of imports). Unexpectedly rapid and often large movements in commodity prices have emerged since the early- 1970s, which have profoundly complicated efforts .to manage commodity revenues. Using The Economist database to trace long-term shifts in the industrial commodity price index between 1860 and 1999, one finds that a downward trend set in at the start ofthe twentieth century so that prices fell at just over 1 percent annually, with no evidence of break points in the line. By 1999 real industrial commodity prices were one-fifth of their value a century earlier (Cashin and McDermott, 2002).

7. Two additional adverse features of commodity revenues are: (i)the volatility of prices around the trend line, which is of much greater magnitude than the long-term price decline; and (ii)an increased variation in the frequency of price volatility over time. More recent research has focused upon the duration of commodity shocks rather than their scale. Mineral exporters, which performed especially poorly during the last two decades, experienced more prolonged price downswings. This can be traced to the capital-intensive production function of most mining and the associated scale economies. New mining investment has lengthy lead-times so that capacity expansion is lumpy rather than incremental, causing more volatile revenue streams and also revenue downswings and upswings of longer duration than in the case of, say, crops that are planted ann~ally.~

3 Interestingly, there is evidence that whereas governments tend to react as if the increased income from a commodity boom is permanent, private economic actors exhibit greater caution (Bevan et al. 1987). Consequently, private economic agents are more likely to save for future downturns and where governments permit, their responses include investing overseas, which helps to sterilize the revenue inflow and thereby limit Dutch disease effects (Collier and Gunning 1999). In the case ofoil, the long-run cycle appears to be around twenty-five years, with some eight years ofhigh prices giving way to a longer period ofrelatively depressed prices. 4

8. Mechanisms to cope with commodity shocks include price agreements based upon producer cartels or pacts between consumers and producers (which have proved singularly unsuccessful); use of risk instruments such as forward contracts to stabilize producer revenue; producer government revenue stabilization funds (potentially the most effective response - See Chapter 3 below); compensatory financing of individual producers by either domestic governments (through domestic stabilization funds) or international financial institutions; and stabilization of producer/consumer prices by variable export taxes or tariffs, marketing boards and domestic stockpiles.

1.2.2 The Dutch Disease Effects of Over-rapid Domestic Revenue Absorption

9. A second theory for the adverse impact of natural resources on economic performance focuses upon the Dutch disease effects', whereby the booming commodity sector keeps the value of the currency so high that other tradable sectors, usually non-boom agriculture and manufacturing, cannot compete internationally. Dutch disease can be easily explained by considering a three-sector model comprising a resource sector, a sector of other tradables, and a non-tradable sector. A boom in the resource sector has two basic effects on the economy: (i)a spending effect that alters relative prices; and (ii)a resource movement effect that transfers capital and labor between sectors.

10. First, the expenditure ofthe increased export revenue boosts demand for both tradables (e.g. agriculture and industry) and non-tradables (e.g. most services), but global competition precludes price rises for tradables so the spending effect of the extra commodity revenues shifts relative prices in favor of the non-tradable sector. Domestic prices of tradable goods are therefore held down by import competition, whereas domestic prices ofnon-tradables rise due to increased demand, being unaffected by either the currency appreciation or by import competition. This brings a real appreciation (Le. strengthening) of the currency, which reduces the competitiveness ofnon-booming tradable activity (Corden and Neary, 1982).

11. The second effect sees capital and labor move from tradable activity into non-tradable in response to changed relative prices, which reduces agricultural and manufactured exports and expands imports. It also reduces capital accumulation if the non-tradable sector is more labor-intensive than the tradable sector because such movements in favor of the non-tradable sector raise wages and lower returns to capital. Furthermore, if resource booms cause manufacturing to shrink and, as many believe, there are increasing returns to scale in manufacturing, the resource-abundant economy can experience slower long-term growth than it would if it had no resources at all and the manufacturing sector had not been shrunk by the Dutch disease effects (see Matsuyama 1992, and Annex 1).

12. However, some contraction in agriculture and industry may be a symptom of the economy's adjustment to a new equilibrium rather than a symptom of a disease (Neary and van Wijnbergen 1986: 40-1). Provided the rate of absorption of boom sector revenues is

' The term originated in Holland after the discovery of North Sea gas. The term "Dutch Disease" was put forward by The Economist in 1977, claiming that Dutch natural gas exports had triggered an overvalued currency, excessive government spending, loss of Dutch competitiveness, and eventually a sustained process ofDutch de-industrialization. 5 matched to domestic absorptive capacity (typically by sterilizing a fraction of the revenue in capital funds held offshore) and unsustainable patterns of domestic consumption are not established during the boom, a well-managed economy can adjust smoothly to the changing composition of sectoral activity (Gelb and Associates 1988). Consequently, those who argue that Dutch disease effects largely explains the growth collapses in resource-abundant economies neglect the importance ofpolicy in mediating outcomes (e.g. Sachs, 1999).6

1.2.3 Adverse Nature of Point Source Commodity Linkages

13. The third set of explanations has its roots in export base theory and focuses upon the economic linkages generated by the rent streams from different commodities. It suggests that commodities with a capital-intensive production function, such as most mines and plantations, produce what are sometimes termed “point source linkages” that are detrimental to economic growth (Engerman and Sokoloff 1997, Woolcock et al. 2001). It argues that the capital-intensive production function of, for example, mining stunts both backward linkages (local production ofinputs) and forward linkages (resource processing prior to export).

14. In addition, mining also exhibits limited final demand linkages (local expenditure by workers and owners) due to the small size of the highly productive mine workforce and the leakage ofprofits abroad due to foreign ownership ofcapital. Consequently, fiscal linkages -- such as the taxation of the returns to labor and, particularly, capital -- is left as the principal stimulus to the domestic economy, i.e. most of the economic impact of mining is controlled by the government (this is the case of iron ore production in Mauritania). Economies that produce point source commodities (such as oil) are therefore more likely than diffuse linkage economies to become locked in a staple trap of increasing dependence upon a commodity with declining growth prospects.

15. In contrast, the “diffuse linkages” associated with yeoman farms growing wheat and maize in the “West” regions of the in the nineteenth show much greater flexibility. There are few scale economies so there are many entrants and farm productivity responds to small increments in investment that steadily raise output, incomes and consumption (Baldwin 1956). This creates an expanding market for simple consumer goods (forward linkage) and farm implements (backward linkage) that can be locally supplied, triggering a virtuous circle of economic diver~ification.~In addition, the low sunk costs associated with crops like wheat, maize or ground nuts, allow producers to respond to falling commodity prices by switching from low-growth to high-growth commodities.

16. Evidence obtained comparing the record of “point” and “diffuse” resource exporting countries over the period 1957-1997 shows that point resource-exporting countries are characterized by comparatively poor governance indicators in comparison with diffuse resource exporters, which also engender more robust growth (Isham et al. 2005). Yet, central governments have proved all too capable of transforming diffuse linkages into point source

6 According to the Dutch diseases story, countries would be doing poorly when oil is doing well, and would be improving when oil become less dynamic. However, looking at the growth performance of oil exporters over the period 1960-1998, Hausman and Rigobon (2003) find that countries grew faster in the period of rising oil prices and collapsed when oil revenues declined after the 1980s. ’ Farmers also willingly contribute to taxation because they directly receive the benefits of public spending in the form of improved infrastructure and education for their children, many of whom will fill the proliferating jobs in off-farm activity. For a similar set of circumstances see Mellor (1976) for South Asia. 6 linkages by imposing swinging taxes through, for example, commodity marketing boards that allow the government to siphon away crop rent and more (Osei 2001, Krueger et al. 1992). A second weakness of the linkage theory arises from the fact that Chile, Western Australia and the Witwatersrand (South Africa) all show that a diversified economy can be driven by point source commodities like mining.

1.2.4 Political Economy of Rent-Driven Development

17. The fourth set of theories centers upon the impact of resource rent on the political economy. The central insight from resource-driven political economy models is that differences in the scale and degree of concentration of the rent affect both the motives of the political state and the development trajectory of the economy. Low rent motivates governments to create wealth in order to increase the resources at their disposal through taxation. In contrast, high rent sparks political contests and governments seek to distribute it at the expense ofefforts to create wealth.

18. Differences in rent also affect the development trajectory. A short dependence upon commodity exports causes low-rent countries to embark on industrialization at a relatively low per capita income, so the industry is labor-intensive and must be competitive. This development trajectory (shaded column in Figure 1) triggers virtuous economic and political cycles that are summarized in the competitive industrialization model. The virtuous political cycle that accompanies competitive industrialization eases social tension by maintaining a relatively egalitarian income distribution because the early elimination of surplus labor puts a floor under the wages of the poor while the rapid expansion of skills caps the skill premium.

19. Moreover, sustained rapid per capita income growth strengthens three key sanctions against anti-social governance. First, the necessary diversification of taxation away from commodity exports towards income, profit and expenditure strengthens demands for the political accountability ofpublic spending (Ross 200 1). Second, early industrialization within a competitive economy generates self-help social capital that strengthens civic voice (Isham et al. 2005). Third, the proliferation of competitive enterprises intensifies demands for the rule of law and property rights to protect the returns to investment (Li et al. 2000). These trends are associated with an incremental democratization that is endogenous as, in line with low-rent incentives, the stylized facts of the political economy move within the trajectory described in Table 4 (low rent).

20. In contrast, the longer dependence by high-rent economies on volatile revenue from the primary export sector combines with maladroit rent deployment by a predatory government to lock the economy into a staple trap development trajectory that increases its vulnerability to a growth collapse. The staple trap model skips the labor-intensive manufacturing stage with three adverse consequences (shaded column in Figure 2). The staple trap trajectory also reinforces sanctions against anti-social governance less than competitive industrialization. Rent recipients make fewer demands for political accountability than taxpayers do while rent- seeking entrepreneurs lobby government officials for mutually beneficial favors instead of pushing for property rights and the rule of law. Moreover, social capital relies on state largesse, which discourages civic voice. These trends give rise to the political accountability trajectory described in Table 4 (high rent). sL

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1.3 DEPLOYMENTOF MINERAL RENTS: GLOBALEXPERIENCE AND POLICY OPTIONS

2 1. During 1974-78 and 1979-8 1 Algeria, Ecuador, Indonesia, Nigeria, Trinidad and Tobago and Venezuela benefited from substantial oil windfalls. The windfalls ranged in size from an additional 9 percent of non-oil GDP annually in Venezuela up to almost 40 percent in the case of Trinidad and Tobago (Table 5). Indonesia was successful in sustaining rapid GDP growth that brought substantial poverty alleviation, whereas the other five countries all experienced growth collapses. Trinidad and Tobago took almost fifteen years before renewed growth took secure root (in the mid-l990s), whereas the four other countries that experienced growth collapses have struggled for even longer and they still need to further restructure their economies with the attendant political risks (Gelb and Associates 1988, Auty 1990).

Table 5: Windfalls 1974-81, Selected Countries (% non-mining GDP/annum) Algeria Ecuador Indonesia Nigeria Trinidad + Venezuela Tobago Oil Windfalls 1974-78 27.1 16.8 15.9 22.8 38.9 10.8 1979-8 1 29.7 22.1 22.7 21.9 34.7 8.7 Source: Gelb and Associates 1988:62-65. The windfalls are estimated by taking 1970-72 as the base period and calculating changes in two components, namely real output and price

22. A common feature of unsuccessful mineral economies was that the rate of rent absorption was such as to lead to the accumulation of foreign borrowing, notably when the 1979-8 1 oil boom doubled the windfall and appeared to ease previously mounting pressure to rein back expenditure. This unwise policy of borrowing failed to provide a prudent cushion of savings with which to buffer the economy against price downswings, and exacerbated the inflationary effects of excessive domestic expenditure. The result was usually and a real appreciation ofthe exchange rate (Table 6) that inflicted Dutch disease effects, leading to the premature contraction ofthe share ofagriculture in GDPU8

23, Manufacturing was less adversely affected because investors were wealthier than farmers and they successfully lobbied their governments for import protection, without which they could not survive. When oil prices collapsed through the mid-l980s, the less successful governments postponed the required cuts in public expenditure and delayed depreciating their real exchange rates. Instead, they chose to further expand their foreign borrowing in the vain expectation that oil prices would rebound and solve all the immediate problems.

* Gelb and associates (1988:86-93) analyze the sectoral structures of the six economies and construct a Dutch disease index for the period 1974-1983. According to their results, Algeria and Venezuela managed to strengthen their non-oil tradable sectors over the decade, but the size of agriculture in these countries was already small to begin with. Indonesia, by contrast, had a sizeable agricultural sector, as oil production started and managed to sustain a strong performance in the non-oil traded sectors through the period of oil price booms (this was due chiefly to the introduction of disease-resistant and high-yielding rice varieties). Trinidad and Tobago and Nigeria experienced the most marked shifts to the non-traded sectors. In the latter, a static agricultural technology and a shrinking labor force due to urban bias, had adverse effects on agricultural production. 11

Table 6: Real Effective Exchange Rate Movements, Selected Countries 1970-84 Average trade-weighted real effective exchange rate Country 1974-78 1979-81 1982-83 1984

Algeria 96.3 104.4 114.1 123.3 Ecuador 120.6 127.9 131.9 119.2 Indonesia 133 104.4 108.5 91.5 Nigeria 129.4 162.6 194.2 287.3 Trinidad and Tobago 105.4 115.8 139.5 169.8 Venezuela 92.9 110.1 119.8 86.9 United States 92.3 93.4 105.2 Iran 100.4 119.2 194.2 MUV Index 139 138 110 106 Source: Gelb and Associates 1988:79. Note: 1970-72 equals 100. MW = Unit value index of manufactures imported by developing countries relative to US consumer price index

1.3.1 Unsuccessful Mineral Economies: The Nigerian Case

24. During 1967-74, the Nigerian economy grew strongly at around 7 percent per annum, driven by exports of cocoa, palm oil and groundnuts. The oil windfalls of 1974-78 and 1979- 81 conferred annually an additional 23 and 22 percent, respectively, of non-oil GDP. The government of Nigeria sensibly sought to disperse the oil revenues from the 1974-78 oil boom across the politically fragile federation by investing more than two-fifths of the windfall in building rural roads and expanding primary education (Bienen 1983). But, during the 1979-8 1 boom, the government unwisely favored investment in resource-based industry (RBI) within the state sector, mainly and petrochemicals.

25. An initial sharp increase in offshore investment of foreign exchange reserves was prudently made, but thereafter domestic absorption was accelerated in response to domestic political pressure. On aggregate, between 1973 and 1980, the capital stock grew at an average of 14 percent per year (resulting in a threefold increase in the country’s capital stock over the period), a substantial part ofwhich was accounted for by public capital spending. The quality of this investment was poor: capacity use in manufacturing, for example, declined from 77 percent in 1975 to 50 percent in 1983 and has languished at 35 percent since the mid-1980s. Hence, Nigeria over-invested in physical capital and suffered from poor productivity (Sala-i- Martin and Subramanian 2003).

26. Nigeria, far from saving oil revenue, became a net borrower and by the mid-1980s the external debt was equivalent to total GDP. The real effective exchange rate rose 30 percent above the 1970-72 level through the 1974-78 boom, to 63 percent above during the 1979-81 booms and reached 287 percent by the mid-1980s (Gelb and Associates 1988: 79 - Table 6). Former export industries like agro-processing declined and people migrated to the cities in search of subsidized employment in the over-expanded civil service and protected manufacturing, consistent with the staple trap model: as a result, agricultural production sharply diminished and prices increased, fuelling inflation.’ As agnculture shrank, the

NB. Agriculture as a share of GDP fell from 65 percent in 1965 to 35 percent of GDP in 1981 (Sala-i- Martin and Subramanian 2003). A country that during the early 1970s had been able to feed itself, became a major food importer. 12 offsetting increase in manufacturing depended upon rising levels of protection. The loss- making RBI projects became public sector sinks that absorbed capital instead of contributing to the competitive diversification ofthe economy.

27. Waste clearly played a central part in explaining the poor performance of the Nigerian economy. The economy also experienced Dutch disease effects. On the latter phenomenon, however, some commentators maintain that: (i)the sharp decline in agriculture was not attributable to adverse prices movements but to a conscious decision of the government to invest in the secondary and tertiary sectors ofthe economy. It was the (increasing size) ofthe government in economic activity that had detrimental effects on growth in the long-run; and (ii)since the 1980s, Nigeria has experienced a substantial and prolonged depreciation that has failed to offset or mitigate the above problem. Despite some pronounced changes in relative prices, the share of the various sectors in GDP has stayed remarkably constant (Sala-i-Martin and Subramanian 2003).

1.3.2 Successful Mineral Economies: Indonesia and Malaysia

28. Indonesia and Malaysia are two notable exceptions to the resource curse. In these countries, the government pursued a dual track development strategy: developing a competitive market sector alongside the protected economy. This avoided locking the economy into a staple trap as in the less successful oil-rich economies, characterized by a parasitic sector that depended on transfers that the oil sector eventually proved unable to maintain. Botswana might be also added to the list in that a very high fraction of diamond revenue comprises rent, which gives that commodity much in common with oil (See Annex 2). These three countries share another important characteristic, namely an explicit concern to raise the welfare ofthe rural poor.

29. Indonesia and Malaysia got three policies right:

> First, they gave priority to effective macroeconomic policy, which was achieved in the case of Indonesia by placing astute technocrats in control with free rein to promptly implement measures to remove imbalances in the face of external shocks. The technocrats also slowed the rate of absorption of the oil rents, which were the equivalent of an additional 10 percent per annum of non-oil income during 1974-78 and a further 15 percent during the second oil boom of 1979-81. The laxer stance adopted during the shorter second boom led to some evidence of Dutch disease effects by the mid-1980s. Malaysia was less dependent on oil revenue, being more reliant on palm oil, timber, rubber and tin. However, it too managed to limit the Dutch disease effects, despite the fact that it also embarked on over-rapid absorption ofthe commodity rent during the second oil boom (Auty 1990). P Second, they retained control of rent-seeking activity. Rent seeking was a feature in both countries, but protectionist policies that helped to sustain it were dismantled if they clashed with macro policy goals and rent seeking was controlled so that firms knew what illicit imposts they would face. Nevertheless, successful lobbying in Indonesia for higher protection when the real exchange rate appreciated during the early-1980s did create rents that the newly expanded state enterprises and some (but by no means all) private firms took in terms of reduced levels of efficiency. In Malaysia, a more conscious effort was made to build competitive manufacturing by 13

establishing export processing zones from 1971. This was done in direct response to the disappointing returns from import substitution. Third, both governments ensured that a significant fraction of the commodity rent filtered through to rural communities (mainly by expanding rural infrastructure and diffusing green revolution techniques) to drive labor-intensive agricultural growth by expanding the agricultural frontier and subsidizing irrigation, road improvements and green revolution technology.

30. When oil prices collapsed in 1985, the Indonesian technocrats promptly stabilized the economy, engineered a sharp depreciation of the real exchange rate and further opened trade policy. This permitted those manufacturers that had previously benefited from tariff protection by earning high returns, rather than using protection to offset inefficiency, to expand rapidly into global markets. Within less than a decade, the Indonesian economy was restructured away from oil dependence and into competitive industrialization, which absorbs surplus rural labor while rapidly accumulating all forms of capital. Malaysia achieved a similarly rapid diversification away from primary export dependence (Table 7)."

Table 7: Changing Export Structure, Indonesia and Malaysia 1970-2000 (% total exports) 1970 1980 1990 2000 Indonesia Agricultural raw materials 34.8 14.1 5 3.6 Food 19.6 7.7 11.2 8.9 Fuel 32.8 79.8 44 25.4 Manufacturing 1.2 2.3 35.5 57.1 Other 11.6 3.9 4.3 5 Share ofexp. in GDP (%) 13.5 29 25.3 42.9 Malaysia Agricultural raw materials 50 31 13.8 2.6 Food 12.6 15 11.7 5.5 Fuel 7.3 24.7 18.3 9.6 Manufacturing 6.5 18.8 53.8 80.4 Other 23.6 10.5 3.2 1.9 Share of exp. in GDP (%) 41.4 56.7 74.5 124.4 Source: World Bank 2005.

1.4 MAINCONCLUSIONS AND RECOMMENDATIONS

3 1. Empirical research suggests that a majority of countries with large natural resource wealth tend to lag behind comparable countries in terms ofper capita GDP growth, quality of institutions and governance, and social indicators. In addition, these countries are more prone to develop civil conflicts. This chapter reviewed the four leading theories that seek to explain the disappointing impact of natural resource windfalls, including: (i)volatile and declining loSome commentators argues that Indonesia somewhat stumbled on successful oil management rather than because of careful planning. While the country was remarkably successful in reducing poverty and improving social indicators, much ofthis progress was rolled back in the 1990s. By the early 1990s a series of banking scandals demonstrated that regulation and supervision had become a problem for the banking system, and these failures subsequently undermined much ofthe progress achieved. The Indonesia example may be therefore used with caution. 14 terms of trade, (ii)currency appreciation and the contraction of non-boom tradable activity (the Dutch disease effect), (iii)the skewed linkages generated by commodities with capital- intensive production functions; and (iv) the impact of rents on political incentives.

32. Some observers argue that Mauritania faces considerable pressure to use the oil revenue to boost social expenditures rapidly, given the need to reduce the country’s 46.7 percent poverty headcount, potentially high social returns to pubic investment and early loss of aid and IDA privileges. However, the over-rapid absorption of a natural resource rent stream that will emerge quickly but be relatively short-lived poses severe risks to the political economy. As examined in the next chapter, the pre-conditions exhibited by the Mauritanian political economy are not propitious. The projected revenue stream is sufficient to amplify potential Dutch disease effects, feed corruption and heighten the eventual socio-political costs ofadjustment to the inevitable decline in oil revenues, even if the decline is gradual.

33. The experience of established oil-exporters underlines the wisdom of a cautious rate of spending that is matched to expanding domestic absorptive capacity and, in terms of environmental accounting, seeks to maintain or enhance the total capital stock while limiting the growth of the non-oil fiscal deficit. The adoption of the following three basic policy components, buffered by appropriate institutions, will permit Mauritania to take advantage of the capital-abundant oil sector to benefit the labor-surplus sectors ofthe economy to promote pro-poor development:

k Adapt institutions to constrain the over-rapid domestic absorption of natural resource revenues. Responsible oil revenue management must resist political pressure for over-rapid domestic absorption and match the rent flow to domestic absorptive capacity. This also entails constraining wealth-damaging rent-seeking, by promoting good governance and putting in place a sound and transparent system to manage oil revenues (see Chapters 2,3 and 4). k Give priority to macro-economic stability, by conducting appropriate (prudent) fiscal and monetary policy, and by avoiding Dutch disease and the loss in competitiveness of non-boom sectors. Doing so will help maintain a competitive real exchange rate so that the rent flows into efficient wealth creation rather than being dissipated through channels ofpolitical patronage (see Chapters 3 and 4). k Channel sufficient resources to the less prosperous citizens to enable them to participate in competitive activity. In the case of Mauritania, this implies following a dual-track strategy. The strategy promotes a dynamic market economy in rural areas (track one) while the rent-distorted urban sector (track two) is gradually reformed. This strategy postpones confrontation with established rent-seekers while the dynamic sector not only drives competitive diversification of the economy but also builds a pro-reform political constituency (See Chapter 5).

16

2.2 MAURITANIA’SINITIAL CONDITIONS

2.2.1 Does Mauritania Already Suffer from Dutch Disease Effects?

37. Mauritania underwent significant structural changes in the last 50 years. Nomads constituted around 65 percent of the population in 1962, 25 percent in 1977, only 12.8 percent in 1988 and less than 5 percent today. The post-colonial capital, , dominates the urban settlement hierarchy, hosts over 50 percent of the urban population and around a quarter of the national population. The severe drought of the late-1960s and early- 1970s caused many Mauritanians to seek refuge in the cities and the sharp increase in aid flows appears to have made it possible for most of them not to return to their rural homelands. The attractions of returning were also diminished by the relative neglect by successive governments of the rural sector.

38. The mass urbanization has had an impact on the structure ofGDP. Today, the tertiary sector dominates the productive sector of the economy, accounting for more than 50 percent of GDP (52.6 percent in 2004). The share of agriculture and livestock in GDP sharply declined from an average of 3 1 percent of GDP during 1970-73 to barely 20 percent of GDP during 2001-2004. In 2004, the rural sector accounted for only 15.2 percent of GDP. The share ofthe secondary sector ofthe economy stayed roughly constant over the period (Figure 4).12 Surprisingly given its size in relation to GDP, the most recent estimates for agricultural employment, available for 1998 (UNDP 2001), suggest the sector employed 51 percent ofthe workforce. This may include urban dwellers, many of whom retain some dependence on the rural economy, if only by holding land as an insurance policy should urban living fail them.

Figure 4: Evolution of Gross Domestic Product by Sector (1970-2004)

100%

80%

60%

40%

20%

0% \p’? \9% \93 \@ \9j \96 \.” \@ \99 %@Q >@’ lpo” p? %@“ 0 Primary Secondary 0 Tertiary Source: World Bank 2003 and IMF 2005.

39. These structural changes were associated with sharply higher levels of overseas assistance, which, as a percentage of Gross National Income (GNI), rose from an average of 6.5 percent during 1970-73 to an average of 25.4 percent during 2000-2003. This is considerably above the averages for other selected SSA countries, with the exception of Congo DRC (Table 8). Consistent with the staple trap model (See Figure 2 above), the over-

12 In percentage of GDP, agriculture and manufacturing in Mauritania are about half and two-thirds of the comparator group size (Le. countries at a similar level ofper capita GDP) in 2004. 17 centralization of government control ofthe economy after independence was associated after an initial lag with declining real per capita income from 1970. This trend in GDP growth was eventually reversed during the reform period ofthe 1990s.

Table 8: Aid Flow, Selected African Countries 1960-2003 (YOof GNI) Countrv 1970-73 1988-91 2000-03

Cameroon 4.7 3.7 6.2 Republic ofCongo 5.6 6.1 2.6 Nigeria 0.9 1.1 0.6 Zambia 1.4 17.6 16.8 Congo, Dem. Rep. 1.9 7.9 32.7 Senegal 5.5 13.9 8.8 Chad 5.8 17.0 10.8 Burkina Faso 6.3 ' 11.3 13.1 Guinea ... 13.0 7.2 8.5 ... 14.3 Botswana 15.4 4.9 0.6 Ghana 2.4 12.2 11.9 Mauritania 11 6.5 21.4 25.4 1/ The figure in the last column - referring to Mauritania- is for 2001-2004 (rather than 2000-2003). Source: World Bank 2005.

40. The real effective exchange rate (REER) depreciated by about one-third during 1992- 2004, but has begun to appreciate ever since (Figure 5). However, given that it has recently become known that public expenditure was substantially higher than reported since the 1990s, this trend may overstate the scale of any depreciation (See Chapter 4).13 The REER has appreciated 2004-05, barely offsetting its significant depreciation in 200 1-03, but the tradables sector has not developed beyond the traditional iron ore and fish exports. Going forward, the likely further real appreciation of the ouguiya may slow down growth of other, more labor-intensive activities, including agriculture and fish processing.

41. In sum, a shrinking agricultural sector and a rapid urbanization process accompanied by an increase in foreign aid could have inflicted Dutch disease effects on the economy. This has resulted in an expanded service sector, which has a larger size than expected for a country at Mauritania's level of development. Also, it has limited the extent to which the Mauritanian agricultural sector has been able to effectively provide an important contribution to early development. Comparing Mauritania with Chad - which has similar per capita oil reserves - suggests that the latter embarked on oil-driven growth with stronger oil revenue absorptive potential than the former. With little more than half the per capita GDP of Mauritania in US$ purchasing power panty (PPP) terms, agriculture in Chad generates 38 percent of GDP, more than double that of Mauritania, while its manufacturing sector is

l3 An IMF study suggests that the REER actually depreciated in some African countries receiving substantial amount of aid. In Sierra Leone, Tanzania and Mozambique - besides Mauritania - the REER depreciated during the aid surge. One recurrent line of explanation for the apparent immunity to Dutch disease is that, in low-income economies, export supply is more likely to be determined by non-price constraints, such as poor transport or storage facilities (OD1 2006~). 18 similar in relative size. Aid provides 11.5 percent of Chadian GNI, less than half the rate of Mauritania.

Figure 5: Mauritania: Evolution of the Real Effective Exchange Rate (1990-2005)

70 \\

60 1an 41) 1990 1991 1992 1993 1994 1995 19Q6 1897 1998 1999 2000

ItNEER t REER I

Source: IMF 2006a

2.2.2 The Political Economy of the Mauritanian State: A Snapshot

A. Power and Class in Mauritania

42. Since the end of the 1950s, mining rose as the key sector of the Mauritanian economy. MIFERMA (Sociktk Anonyme de Mines de Fer de Mauritanie) was set up in 1952 by big European steel companies under the auspices of the French state. It made massive investment and the pace of iron ore extraction accelerated from 1.7 million metric tons in 1967 to 11.4 million metric tons in 1972. The labor force at MIFERMA was highly polarized, characterized by an underpaid indigenous proletariat on the one hand and an overpaid - mainly European - management team on the other. On the wider scale, this reflected the structure ofthe Mauritanian labor market at that time. A significant amount of surplus - some estimate around two thirds oftotal receipts from sales - was channeled to Europe.

43. The combination of the exploitation of international capital, and the resulting structural changes opened the doors to the emergence of a new political nationalism, willing to assert Mauritanian controls over resources. The first strike against MIFERMA took place in Zouerate in 1968, and was hailed as the first notable opposition to the “neo-colonial” system by the Mauritanian Workers Union (UTM). This movement, of Marxist inspiration, appealed to many segments of the Mauritanian society, transcending ethnic/community identities. The protest crystallized at the end of the 1960s around the National Democratic Movement (MND) and its vanguard, the Proletarian Party of Mauritania (PKM). More labor agitations took place during the 1970s, often violently crushed by the army (Bennoune 1978).

44. In the early 1970s, therefore, there was an opposition between a “bureaucratic bourgeoisie” - essentially linked to the structure of the state14 - and a “working class”

l4 This group was mainly composed of high level civil servants who - while still practicing a frugal lifestyle - felt invested with authority and prestige, spoke mainly French (ignored by the majority of the 19 composed of mine workers in the north of the country, small employers, the unemployed in urban and peri-urban areas and the rural poor. However, class antagonism was progressively replaced by an opposition between “rich” and “poor”, filtered through membership of the ethnic group, tribe or particular social caste. The climatic crises of the 1970s and the Sahara conflict also contributed to alter the status quo. The droughts and resulting mass exodus to urban areas meant that the administration had suddenly to face huge demands for schooling, housing, employment, health, administrative and other services. Paralyzed and losing revenues, the state bourgeoisie began to merge with a class of traders who, from being the mere suppliers ofthe ruling classes, rapidly acquired a privileged status.

45. The “new bourgeoisie”, neo-traditional and observant, was not opposed to modernization per se but rather to the westernization of the country. The increasing income disparity between this group and the rest ofthe population progressively fostered a process of wealth redistribution towards a clientele chosen because of “ethnicity”, “tribalism” or “status” within the cast system of the Mauritanian society. At the other end of the spectrum, the proletarianization of the workforce rapidly evaporated, in the face of weakening trade union, as workers’ demand became progressively captured by the nationalistic aspirations expressed by the ruling classes - aiming at the “Mauritanianization” of natural resources (Seddon 1996).

B. The Emergence ofa Dependent Social Capital

46. The blurring of class antagonism went hand in hand with the gradual emergence of a nominal democracy that has effectively functioned as a concentrated oligarchy (see Annex 2 for a political economy classification of oil exporters). The regime that came to power in 1984 comprised a group of army officers who gradually embraced pluralistic politics and an institutional model resembling those of the Western world. The leader of the group, Ould Taya, promoted and easily won the presidential elections in 1992, 1997 and 2003, in the face of a splintered opposition. However, fractiousness within the dominant groups encouraged the leadership to maintain power by using state control of productive activity in order to generate resources to sustain a clientelistic patronage system. Office holders were rotated to spread access to state largesse and to limit incentives to defect to the opposition (Marianne 200 1, Ould Ahmed Salem 1999).

47. The government’s recourse to negotiating access to patronage in order to retain political power had strong appeal for a part ofthe Mauritanian elite. As members of a society with deep roots in trade, some enterprising members of Mauritania’s elite sought high returns through the short-term. Foregoing long-term investment in production such as cropping and fabrication, which are associated with an under-class that lacks other options. The business class tended to look to the Gulf States as a model for rent deployment: the expectations being that Mauritania should function as a trading nation, building an entrep6t service economy, supported by a rapid transformation ofthe mineral rent into human ~apita1.l~

population), and treated with condescension the aspirations of the dominant segments of the “traditional society” (the “marabouts”), ready to acquire their emancipation form the colonial masters. l5Yet Mauritania’s likely ratio ofoil reserves to population and number ofyears ofexpected production are almost certainly far too smallifew to sustain that ambition. Meanwhile, the preference for trading that is based on political links encourages monopolies and diminishes domestic competition. 20

48. Some examples may clarify the way in which the socio-economic system functions to the detriment of long-term growth, Large firms with political connections have dominated state procurement, while smaller firms have been unable to bid in competition and therefore relied upon their political connections. This outcome discouraged efficient investment and worked against the expansion of competitive enterprises that is required to sustain long-term national welfare. A critically distinctive consequence of such clientelistic regimes is the dependent form of social capital.16 The net effect of past rent absorption has been to encourage Mauritanians to migrate to cities in search ofpolitical patronage, a process that has transferred the local traditional extended family links into a national system that is clientelistic.

49. New urban residents tend to rely on relatives while they wait for a fortunate break to provide access to the political patronage system, rather than taking steps to create opportunities for themselves. The result is a dependent form of social capital whereby ‘successful’ urbanites hold their employment due to political and kinship favors rather than competitive merit and they too come under social pressure to redistribute some income to those less fortunate. Such social capital is in marked contrast to the dynamic social capital generated by the self-help group relationships that arise out of the competitive industrialization model (See Figure l),which in marked contrast serves to lower transaction costs and expand economic opportunities.

50. Moreover, the welfare safety net afforded by the extended family is coming increasingly under strain as successful urban residents find that although their incomes may rise substantially (while those ofrural residents may even shrink) the obligations to look after the less fortunate become onerous. Such concerns add to the pressure for ministerial policy to be distorted to help serve this social safety-net function rather than that of long-term national wealth creation. The net effect is to diminish the efficiency of resource use and thereby constrain the emergence ofa competitive economy (Marianne 2001).

2.3 MAURITANIANATURAL RESOURCE POTENTIAL

2.3.1 The Oil Sector

5 1. New information on oil reserves, extraction rates, and technological developments affect the calculation of Mauritania’s oil wealth. Oil wealth estimates need to be updated frequently as new information on these aspects becomes available. The following discussion utilizes the most accurate information available in November 2006 on exploration results, production scenarios, the fiscal regime and operating costs in order to produce revenue projections for the period 2006-2025.17

l6 Social capital is defined here as the system of formal (legal and institutional) and informal (personal) interactions within society. 17 Considerable uncertainty surrounds the calculation of oil wealth at any point in time. Oil prices change in unpredictable ways. Even small changes in the current price of oil could lead to large changes in estimated oil wealth, given that a price change today would lead to a revision of all hture prices. 21

A. Exploration Results and Fields’ Potential

52. The progress made in the development of deep-water technologies allowed the exploration of several offshore areas of Mauritania since the late 1990s. The deep-offshore basin was licensed in the late 1990s. As of mid 2005, eight blocks were already contracted: five to a group of companies led by Woodside Energy (Australia) and three to a group led by Dana Petroleum (UK). Two other Australian companies, Hardman Resources and Roc Oil, have taken an interest in each block (see Table 18 and Map 1 in Annex 5). The characteristics the discoveries are summarized as follows:

> Chinguetti. The well is located 80 km off Nouakchott in 800 meters of water depth. After two appraisal wells, in May 2004, Woodside launched a development project. The initial production was estimated to peak at 75,000 barrels per day from six producing wells supported by four water-injector wells and one gas-injector well. Production is handled by a floating production, storage and offloading (FPSO) vessel. However, owing to unexpected technical difficulties (notably the low connectivity of reservoir rocks), oil production has rapidly declined from a level close to 75,000 barrels a day (the maximum installed capacity) in March 2006 to a level of around 30,000 barrels a day. It is expected that this level of production will be maintained throughout 2006 and beyond thanks to new production and injection wells.’*. The field’s reserves have been revaluated at 60 million barrels. > Tevet. Close to the Chinguetti field there are two proven small structures known as Tevet - 20 miles south of Chinguetti -, which could be brought into production using the Chinguetti FPSO facilities in 2010. Production could reach a peak of 25,000 barrels per day by mid-2015. Estimated reserves at Tevet and others smaller fields around Chinguetti (Le. Labeina) are in the order of70 million barrels. > mf. In the same Block 4, just 25 km north, Woodside discovered the Tiof field on November 2003. In the case ofTiof, the production is expected to start mid-2010 and could reach a plateau in 2013 at around 50,000 barrels per day. However, for the base production case, assuming that there is no additional discoveries, the production of Tiof - and the other fields (Chinguetti, Tevet) - will have to be restricted to the capacity of the existing, FPSO (75,000 barrel per day). In the event of a new discovery, as assumed for the high production case of our analysis, Tiof could be developed to reach its maximum production level. > Other discovery. Woodside has discovered another two fields, Banda with predominantly gas reserves, and Labeina with predominantly crude oil reserves. Dana has also had a successful exploration campaign. The first well drilled in Block 7, discovered the Pelican structure (175 km from Chinguetti) that has showed several oil and particularly gas accumulations. There are speculations that the offshore in Mauritania holds sufficient gas reserves to launch a liquefied natural gas (LNG) export project.

53. Operators are committed to continue the exploration effort in all the adjacent offshore blocks as well as onshore in the Taoudeni Basin. Offshore, the proposed wells were looking

18 This situation also involves further in-filed horizontal drillings, ratcheting up the development cost of the Chinguetti field. 22 for relatively high-risk high rewards targets. Examples are the Sotto and Colin exploratory wells drilled in an area of 200 meters of water depth midway between Nouakchott and the Senegalese border; or the Espadon well close to the Tiof discovery. In the Taoudeni Basin the contractors Total, Repsol, CNPC are starting to collect additional geophysical data and should in the coming years start exploratory drilling.

B, Production Scenarios

54. Mauritania's proven and probable crude oil reserves, so far, are estimated at around 310 million barrels. These reserves, could produce up to 75,000 barrels per day and last in production for 20 years (Le. until 2025). On a per capita basis, Mauritania's estimated oil reserves are close to Chad, Nigeria, and Yemen, but much lower than Republic of Congo, Angola, Equatorial Guinea, and Azerbaijan (See Table 9). Two possible scenarios are assumed. The base production case assumes oil production only from the Chinguetti, Tevet and Tiof fields. The high case assumes that at least one additional field is discovered in the coming years, whose reserves' size is between Chinguetti and Tiof (approximately 200 million barrels). Production from this new field is assumed to start in 2012, peaking at 75,000 barrels per day in 2015. As illustrated in Figure 6, whereas the production curve in the base case gets to a maximum of around 75 thousand barrels per day in the year 20 15, the high case assumes production peaks at 160 thousand barrels per day by the same year.

Figure 6: Oil Production Profile - Base and High Cases (2006-2024): bbYday

~

Source: Authors' own calculation, 2006. 23

Table 9: Proven Crude Oil Reserves and Average Daily Production in Selected Countries

P P Country Oil Reserves- Average daily Population Per capita production oil reserves Million Number (000 of barrels) in millions (in barrels) of barrels of years (2003) Mauritania (base case) -310 20 45 2.9 107 Chinguetti 60 13 30 (March 06) Tevet 70 11 25 (peak) Thiof 180 16 50 (peak) Chad 2,100 29 200 9.5 22 1 Equatorial Guinea 1,600 18 247 1 1,600 Angola 5,412 17 874 11 493 Nigeria 35,000 43 2,223 137.3 255 Yemen 4.000 28 390 20 200 Oman 5,506 16 964 2.9 1,899 Kazakhstan 9,000 22 1,100 14.9 604 Russia 48,573 19 7,014 143.8 338 261,900 84 8,528 25.8 10,151 Iraq 115,000 133 2,377 25.4 4,528 Kuwait 101,000 151 1,838 2.3 44,912 Iran 125,800 91 3,775 67.5 1,864 Libya 39,000 75 1,427 3 13,000 Source: IMF 2005, Authors’ own calculations, 2006.

C. Revenue Scenarios

55. Based on the exploration and development cost and the fiscal regime (See Annex 3), this section reviews the revenue projections for oil for the period 2006-2025. The base and high production cases are defined as above, but alternative price scenarios are also taken into account here: (i)The IMF price scenario, where the real price of oil declines from US$60/bbl to around US$42/bbl by 2014 (high price); and (ii)a more conservative price scenario, whereby the real price of oil declines to US$32/bbl (Table lo). A discount ofUS$7 is applied to take into account the quality ofthe Mauritanian crude oil and freight costs.

Table 10: Oil Price Scenarios - Scenario I(IMF) Scenario- I1 (Conservative) Real Oil Price Nominal Oil Price Real Oil Price Nominal Oil Price 2006 59.3 60.8 59.3 60.8 2007 53.4 56.0 52.5 55.0 2008 53.0 56.8 48.6 52.0 2009 50.2 54.8 45.7 50.0 2010 47.4 52.9 40.3 45.0 201 1 44.9 51.3 36.8 42.0 2012 42.9 50.1 35.0 40.8 2013 42.9 50.1 35.0 40.6 2014 42.9 52.3 33.0 40.2 2015 42.9 53.5 32.0 39.9 2016-25 Constant in real terms Source: Authors’ own calculations, 2006. 24

56. Mauritania’s wealth in nominal terms oscillates between US$3.0 billion (Le. base production case I1[low price]) and US$lO billion (high production case I[high price] - Table 11). This variation in magnitude is shown in Figure 7. In the base case-low price scenario (panel [a]), oil production peaks in 2013 and oil revenues in that year (Government’s take) would constitute around 25 percent of total government revenue and around 7 percent ofnon- oil GDP. By contrast, in the high case-high price scenario (panel [d]), oil production would peak in 2015. In that year, the government’s take would constitute around 22 percent of non- oil GDP and almost the totality of Government revenue.

Table 11: Projections on Government Take (US% million, nom. and real) 2006-2024 Base Case Base Case I1 High Case I High Case Base Case Base Case High Case High Case Year I11 I2 13 I1I4 I11 I112 I 13 I114

Nominal Real 2006 252.62 252.62 253.10 253.10 246.44 246.44 246.90 246.90 2007 159.46 156.23 159.75 156.51 152.18 149.10 152.45 149.36 2008 92.75 68.84 92.38 68.51 86.67 64.32 86.32 64.02 2009 59.25 55.98 59.25 55.98 54.20 51.21 54.20 51.21 2010 162.27 131.09 160.25 128.93 145.26 117.35 143.45 1 15.42 201 1 249.55 197.83 245.02 193.11 218.57 173.27 214.60 169.14 2012 287.51 228.21 349.36 276.35 246.38 195.57 299.39 236.82 2013 312.24 24 1.94 473.69 367.04 261.79 202.85 397.16 307.74 2014 309.97 232.85 585.07 440.15 254.28 191.02 479.95 361.07 2015 3 17.99 232.69 749.34 549.19 255.22 186.76 601.42 440.78 2016 320.58 235.23 1014.36 511.49 25 1.74 184.72 796.54 401.66 2017 297.29 198.87 1126.34 401.28 228.41 152.79 865.38 308.3 1 2018 303.51 148.36 935.43 313.45 228.15 111.52 703.17 235.62 2019 239.41 101.28 748.26 283.68 176.08 74.49 550.33 208.64 2020 265.37 103.25 704.54 433.84 190.95 74.29 506.98 312.18 202 1 201.30 72.79 596.67 372.04 141.73 5 1.24 420.08 261.93 2022 161.44 61.32 497.5 1 3 17.98 111.20 42.24 342.70 219.03 2023 174.36 62.44 450.38 297.90 117.51 42.08 303.53 200.77 2024 119.99 50.17 342.18 226.82 79.12 33.08 225.63 149.56 2025 124.22 47.3 1 254.43 169.89 80.14 30.52 164.15 109.60 Total 4411.1 2879.3 9797.3 581 7.2 3526.0 23 74.9 7554.3 4549.7 Source: Authors’ own calculations 2006 1/ Base Case: Chinguetti, Tiof, & Tevet, IMF Price ($7 discount) 2/ Base Case: Chinguetti, Tiof, & Tevet, Conservative Price ($7 discount) 31 High Case: Chinguetti, Tiof, Tevet and Other Fields, IMF Price ($7 discount) 4/ High Case: Chinguetti, Tiof, Tevet and Other Fields, Conservative Price ($7 discount) W W .-V .-V L L a a r& cz, E E I I W W VI VI m m u V W A VI M m .- m sl n n e z -W -0 e E I I a a - W e c W >e, a d n x 0 w -a - 1 I* 0 0 b c c L 0 0 I -e e e, u ue, e,L e, a a W F I W .-0 - - V L .-L a a W 0) .-c e, c Y 3 .- Y I E e, I c >e c L L W d v1 P W I VI e n > C 0 0 0 0 u .-- 0 u W ? -a I 0 VI 0 m 0 VI F b m L L V u 0 0 W 1 * Jz VI : : M m W0 ue, .- m e, e, E n a a n I s F V w - w -0 -W C e I I a i P, 26

2.3.2 The Mining Sector

57. Mauritania has a favorable geological environment for a large variety of minerals. Besides the traditional iron ore, and copper and gold the recent pick-up in exploratory activity has also generated interest in the potential for diamonds, chromium, platinum group elements and phosphate. The Mauritanian Government assigned high priority to mineral sector development and stimulated private sector investment in the mining sector (Box 1).

Box 1: GIRM Activities to Promote Mining in Mauritania rk in the mining sector; (ii)

Environmental Management d to mining. These measures anies did not consider

arison with other Sub-Saharan African countries

First, the lack of technica infrastructure is another s

58. Mining, however, will make a much smaller contribution than oil to the national budget. Even at current high commodity prices, SNIM pays around $20 million annually to the government, which is about 10 percent ofits total revenue. Although SNIM’s profitability may improve, its contribution to government revenue will continue to be modest through the period ofthe scenario projections. The combined fiscal contribution from the new projects in gold and copper through 2010 will also be modest and driven mainly by the royalties, running at $4-5.5 million annually combined (Le. around 2.2 percent of the export earnings). Thereafter, the distribution (and longevity) of the revenue will be sensitive to global prices for copper and gold, which seem likely to fall below the current peak levels.

A. Iron Ore

59. Mauritania’s share of world iron ore production has remained small and broadly constant during the past decade, at just above 1 percent (Table 12). This happened despite the collapse of the Russian market share after the fall of the Soviet Union in 1992 and the fact that Mauritania exchange rate competitiveness against competitors in the iron ore market did not deteriorate to a significant extent. Hence, Mauritania’s share of world iron ore exports 27 showed little sensitivity to aggregate exchange rate movements. This may be partially explained by the fact that Mauritania mainly exports unprocessedraw ore, the demand for which is relatively stable. Besides, SNIM has been operating at levels close to full capacity during the last decade, preventing it to increase production even in response to favorable changes in the aggregate real exchange rate. Data on the SNIM’s costs in fact suggest that competitiveness ofthe mining sector has been stable since the mid-1990s (IMF 2004).19

Table 12: Shares in World Iron Ore Production, 1990-2000 (In percent) Year Mauritania Australia Russia South Africa 1990 1.2 12.6 17.1 9.5 3.4 1995 1.3 16.4 20.0 13.3 8.8 3.6 1996 1.3 17.4 20.3 13.3 8.1 3.5 1997 1.3 17.9 20.3 13.6 7.7 3.6 1998 1.3 18.0 20.2 12.8 8.0 3.6 1999 1.2 17.3 21.4 12.6 9.3 3.3 2000 1.2 18.3 21.7 10.9 9.0 3.5 Source: CRB 2005.

60. Indeed, a planned major expansion ofthe mining sector commenced at the turn of the millennium, with investment in the early-2000s at a rate of around 5 percent of GDP by SNIM. The investment already expended had yet to realize the expected gains in output by 2006, a shortcoming that has been somewhat fortuitously alleviated by unexpectedly high ore prices. The new management installed after the 2005 change in government plans to invest a further $200 million to increase production capacity by around one-fifth from around 11.0 to 13.5 million tons by 2006. The investment also aimed to boost productivity, remove bottlenecks in shipping and power supplies (Table 13).

Table 13: SNIM Production and Exports (2000-2005) Export Volume Production Volume Value Exported Value Produced Year (Thousand tons) (thousand tons) (US$ m) (US$ m) 2000 11,069 11,345 183.6 190.9 200 1 10,093 10,302 178.5 182.2 2002 10,460 9,553 183.8 167.9 2003 9,627 9,627 175.3 175.3 2004 1 1,003 1 1,003 246.8 246.8 2005 10,639 10,880 389.4 389.3 Source: IMF 2006a.

6 1. The iron ore mine has plans for at least a further thirty years of operation. In addition, SNIM is undertaking a feasibility study with Australian partners for a second expansion potentially, involving $1 billion of investment to produce iron ore pellets, which are cheaper to transport and handle, and command twice the price of iron ore. The production rate might be 7 million tons per annum in the first instance. This investment is speculative at this time,

19 Since the mine commenced production in the early-1960s the ratio of iron ore content to over-burden removed has fallen from 1:l to 1:6, which has increased the cost to $15 per ton in recent time (after averaging around US$11 between 1994-2001). If achieved, the resulting economies of scale are expected to reduce average costs by 20 percent to $12 per ton ofiron ore. 28 and depends largely on the availability of water and energy in the area. Such a scheme, should it proceed, is unlikely to add to government revenues before 2011 however, and even then capital recovery is likely to dominate the initial revenue stream. The existing iron ore mines will continue to dominate SNIM’s economic contribution through the medium-term.

B. Gold and Copper

62. Mauritanian mining exploration has focused on gold, uranium, diamonds, and to some extent base metals, especially since 1997, when the country started fiercely pursuing diversification of its mining activities away from iron ore. A spike in most commodity prices has further fuelled international investor interest in recent times, and the Mining Cadastre (MC) reports specific gold exploration permits held by a number ofmining companies.

63. The Tasiast gold project construction was launched in November 2005 by the local subsidiary of the Canadian Rio Narcea, Tasiast Mauritanie Limited SA, about 310 km northeast of Nouakchott. The gold mine is expected to be in production in mid-2007. Over the current 8-year mine life based on the current reserves, Tasiast is forecast to produce an average of 3.25 tons of gold annually at a cash operating cost of approximately US$240 per ounce. The mine has measured and indicated resources of approximately 12.1 million tons averaging 3.1g/t gold. Of these resources, 9 million tons, containing 27.6 tons of gold, are economically exploitable at a gold price of US$370/ounce. In addition, Tasiast has inferred resources of 12.4 million tons averaging 2.25g/t gold or approximately 30 tons of gold. At present gold prices (US$600/ounce) the life of the mine will probably be extended to 15-20 years.

64. The Guelb Moghrein Copper/Gold Mine, known as the Akjoujt mine, is owned and operated by Mauritanian Copper Mines S.A. (MCM), whose majority shareholder is First Quantum Minerals Limited (80 percent) of . Production is due to begin by mid-2006. The mine life is expected to be 9 years. However, MCM has some tenements with good exploration targets that might increase the mine life. The resource base at Guelb Moghrein consists of 18.2 million tons of sulphide ore grading 1.8 percent Copper and 1.4g/t Gold. The Guelb Moghrein operation will produce 30,000 tons of copper per annum, 1.6 tondyear per annum in concentrates and a further 470 kg per annum of gold dore. Figure 8 below illustrates the export value for gold and copper for the period 2006-20 18 (MMIG 2006).

Figure 8: Export Value (in US$ million) of Gold and Copper (2006-2018)

I20

IO0

80

60

40

20

0 2006 2007 21108 21x19 20111 2011 2012 2013 2014 2015 21116 21117 2111% -+-Gold -Couuer 29

2.4 MAINCONCLUSIONS AND RECOMMENDATIONS

65. Mauritania’s proven and probable crude oil reserves are estimated at around 310 million barrels. The country’s wealth in nominal terms oscillates between US$3.0 billion (Le. base production case, low price) and US$lO billion (high production case, high price), over a period of20 years (2006-2025). Iron ore and other mineral will provide additional revenue. If deployed responsibly and protected against corruption, the expected revenue stream will provide an opportunity for the government to accelerate economic growth and reduce poverty on a sustainable basis. However, Mauritania exhibits three adverse conditions for effective rent deployment: early Dutch Disease effects, a dependent social capital, and a weak governance framework. The Taya regime fuelled a politicized bureaucracy and an ineffective judicial system.

66. Recent political developments offer a window of opportunity to address the problem of corruption. The transition authorities, in power since August 2005, have initiated a wide range of reforms to improve transparency on the economic and political fronts, based on the priorities that emerged from consultations with civil society and political parties. These focus in particular on: (i)a smooth transitions to constitutional order, (ii)good governance, including judicial and public finance reforms, and transparent management of oil revenues, and (iii)the respect of human rights. On the political economy front, the following priorities emerge from the analysis undertaken in this chapter:

> Combat corruption. The government has signed the United Nations Convention Against Corruption, recently passed Anti-money Laundering (AML) legislation and joined the Financial Action Task Force AML for the Middle-East and North Africa (MENAFATF). Perhaps most importantly, it has also announced plans to formulate a National Anti-Corruption Strategy -with the support of the Bank and other donors. It is important, in this respect, to elaborate the strategy before the end of the transition period, that is, before March 2007. In addition, it is imperative to design and implement a sound framework for the transparent management of oil revenue, as examined more in detail in the next chapter. > Strengthen the judicial system. This would entail establishing a fairer system for individuals and a more attractive investment climate for businesses. A “Report on the Justice System”, released in November 2005 painted a harsh picture and the authorities have since launched measures on several fronts. A decree was issued in April 2006, creating the Commission d’Analyse des Informations FinanciBres (CANIF), which is responsible for collecting and processing suspicious financial transactions. The authorities now need to take concrete actions to set up the CANIF and strengthen capacity ofthe judiciary system. > Strengthen transparency in the public sector. Given the complexity and size of public administration, it is important to find feasible entry points for anti-corruption measures. The authorities would do well to review the regulatory framework affecting civil servants’ behavior. Measures that can be implemented relatively easily are the finalization and adoption of an ethics code, the declaration of personal assets for higher level civil servants and other regulatory measures that can play a role in strengthening good governance. Public procurement tends to be particularly prone to corrupt activities, and action on the weaknesses in the country’s procurement practices would thus offer a useful entry point. 30

3. MANAGING NATURAL RESOURCE WEALTH IN MAURITANIA: CHALLENGES AND GOVERNMENT RESPONSE

3.1 INTRODUCTION

67. Mauritania’s natural resource wealth, quantified in the previous chapter, can have beneficial effects on the development path of the country in the years to come. However, countries rich in non-renewable resources that account for a substantial part of revenues face two key problems: (i)uncertainty and volatility of the resource stream; and (ii)the exhaustible nature of the resource. These problems raise important challenges for economic policy in general and fiscal policy in particular. The following challenges are usually recognized:

> On the macroeconomic side, a large inflow of revenue can cause real exchange rate volatility and Dutch disease. While domestic tax revenues reduce spending in the private sector, petroleum revenues do not. An increased use of petroleum revenues may therefore result in too high economic activity, generating cost pressures and weakening the basis for those sectors ofthe economy that are exposed to international trade. > The challenges for fiscal policy are evident in both the long- and short run. Long-run issues involve deciding how to allocate natural resource wealth across generations, reflecting a concern for intergenerational equity. In the short-run, fiscal management, budget planning and the efficient use of public resources are complicated by the instability offiscal revenue. 68. Besides conducting appropriate (and prudent) fiscal and monetary policies, an optimal management of natural resource wealth will also require Mauritania to put in place an institutional framework for the management of natural resources, which should culminate with the production of a Hydrocarbon Law. Key elements concerning natural resource management strategy include: (i)the establishment of an oil account/fund with an appropriate governance and investment policy framework; (ii)the implementation of the Extractive Industry Transparency Initiative (EITI), which supports improved governance through the full publication and verification of company payments and government revenues from oil, gas and mining; and (iii)the strengthening ofnational capacity in the oil sector.

69. This chapter is organized as follows. Section 3.2 focuses on the key challenges in the management of natural resources, namely: (i)Coordinating policy response to the oil boom, fiscal options and sustainability; (ii) Establishing appropriate mechanisms for the management of oil revenues, focusing in particular on transparency and accountability; and (iii)Developing institutional capacity in legal, economic, technical and management areas, so that nationals will have capability to develop and implement sound oil sector policies. Section 3.3 reviews the government’s response on the three counts, and highlights the challenges that still lie ahead. Section 3.4 presents the main conclusions and recommendations ofthis chapter. 31

3.2 KEY CHALLENGES IN THE MANAGEMENTOF NATURAL RESOURCE WEALTH

3.2.1 Coordinating Policy Response to Oil Booms, Fiscal Policy Options, and Sustainability

A. Long-run Challenges”

70. A sound overall long-term fiscal strategy, well coordinated with monetary and exchange rate policies, is key to avoiding some of the macroeconomic problems commonly associated with oil-producing countries. The fiscal policy challenge consists of simultaneously targeting realistic spending objectives (in line with development strategies - as presented in the new PRSP [2006-20101 - as well as public absorption capacities), while limiting volatility, together with monetary and exchange rate policies, coping with Dutch disease. Three issues are examined here: (i)A sustainable non-oil primary deficit; (ii)The optimal size ofthe deficit; and (iii)The need for asset accumulation, should oil revenue prove to be substantial.

71. (i)Sustainable non-oil primarv deficit. The sustainable non-oil primary deficit sets a simple and transparent rule for the level ofexpenditures financed from oil revenue, consistent with long-term savings objectives. In other words, it defines what the government can afford to spend over the long term without exhausting its assets, and corresponds to a path of expenditures that can be financed from the use of oil revenue. Unlike the overall fiscal balance, the non-oil budget balance is not directly affected by temporary fluctuations in oil revenues, and therefore is a good gauge of the stance of fiscal policy. The sustainable non-oil primary deficit would be easy to measure, and compliance with the rule could be well monitored. The sustainable deficit ceiling is determined based on a savings prescription that needs to be regularly reviewed in light of changing information (on international prices of oil and on the production level) and economic conditions.

72. (ii)ODtimal size of the non-oil deficit. From a long-run perspective, the key is to choose a primary oil deficit consistent with fiscal sustainability and taking into consideration the uncertainty surrounding oil wealth. Under the Permanent Income (PI) rule, fiscal policy is based on the consumption of government wealth rather than on government income. Government wealth includes the value of its financial asset as well as the present discounted value of future oil revenues. Under the PI option, an oil exporting country does not spend more than its permanent income, which is equal to the real return on total wealth, therefore keeping government wealth constant over time.21Under the simplest option, the rule implies that non-oil fiscal deficits do not exceed the real return generated from total wealth. This option ensures that expenditures are financed by investment earnings rather than drawing down on capital which would result in wealth depletion. However, this rule does not prevent fluctuations in the fiscal policy stance when projections have to be revised. [preferred rule].

73. It appears economically reasonable to expect, the non-oil deficit to be equal to the anticipated returns on existing financial assets. This position is usually called the Bird-in- Hand (BH) rule. Under the BH rule, all oil revenues are saved and only the expected return

2o This section draws partially on IMF 2005. 21 Government wealth can be kept constant in real terms, in per capita, or as constant share of GDP leading to different non-oil deficit targets. 32 of the accumulated assets is spent. The rule eliminates the volatility associated with projection changes, except for the assumed return in financial assets during the following years. The BH rule implies a balanced non-oil budget each year.22 For new oil producers under such a rule, fiscal expenditure would increase slowly from the beginning of the oil production. Although the BH rule provides time for an increase in absorptive capacity, it might be perceived as excessively cautious, notably when there are pressing spending needs.

74. An alternative to the above rules would be the Balanced Budget (BB) rule. Several oil-exporting countries, including recently Cameroon, Republic of Congo, and Kazakhstan target a balanced budget based on conservative oil price assumptions. The budgeted price of oil could be constructed around an oil price at the long-run average (for example 1985- 2004), or significantly below the consensus price expectation at the time. In the Republic of Congo, for example, the 2005 budget was prepared under the assumption of an oil price of $4 per barrel below the World Economic Outlook (WEO) price. Under the BB rule, surpluses would be accumulated during periods of higher oil prices and/or production, and deficits accommodated during periods of lower oil prices and/or production. The budget balance rule has the benefit ofbeing easily monitored and understood.

75. (iii)Accumulation of assets. The Government should also accumulate a portfolio of diversified assets in order create an alternative source of revenues to sustain the non-oil deficit when oil reserves are depleted. In particular, the returns on accumulated assets should be sufficient to finance the non-oil deficit once oil is exhausted. By contrast, an unsustainable policy would be to finance the non-oil deficit - once oil production ceases - by drawing down accumulated assets: this would lead to the depletion of the assets as well as to steady government borrowing and explosive debt dynamics. Even stabilizing the net debt to GDP ratio or eliminating all the debt may not be consistent with fiscal sustainability in the post-oil period. Hence, the Government should accumulate substantial assets during the oil period to sustain the non-oil deficit in the post-oil period.

B. Short-run Challenges

76. Besides delivering government savings consistent with optimal consumption out of permanent income, fiscal policy is also a key tool of short-run macroeconomic management. The evidence on oil price volatility in the short-run and large fluctuation over the medium term is well-established. In addition, predicting oil price fluctuations turns out to be virtually an impossible task. High oil price volatility translates into volatility in the fiscal cash flow, confronting policymakers in countries dependent on oil as a major source of export earnings and government revenue, with the short-run issues of how to address sharp and unpredictable variations. Hence, in the short-run, the challenge would be to immunize, to the extent possible, government spending from the volatility of oil prices by smoothing fiscal expenditures and developing a source ofrevenues from accumulated financial assets that will help avoid abrupt changes in Government spending and non-oil deficits.

77. Some countries (e.g. ) have managed to pursue prudent, short-run fiscal policies that have been successful in avoiding fiscal instability and helped insulate the economy from oil revenue volatility. These policies managed to smooth expenditure and the

22 This rule would lead to very restrictive primary non-oil deficits or - in countries with negative net financial assets -primary non-oil surpluses (Barnett and Ossowski 2002). 33 non-oil balance in the face of cash-flow volatility, decoupling the use of oil revenues from current earning, and therefore enhancing the stabilization role of fiscal policy. Some other oil-producing countries, by contrast, have adopted pro-cyclical fiscal policies and persistent fiscal deficits, leading to less favorable financial positions, and eventually to painful adjustments. In these cases, fiscal policy has transmitted oil volatility to the rest of the economy. In countries such as Mauritania that are characterized by a liquidity constraint, feeble absorption capacity, and other policy concerns, a prudent fiscal strategy should aim at breaking (potential) pro-cyclical responses of expenditure to volatile oil prices.

78. This would imply: eliminating expansionary fiscal policy biases during oil booms and targeting prudent non-oil fiscal balances that reduce the non-oil fiscal deficit overtime. In so doing, the authorities would be in a better place to deal with oil market volatility, weather temporary oil shocks without drastic short run fiscal adjustment, and allow for an orderly adjustment to catastrophic oil shocks that are long-lasting. The formulation ofmedium term- expenditure frameworks (MTEF) can allow a better appreciation of the future spending implication of current policy decisions and help limit the extent of short-run spending responses to rapidly changing oil revenues. The volatility of oil revenues can be also reduced using financial instruments such as swaps, futures, and options, which contribute to the transfer ofthe risk to international financial markets (Barnett and Ossowski 2002).

3.2.2 Establishing Appropriate Mechanisms for the Management of Oil Revenues

79. A nonrenewable resources fund (NRF) can be a useful instrument to build popular support for sound fiscal policy and wise management of the petroleum wealth. Funds can help crystallize public support for saving petroleum resources, let the public see how petroleum revenue is spent and how much is being saved. They also allow politicians to justify budgets that build up fund resources by referring to the need to save for future generations. The key rationale why a fund could help countries manage efficiently their petroleum wealth well is political. Saving petroleum revenues means spending less today to provide for future needs, something that can be notoriously difficult.

A. Variety of Oil Funds

80. NRFs have been established to address issues posed by exhaustible revenue streams from depleting resources such as short term stabilization, long run savings and sterilization of revenues. Two basic types of oil funds, have been established to insulate government revenues from volatile oil prices and to allow for savings for future generations: (i) Stabilization funds (StabF) are designed to smooth revenue flows; and (ii)Savings funds ( also referred to as funds for the future -- SavF), are designed to create a store of wealth for fhture generations by converting present revenues into income generating assets. This distinction is rather artificial since a single fund can be established to achieve both objectives. There are other types ofNRFs such as the Financing Fund (FinF, i.e. Norwegian Fund) or the Contingent Stabilization Fund but they are only variations of the two basic types. A single fund can in effect address all the issues discussed above (see Box 2).

81. If the likely saving is only of a small magnitude it may be best not to plan for a savings fund but merely to concentrate on how best to permit fairly steady changes in government expenditures over the projected peaked profile of oil revenues (smoothing 34 function), and against plausible downside risks (stabilization function). Especially in the early years of oil production when revenues will be below desirable incremental government expenditure, it may be counterproductive to start putting money permanently aside. Citizens may feel that they are not yet receiving the benefits of oil and press for the liquidation ofthe fund. A scheme of management can be designed that could transform a smoothinghtabilization fund into a savings fund if oil revenues become sufficiently large (Bacon 2006).

Box 2: Variety of Oil Funds A StabF is designed to stabilize revenue flows and implicitly expenditure. StabF can be price- or revenue-contingent funds, or both. These funds accumulate resources when the price or exceeding some pre-announced threshold (i.e. the pricehevenue is “high”), and pay revenue fall below a second threshold (Le. the pricehevenue is “low”). In so

ctively financing the overall budget balance. In Norway, net oil revenues are

Source: Devlin and Lewin 2005, Barnett and Ossowski 2003.

82. Some best-practice design principles for a Petroleum Fund are as follows:

k The fund should be coherently integrated into the budget process. This is best achieved by ensuring the fund operates only as a government account rather than a separate institution. Budget formulation and reporting should focus on the consolidated presentation, and expenditure should be executed by the Treasury (within the Ministry of Finance). The fund should ideally be a “financing” fund, 35

where the fund’s balance reflects the government’s saving of its petroleum wealth and is presented in the context of all the government’s financial assets and liabilities. P Fund assets are managed with an explicit governance framework according to international best practice. Funds can accumulate significant financial assets. Their objective is to maximize investment returns subject to the primary objective ofcapital preservation. Funds operations are supervised by an Investment Committee and are governed by an investment policy and investment guidelines. In this framework, investment management is conducted transparently, with controlled risk management and regular reporting. Qualified professionals, subject to the highest code of ethics and professional rules of conduct are selected and trained in state of the art investment and risk management techniques. Holding assets in foreign financial instruments helps diversify risk and reduces the impact on the domestic economy. Funds should also not lend or otherwise pledge their assets as collateral for borrowings. P The rules and operations ofthe fund should be transparent with stringent mechanisms to ensure accountability and prevent misuse. This requires regular and frequent disclosure and reporting on the principles governing the fund, its inflows and outflows, and its investment strategy and return on assets. The fund’s activities should be audited by an independent external agency, and investment performance should be periodically evaluated and published.

B. Implementing the EITIInitiative

83. The EITI is a multi-donor trust fund, which supports improved governance through the full publication and verification ofcompany payments and government revenues from oil, gas and mining. It aims to foster transparency and accountability, and is supported by an International Secretariat. The Secretariat works closely with other donor agencies and the IMF. In addition to the implementing governments and donors, the EITI is supported by many of the largest oil and mining companies in the world, as well as investors in those companies; and by different civil society groups including a large number of them working under the umbrella ofthe Publish What You Pay Coalition (see Box 3).

Box 3: Characteristics of the EITI 36

The EITI involves typic identified - government, Multi-stakeholder commi

Publication: Design rep0 data is to international identifying any discrepa review data; (vi) Review reporting continues. Some across the world.

Source: http://www.eitransparency.org/index.htm, 2006.

84. The primary beneficiaries of EITI are the governments and citizens of resource-rich countries. Knowing what governments receive, and what companies pay, is a critical first step to holding decision-makers accountable for the use of those revenues. Resource-rich countries implementing EITI can benefit from an improved investment climate by providing a clear signal to investors and the international financial institutions that the government is committed to strengthening transparency and accountability over natural resource revenues. Companies and investors, by supporting EITI in countries where they operate, can help mitigate investment risk: corruption creates political instability, which in turn threatens investments, which are often capital-intensive and long-term in nature. Civil society can benefit from an increased amount of information in the public domain about those revenues that governments manage on behalf ofcitizens.

C. Building Capacity

85. Building national capacity includes training of local personnel who are able to elaborate and put in place a clear legal, regulatory and contractual framework in the petroleum sector. Such a framework - the cornerstone for private sector involvement in the oil and gas sectors - should: (i)emphasize the government’s objective in maximizing the impact that the oil and gas sectors have on overall economic development; and (ii)be translated into petroleum laws, regulations, contracts and institutions that promote foreign and domestic direct investment and competition. Environmental management is also important in Mauritania, as offshore fishing represents a sizeable export. Oil exploration and production also generates a large number of seismic, economic, financial, and environmental data. The near-term agenda includes setting up the reporting system, and training of staff that will be responsible for preparing monthly reports on hydrocarbon production and sales; updating oil production and revenue projections, and implementing the EITI recommendations.

3.3 OIL REVENUE MANAGEMENT:THE GOVERNMENTRESPONSE TO DATE AND REMAINING CHALLENGES

86. The actions taken by the authorities to set up an institutional framework for the transparent and effective management of oil revenue have been encouraging. Oil revenues have been treated transparently in the 2006 and 2007 budgets. The authorities have engaged in prudent fiscal and monetary policies and set up the National Hydrocarbon Revenue Fund (FNRH). The government has also created a National Oil Company (SMH), adhered to the 37

EITI and agreed to implement all its steps; and sought support and technical assistance in the oil sector and in the management of oil revenues from the World Bank and International Monetary Fund. The key stages of the “oil circuit” in Mauritania are discussed in Box 4.

3.3.1 The Oil Sector Institutional Framework

A. The National Hydrocarbon Revenue Fund (FNRH)

87. An ordinance establishing a the FNRH was adopted by the Military Council on April 4, 2006. Although the system has not been fully tested, it includes a number of encouraging features. The FNRH is an account of the treasury that centralizes petroleum revenues (essentially government share in the profit-oil under PSAs, corporate income tax and all applicable taxes on oil companies’ and their subcontractors, signature bonuses and other bonuses and fees applicable under PSAs and arising from contractual relations with oil producing companies and companies prospecting for oil and other hydrocarbons in Mauritania). The Fund’s resource base is clearly defined; it includes fiscal revenues from exploration, production and sale ofcrude oil, as well as the return on investments.

88. The fund’s resources are invested offshore (at the Banque de , until such time that the BCM selects through a Request For Proposal (RFP) process a global custodian) so as to limit pressures on the real exchange rate. The FNRH is managed independently by the Central Bank of Mauritania (BCM) under a convention, adopted on May 10, 2006 by the Council of Ministers, which delegates the administrative powers for the FNRH from the Ministry of Finance (MOF) to the BCM. Government accounting principles apply to FNRH and an investment committee (Comite Consultatif d ’Investissement, CCI) oversees the management. The BCM will send the MOF: (i)a monthly report on the daily operations made by the FNRH; (ii)a quarterly reports on the functioning of the FNRH (detailed data on the transfers, and level of funds in the oil account at market prices); and (iii)a yearly report on the risks and returns of the Fund during the previous 12 months.

89. The FNRH is a financing fund. According to its establishing decree, the resources of FNRH are saved or used to finance the non-oil budget deficit. The fund covers the financing needs identified in the annual government budget, reflecting the level of non-oil deficit net of available financing from sources other than domestic banking system (such as net external financing and privatization) and domestic debt management needs in support, among others, of foreign reserves of the central bank. The FNRH will not borrow and its assets may not be pledged or subject to any encumbrances.

90. The Comiti National de Suivi des Revenue des Hydrocarbures (CNSRH) is vested with the role of monitoring oil revenues and their use. It is expected to provide the ground work including projections of flows between the FNRH and the budget as a basis for drafting the Budget law. Withdrawals from the Fund in any given year are limited to the ceiling authorized by the budget law, and must de deposited to the Treasury account at the central bank.23 The fund is audited by the Audit Office (Cow des Comptes) and by an independent international auditing company selected through competitive bids (audits can be appended to

23 The supplementary budget for 2006 authorizes withdrawals amounting to US$ 181 million. These resources will cover the non-oil deficit. 38 the Budget Execution Law). The decree calls for quarterly reports on the activities of the fund, including through the internet.

91. Despite good progress, the overall legal framework and procedures need to be strengthened. The links between the FNRH and the annual budgets and the medium-term expenditure framework (MTEF) need to be clearly defined. In particular, the surveillance role of Parliament (after the November 2006 elections) over the use of the resources of the oil fund is to be stressed. The existence of the fund should not weaken the budget process. Also, clear guidelines, based on a long-term fiscal strategy, need to be established on the transfer of resources from the oil find to the budget. Finally, procedures with regard to the FNRH revenue (most notably, tax revenue) assessment, collection, and certification should be strengthened at the level of General Tax Directorate (GTD). GTD and the Treasury should also be equipped and staffed to make reliable projection of all (tax and nontax) revenue that would accrue to the FNRH (IMF 2006e).

B. The National Oil Company (SMH)

92. The Government has decided to establish a national oil company, SMH. The SMH will have the responsibility for managing the state participation in the oil sector and facilitate the development of national capacity in this sector. Some observers reviewing the performance of national oil companies (NOC) in natural resource countries argue that NOCs often become a “state within the state”. NOCs are in fact often involved in accomplishing a broad range of national economic, social and political objectives that go well beyond their original sector-focused objectives (these include job creation, development of local capacity and social infrastructure, regional development, income redistributiodtransfers, and state borrowing).

93. Weak governance has often undermined the performance of NOCs - especially when the Government is the sole shareholder - which usually lack transparency (accounts are not published, internal financial controlsiaudits are weak), accountability, commercial oversight, sound management structures and commercial “signaling”. In addition, NOCs in many countries formulate and implement oil sector policies, and, at the same time, to enforce sector regulations, generating potential conflicts of interests (McPherson 2003). In Mauritania, the role of the newly-formed state oil corporation, SMH, should be clarified and its commercial mandate safe-guarded and made paramount. SMH risks turning into an annex of the MEP without such safeguards, which could lead to the leakage of funds from the commercial enterprise and into the political patronage system and undermine the capacity of SMH to execute its commercial responsibilities in the long-term national interest.24

94. The elaboration of a long-term strategy of the SMH is currently underway. This strategy should be geared at: (i)ensuring the SMH commercial efficiency; (ii)limiting the SMH non-commercial obligations (social, economic and political functions); (iii)ensuring transparency in SMH operations; (iv) limiting SMH cash requirements; and (v) allowing the Government (Le. the MEP or a quasi-independent regulatory agency) to manage policy and regulations, thereby avoiding any conflict of interest. On the transparency side, measures that

24 In short, SMH is vulnerable to political predation, which SNIM has thus far managed to contain within the iron ore sector only by internalizing as much revenue as possible (through its subsidiaries and welfare- state functions) and by stressing its need to maintain the confidence ofits international equity partners. 39 can be taken are the yearly presentation to Parliament for approval of the budget of SMH in conjunction with the state budget; the publication of the SMH audited accounts and of the contracts to which SMH is party, on behalf of the state, to make the SMH assets and liabilities transparent.

3.3.2 The EITI

95. The Government decided to adhere to the EITI in September 2005. The implementation of the EITI at the national level is a responsibility of the Government, and it requires the active participation of key stakeholders from the Government, industry and civil society. Priorities for action in the near future include: (i)facilitating the task of the international auditor to launch the process of reconciliation of revenue figures; (ii)training the representatives of civil society on basic oil industry and macroeconomics concepts; (iii) preparing the 2005 audit report on SNIM and the 2006 report on oil and mining companies; and (iv) launching the communication campaign to manage the expectations of the general public. The EITI reports should be disclosed, through a process involving active participation ofcivil society. Key steps taken to date include the following:

9 On September 20 2005, the Prime Minister Sidi Mohamed Ould Boubacar announced the Government's intention to adhere to the EITI. In addition, the Head of State reaffirmed his Government's commitment to EITI implementation. The Prime Minister designated an EITI coordinator, with counterparts in key Ministries and the BCM. Oil and mining companies active in Mauritania confirmed their disposition to support the implementation of EITI. Civil society representatives also expressed willingness to support EITI. 9 On January 13,2006 the Government adopted the Decree No 2006-001 establishing a National Committee responsible for the EITI (EITI-NC) in Mauritania. The EITI-NC comprises 28 members, including 18 representatives from civil society. On May 9, 2006, a national EITI workshop was held in Nouakchott. Participants included political parties, representatives of trade unions, civil society, private sector, mining and oil companies, government official. 9 On June 6 and 9, 2006, the EITI-NC met to designate the Monitoring Committee (MC) and to define its mandate. It also approved the 2006 action plan and a set of rules governing the functioning of the NC. The MC subsequently approved the TOR for an audit firm to prepare the reports covering 2005 and 2006, which will include (i) the reconciliation of the payments declared by the companies with the receipts reported by the Government; and (ii)the development of standardized declaration formats to be used by the companies and the Government. 9 Training of the parties involved was due to begin in mid-October 2006. The training covers a wide range oftopics including the legal and fiscal framework for the PSAs and basic economic and accounting concepts. In parallel, a communications strategy is currently being developed to disseminate the objectives of the EITI initiative and inform the public of the progress achieved to date, taking advantage ofthe publication ofthe first EITI report on the mining sector (expected in the final trimester of2006). 40

Box 4: The Oil Circuit in Mauritania

Marketing of the profit oil t

are transferred

BrwdRi Wy",*"(*,

Source: CEM team 2006 41

3.3.3 Capacity Building

96. The authorities fully realize that building national capacity is essential to a successful management of the oil and gas sectors and asked for technical assistance (TA). In July 2006, the World Bank will deliver TA in the form of an additional component to the existing mining operation (PRISM-2, US$5m), focusing on five sub-components: (i)Legal and regulatory framework; (ii) Human resources capacity building; (iii) Environmental management; (iv) Data management/Petroleum cadastre; and (v) Sector strategic studies. The TA supports a comprehensive approach to petroleum sector management. Every process along the revenue chain will be closely monitored, with technical assistance provided along the way (see Figure 9), to ensure good governance and transparency. Other donors, such as the Islamic Development Bank (IDB), Norwegian Development Agency (NORAD), and GTZ are also providing funding on petroleum sector capacity building. The development agencies are planning on close collaboration to provide a cohesive sector TA.

97. Mauritania is participating in the World Bank Treasury Reserve Asset Management Program (RAMP). Under this program, RAMP provides highly professional technical assistance and capacity building in investment management and the design and establishment of oil funds drawing on its extensive experience and advanced technical capabilities to a significant number of oil and non-oil producing countries central banks. The BCM is receiving RAMP assistance for setting up the Fund and establishing the governance framework for operating the FNRH including the various steps necessary for establishing and operating an investment management platform.

Figure 9: Holistic Approach to Petroleum Sector Management

Contracts Operators Royalties entremegions

A. The Legal, Regulatory and Contractual Framework

98. A comparative assessment on the competitiveness of the existing Mauritanian legal and contractual framework vis-a-vis state of the art modem oil sector legislation and PSAs needs to be carried out. The existing legal and fiscal regime applicable to the oil sector was adopted in 1988 and the PSA model in 1994. This framework was prepared before the oil price increase and with the basic idea of promoting areas considered frontier for risk investments. Based on the results ofthis assessment, the government is committed to develop a new Oil Sector Policy Letter (OSPL), including a revision ofthe current PSAs, defining the strategic importance ofthe oil sector for Mauritania and laying the legal basis for a maximum possible degree oftransparency in oil operations.

99. Once the OSPL is adopted - either by an ordinance or by a new legislation - a coherent package of secondary legislation - covering technical, economic and environmental issues - should also be prepared. Among the important aspects to be determined under the new regime is a precise regulation on the functions, mandate and organization of the MEP 42 and its respective Directions, the SMH, and other sector related agencies. In addition, an inter-ministerial working group was created in May 2006 to prepare a draft Law on Hydrocarbon Revenues by end-December 2006. This law deals with the macroeconomic aspects of oil revenue management, including inter alia, the principles that should guide the optimal management of these resources and determination of the annual contribution of the FNRH to the financing ofthe budget.

B. Human Resources

100. Both the MEP and SMH have a serious deficit of qualified staff. Therefore, there is a need to recruit a consultant team that in a coherent way, following a learning program based upon an “on-the-job-training” approach, will perform the task and build capacity in both institutions. The aim here would be to build up gradually the institutions responsible for sector management in accordance with the adopted sector policy. The authorities - under the leadership of the MEP - are currently developing a comprehensive plan for strengthening human resources. In particular, the MEP will finance all local training courses as well as training outside Mauritania, while the World Bank will put in place a team of experts who will be responsible for implementing the training programs. A “coach” will also be recruited to advice on oil sector development and aid in the identification of local personnel and training schemes tailored to the Mauritanian context.

101. One aspect that deserves particular attention is the regular assessments of the future oil price, oil production and oil revenues, which implies an overlap and coordination between the MEP (to monitor progress in the oil sector) and the MOF (to assess tax and royalty payments received). Assessing the oil production profile is clearly a specialist function, which has to be undertaken by the MEP, possibly with the help of consultants. Assessing tax revenues paid can also be assisted by specialist auditors. The key issue is the determination of the oil price foreca~t.~’Once the best forecast price, or price range, is available, the MOF should then determine the “planning” price for budgetary purposes, that they feel will give sufficient coverage against risks ofa lower actual price than forecast. With this price scenario a new set of revenue forecasts can be prepared and the budget expenditure plan produced, subject to specific rules if the forecast is incorrect.

C. Environmental Management of the Petroleum Sector

102. An important way of integrating environment considerations into the sectoral decision making and planning processes would be to undertake a Strategic Environmental and Social Assessment (SESA), which will be financed and implemented through the PRISM-2 petroleum component. The Government has already adopted Law 2000-45 (Code de I’Environnement) and prepared a draft Law on the National Park of Banc d‘Arguin (a national preservation site, located on the coastline near petroleum exploration areas), but has not yet worked on the required regulations for its enforcement. The SESA will permit to

25 Two main approaches can be used for predicting oil prices: (i)A 3-5 year moving average of actual prices. If initial asset levels are low as in Mauritania, then fiscal smoothing through the use of moving averages reduces the chance of fund exhaustion, because of the slow change in fiscal policy involved; (ii) An expert assessment produced by a committee of experts, who are independent of the spending decision process, and can draw on numerous sources ofinformation to produce their assessment. (Bacon 2006). 43 identify the critical areas, the main institutional gaps and the basic missing regulations for the oil industry in the offshore areas. A round-table on the SESA is expected in December 2006.

103. Following the SESA, there are two areas of work to be considered: (i)the preparation of environmental regulations, and (ii)the training of a core team that will be responsible for the approval, and monitoring ofthe environmental assessment of oil projects. The experience gained in turn could be used to replicate this knowledge in the neighboring countries of West Africa. To prepare the environmental regulations for offshore oil operations, it would be possible to use as a starting point (i)the procedures for the Environment Impact Assessment (EIA) cycle that have been developed for the mining operations and (ii)the regulations developed in other mature offshore oil basins (i.e. Norway).

D. Data Management and Petroleum Cadastre

104. Oil exploration and production generates a large quantity of seismic, economic, financial and environmental data - mostly in digital form - that are submitted by the operators to the Government. After due processing, these data from seismic lines, well drilling and production performance conforms a real government asset. At present, lacking the required databases, including hardware and software, the information from the industry is not properly stored or vital information is not received. The creation of a data bank and a related information system is of critical importance for the management of the sector and for valorizing the hydrocarbon resources of the country. The development of the information system and the data bank should be contracted to a specialized cabinet in two steps:

P An inventory and evaluation ofthe existing data, a projection ofthe amount ofdata to be received in the medium-term and the conceptualization of the required system for storage, processing and exploitation of the sector data; and P The design, planning and procurement of the equipment and software including the training ofthe local staff,

105. Among the most critical parts of the information system there is the cadastre of oil contracted areas and the collection and processing of the cost data reported by the contractors. These are essential inputs for an adequate operational model, which is the central tool for the sector policy decisions and negotiations of future acreage. In addition to the above sub-components, the technical assistance resources could be used to fund a number of strategic assessments, including: (i)Protection of the environment and management of the coastal communities;(ii) Utilization of natural gas; and (iii)a Strategy for the promotion of exploration in acreage from relinquished blocks.

3.4 MAINCONCLUSIONS AND RECOMMENDATIONS

106. Countries rich in non-renewable resources that account for a substantial part of revenues face important challenges for economic policy in general and fiscal policy in particular. On the macroeconomic side, a large inflow of revenue can cause real exchange rate volatility and Dutch disease. The challenges forfiscalpolicy are evident in both the long- and short run. Besides conducting appropriate (and prudent) fiscal and monetary policies, a correct management of natural resource wealth will also require Mauritania to put in place an 44 institutional framework of the management ofnatural resources, which should culminate with the production ofa Hydrocarbon Law. The following elements emerge:

k Conduct appropriate fiscal policy in both the short and long-run. In the long-run, the Government should concentrate on a sustainable non-oil primary deficit. Under the PI option, an oil exporting country should not spend more than its permanent income. This would ensure that expenditures are financed not by current income but out of permanent income from total government wealth, effectively smoothing government spending over time. In the short-run, fiscal policy needs to be geared towards avoiding fiscal instability and helping insulate the economy from oil revenue volatility. Policy makers should aim at breaking (potential) pro-cyclical responses of expenditure to volatile oil prices. > Strengthen the framework for the management of oil revenues. Despite good progress to date, the overall legal framework and procedures need to be strengthened. The links between the FNRH and the annual budgets and the MTEF need to be clearly defined. The surveillance role of the new Parliament over the use of the resources ofthe oil fund is to be stressed. It is now important to prepare the National Hydrocarbon Law on the management of oil revenue, and a Oil Sector Policy Letter. These laws will define a permanent institutional framework and the principles that should guide the optimal management of these resources and determination of the annual contribution ofthe FNRH to the financing ofthe budget.

k Foster Transparency in the management of the oil sector. On the EITI front, Priorities for action in the near future include: (i)facilitating the task to the international auditor to launch the process of reconciliation of revenue figures; (ii) training the representatives of civil society on basic oil industry and macroeconomic concepts; (iii)preparing the 2005 audit report on SNIM and the 2006 report on oil and mining companies; and (iv) launching the communication campaign to manage the expectations of the general public. It is also imperative to ensure that the SMH will not become a “state within the state”. Measures that can be taken are the yearly presentation to Parliament for approval ofthe budget of SMH in conjunction with the state budget; and the publication of the SMH audited accounts and of the contracts to which SMH is party.

k Strengthen capacity in the oil sector. Building national capacity is essential to a successful management of the oil and gas sectors. The TA provided by the World Bank, Norway and IDB in the petroleum sector will be important to ensure good governance and transparency. The following domains are considered as priority in the initial stages of oil production: (i)Legal and regulatory framework; (ii)Human resources capacity building; (iii) Environmental management; (iv) Data managementIPetroleum cadastre; and (v) Sector strategic studies. , 45

4. THE IMPACT OF NATURAL RESOURCE WEALTH ON THE MAURITANIAN ECONOMY

4.1 INTRODUCTION

107. New production of oil or a rise in international prices will bring windfall revenues to the producing country in the form of an increase in income. In developing countries, and this is also the case in Mauritania, the windfall takes the form of an increase in total exports and in government revenue, as domestic private ownership of the natural resource is negligible. The rise in exports accompanied by an increase in government spending will raise domestic prices relative to foreign prices (or the price ofnon-traded relative to traded goods), which is usually referred to as a real appreciation of the exchange rate. This can occur under either fixed or flexible exchange rate regimes. In the former case all the adjustment occurs through domestic inflation whereas in the latter case the adjustment can occur through both the appreciation ofthe nominal exchange rate and domestic inflation (See Annex 1).

108. At the same time as the government absorbs the oil revenues, income and employment will increase (ceteris paribus). In industrialized countries there is often a paradoxical rise in unemployment following an oil windfall. Workers in declining industries are laid off and real wage rigidity slows employment growth in non-traded goods. In developing countries, by contrast, the public sector is often the expanding sector and it is rising government employment that usually generates the expansion. Hence, consumption and saving will increase and so should investment and growth. However, there are also some detrimental effects. The real appreciation will cause a fall in traditional or non-oil exports and sectors. The amount of non-oil exports relative to imports will decline. Similarly, since traditional non-oil production declines initially, the tax base narrows (relative to expenditure) and the fiscal authority becomes increasingly dependent on oil revenues.

109. Although the beginning of oil production from the offshore Chinguetti field has created new opportunities for realizing Mauritania’s millennium development goals (MGDs - see Annex 4), large uncertainties remain with regard to oil revenue prospects from other fields. Prospects for Mauritania’s main commodity exports (fish, iron ore and oil) are relatively good, and Mauritania will use the improved PSA terms to strengthen its external position and build up reserves. However, realistically, over the medium-term, Mauritania will continue to depend primarily on mining and fishing as the two main (non-oil) sources of growth. Without massive investment in important infrastructures and services, there is little chance that the country would be able to diversify its economic and export base in a meaningfbl way.

110. In addition, Mauritania starts from a situation of weak governance, low levels of foreign reserves, the presence of significant government arrears, and declining execution rates of investment spending in the last few years, notably in the social sectors (World Bank 2005). There are therefore concerns about the real potential of the economy to absorb a large part of the resources rent. This chapter reviews the recent economic developments and the medium-term outlook for the economy (Section 4.2). It also discusses the key challenge for policy makers in Mauritania, i.e. to decide how much natural resource rent can be absorbed, what type of investments need to be carried out, and which sectors should benefit from this investment. Section 4.4 presents the main conclusions and recommendations. 46

4.2 RECENTECONOMIC DEVELOPMENTS

4.2.1 Deterioration in Macro-budgetary Discipline and Recovery

111. Mauritanian economic growth has been relatively good in recent years, averaging 4 per cent between 2001 and 2005. But the country departed from the long-standing prudent policies that had earned it the reputation of a strong performer. Indications emerged in 2004 of the execution of significant extra-budgetary spending financed predominantly by BCM credit. For instance, only US$32 million of the US$415 million in gross official reserves reported to the IMF in 2003 could be reliably confirmed. Instead of a large fiscal slippage and monetary expansion in 2003-2004, however, revised data indicate that significance imbalances and low levels of foreign reserves persisted over many years, probably since the early 1990s.

112. Instead of capitalizing on its solid fiscal stance and comfortable foreign exchange position to pursue the second generation of reforms, the authorities backtracked on many objectives outlined in their PRSP (200 1-2005). Important structural reforms stalled, most notably in banking, exchange market, governance and capacity building. As a result, As a result, the IMF PRGF, approved in July 2003, was canceled on November 2004, while the World Bank stopped the preparation of the first Poverty Reduction Support Credit (PRSC), planned for FY05. The IMF Board agreed that Mauritania should repay two non-complying disbursements under the 1999-2002 PRGF-supported program (SDR 12.14 million in total plus the accrued interest) in two tranches by June 15,2006 (IMF 2006b and c).

113. Therefore, in mid-2004, Mauritania found itself in the need of a radical stabilization to avert the prospect of a balance ofpayments crisis and tame a double-digit inflation. Some remedial measures were initiated in mid-2004 to reverse the unraveling of macroeconomic stability by curbing extra-budgetary expenditure and withdrawing BCM financing. The establishment of the new Government, after the coup of August 2005, accelerated the re- establishment of macro-budgetary discipline and transparency. The transition authorities started to re-establish a stable macro-budgetary framework. Since taking authority in mid- 2005, the transition Government has taken concrete steps to reverse negative trends. Fiscal policy in particular was tightened in the last quarter of 2005. Expenditure controls were quickly implemented but extra-budgetary operations continued through the summer of 2005, resulting in further accumulation of domestic arrears. However, the new authorities stopped circumventing budgetary ceilings and adopted a supplementary budget in November 2005 with cuts in non-priority expenditures and nondiscretionary spending envelopes adjusted to realistic levels. These measures and the stopping of expenditure commitment orders in mid- November 2005 helped contain the fiscal deficit.

114. Stabilization efforts have continued through 2005/2006 and show first results. A six- month IMF SMP - covering the first half of 2006 - was negotiated, paving the way for a PRGF (covering the period 2006-2009, with a total access of SDR 16.1 million), which should be approved by the IMF Board in December 2006. In 2006, growth is expected to reach 13.9 percent due to the start of oil production.26 Strict observance of the fiscal and monetary policy stances was instrumental in bringing 12-month inflation down to 5 percent over the first six months of 2006. Fiscal performance has been strong, reflecting revenue collection efforts and sustained spending discipline. As a result, the basic non-oil fiscal

26 Oil revenues (including an exceptional signature bonus of US100 million) are projected at US$240 million (1 1.2 percent of non-oil GDP) in 2006. 47 deficit excluding grants was estimated at 1.8 percent of non-oil Gross Domestic Product (GDP) in June 2006. The external position has begun to strengthen: gross official reserves are projected to increase from US$70 million in 2005 (1.0 months ofimports) to US$173 million in 2006 (2.3 months of imports, year-end) and the parallel foreign exchange market premium has been brought down to insignificant levels (see Table 14).

Table 14: Selected Economic Indicators (2001-2006) 2001 2002 2003 2004 2005" 2006* Real GDP growth (%) 2.9 1.1 5.6 5.2 5.4 13.9 CPI (period average, %) 7.7 5.4 5.3 10.4 12.1 6.4 Current account balance (% ofGDP) -11.7 3.0 -13.6 -34.6 -46.9 -3.1 Primary balance incl. grants (% ofGDP)" -7.7 -0.4 -9.0 -1.8 -3.8 -6.3 Overall balance incl. grants (% ofGDP)" -10.3 -2.9 -1 1.8 -4.8 -7.0 2.2 Gross official reserves (in months of 1.5 2.4 3.4 0.6 1.0 2.3 imports) GNP per capita (US$) 265 359 499 566 685 913 Nominal GDP (US$ billion) 1.1 1.1 1.3 1.5 1.9 2.8

A Non-oil primary and overall balance for 2006 * preliminary Source: IMF 2006a

4.2.2 The Economic Outlook (2006-2010) and Debt Sustainability Analysis

115. Oil production has improved Mauritania's economic prospects, but lower than expected production figures from the Chinguetti field have dampened expectations. Average annual real GDP growth between 2007 and 2009 is expected to be 4.2 percent; oil production will not push GDP growth above 9 percent until 2010, when production is expected to begin in the two additional oil fields (Tiof and Tevet). Per capita gross national product (GNP) is projected to breach the US$l,OOO mark in 2010. Based on current policies, Consumer Price Index (CPI) inflation is expected to be brought below 5 percent within the next three years and official reserves are expected to reach 3 months ofimport cover starting in 2008.

116. On the fiscal side, the recent fiscal adjustment will facilitate a substantial reduction of domestic arrears under conservative revenue and realistic spending assumptions. The overall fiscal position will, however, weaken slightly until 2009, reaching an overall deficit of 5.5 percent of GDP, but is expected to improve starting in 2010 in view of increased oil production. The revised oil production figures will have an impact on Mauritania's external position in the next thee years. The current account balance will decline through 2009 and then significantly improve from 2010 onwards. Mauritania is now expected to have a financing gap in its balance of payments: latest projections foresee an unidentified gap of US$3 1.5 million in 2008 and US$45.2 million in 2009.

117. According to the recently completed DSA (2006), following substantial HIPC and MDRI relief Mauritania faces only a moderate risk ofdebt distress despite some vulnerability to adverse shocks. This scenario assumes that the authorities succeed in obtaining debt relief from the bilateral creditors that have not yet implemented the HIPC initiati~e.~'Under the

27 Negotiations have stalled with a few creditors (Algeria, Iraq, Kuwait, Libya, and the United Arab Emirates), causing Mauritania to build up substantial arrears. These arrears amounted to $1.3 billion at end- 2005, representing 46 percent of Mauritania's total external nominal debt and contributing disproportionately to its NPV. 48 baseline scenario, Mauritania’s debt appears sustainable in the light of external and fiscal sustainability criteria.

118. Ensuring this favorable debt dynamics, however, will require prudent macroeconomic policies and a careful approach to new borrowing, given that Mauritania remains vulnerable to adverse shocks, notably the risk of lower-than-projected growth of GDP and exports (notably oil). Mauritania’s stock of domestic public debt has significantly increased in recent years, mostly reflecting the government recognition of central bank claims on the Treasury and domestic arrears, which resulted from substantial extra-budgetary spending over the last ten years. Domestic gross claims on the government stood at nearly 43 percent of GDP at end-2005, with nearly two-thirds in the form of a consolidated long-term debt vis-a-vis the central bank. The remainder represented short-term debt including treasury bills held by banks and non-banks and arrears toward domestic suppliers, which are expected to be eliminated by end-2006. m

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4.3 OPTIONS FOR ABSORBING THE OIL RENT INTO THE MAURITANIANECONOMY

119. Realistically, over the medium term, Mauritania will continue to depend primarily on mining and fishing as the two main sources of growth. Without massive investment in important infrastructures and services, there is little chance that the country would be able to diversify its economic and export base in a meaningful way. Mauritania starts from a situation of weak governance, low levels of foreign reserves, the presence of significant arrears and - as highlighted in the PER 2004 (World Bank 2005) - declining execution rates of investment spending, notably in the social sectors. The country is also prone to periodic exogenous shocks, e.g. i.e. drought, locust invasions. These considerations, inter alia, should guide the absorptive strategy ofthe Mauritanian authorities (see also Box 5).

Box 5: Key Elements for Consideration on Absorptive Capacity following elements:

roductivity of spending, de smoothing it over a longer period may be prefera > (ii)How much money will be spent, e.g. the ables and non-trad ublic or private sectors. ating without reserves to smooth cash flow imbalances, andor is using the n nt ofbills to the private sectors as a management tool, there is a strong caser for devoting natural resource revenues to eliminating payment arrears andor building a large cushion ofreserves. > (iv) The overall macroeconomic situation. For example, spend commodity boom - as seen in the previous chapter all through increased imports might not be the bes are large andor foreign exchange reserves are low. > (v) The authorities’ expectations on whether the surge in natural resource revenue is temp or will be sustained. As seen in Chapter 1, governments of oil-producing countries have often incorrectly assumed that a temporary increase in revenues would be sustained leading to painful adjustment in later years. > (vi) Managerial and techn 1 constraints. Many poor countries are finding it difficult to recruit, train and retain qualifi personnel (e.g. doctors and nurses, teachers, mangers and

standard ofliving.

4.3.1 Strategic Options for the Use of Hydrocarbon Financial Resources in Mauritania

120. Projected high oil revenues will provide finance for growth but will not necessarily spur sustained growth in the non-oil sector. To date, Mauritania has not been successful at diversifying its economic base. Drawing on the experiences of other oil-producing countries, three broad strategic options for using the financial resources from oil as a means to foster non-oil growth are suggested: 51

A. Option 1. Using accumulated oil revenues to expand public investment in infrastructure as a means to directly propel non-oil sector growth. This would also increase household revenues and thus provide a multiplicative impulse to growth. B. Option 2. Distributing oil windfalls to households, as a means of bolstering incomes and domestic demand growth, while possibly ensuring a better stabilization mechanism against oil revenue volatility. C. Option 3. Saving part of the oil windfalls for the future; using the rest strategically to improve human capital and build strong social safety nets, while, at the same time, accelerating the pace of structural reforms.

4.3.2 Option A: Boosting Public Investment in Infrastructures

121. It could be argued that using surplus oil revenues to fund higher public investment may have a better growth pay-off than accumulating savings. Indeed, higher public investment could generate productivity gains by filling “infrastructure gaps” that increase the cost of doing business and reduce competitiveness. Filling such infrastructure gaps, especially in transport and in the rural sector, could also contribute to boost rural income, reduce poverty and better integration into regional trade. It could also be argued that higher public investment (especially in non-traded goods sectors) would also contribute to increasing household incomes and could thus have a multiplicative impact on non-oil GDP growth. However, it could also lead to higher imports and balance of payment vulnerability (World Bank 2006a).

122. Public sector investment in Mauritania has recently been around 12 percent ofnon-oil GDP (average 2001-2005, 50 percent ofwhich financed by external sources)28with a modest level of efficiency in its application and with some lag in disbursement, especially for pro- poor activity and also in the lagging regions. The Government plans with respect to investment for the next three years show that capital spending is projected to stay at around 10 percent of non-oil GDP (Table 16). This increase is less than that projected in the draft MTEF 06-09 and takes into account Mauritania absorption capacity constraints as well as the revised, lower, oil revenue projections. The absorptive capacity of the domestic economy, however, could increase over time, possibly quite rapidly if measures for effective deployment are strengthened (Le. capacity-upgrading strategies were pursued by some Gulf countries during the 1974-78 and 1979-81 oil booms [Auty 19901).

Table 16: Expenditure and Net lending (2005-2010, YOof Non-oil GDP) 2006 2007 2008 2009 Expenditure and net lending 37.5 33.2 32.3 31.9 Current 27.5 23.1 22.2 21.7 Capital 9.4 10.2 10.2 10.2 Capital exp. (UM bn) 58.8 68.8 73.8 78.5 Capital exp. (US$ m) 218.8 256.3 274.7 292.3 Source: IMF 2006a.

~~

28 However, between 1992-2000 and 2001-2005, the portion of actual spending of the BCI financed by domestic resources increased from 15 percent to 44 percent. (GIRM 2006 MTEF). 52

123. In evaluating domestic public investment, a basic distinction can usefully be made between investments that are large and indivisible (such as a major port or arterial road linking key economic centers, neither ofwhich is likely to contribute much in an incomplete state) and those that can be effectively broken into sub-stages (such as blocks of irrigable land). The former must invariably remain within the remit of the central government and its line ministries, albeit subject to budget scrutiny by the project evaluation unit, reputable auditors and informed public opinion. Large projects are especially vulnerable to the padding of contracts and cost overruns that leak revenues to rent-seekers at the cost of investment efficiency. Meanwhile, public investments without large indivisibilities can proceed on a stage-by-stage basis, with the funds for subsequent stages being contingent on the satisfactory implementation ofthe previous stage.

124. Shah (2006) reports empirical evidence that suggests such decentralization does reduce high-level scope for abusing public expenditure, although it may raise petty corruption through the short-term. The decentralization of government in China through the late- 1980s and 1990s provides further evidence of efficiency benefits from decentralization (Li et al. 2000). However, Russia encountered net costs from decentralization (Blanchard and Shliefer 2000), which may reflect the adverse incentives afforded to local government by a rich regional resource endowment in contrast to the wealth creating incentives in resource- poor China. In Mauritania, decentralization in its early stages and administrative capacity at the regional (wilaya) level is very poor. Although inroads are being made in de-concentrating public expenditure - i.e. conferring first line ministries and then de-concentrated structures in regions the power of issuing payment orders - such policy could punish neglected regions, where such capacity is clearly under-developed. Also, rent seeking activities may increase at the local level.

125. A public sector investment evaluation unit can objectively compare the prospective returns to alternative applications of the oil rent (eg offshore investments, domestic capital formation - including human capital and rural infrastructure). The MAED might take responsibility for evaluating the returns to alternative public sector investment options, noting the scope such investments afford to stimulate efficient private sector investment. Competition between line ministries for extra resources, as well as between local tiers of government (with their implementation capacity suitably strengthened) could provide an automatic mechanism to adjust the annual flow ofrevenue to absorption capacity and thereby maintain investment efficiency by slowing (boosting) flows to less (more) effective uses.

126. Also, the decisions concerning public investment in (social and economic) infrastructure would better be de-linked from the presence of hydrocarbon windfalls, and based on a long-term investment plan. Despite the attractiveness of using hydrocarbon windfalls to fill infrastructure gaps and as a direct stimulus of growth, several considerations would argue for de-linking oil revenues and public investment in infrastructure:

9 Using hydrocarbon windfalls to expand public investment, instead of saving part of the surplus revenues, would not insulate fiscal policy from the volatility of oil revenues. Demand-driven growth in the non-oil sector would be vulnerable to a downturn in the price ofoil. 9 Efficiency considerations would call for public investment to be driven by the productivity and cost of public capital. Although the presence of hydrocarbon windfalls could temporarily lower the cost of financing public investment, eventually 53

the decisions whether the return to investments is worth the expense is independent of hydrocarbon wealth and should be better taken in the context of medium-term expenditure planning. P Using oil windfalls to finance increases in domestic demand would risk exerting pressure on domestic costs. Higher domestic costs, along with a possible exchange rate appreciation due to current account surpluses, would expose the economy to the “Dutch Disease” syndrome-unless strong efficiency and productivity gains offset the increase in unit labor costs (World Bank 2006a).

4.3.3 Option B: Transferring Oil Revenues to Households

127. The intermediation of part of hydrocarbon windfalls through the household and business sectors might produce superior growth performance in the long-run and may also better insulate the economy from the volatility of oil The way hydrocarbon revenues are intermediated matters for economic performance. When the hydrocarbon revenues are exclusively intermediated by the state the pattern of expenditures and the amounts allocated to savings and investment may be different from the patterns that would prevail if the rents were transferred to the private sector. Distributing the revenue on a per capita basis can improve income distribution, strengthen the efficiency of allocation between saving and consumption, limit scope for political corruption and also improve management ofoil revenue volatility. .

128. Hydrocarbon windfalls may be transferred to households and businesses through different channels, such as lower personal and corporate income taxes, lower indirect and payroll taxes, or through direct transfers. Increased household savings out of oil revenue transfers could funnel investment, if properly intermediated by the financial system, thus expanding productive capacity and output in the long term. However, given the already rent- distorted structure of the Mauritanian economy - and the relative scarcity of farmers and people living in rural areas - it seems likely that a system for per capita distribution ofthe oil rent would trigger a consumption-driven import boom rather than investment. The underdevelopment of the financial and private sectors and the still to be improved domestic investment climate also reinforce this perception.

129. The Alaskan model has become a famous example of dividend distribution from oil revenues to citizens. Alaskans decided to distribute a portion of the income of from the Alaska Permanent Fund each year to eligible Alaskans as a dividend payment. In the Alaskan model, the government equitably distributes resource rents to the people, thereby securing democratic common heritage rights to land and natural resources. Practically, oil income goes into a fund and dividends are distributed among Alaskan citizens, not from current oil revenues, but from the fund income. Eligible Alaskans receive a yearly dividend since 1982.

29 Effectively insulating the economy from volatile oil revenues calls for saving temporary revenues for the future, with a view to stabilizing expenditure. Experience suggests that governments often fail to do so, either owing to poor governance, or because they find it hard to resist pressures from various constituencies when sizeable financial assets have been accumulated. Governments thus often resort to procyclical policies that exacerbate the cycle of oil. By contrast, there is ample empirical evidence that the consumption behavior of households is precisely grounded on their perception of permanent income. Temporary changes in oil revenues, if intermediated by households, could thus spur savings rather than unsustainable domestic expenditure. 54

For many Alaskans, the dividend adds more than 10 percent to the income of their family, principally in rural areas (Ibid. 2006a).

130. Although this option, distribution through households, might produce superior economic growth in the long-run and may also better insulate the economy from the volatility of oil revenues, the already rent-distorted structure of the Mauritanian economy and the associated relatively high urban population seem likely to cause per capita distribution ofthe oil rent to trigger a consumption-driven import boom rather than investment. The under- developed financial and private sectors along with a weak domestic investment climate reinforce this perception.

4.3.4 Option C: Saving Part of the Windfall for the Future

13 1. The third option would call for using part of Mauritania’s surplus oil revenues both for improving infrastructure, improving access to basic services and enhancing the quality of human capital. The rest of surplus revenues could be saved for stabilization purposes or for future generations. A variant ofthis option could also allow some fraction ofthe oil revenues to be reinvested in the oil sector, to expand and modernize production capacity and take advantage of high oil prices. Central deployment of the oil revenue appears the more appropriate option for Mauritania, provided recent moves to strengthen scrutiny of public expenditure are maintained. The higher public revenue may be deployed more effectively if it is part of a dual track strategy that gradually shifts the revenue expenditure from patronage channels to markets by rapidly stimulating a dynamic market sector in the neglected rural economy (Track 1) while proceeding more slowly with reform of the rent-distorted urban sector (Track 2 - See Chapter 5).

132. Some ofthe oil revenues are being saved into the FNRH, for the moment just a buffer in the light of the lower than expected production at the Chinguetty offshore field. Looking forward, however, the FNRH (or another type of fund, such a fund for the future generations) could accumulate a substantial amount of revenue, as production from Tevet and Tiof gets underway. A mechanism to automatically adjust the annual flow of revenue to absorptive capacity can be provided by encouraging competition for extra resources between line ministries and also between local tiers of government (with their implementation capacity suitably strengthened). This will also help maintain investment efficiency by slowing flows to less effective uses and boosting them to more effective ones.

133. In practice, it would be necessary to strike the right balance in the allocation ofthe oil revenue between the FNHR and domestic investment. In Figure 10 below, it is assumed that a “fund for the future” would yield a 3.5 percent financial average annual return on offshore investments, which provides a target threshold for domestic projects. Current oil price projections value the oil reserves at around US$5 billion in nominal terms (base case, IMF, price in Table 11, Chapter 2), so that the permanent real income stream with a 3.5 percent return is around US$80-100 million annually, that is about a tenth of GDP in the early 2000s (Figure 10). Using the high case scenario (4 oil field in production and high oil price) would yield an annual spending of around US$200 million. Figure 11 shows the income available for spending from both fund revenues and oil under “permanent income” approach, with annual spending from oil capped at 4 percent of total wealth and discount rate of 12 percent for present valuing expected oil revenues (same scenario as above). A “balanced investment” 55 strategy is considered with expected real return of 4.0 percent and annual volatility of 8 percent. The figure shows the mean, best and worst case at a 90 percent confidence interval.

Figure 10: Size of the Permanent Fund and Spending Patterns (2006-2024)

Panel (a) Real Oil Revenues and Spending Patterns (US $ m) Panel (B) Available for Spending (US S m)

300 !10

2'0 IC,.

2co ec

I50 6)

I93 4c

20 50

0 0

Real Revenus (Millions USD) -fSpending at 3 5% Spending at 10% Spending at 20%

Panel (c) Size of Permanent Fund (US $ m) Panel (d) Oil Production and Revenues

I"

35 L

:r

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I"

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Figure 11: Income Available for Spending from both Fund Revenues and Oil under "Permanent income" Approach

Size of Permanent Fund(Mlll1on USD) Available for Spendlng(Mllllon USD) I-mnn - mn . Best (93% oontid3nce inteml)

3300- 100 -

50- 2m - Q-

40 loo0 - 20-

0' 0' 2005 2010 2015 2020 2025 2033 2035 2005 2010 2015 2020 2025 2033 2035

Source: World Bank Treasury 2006 56

4.3.5 Which Sectors should Benefits from Investment

134. A further question about the deployment of the oil revenue concerns the scope for investment within specific economic sectors. The reorientation of a sizeable chunk of non- development spending towards human resource development achieved in recent years is highly commendable. However, as documented in the recently completed PER (World Bank 2005) and PER update (World Bank 2006, forthcoming), this phenomenon has coincided with stagnation, and in some case reduction, of public financial flows to the productive sectors of the economy (rural development and fisheries, industry, growth-supporting infrastructure). As a result, policy reform has had limited impact on the diversification of the productive and export base, and foreign direct investment has not responded strongly. The challenge facing the authorities at present is to increase the flows of public funds to these sectors, without jeopardizing the progress achieved on social indicators to date by penalizing social sectors, which will continue to exert upward pressure on spending (public expenditures in these sectors remain below the level needed to provide quality basic services).30

135. The increase in inequality in recent years also calls for greater attention to this phenomenon. More efforts need to be undertaken to contain this worrying trend including: (i) better targeting of expenditure that helps the poor; and (ii)better targeting of the regions where the poor are concentrated. In particular, as emphasized in the PER 2004 (World Bank 2005), expenditure on health and education, as well as HIPC resources destined to poverty- reducing projects, seem to benefit the richer, rather than the poorer regions. The trends in social spending show that, mostly, efforts have been made in aligning the inter- and intra- sectoral resource allocation with the objectives of the PRSP and MDGs. That is, overall allocations to the social sectors have been on the rise in recent years; and primary education and first level health care have progressively benefited from greater budget allocations at the expenses of secondary and tertiary levels within these sectors. However, the data shows that richer areas still get the bulk of social spending, a fact that will contribute to exacerbate inequality.

136. The expansion of competitive employment is an urgent priority, but it will take time to improve the efficiency of investment in the Nouakchott economy. Consequently, a dynamic market economy is likely to make most progress in the long-neglected rural areas. To the extent that the public provision of socio-economic infrastructure facilitates wealth- generating activity within the private sector and draws upon the country’s “surplus labor” together with imported equipment, such a rural program will exert minimal inflationary pressure, if contracts are awarded through open competitive bidding within an administrative system that promotes competition for public funds. More long-term, as skills and incomes both expand, the manufacturing and commercial service sectors within the largest cities will assume an increasingly dominant role. This CEM proposes a dual track strategy, more fully articulated in Chapter 5. In the context of Mauritania, such a strategy would deploy some oil rent to stimulate a dynamic market economy in the hitherto neglected rural areas while the rent-driven urban economy is reformed more gradually, commencing with an urban early reform zone (ERZ).

30 For instance, according to the Abuja resolution on health financing, the proportion ofthe national budget devoted to health financing, should be at around 15 percent. In Mauritania, according to the draft MTEF, the proportion ofthe national budget devoted to health should reach 15 percent in 2009. 57

4.5 MAINCONCLUSIONS AND RECOMMENDATIONS

137. The beginning of oil production from the offshore Chinguetti field has created new opportunities for realizing Mauritania’s MDGs. In the next 3-5 years, oil production (directly and via its impact on public investment) and important FDI-driven non-oil mining developments will raise annual real GDP growth considerably. But Mauritania starts from a situation of weak governance, low levels of foreign reserves, the presence of significant government arrears, and declining execution rates of investment spending in the last few years, notably in the social sectors. There are therefore concerns about the real potential of the economy to absorb a large part of the resources rent. On the basis of the analysis conducted in this chapter, the following recommendations emerge:

k Continue to maintain a stable macro-fiscal framework. The authorities have made considerable inroads in stabilizing the macro-fiscal framework during the last 12 months. Inter alia, this has guaranteed access to the MDRI debt relief, and led to a new PRGF arrangement with the Fund. It would be important to continue to consolidate the fiscal adjustment achieved to date and map out a sustainable non-oil deficit and level of primary spending. Moreover, despite the relatively rosy outlook on the external side, it is imperative to pursue very prudent medium- and long-term policies on contracting of new loans, notably on non-concessional terms. In addition, in order to improve debt sustainability, an agreement with bilateral creditors (notably Kuwait) on the outstanding “passive debt” needs to be reached in due course. k Pursue prudent policies with respect to rent absorption. After a period of euphoria, the recent revision of oil revenue projections means that - as oftoday - the amounts available for spending could be significantly less than previously thought. But rent absorption should be prudent and based on the initial state ofpublic finances, the overall macro-economic situation, and a careful analysis of sectoral priorities and absorption capacities. In practice, the outcome of the decision-making process would be to: (i)strike the right balance in the allocation of the oil revenue between the FNHR and domestic investment; (ii)attempt to find an optimal level of capital investment (the periodical update of the MTEF should guide this process); and (iii) decide which sectors should receive the bulk of such investment (e.g. social sectors versus productive sectors of the economy). k Promote an investment strategy that keeps in mind equity and geography. The authorities could consider deploying some of the oil revenue in the long-neglected rural areas, notably the regions where the poor are concentrated (in the poverty profile these are referred to as Rural River and Rural Other). A sound infrastructure development plan (water, electricity, roads) to initiate priority investment should be elaborated. A public sector investment evaluation unit can objectively compare the prospective returns to alternative applications of the oil rent (e.g. offshore investments, domestic capital formation - including human capital and rural infrastructure). Competition between line ministries for extra resources, as well as between local tiers of government could provide an automatic mechanism to adjust the annual flow of revenue to absorption capacity and thereby maintain investment efficiency by slowing (boosting) flows to less (more) effective uses. 58

5. IMPLEMENTINGCROSS-SECTORAL REFORMS AND BUILDING A DYNAMIC MARKET SECTOR

5.1 INTRODUCTION

138. As examined in Chapter 2, projections of cumulative oil wealth in nominal terms range between US$3.0 billion, assuming base case production and low oil prices and US$10 billion with high case production and high prices. In addition, good mining prospects and a newly signed lucrative fishing arrangement with the EU will further generate much needed foreign exchange. If shrewdly deployed, such a revenue stream provides scope to accelerate economic growth and attain most of the (MDGs - See Annex 4), including reducing poverty on a sustainable basis. However, acquiescence to political pressure to absorb the rent too rapidly into the domestic economy, whether to alleviate poverty or to enrich an elite, risks damaging the political economy in ways that render recovery both difficult and protracted.

139. Unfortunately, Mauritania’s capacity to withstand such pressure isjeopardized by the legacy of four decades of rent-driven development that has been based on rent from iron ore, fisheries and foreign aid (which can be conceptualized as a geopolitical form of rent). The legacy includes Dutch disease effects, rent-seeking and dependent social capital. To reduce the risk of adverse deployment of the oil rent, this chapter sets out a dual track economic strategy that can furnish a politically viable way to transform the mineral rent into assets to sustain wealth creation indefinitely. The experience of the formerly centrally planned Zow- income economies suggests dual track reform offers a politically practical way of reorienting the distribution of rent towards sustainable growth that is pro-poor than does either rapid or gradual economic reform on its own.

140. The dual track strategy creates a dynamic market economy within the neglected rural economy (track one), and incrementally promotes politically sensitive reform of the largely rent-driven urban economy (track two). The dynamic market sector eventually acquires the capacity to absorb labor from the rent-distorted sector into skill-raising employment, while also expanding foreign exchange, and boosting and diversifying non-oil taxation. The expansion of the market sector ultimately allows the gainers from reform to compensate the losers so that reform of the rent-distorted sector can accelerate through the later stages of the strategy. The success of the dual track strategy, however, depends on the establishment of a favorable environment for growth and solid institutions to manage public expenditure.

141. Section 5.2 defines the priorities of the cross-sectoral agenda. Section 5.3 examines the pro-poor program to promote a dynamic market economy within the hitherto neglected rural sector (track one) and the rent-driven urban economy, essentially Nouakchott (track two). Section 5.4 presents the main conclusions and recommendations. It is important to underline that some of the findings of this chapter derive from existing studies (Le. the analysis in Section 5.2), while others will be further fleshed out in the upcoming work on Sources of Growth, to be undertaken in collaboration with the Mauritanian authorities (Le. the analysis in Section 5.3). 59

5.2 THE CROSS-SECTORAL REFORM AGENDAAND GOVERNANCE

142. Policy reforms have not stimulated a great deal of diversification of the Mauritanian economy. This may reflect the lack of trust in the judicial system and the difficulties experienced in the foreign exchange market until recently. Private sector development is hampered by a malfunctioning financial market and lack of enforcement of competition laws. Laying the foundation for dual track economic strategy would require, inter alia: (i)Creating an enabling environment for the private sector; (ii)Improving public sector governance; (iii) Building capacity in the public administration; and (iv) Improving the management ofpublic expenditure. The latter important issue is covered exhaustively in a companion PER Update (World Bank 2006) and will not be treated here.

5.2.1 Creating an Enabling Environment for the Private Sector

143. Without a better enabling environment for the private sector, the potential of key economic sectors - including natural resources - is likely to go unrealized. While sector- specific reforms are not discussed here, several themes recur which fall under this general rubric. Reforms should focus on three goals to enhance the business environment: (i)increase internal competition by strengthening the institutions responsible to enforce the rules of the game; (ii)attract domestic and foreign private investment by simplifying bureaucratic requirements for investors and implementing a clear regulatory framework; (iii) strengthening the financial sector; (iv) Combat corruption. Achieving these goals could bring significant benefits to Mauritania.

144. Promoting competition is an important component of the enabling framework for private sector development, in that it promotes efficiency in production and innovation. Competitive markets can improve opportunity and economic efficiency. Actions to promote competition include relaxing over-regulation of business entry in domestic markets and restrictions on international trade, as well as collusive behaviors that restrict the competitive functioning of markets. The latter case is pervasive in Mauritania as non-competitive practices including (often de facto rather than de jure) monopoly (single seller) or monopsony (single buyer) are widespread. Excluding oil, Mauritania’s FDI is still rather low, despite investments in the telecom and mining sectors, and ranks closer to Mali and Senegal than to countries like Tunisia, a level that certainly is within reach for Mauritania in the short term. This calls for simplification of bureaucratic requirements for investors and the implementation ofa clear regulatory framework.

145. The financial system of Mauritania is not yet in a position to promote high growth, owing largely to its lack of depth and the heavy concentration of banking sector activities (notably credit). The oligopolistic nature of the banking system, its deep links to commercial and industrial groups and high concentration ratios, pose an impediment to the development of new economic activities. The government has agreed to reduce the concentration ratios in commercial banks, both to reduce risk exposure and make credit more widely available to the private sector. But this task has proved more difficult to implement than expected, owing to the limited number of creditworthy borrowers and commercial banks’ linkages to major groups.

146. Domestic financial transactions remain largely cash-based. Cultural factors play a significant role in the relatively low use of banks for conventional banking functions. 60

Businesses and individuals rely a great deal on cash and the informal financial system known as “tontines”, and the availability of long-term credit remains scarce. Bank credit is very expensive, except for the very best creditors; it is heavily concentrated on parties affiliated with the banks; and it is made up largely of short-term credit. Intermediation margins appear very high, reflecting the oligopolistic structure of the banking sector, which encourages neither competition nor efficiency in banking services. A joint Fund/Bank FSAP took place in 2006 and the main conclusions and recommendations are presented in Box 6.

Box 6: Preliminary Findings of the FSAP Mission

Banks’ financial conditions f equity and profitability. Overall, this does not raise

only from 20 percent to 12.2 percent on average.

Stress testing has identified two main vulnerabilities. Credit Mauritanian banks’ main vulnerability. Banks are also highly sens lower rates having a large negative impact on their financial performance, because interest income

The FSAP mission found

Non-bank financial servic

147. In addition, empirical evidence shows that corruption significantly weakens the business and investment climate. Wei (2000) shows that higher corruption is associated with lower foreign direct investment (but higher foreign bank loans), which also makes corrupt 61 countries more vulnerable to future currency crises. A potential cause for corruption in many developing countries are heavy regulations and red tape, which pose an obstacle to efficiently conducting business. Corruption can also encourage “quick (and excessive) profit-taking in circumstances of unpredictability”, and may pose significant obstacles for new businesses to enter, thereby diminishing the potential for private-sector led growth (Pope 2000). Initial results from a recently completed Investment Climate Assessment (ICA) show that while corruption is only seen as a “severe” or “major” concern by less than a third of the respondents, the cost of corruption is, at 6.6 percent of annual turnover, quite high (Figures 12 below). This suggests that corruption is expensive but - to some extent - predictable, possibly being factored into business decisions.

Figure 12: Corruption as a Constraint (YOof Respondent) and Cost of Corruption (YOof Yearly Turnover Spent on Informal Payments)

-839 9 8.4 800 - , 8 700 - 61 2 7 6.6 600 - 6 5 .O 500 - 5 400 - 4 300 - 3 22 4 200 - 2 no - 1 0 00 T 2 E E L 4 m 3 : u Source: PrelmmryICA Results (World Bank 2006c)

5.2.2 Improving Public Sector Governance

148. Successfully implementing any strategy to improve development outcomes will also require Mauritania to substantially improve its governance framework. As noted earlier, recent research indicates that large natural resource revenues have typically had such a deleterious impact on institutions that their overall impact on growth is negative. “Point- source” natural resource revenues - e.g. oil, minerals-are found to have had a particularly negative impact. These findings are of particular relevance for Mauritania because: (i)of its prospective natural resource revenues (oil, gas and mining); and (ii)its governance setting remains weak.

149. Looking at the WBI governance indicators, Mauritania performs better in the five indicators than the sub-Saharan African average. But it ranks lower than regions such as North Africa and Middle East, and lags far behind the average for OECD countries. Despite recent progress, the authorities have not established a sufficiently long track-record (See Figure 13). In the short-term it is important to start where the country is, which can be assessed by answering the following questions: (i)What is the current situation with respect to the core governance agenda? (ii)What are the main barriers and weak points? (iii)What are the politically feasible reforms? Reform is as much a political as a technical exercise. (iv) How will the local context affect the approach taken? Table 17 provides some ideas. 62

150. Figure 13: Selected Governance Indicators for Mauritania (2004)

WAURITANIA <2004>

Voica and Rccountability

Political Stability

Government Effectiveness

Regulatory Quality

Rule of Law

Control of Corruption

25 58 75 18 Comparison with regional averaes (SubSaharan Rfrica) (louer bar) Country's Psrcsntils Rank (8-188)

Table 17: Governance Fundamentals - Based on Political Arena and Key Principles

Fairness Decency Accountability Transparency Society free Freedom of Respect for Freedom of the association from expression governing rules media making discrimination Political Society Legislature Policy reflects Peaceful Legislators Transparency of Legislative representative public competition accountable to political parties functions of society preference for political public affecting power policy Government Intra- Adequate Personal Security forces Government Best use of govemmental standard of security of subordinated to provides available consultation living citizens civilian accurate resources government information Bureaucracy Higher civil Equal access to Civil Civil servants Clear decision- Merit-based servants part of public services servants accountable for making process system of policy making respectful their actions recruitment towards citizens Economic Society Consultation Regulations Government Regulating Transparency in Interventions with private equally applied respects private sector economic free from sector property in the public policy corruption rights interest Judiciary Consultative Equal access to Human rights Judicial officers Clarity in Efficiency of process of justice for all incorporated held administering the judicial conflict citizens in national accountable justice system I resolutions practice Source: OD1 200

151. Countries that successfully managed their natural resources rents in Africa (Botswana, Namibia and South Africa) got three policies right. First, concepts of representative government and public accountability were deeply entrenched. In all cases, the independence ofthe judiciary and public service; the role ofthe auditor general's office; basic human rights; and freedom of speech and association were constitutionally enshrined. The rule of law and legislative processes were respected. Laws affecting taxation, labor relations and the granting ofmineral/oil concessions were transparent and fairly enforced. 63

152. Second, measures were put in place early on to strengthen the domestic institutional capabilities necessary to ensure that the public sector functioned efficiently. The included developing core governmental functions such as economic planning and public service management capabilities; budget system; effective tax, geological survey and mining departments; central statistical bureaus; and the ability to control, support and regulate natural resource development. A major factor in Botswana's success, for example, was the avoidance of disputes within the government through the centralization of responsibility for planning and coordinating national development, with the support of the President.

153. Third is the integrity of public polices. Central to those polices has been the commitment ofthe national leadership that the benefits from the utilization ofnon-renewable national resources should accrue to the entire nation, and for the benefit of future as well as current generations. There was a strong resolve not to dissipate mineral rents on non- productive activities or for purely short-term political purposes. Recognizing that large mining developments could result in dualistic economies, the governments of all three successful African countries took important steps to increase participation in, and distribute the benefits accruing from mineral development. While private operation of mines was encouraged on grounds of efficiency and to ensure access to adequate capital and modem mining technologies, ownership of the mineral resources was effectively brought under the control ofthe state through negotiation or by legislation.

5.2.3 Building Capacity in the Public Administration

154. There is no single policy or set of policies, which will permit Mauritania's natural resource endowment to be harnessed efficiently to generate sustained development. Without strenuous efforts to build institutional capacity in government, even the best policies are unlikely to be efficiently implemented. Public sector reform will have to play a central part in improving governance in Mauritania and in delivering upon any reform strategy. The public sector must be capable of designing and implementing appropriate policies and programs; raising adequate resources and allocating them to sensible priorities; and ensuring that those resources get translated into useful outputs that improve social and poverty outcomes. This requires a reasonably well functioning public administration at both the central and local levels.

155. The Government has agreed with the World Bank and other donors on a program to strengthen the public administration human resource management, through the implementation of a Public Sector Capacity Building Operation (PRECASP). Presently, the management ofthe administration's human resources is based on an outdated centralized and poorly adapted model. The civil service is also characterized by lack of transparency and lax controls for recruitment, structure, amount of remuneration, job description, status, and financing (national budget, project and local a~thorities)~'.The management ofremuneration as well as human resources is concentrated and disorganized, while computerized management systems are outdated and not operational.

156. The PRECASP supports improvement of Government human resource management (HRM) to reach two objectives. First, simplify civil service structure and management by

3' Entry points for anti-corruption measures here could be on the framework affecting civil servants' behavior, An ethics code, the declaration of personal assets for higher-level civil servants and other regulatory measures can play a role in strengthening good governance. 64 adopting and finally implementing reforms prepared since years: specific statutes, new salary scales and modernization of career management. Second, increase HR efficiency by creating reliable information on all Government employees (numbers, postings, jobs, positions, budget positions, compensation, and financing source) and by improving HRM computerized and institutional tools (see World Bank 2006a). It is of paramount importance that these reforms are implemented according to the agreed timetable.

5.3 DUALSECTOR RENTABSORPTION STRATEGY

5.3.1 Track 1: Boosting Income and Employment in Rural Areas

157. The primary sector contribution to economic growth has been not impressive in recent years and projections shows that it will continue to be marginal (Figure 14). However, combining estimates for increased crop and livestock potential suggests that the combined agricultural sector could provide the equivalent of 30 percent of current GDP that is double its 2004 level. Moreover, the multiplier from agricultural incomes will expand local demand for input supplies, boost demand for simple consumer goods and generate products for agro- processing and more sophisticated distribution. Scope for agro-processing is presently woefully under-exploited in Mauritania, with potential in canning, food drying, juice production, animal feed, dairy products, poultry, leather and poultry products for both domestic and export markets.

Figure 14: Sectoral Contribution to GDP Growth (1999-2007)

I 2o I 15

10

5

0

1999 2000 2001 2002 2003 2004 2005 2006 2007 Primary Sector -Secondary Sector 0 Tertiary Sector Total Real GDP growth rate Source: IMF 2006.

158. Evidence from a 2003/04 village labour market study shows that the degree of dynamism of local economies, in terms of activities, transactions, markets and infrastructure is crucial for the development of rural (village) labour markets. In particular, there is evidence of social and economic barriers to entry into various activities. For strategies aiming at expanding employment opportunities these barriers must be understood and creative measures can be devised to promote the expansion of labour supply and demand in local labour markets by tapping into existing entry barriers. The presence of large-scale agribusiness farms can help in the development of local rural labour markets directly and indirectly. Local private agents (farmers, transporters, etc.) show a significant labour hiring potential that may concern some ofthe poorest workers. 65

159. Measures to reduce the impact of seasonality on livelihoods and the promotion of infrastructural investments (roads, irrigation, electricity, ports) which facilitate access to currently isolated villages and areas have enormous significance, as they can directly affect the extent and nature of rural labour markets, the availability of job opportunities and the level of remuneration for the poorest individuals. This happens insofar as these investments attract more potential employers or facilitate services that contribute to the development of more profitable own-account activities. Moreover, these investments can also facilitate rural labour mobility and reduce the degree of labour market segmentation that is associated with transport constraints (GIN2006 EMRT).

A. Intensifying Cropping Activity

160. Agriculture continues to furnish the principal livelihood for half the population, mostly in the form ofherding and cropping, which are estimated to contribute approximately 12.4 percent and 2.8 percent of GDP, respectively in 2004.32In spite of the low productivity of the sector - the result from past neglect - agriculture offers good prospects for labor- intensive growth through the medium term, with substantial positive externalities and multiplier effects. The benefits are likely to manifest themselves in both new direct job creation in cropping and in boosting the productivity and commercial participation ofexisting farmers, principally within the potentially irrigable areas, so that their local expenditure creates indirect employment in the local provision of producer and consumer goods within the farming region.

161. A critical missing element in rural planning to date has been an appreciation of the fact that agricultural improvements should not be piece-meal but rather part of a coherent package. Irrigation, for instance, requires not only water and canals to function, but also rural roads to move inputs (seeds and fertilizer and pesticides) in and crops out to market in a timely fashion so that inputs are available when the crops require them and output can be marketed before it perishes. Irrigation also benefits from the provision of electricity, which can reduce by half the high cost of pumping water, boosting farmers’ margins while also providing strong positive externalities in terms of scope for evening study skills, access to information and household welfare generally. Poor transport infrastructure in the most promising agricultural areas add substantially to the cost of marketing, and so does the absence of official cold storage either at the transshipment points or at the airport. As such, the marketing possibilities inside the country, which are already limited because of low incomes and a sparse population, are further stymied and competitiveness undermined.

162. A number of projects will bring partial solutions to this situation: (i) surfacing the road from Rosso to Boghe to the East along the Senegal River; (ii).the installation of extensive cold storage facilities at the new airport and maybe in Rosso; and (iii).the electrification of the Senegal Valley using the new Manantali hydro station. Access to affordable credit is also important. Large farmers, associated with foreign direct investment or with solid financial backing form outside the sector, can do without access to expensive local credit. However, the smaller farmer cannot modernize his operations without access to reasonably priced credit. The shortage of affordable farm credit presents a major handicap to the development of the sector. In addition, it is necessary to resolve lingering land tenure

32 However, the distribution of employment share between herding and cropping is the reverse of the distribution of output; cropping accounts for two-thirds of farm employment. The value of herding output that is commercialized is estimated at 6 percent of GDP while for crops it falls to a mere 1 percent of GDP. 66 issues in the Senegal River Valley, which continue to cause tension between and within communities.33 The land tenure legislation might need to be reviewed to ensure that the legal framework is consistent with the practices on the ground and the capacity of the State to enact these provisions.

163. The scope for Mauritanian agricultural exports is good. Given that the domestic market remains small and purchasing power is low, the development of exports would greatly contribute to the potential for product diversification. Mauritania is the closest tropical country to the European market and consequently, substantial potential exists for it to supply Europe with fruits and fresh vegetables during the fall and winter seasons. Recent experiences in the production and exports of vegetables and fruit to Europe have shown real potential, and the export of melons, okra, sweet potatoes and green beans is promising.34For some commodities the prospects for biological farming, where prices are very firm, are also very good. Yet, the obstacles to volume production are substantial. Most farmers do not have the necessary technical production know how, appropriate seeds, the marketing skills and the access to credit to finance their operations to initiate this process. Only if all these conditions are fulfilled does the development of agricultural export stand a chance. The road to success is likely to involve the introduction oflarge farms or association with foreign groups.

164. This broad brush assessment of the growth potential of the cropping sector suggests that relative to current cropland output (estimated at 4 percent of GDP, with 1 percent attributed to irrigation undertaken at a low-productivity), production can be increased by several orders of magnitude, the ultimate scale depending upon water supplies and the efficiency of their allocation. More specifically, the extension of improved productivity to 30,000 hectares of irrigated land could triple the modest commercial contribution from the sub-sector to GDP (currently 1 percent); and if the irrigated area was extended four-fold by 2025, this could boost agricultural GDP to 12-15 percent in terms of current total GDP. A conservative estimate of the rural multiplier from down agro-processing and subsequent rounds of expenditure might lift the indirect and induced contribution to total GDP from a revitalized rural economy by a further 50 percent. When added to current livestock production this might raise agricultural output to the equivalent of 30 percent ofcurrent GDP. The rural multipliers would augment the impact still further.

B. Raising Commercial Returns to Livestock Herding

165. The livestock sector is also capable ofraising income. World Bank (2003) projection suggested that a two-thirds rise in herding sector value added can be achieved during 2000-

33 The 1983 legislation and its 1990 decrkt d’application abolished the traditional land ownership system and vested all rights of land ownership in the state, which would then grant ownership to those fulfilling several conditions, amongst which the most important are the actual exploitation of the land. After nearly ten years, the situation appears rather confused, as few properties have reached the stage of registration while land transfers, collective exploitation and rental agreements are frequent. Many potential owners do not go through the full procedure and the State appears unable to verify the conditions for regularizing the situation and in any event is slow in attributing the titles. In fact, a general state ofpermitted irregularities a pears to characterize the land tenure situation (World Bank 2001). 39 Several observers suggest prospects would be improved further if foreign firms, with links to leading EU outlets (basically, the main supermarket chains) contributed their logistical skills to those of local farmers, effectively creating an out-grower scheme of the type that proved so successful in Malaysia (Graham and Floering 1984). 67

20 15. This implies that output from herding could be raised to the equivalent of 18 percent of current GDP by 20 15. In 2000, the livestock was estimated to comprise 1.5 million cattle, 1.1 million camels, 5.1 million sheep and 3.4 million goats. The regional demand for Mauritania livestock exports appears strong, boding well for the expansion of regional exports if supported by adequate policies and investment. Exports of livestock and hides towards the sub regional markets is quite significant but are insufficiently reflected in the trade statistics in part because this activity is undertaken by the informal sector and is destined for neighboring countries such as Senegal and Cdte d’1v0ire~~

166. Exports of livestock are handicapped by; the quality of the animals available on the local market; the absence of timely and reliable information on prices and demand in the import countries; the lack of professionalism of the exporters, who operate mainly in the informal sector; and the many “informal taxes” traders must pay along their route. The export of hides is hindered by the absence of a local tannery or modem slaughtering processes combined with the poor conditions of the skins offered for sale. The scope of export of milk and milk products is limited due to low supply, and ongoing efforts to export camel milk and camel cheese are hurt by strict zoo-sanitary conditions prevailing on the EU market. In the short run, Mauritania should focus on the profitable regional trade, where it clearly has a comparative advantage, and where more modest investments could yield substantial returns.

167. World Bank (2001) points to several policy actions in support of better export performance by the livestock sector. First of all, it is necessary to improve the health condition of the livestock to underpin export growth. Secondly, there is the need to improve the information base of the sector and prepare and implement a comprehensive sector strategy. Capacity also needs to be strengthened, both at the ministerial level and amongst professional organizations. Further, the promotion of export of livestock on the hoof should be encouraged, as this method has shown the effectiveness of the informal sector, by promoting measures to reduce the commercialization costs (credit, infrastructure along traders’ routes). Finally, there is potential in boosting the production and export of side products of the livestock sector. Present exports of hides, for instance, are small and of low value added due to the absence ofprocessing facilities and the poor quality ofraw hides.

168. As with irrigated agriculture, improved rural transportation is required to speed shipment and lower the costs of access to markets, reduce spoilage and permit products to be efficiently processed, standardized and packaged. Moreover, the security of herding income can be improved with further integration of livestock and crop production. For example, stock that are producing milk or being fattened for slaughter might be grazed on the higher (and healthier) ran-fed river terraces in the Senegal Valley (leaving irrigated and flooded crop production on the lower levels), where the rangeland feed can be augmented with forage from the farms during the dry season, while the younger breeding stock is grazed further away on the drier rangelands.

35 About 30 percent of the national livestock production is exported: 7,149 tons of cattle, 5,058 tons of camels and 11,562 tons of sheep. This yields a total estimated at UM 9 billion, close to 3 percent of measured exports in 2000. Two thirds of the exported sheep and one third ofthe cattle exported is destined for Senegal, with the remainder of the cattle and sheep exported to Cote d’Ivoire. Camels are exported to Algeria and Morocco. Hides are largely exported to Senegal, Mali, Ghana and Morocco and are partly reflected in the exports ofthese countries. No livestock products are exported to the EU, where there would be no tariff restrictions, but where significant zoo-sanitary conditions would prevail. 68

5.3.2 Expanding Niche Tourism in Rural Centers

169. Tourism assets are substantial but need careful management because oftheir fragility. If carefully managed tourism can confer substantial economic benefits through the medium- term upon the local economies within which it occurs (OD1 2006). Moreover, its reliance on modest lodges and tents, as opposed to the large foreign-owned hotels associated with mass tourism, has the advantage of easing entry by local firms. Overall, tourism could expand to 100,000 visitors by 2015, which with a mean local expenditure per visitor of E400 implies a contribution equivalent to 8 percent of current GDP.36There is also scope to boost this basic contribution made by tourism further by attracting some higher margin tourists and by encouraging greater participation by local package holiday firms in marketing the sector to domestic and overseas tourists alike.

170. The main tourist season in Mauritania is during late-October to early-April with the principal attraction as the scenery, which is viewed by a mix of desert walks, camel rides and motoring. Two-thirds of the visitors include an excursion to the ancient oasis towns (dating from the 1lth to 13th century like the holy city of Chinguetti), which attract returning visitors in particular. Just under three-fifths of the trips by OECD visitors involve stays of one week and the rest last for two weeks. The number of OECD tourists expanded from 1,000 in 1996 to 12,000 during 2003-04 before dropping by around 20 percent in response to domestic political uncertainty. An additional 7,000 domestic and local regional tourists are also estimated to visit Mauritania each year. Further opportunity for expanding rural employment, boosting worker and business skills and building self-help social capital lies in the expansion of niche tourism, which has begun to develop around the oasis centre of Atar (population 26,000).

171. Four areas in Mauritania offer potential. In the centre of the country, Tagant boasts spectacular desert scenery and has similar growth potential to Atar, but it remains undeveloped. The same is true of Nema (currently 15,300 populations) in the southeast comer, which in addition to its scenic and historic attractions can link up with tour packages across the border in Mali's Timbuktu. A new airport is scheduled to open at Nema. Elsewhere, two national parks are located near the coast, namely Banc d'Arguin in the north, which combines within its 16,000-km2 scope both for observation of marine life and coastal scenery; and the inland Parc National Diawling with 16,000 ha in the extreme southwest of the country. They too have niche tourism potential according to the OTN (2005). While Mauritanian beaches are plentiful and unspoiled, they are no match for the beaches in neighboring countries (particularly Morocco and Tunisia) in terms of accessibility, entertainment facilities and infrastructure.

172. The sustainability of a well functioning tourism sector could benefit from (i)Giving high level support to the development of tourism, by drafting a strategy clearly spells out the

36 The typical vacation package in Atar now costs around E800 per week or E1300 per fortnight. Of this, the air fare absorbs E300. After deducting the costs ofcentral management, marketing, profit and taxes, one foreign company (SOMASERT) reported in 2001 an average local expenditure through the tour company of E240 per person per week, with perhaps a further 50 percent spent in the local area directly by the tourists (E360 total). Transport is the largest local tourist expenditure component, with vehicles absorbing 27.7 percent (including 2.3 percent fuel) and camels 17.4 percent. The accommodation takes 15 percent, plus salaries 10.4 percent, local purchases at cafes and on souvenirs 10.5 percent and miscellaneous (including taxes) around 18.5 percent. 69

government perceived priorities and orientation for the sector; (ii)Improving and multiply tourism destinations in the country. For instance, desert destinations could be expanded beyond Atar, where absorption capacity at 10,000 is close to levels presently attained. Moreover, coordinating efforts with the tourism services of Saint Louis-Senegal (with its renovated airport), could also promote tourism along the Senegal River; (iii)Training tourism personnel, beyond ad hoc schemes due to the recent development of the sector; (iv) Designing and implementing a marketing and communications campaign, to promote Mauritanian destinations abroad; and (v) Preserving the cultural and natural assets that sustain the tourism sector, which is crucial for the sustainable growth ofthe sector.

5.3.3 Encouraging Manufacturing Growth

173. The comparative advantage in manufacturing of a small low-income country like Mauritania might be expected to lie initially in agro-processing, fish processing, some mine- linked activity (such as metal fabrication and logistical supply) and a modest range of import substitution in products like beverages. Yet the distorted structure of the Mauritian economy (most notably the minimal commercialization of agriculture) stunts an important early market for basic household consumer goods and it also severely constrains opportunities for agro- processing. At the present, in the absence of more commercial farm production, the small size of the local domestic market limits the immediate potential for manufacturing growth in Mauritania. This adverse situation is compounded by the under-development of financial markets, unreliable infrastructure, lack of skilled workers, scarce industrial entrepreneurial experience and the proliferation ofrent-seeking activity like the import monopolies.

174. One negative consequence arising from the acceptance by government and the business elite oftrading monopolies is that they discriminate in favor ofimported goods. This prevents locally processed items that are domestically competitive from being sold. For instance, imported German dairy products flow through a segmented market that excludes local suppliers from the distribution channel, even when the domestic product has lower costs (and, of course, a lower margin on domestic sales). If the leading importer of dairy products were to allocate a share of sales to a local producer, he claims his overseas supplier would withdraw his contract and award it elsewhere. These conditions exacerbate the problems of new domestic entrants, an outcome that government does nothing to ameliorate by, in effect imposing an off-budget 4 percent turn-over tax (irrespective of profitability). Such a tactic is indicative ofthe Mauritanian government’s weak grasp ofbusiness efficiency.

175. The neglect of agriculture has combined with the various impediments to the expansion of SMEs to cause the economy of Mauritania to skip a significant stage in the expected pattern of its development. During the omitted stage, the expanding output of the non-mining primary sector (agriculture and fishing) would stimulate domestic manufacturing. What ago-processing there has developed had been forced to struggle. Currently the domestic dairy sector has two plants with a combined annual capacity of 50,000 tons, but they also struggle with low plant utilization due to the control of domestic sales by import monopolies and also to non-tariff restrictions on the entry of goods into the EU. Similarly, with regard to fish processing, some sixty operations are located along the coast between Nouakchott and Nouadhibou but they function at cost-boosting low levels of capacity utilization (30 percent) because of limited local landings. Most processing occurs on foreign vessels. The local processing plants also suffer from poor access to credit, with loans typically available at interest rates above 20 percent. 70

176. Nor have efforts at privatization met with much success in Mauritania with the notable exception of telecoms, which attracted Tunisian and Moroccan investment. The subsequent improvements in the domestic telephone service contrast with the continuing under-performance of electricity and water, which failed to entice bidders. State ownership created monopolies with relatively high charges (20-60 percent above regional levels with regard to water for example). Power is generated from thermal stations with a connection to the 200 MW Manantali hydro-electric plant but supply is intermittent so that larger firms invest in in-house sources whose small scale pushes up unit costs. In addition, the high costs of water supply might be ameliorated by, for example, tapping ground water reservoirs that are believed to contain substantial reserves. In the meantime, the inadequacy ofbasic services in the capital city let alone the rural areas deters long-term investment and favors trade.

177. One ofthe priorities is to update the Industrial Sector Strategy in Mauritania, which is currently being revised. In particular, attention needs to be paid to important sub-sectors such as the by-products of livestock, horticulture, milk, and so on (see above). At the same time, cross-cutting reforms to improve the business climate, discussed above, are also important to create a favorable environment for the development of enterprises. A start can be made in providing business areas that offer reliable infrastructure, efficiency incentives and enabling public services within early reform zones (ERZ). The road from Boghe to Nouakchott is the logical place to start, so that competitive manufacturing can get a flying start once the revival of the primary sector gets The establishment of an industrial park adjacent to Nouakchott could bring the ERZ to the capital city.

5.3.4 Boost the Emergence of a National Fisheries Industry

178. The fisheries sector contributes substantially to Mauritania’s budget and foreign exchange receipts, but its role could be further enhanced. Key sector constraints for the development of a national fishing industry include limited infrastructure, a lack of effective private sector financing, limited human capital, and weak institutional and administrative framework. Before the arrival of oil, the fishing sector in Mauritania generates over 30 percent of the public budget (fishing royalties and penalties only), more than 40 percent of export proceeds or $150 million in 2000 and about 5-6 percent of GDP. Over. 90 percent of the fish caught in Mauritanian waters is exported and the activity of foreign vessels dominates the sector (World Bank 2001). Fisheries employ between 30 and 35.000 people, contributing to around 36 percent of total modem sector employment. Industrial and artisanal fishing employ around 4,000 and 1 1,000 workers respectively. In addition, around 18,000 people are employed on land (GIRM 2006b).

179. Foreign interests play a dominant role in the sector. The recently concluded 6-year fisheries agreement with the EC highlights the importance of this foreign role. The new fishing agreement will yield an annual revenue of €108 over six years, or nearly twice what had been projected for the proceeds from the sale of fishing licenses in 2006. Of this annual amount, €86 million will be disbursed from the EC budget (the first annual contribution is

37 The country’s road network comprised in 2002 only 2,165 km of paved road, 776 km of improved dirt roads and 7,361 km of trails (World Bank 2003, 55). Until recently there was no paved road to link Nouakchott with Nouadhibou and Rosso, while the Rooso-Boghe road was being paved in 2005. Yet in the absence of paved roads, passage becomes difficult if not impossible during the rainy season and tardy at other times. 71 expected to be disbursed by end-2006) and €22 directly by the EC fishing companies. The amount ofcompensation stipulated in the agreement is subject to negotiation every two years. Fishing ceilings for the species that of particular concern for the domestic fishing industry have been lowered compared with previous agreements.

180. The Government just produced an updated Strategy for the Development of Fisheries and the Maritime Economy (See GIRM 2006b). The challenge in the future will be to improve the competitiveness of Mauritania’s fisheries sector, while enhancing the country’s ability to better manage the sector and its resources. In particular, there is need to: (i) Maintain the level of fishing at sustainable levels; (ii)Gradually increase the share of catches caught by locally owned or chartered vessels, and support those catching and processing technologies that optimize local value added; (iii)Improve the enabling framework ofpublic policies, regulations, taxes and private credit; (VIImprove the performance of key public and private institutions, and (vi) provide essential infrastructure at reasonable cost.

18 1, If Mauritania is to increase its share oftotal catches and its share ofvalue added, then the problems posed by the coexistence of a mostly old and obsolete local industrial fishing fleet with foreign fleets that include some ofthe largest and most sophisticated vessels in the world needs to be addressed. A development strategy to tackle these issues and review the practical feasibility of developing local production should be prepared jointly by the public and the private sector - in both fishing and processing. Current port and transport facilities for industrial and artisanal fisheries are inadequate. In line with the objectives to require local and foreign vessels to trans-ship their catch near Nouadhibou, to eventually build a fishing port in Nouakchott, to modernize the Mauritanian fleet, and to develop artisanal fishing port, preparing a Fisheries Development Implementation Program would generate substantial benefits.

5.3.5 Track 2: Reforming the Rent-Driven Urban Sector

182. The prolonged dependence of many urban Mauritanians upon rent distribution rather than wealth creation, and the associated neglect of the rural economy, caused the development trajectory to omit an important stage during which an expanding section of the population acquires the assets and skills to exploit a dynamic market economy through specialization to raise their productivity. Rural-urban migration has out-stripped the capacity of the cities to provide unsubsidized livelihoods and accommodation. The Mauritanian government should resist the temptation to apply the oil revenue to further subsidize urban employment. Gelb et al. (1991) show that in Zambia that such a strategy is self-defeating as it accelerates rural-urban migration while, consistent with the staple trap model, depressing the economy-wide efficiency ofcapital to growth-eliminating levels within just a few years.

183. Nor can Mauritania leap-frog the omitted development stages to emulate the capital- surplus Persian Gulf oil exporters and become a sophisticated service economy. The Gulf States had much higher per capita endowments of oil with which to sustain investment for three decades at the levels needed to build the infrastructure and skills that a modem economy requires. Neither does the remoteness of Mauritania from global and regional markets support such a strategy, so the country lacks a comparative advantage in specialized high-order services like banking. However, a dual track strategy offers a sustainable solution to the problem of rent-driven over-urbanization, with the urban track calling for incremental reform towards competitive markets for manufacturing and services. 72

184. As the first step in the incremental reform of the urban economy, some of the oil revenue could be used to establish an urban ERZ within a geographically defined area within which post-reform conditions would immediately apply, comprising excellent infrastructure, unsubsidized incentives for efficient investment by domestic and foreign agents and enabling institutions. The urban ERZ should not be confused with either growth poles or export processing zones, although it shares some attributes. The greatest risk to the ERZ (and growth poles) comes from policy capture by rent-seeking interests, which at best raises costs and deters investment and at worst undoes the strategy entirely. Consequently, its management might secure appropriate autonomy by being run by a reputable commercial firm. A further objective of the ERZ is to establish a coalition of local and external agents with an interest in the success of the ERZ and ring-fence it from predation. The urban ERZ will also provide a demonstration effect that has the potential to diffuse the dynamic sector beyond the original location, acting as a catalyst for reform of the urban economy, as both Malaysia and Mauritius demonstrate.

185. Gradual reform is required to shrink the scale of rent-seeking activity in the urban economy. Most urban workers support themselves through the extended family and petty trade, induced largely by the first round expenditure of public revenue, and external trade, which in turn draw upon rent from fisheries and aid. The urban economy is vulnerable to capricious donors and volatile fish stocks whereas the rural economy can fall back on subsistence. In these circumstances, social tension will inevitably intensify if the over-rapid absorption of oil revenue triggers Dutch disease effects and shrinks employment in competitive economic activity. The application of oil rent to expand a competitive rural economy (track one) will, however, diversify the total capital stock, boost incomes in poverty-stricken areas, retard rural-urban migration and support the emergence of a resilient urban economy (track two) as incremental reform diffuses competitive markets for manufacturing and services and diminishes rent-seeking activity.

5.4 MAINCONCLUSIONS AND RECOMMENDATIONS

186. Rent-driven political economy models suggest that high rent triggers contests for its capture that deflect government effort into recycling rent at the expense of promoting efficient wealth creation. If unreformed, investment efficiency declines and growth collapses, but rent-seeking interests will lose from reform so they oppose it. Unfortunately, Mauritania’s projected brief oil boom may harm the country’s long-term development because the economy’s capacity to use the oil rent effectively has already been severely weakened by past rent-driven growth, which has left a legacy of rent-seeking, dependent social capital and Dutch disease effects.

187. The implementation ofpolicies required to make effective use of the oil rent requires a political strategy to manage pressure for over-rapid absorption. This CEM argues that successful oil-rich countries have used a dual track strategy to achieve this objective. In the context of Mauritania, such a strategy would deploy some oil rent to stimulate a dynamic market economy in the hitherto neglected rural areas while the rent-driven urban economy is reformed more gradually, commencing with an urban ERZ. In effect, the rural area becomes an early reform zone and its development avoids expanding the numbers dependent upon rent-seeking for their livelihoods by helping to competitively diversify the economy, absorb surplus labor, diffuse human and financial capital and reduce poverty. 73

188. The dual track strategy also defuses political conflict by postponing confrontation with urban rent-seekers because it steadily shrinks the rent-driven economy relative to the market economy and reforms monopolistic practices gradually. Meanwhile, the strategy builds a pro-reform political coalition in the expanding market sector while the ERZ offers the elite a means of accumulating wealth without being beholden to political whim. In this way the market sector can eventually neutralize rent-seeking interests without creating conspicuous losers, providing a socially beneficial and therefore more sustainable way for both rich and poor to prosper. The following policy priorities emerge:

Intensify cropping activity and raising commercial returns to livestock herding. Increased crop and livestock potential suggests that the combined agricultural sector could provide the equivalent of 30 percent of current GDP that is double its 2004 level. Expand niche tourism in rural centers. Overall, tourism could expand to 100,000 visitors by 2015, which with a mean local expenditure per visitor of E400 implies a contribution equivalent to 8 percent ofcurrent GDP. Encourage manufacturing growth, by improving the overall business climate and providing business areas that offer reliable infrastmcture, efficiency incentives and enabling public services within early reform zones (ERZ). Boost the rise of a national fisheries industry, by establishing an attractive investment climate underpinned by sound, equitable and transparent sector governance as a basis for strategic public and private investments and the gradual transfer ofthe current offshore fishery economy to a sustainable onshore economy. Reform the rent-driven urban sector, by implementing gradual reform is required to shrink the scale of rent-seeking activity in the urban economy, and establishing an ERZ within a geographically defined area. 74

ANNEX 1: EXPLAINING DUTCH DISEASE EFFECTS

Spending Effect. As a result of a natural export boom, there will be a rise in real income. The increased real income will raise spending on both tradables and non-tradables through the income effect, in the form of government expenditures and private spending, thereby stimulating the demand for both goods (provided that these are both normal goods). However, since the prices of tradables are determined on the world market, the higher domestic demand does not push up the prices of tradables. Any excess demand for tradables is met by an increased volume of imports. The domestic prices of non-tradables, in contrast, will rise in response to the higher demand, provided that there is no corresponding expansion in the domestic supply of non-tradables. Accordingly, there is a decline in the prices of tradables relative to the prices ofnon-tradables, which by definition is real appreciation ofthe home currency. The extent of the real appreciation depends on the extent to which the prices of non-tradables rise relative to prices in tradables, namely on the marginal propensity to spend on non-tradables. This is the spending effect of increased real income. (NB. The (bilateral) real exchange rate of the home currency against the foreign currency, BRER, can be expressed as BRE4E eer/eNr’where e is the fixed nominal exchange rate of the home currency, 8’ the prices of tradables and ‘tNr the prices ofnon-tradables. The real exchange rate is merely the relative prices of tradables to non-tradables. A decline in BRER indicates real appreciation of the home currency, and a loss of profitability by producing tradables relative to producing non-tradables.

Resource Movement Effect. Second, the real exchange appreciation will induce a consequent shift of resources from non-booming tradables to non-tradables, by reducing incentives for production and investment in the non-booming tradable sector. With real appreciation of the home currency, the prices of tradables competing with imports in the domestic market as well as the prices of tradables sold in the competitive world market will tend to fall. As a result of the relative price change (real appreciation), incentives for production and investment in the non-booming tradable sector will likely decline in favor of the non-tradable sector. The growth rate of exports in the non-booming tradable sector will therefore slow, while the volume of imports will increase. Correspondingly, there will be a shift of labor and capital away from the non-booming tradables in favor of non-tradables, which will raise the real wage and lower the returns to capital accumulation. Wage rigidities may give rise to unemployment and productivity will decline in the non-booming tradable sector. Real appreciation may also reduce the rents of the booming sector provided that the booming sector participates in domestic factor markets, but it may not be sufficient to bring down the booming sector’s output. When the booming sector operates as an enclave sector, there will be no resource movement out of the booming sector. In summary, real appreciation driven by a natural resource export boom tends to slow down the rate of growth of the non- booming tradable sector relative to the rate of growth in the non-tradable sector, worsening the trade balance.

Export Boom and Monetary Effects. Natural resource export booms are also likely to have an important monetary effect through net reserve accumulation (under a fixed exchange regime) or nominal appreciation of the home currency (under a floating exchange rate regime). Under a fixed exchange rate regime, the increased price of the booming natural resource will tend to raise the supply of money by generating a balance of payments surplus 75 and a net accumulation of international reserves or capital outflows. Unless the increase in international reserves is fully sterilized, the real money supply could increase beyond the demand for money, generating short-term monetary disequilibrium. Inflation will tend to result in further real appreciation of the home currency, exacerbating the Dutch condition. Under a floating exchange rate regime, nominal appreciation of the home currency leads to real appreciation, without reserve accumulation and with partial sterilization. This monetary channel, however, would operate only in the short-run, affecting the dynamics of the real exchange rate, In the long-run real exchange rates respond only to changes in the real fundamentals.

Figure 15: Understanding the Effects of Dutch Disease

Natural resource export boom

Real Sector Monetary Sector ,______-_------______...... Increase inrealI income Current accountI surplus BOP surplus

:Con$dence eflecf Income exect j Fixed+ Floating i ex.rate regime ex.rate regime i Spending on!Ibothtradables & non-tradables increase J 1 j Reserve accumulation Nominal appreciaen : +ending eflect

Relative price Iof tiadables to \ non-tradables declines

/ Real appreciation I (Relative price changes) 1 Reduces incentives for production& investment in tradable sector 1 Resource movemenf Wect Resources move out oftradable to non-tradable sector 1 I Dutch disease (Dutch condition) 76

ANNEX 2: POLITICAL ECONOMY CLASSIFICATION OF OIL EXPORTERS

Political Features Institutional Implications Economic Implications Mature Democracy: Stable party system. Long policy horizon. Savings likely. Range of social consensus Policy stability, transparency. Expenditure smoothing, Strong, competent, insulated High competitiveness, low Stabilization. bureaucracy transaction cost Rents partially transferred to Competent, professional Strong privateitraded public through government- judicial system. Sector, pro-stabilization provided social services and Highly educated electorate interests vis-a-vis insurance or direct transfers Pro-spending interests.

Factional Democracy: Government and parties often Short policy horizon. Savings very difficult. unstable relative to interest Policy instability, Pro-cyclical expenditure; groups. Non-transparency. instability. Political support gained Strong state role in production, Rents transferred to different through clientelistic ties high transactions costs. interests and to public and provision of patronage. Strong interests attached through subsidies, policy Wide social disparities, lack directly to state expenditures; distortions, and public of consensus. Politically weak private employment Politicized bureaucracy and non-oil sector pro- judicial system stabilization interests.

Paternalistic Autocracy: Stable government; legitimacy Long policy horizon. Pro-cyclical expenditure mixed originally from traditional Policy stability, success with stabilization. role, maintained through non-transparency. Risk of unsustainable long-term rent distribution. Low competitiveness, high spending trajectory leading to Strong, cultural elements of transaction costs. political crisis. consensus, clientelistic and Strong state role in production. Little economic diversification. nationalistic patterns. Strong interests attached Bureaucracy provides both directly to state expenditures; services and public weak private sector. employment.

Reformist Autocracy: Stable government, Long policy horizon. Expenditure smoothing, legitimized by military force Policy stability, stabilization. Social range of consensus non-transparency. State investment toward development Drive for competitiveness, complementary to competitive Constituency in non-oil low transactions costs. private sector. traded sectors. Strong constituency for Active exchange rate Insulated technocracy. stabilization and fiscal management to limit Dutch restraint. disease.

Predatory Autocracy: Unstable government, Short policy horizon. No savings. Legitimized by military force Policy instability, Highly procyclical expenditure. of ams. nontransparency. Very high government Lack of consensus-building Low competitiveness, high consumption, rent absorption Mechanisms. Transactions costs. by corruption elites through Bureaucracy exists Strong spending interests petty and patronage, mechanism of rent capture vis-a-vis private sector or capital flight. and distribution; corrupt pro-stabilization interests. iudicial svstem. Little or no civic counterweight Source: Eifert et al., 2003. 77

ANNEX 3: FIELD’S COSTS AND FISCAL REGIME

Exploration and Development Costs

The exploration expenditures for the discovery of Chinguetti, Tiof and surrounding small fields are estimated at US$360 million. Including the additional field of the more optimistic production case, the exploration investments total US$420 million. Over all the life of the project the capital investments for the development and the abandonment ofthe fields for the base production case total US$2,350 million whereas for the high production case the capital investments are estimated to a total of US$3,465 million. Adding exploration and development, the capital investments for the base case would approximately be of US$2.7 billion; whereas for the high production case the total capital expenditure (CAPEX) would approach US$4 billion (See Table 18).

Table 18: Development and Exploration Costs: Base and High Case Scenarios

Source: Authors’ own calculations based on information from Mauritanian authorities and Woodside, 2006.

The contractors have assumed all the exploration costs. In case of a discovery, the government has the option to take a participation in the production venture. In the first contracts the initial participation is 12 percent; a percentage that increases to 16 percent when production reaches 75,000 barrels per day. In other more recent contracts the government has been searching to increase this percentage to 25 percent. To exercise this right the government has to reimburse the contractor the exploration costs until the discovery well with a mark up of 50 percent. After, during the confirmation of the discovery and the development phase, the government reimburses only its share. To increase its participation share when production reaches 75,000 barrels per day, the government for the additional percent points will have to pay its corresponding share in the operating expenses (OPEX) and of the remaining development capital expenses (CAPEX), excluding financial costs and bonuses. Also, according to the PSA the government participation could be bought back with the government’s share in the profit oil.

The operating costs are estimated as a function ofthe number ofwells and the water depth at which operations are taken place. A major component of the operating costs will be the leasing of the floating production, storage and offloading (FPSO) vessel. The unitary operating cost - excluding the FPSO - will range from 7 to 12US$/bbl.

Fiscal Regime

The existing contracts have been signed with the Ministry of Mines (MMI). However, Mauritania has recently created a Ministry of Energy and Petroleum (MEP) and has 78

established a national oil company “Societe Mauritanienne des Hydrocarbures” (SMH) which will be responsible for monitoring the sector and for exercising the government participation rights (see Chapter 3). The main contractual features of the PSAs of Mauritania are the following:

During the exploration phase, there is: (i)Signature bonus, typically between US$lOO,OOO to 250,000 for a license; (ii)Area rental, of US$0.5/ square km during the first 2-3 years of the exploration phase, increasing to US$1/ square km for the next 2-3 years, and then during the third extension of the exploration phase the area rental becomes US$2/ per square km; and (iii)Training Fees, estimated between US$30,000 to 300,000 per year.

During the development phase, the area rental increased to US$170 per square km per year. These rentals are considered as part ofthe cost recovery oil, as production expenditures.

Once production starts, the following are the main fiscal terms: (i)Production Bonuses are paid as production hits a certain threshold for a period longer than one month. Production thresholds above 25,000, 50,000 and 75,000 bbl per day yields respective bonuses of 3,4 and 7US$ m; (ii)Cost recovery is limited to 60 percent of the gross value of production. The CAPEX and OPEX are discounted together from the cost oil; the non-recovered expenses do not benefit of any interest rate. The non-used cost oil becomes a part of the profit oil; (iii) The shares of the profit oil are a function of the production level. Each PSA includes a negotiated table for the split of the profit oil. Table 21 presents an indication of the split negotiated for the first offshore PSAs:

k In the shallow water areas (less than 300 meters) up to 50 percent of production can be channeled towards cost recovery, the remaining ‘profit’ oil is then shared with the government; the contractor is entitled to retain 50-60 percent of the profit oil depending on the level of production. The contractor’s net profits are subjected to direct tax of 40percent; it is also committed to pay a series of relatively small production bonuses ($7 million). 9 In the deepwater areas (more than 300 meters) up to 60 percent ofproduction can be channeled towards cost recovery, the remaining ‘profit’ oil is then shared with the government; the contractor is entitled to retain 50-70percent of the profit oil depending on the level of production. The contractor’s net profits are subject to a direct tax of 25 percent; it is also committed to pay a series of production bonuses ($12-1 5 million).

Table 19: Production Sharing Agreement

Production (b/d) Government % Contractor %

< 25,000 30 70 25,000 - 75,000 35 65 75,000 - 100,000 40 60 > 100.000 50 50 Source: Authors’ own calculations based on information from GIRM and Woodside, 2006. 79

k In the case of gas up to 60 percent of production can be channeled towards cost recovery, and the remaining ‘profit’ gas is shared with the government. The contractor is entitled to retain 50-70 percent of the profit gas depending on the level of production. The contractor’s net profits are subject to a direct tax of 25 percent; it is also committed to pay a series ofproduction bonuses.

Income taxes are charged on the bases of the declaration of benefits made by the individual companies at a rate of 25 percent. Depreciation of assets is linear in 5 years. For modeling purposes, it is assumed that the consortium operating a block pays income taxes without any other taxable activity in the country.

In the case of the Chinguetti field and of the adjacent fields as Tevet and Labedna, the government and the operator have entered into a negotiation that is expected to terminate with an improvement ofthe government take based on the following agreed conditions:

(i) a one-time bonus ofUSD.100 million, (ii) the percentage ofproduction dedicated to cost recovery (Cost Oil) will be only 50 percent as long as FOB prices obtained for the Chinguetti crude are 55US$/bbl or higher; if prices drop below 55US$/bbl the cost oil would become again equal to 60 percent, the same percentage as the one to be applied for the Tiof field and other fields under any price condition. To calculate the FOB price of the Chinguetti crude, the first cargoes have shown in average a differential of SUS$/bbl vis-a-vis the price of a basket of reference crude oils - Brent, Dubai, WTI - used by the IMF in its reference price. (iii) Un additional profit oil - If the FOB price obtained for the Chinguetti crude oil is higher than 55US/bbl, the government will receive a new stream of revenues equivalent to 5 percent of the additional profit oil calculated as the difference between the profit oil with the bottom price of 55UShbl and the profit oil estimated with the actual price. 80

ANNEX 4: SOCIAL INDICATORS AND MDGS/PRSP TARGETS

Table 20: Social Indicators and MDGSPRSP Targets

Main MDGs 81

ANNEX 5: MAPS OF OIL AND MINING FIELDS

Table 21: Mauritania Oil Blocks: Shares and Operators PSA Area Block 1 Block 2 A/1 Block5/2 Block6 Block7 Block8

Hardman 18.0 28.8 24.3 21.6 22.4 16.2 18.0 Woodside 0.0 41.7 53.8 53.8 37.6 15.0 38.5 Petronas 0.0 0.0 0.00 0.0 35.0 0.0 0.0 BG Group 0.0 0.0 13.1 11.6 0.0 0.0 0.0 Fusion Premier 0.0 0.0 4.6 9.2 0.0 0.0 0.0 Dana 60.0 6.2 0.0 0.0 0.0 63.8 41.5 Energy Africa 20.0 20.0 0.0 0.0 0.0 0.0 0.0 ROC 2.0 3.2 4.2 3.7 5.0 4.9 2.0

Woodsid Woodsid Operator Dana e Woodside Woodside e Dana Dana 1/ Block 3 and shallow water blacks 4 & 5 21 Deepwater blocks 4 & 5 Source: http:liwww.hdr.coiiI, 2006.

Map 1. Mauritania Off-Shore Oil Fields 82

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