Bolivia - Reconstruction Import and Financial Sector Adjustment Credit Projects

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 14754 PERFORMANCE AUDIT REPORT BOLIVIA RECONSTRUCTION IMPORT CREDITS (CREDITS 1703-BO AND 1828-BO) AND FINANCIAL SECTOR ADJUSTMENT CREDIT (CREDIT 1925-B0) JUNE 30, 1995 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties, Its contents may not otherwise be disclosed without World Bank authorization. Currency Equivalents (annual average) 1987 US$1 = Bs 2.05 1988 US$1 = Bs 2.35 1989 US$1 = Bs 2.69 1990 US$1 = Bs 3.17 1991 US$1 = Bs 3.98 1992 US$1 = Bs 3.90 1993 US$1 = Bs 4.27 1994 US$1 = Bs 4.62 Abbreviations and Acronyms BAB - Banco Agricola de Bolivia BAMIN - Banco Minero - Bolivian Mining Bank BAMIN - Banco Minero BANEST - Banco del Estado BCB - Banco Central de Bolivia CB - Central Bank of Bolivia COMIBOL - Corporation Minera de Bolivia CPCD - Currency and Publication Credit Division CPI - Consumer Price Index DCD - Development Credit Division ENDE - Bolivian Power Company - Empresa Nacional de Energia Electrica ENFE - Empresa Nacional de Ferocarriles, National Railway Company ESAF - IMF Enhanced Structural Adjustment Facility FSAC - Financial Sector Adjustment Credit GD - Gerencia de Desarrollo (Development Credit Department - Central Bank) GDP - Gross Domestic Product GSF - Gerencial Principal del Sistema Financiero (Financial System Department - Central Bank) IBRD - International Bank of Reconstruction and Development ICB - International Competitive Bidding IDA - International Development Association IDB - Inter-American Development Bank IMF - International monetary Fund LDP - Letter of Development Policy LIBOR - London Interbank Offering Rate NEP - New Economic Policy OECF - Overseas Economic Cooperation Fund OECF - The Overseas Economic Cooperative Fund (Japan) PFMO - Public Financial Management Operation PPF - Project Preparation Facility RIC - Reconstruction Import Credit SAC - Structural Adjustment Credit SAFCO - Financial Administration and Control System SBEF - Superintendency of Banks and Financial Entities SDR - Special Drawing Rights SOE - Statement of Expenditures UNDP - United Nations Development Programme YPFB - Yacimientos Petroliferos Fiscales Bolivianos, Bolivian Petroleum Company FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation June 30, 1995 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Perrormance Audit Report on Bolivia: Reconstruction Import Credits I (Credit 1703-BO) and II (Credit 1828-BO) Financial Sector Adjustment Credit (Credit 1925-BO) Attached is the Performance Audit Report (PAR) for the Bolivia First Reconstruction Import Credit I-RIC I-(Credit 1703-BO), approved in FY86, the Second Reconstruction Import Credit-RIC II-(Credit 1828-BO), approved in FY87, and the Financial Sector Adjustment Credit (FSAC) (Credit 1925-BO), approved in FY88, prepared by the Operations Evaluation Department. The primary objective of these credits was to support the economic stabilization and structural reform program initiated by the Government in August 1985. RICs I and II provided quick- disbursing finance for priority imported equipment, spare parts and other inputs needed to reactivate tin, gas, and oil exports and production; FSAC aimed at: (i) strengthening the financial condition of private and public banks; (ii) increasing financial resource mobilization; and (iii) reducing the high cost of credit. RICs I and II played a useful role in catalyzing major external financial support for the program. The policies supported were highly successful in stabilizing the economy and generating private sector growth. Disbursements, however, proceeded more slowly than anticipated, hampered by Bolivia's limited absorptive capacity, cumbersome procurement procedures, inefficient public enterprises, and small private sector. Allocation of the credits mainly to public enterprises, reduced the effectiveness of these operations. Given their support to the success of Bolivia's adjustment program, the outcome of RICs I and II is rated as satisfactory and sustainability as likely. Institutional development is rated as modest. Financial reforms supported by the FSAC began before loan approval and played a critical role in forestalling a banking sector crisis during the latter half of the 1980s and early 1990s. An independent Superintendency of Banking was established and functioned effectively; the Central Bank took decisive measures to audit all commercial banks and close three that proved financially inviable; prudential regulations and bank capitalization standards were significantly tightened; and interest rates and credit controls were abolished. The volume of commercial bank deposits has increased twenty-fold in real terms and credit to the private sector has increased to historically record levels since 1990. Among its minor shortcomings, FSAC was unsuccessful in restructuring three insolvent state-owned banks and in strengthening the Central Bank's capacity to deal with problem banks. But since the closing of FSAC, the Government, supported by a follow-on Bank Structural Adjustment Credit, has closed all three public banks and has proposed a new charter for the Central Bank which could strengthen its capacity to oversee the banking system. Given its considerable achievements, FSAC's outcome is rated as satisfactory, its institutional development as substantial, and its sustainability as likely. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Contents Performance Audit Report FOR OFFICIAL USE ONLY Preface ........................................................ 5 Basic Data Sheet ................................................. 7 Evaluation Summary .............................................. 19 Introduction and Background ....................................... 27 RICs I and II: Objectives and Results ................................. 29 The New Economic Program (NEP) and Bank Support .............. 29 Objectives and Design ....................................... 30 Implementation ............................................ 31 Borrower/Implementing Agency Performance ...................... 33 Co-financing .............................................. 34 Outcome ................................................. 35 Public Enterprise Performance .............................. 36 Social Impact of Adjustment ............................... 37 Recent Trends .......................................... 38 The Financial Sector Adjustment Loan: Objectives and Results ............. 39 The Banking Crisis ......................................... 39 The Reactivation Decree of 1987 ............................... 39 FSAC Design and Related Operations ........................... 40 Implementation Experience ................................... 40 Outcome ................................................. 41 Conclusions, Ratings and Lessons of Experience ......................... 43 RIC R atings .............................................. 43 FSAC Ratings ............................................. 44 Lessons .................................................. 46 Annexes I Inflation Rate ............................................. 49 II Real GDP Growth .......................................... 50 III Fiscal Balance as a Percentage of GDP .......................... 51 IV External Balance & Capital Inflows ............................. 52 V Real Interest Rates .......................................... 53 VI Nominal Interest Rates ...................................... 54 VII Government Comments ....................................... 55 This report was prepared by John H. Johnson (Task Manager) and Juan L Reus (Consultant) who audited the project in January 1995. Eneshi Irene K. Davis provided administrative support. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. 2 Project Completion Reports Reconstruction Import Credits (Credits 1703-BO and 1828-BO) .... 57 Preface .......................................................... 59 Evaluation Summary.............................................. 61 Part I. Project Review from Bank's Perspective ......................... 65 A. Project Identity ............................................ 65 B. Background ............................................... 65 C. Project Objectives and Description ............................. . . 66 D. Project Design and Organization ............................... 68 E. Project Implementation ...................................... 69 F. Project Results ............................................ 71 G. Project Sustainability ........................................ 73 H. Bank Performance .......................................... 73 I. Borrower Performance ...................................... 74 J. Bank-Borrower Relationship .................................. 75 K. Consulting Services ......................................... 75 L. Project Documentation and Data ............................... 76 M . Lessons Learned ........................................... 76 Part II. Project Review from Borrower's Perspective ..................... 79 Part HI. Statistical Information ..................................... 83 Financial Sector Adjustment Credit (Credit 1925-BO) ............. 87 Preface ........................................................ 89 Evaluation Summary .............................................. 91 Part I: IDA's Assessment ........................................... 97 I. Introduction .............................................. 97 H. The Financial Sector Adjustment Program and its Justification . 99 III. Implementation of the Financial Sector Reform Program and Macroeconomic Performance ................................ 99 Macroeconomic Framework ............................... 99 Institutional Strengthening ................................ 101 Improving Banking Regulations and Accounting Practices ......... 102 Maintaining Market-Determined Interest Rates ................. 103 Reducing the High Cost of Credit - The Central Bank Refinancing Line ................................................ 106 External Audit of Banks by Qualified Auditors .................. 107 3 Establishing Adequate Mechanisms to Manage Problem Banks ..... 107 Restructuring of the Banco Minero, Banco Agricola and Banco del Estado ....................................... 109 Strengthening the Central Bank ............................. 111 Resolution of the Dedollarization Issue ....................... 112 Remuneration of Reserve Requirements ...................... 113 IV. Evaluation of the Technical Assistance Program ................... .. 113 V. Role of IDA .............................................. 114 VI. Lessons Learned ........................................... 115 VII. Sustainability ............................................. 117 Part II: Borrower's Assessment ...................................... 119 Part III: Statistical Information ..................................... 127 Loan/Credit Data ................................................. 127 Timetable of Key Events: Cumulative Loan/Credit Disbursement ............ 127 Mission Data ............................ ......128 Staff Resources Used in Loan Preparation/Supervision .............. 129 Follow-on Adjustment Operations .............................. 129 Annex I - Policy Matrix (Including Evaluation) .......................... 131 Annex II - Borrower's Assessment (Original Spanish Text ) ................. 135 Map ....................................................... 149 8 7 Basic Data Sheet RecoNwrucnom luorr CREDrTs (CREDITs 1703-BO AND 1828-BO) Credit Position (Amounts in USS million) As of December 31, 1994 Credit Original Disbursed Cancelled Repaid Outstanding 1703-BO 55.00 61.85 0.62 0.00 69.34 1828-BO 47.10 48.28 0.04 0.00 52.26 Project Timetable RecoNsrRucnoN luromr CRErrs (CRmD 1703-BO) Benchmarks Date Planned Date Actual Identification Nov 1985 Nov 1985 Preparation Mission Nov 1985-Feb 1986 Nov 1985-Feb 1986 Appraisal Mission Feb 3, 1986 Feb 3, 1986 Loan Negotiations April 14, 1986 April 14-18, 1986 Board Approval May 5, 1986 May 20 1986 Loan Signature June 2, 1986 June 2, 1986 Loan Effectiveness October 1986 October 14, 1986 Project Completion December 31, 1987 December 31, 1990 Loan Closing June 30, 1988 December 31, 1990 8 RECONSTRUCTION IMPORT CREDITS (CREDIT 1828-HO) Benchmarks Date Planned Date Actual Identification October/November 1986 Preparation Mission November 1986 November 1986 Appraisal Mission February 1987 February 3, 1987 Loan Negotiations May 1987 May 28, 1987 Board Approval June 1987 June 23, 1987 Loan Signature July 1987 July 31, 1987 Loan Effectiveness March 1988 March 28, 1988 Project Completion December 31, 1989 June 30, 1990 Loan Closing June 30, 1990 December 31, 1992 9 RECONSTRUCTION IMPORT CREDIrr (CREDrr 1703-BO) Quarterly Disbursements Period Dates Ditdsaude Disbursem&trent Disbursed (Historical USS Eq.) 10/01/86 - 12/31/87 8,865 8,865 18.5 10,542 01/04/87 - 03/31/87 - 8,865 18.5 - 04/01/87 - 06/30/87 5,393 14,259 29.8 7,058 07/01/87 - 09/30/87 6,070 20,329 42.5 7,634 10/01/87 - 12/31/87 4,040 24,370 50.9 5,372 01/01/87 - 03/31/88 2,872 27,242 56.9 3,972 04/01/88 - 06/30/88 3,898 31,141 65.1 5,344 07/01/88 - 09/30/88 1,541 32,683 68.3 1,996 10/01/88 - 12/31/88 1,685 34,369 71.8 2,257 01/01/88 - 03/31/89 3,319 37,688 78.8 4,371 04/01/89 - 06/30/89 251 37,940 79.3 313 07/01/89 - 09/30/89 273 38,213 79.9 344 10/01/89 - 12/31/89 5,120 43,334 90.6 6,625 01/01/90 - 03/31/90 1,018 44,352 92.7 1,343 04/01/90 - 06/30/90 2,208 46,561 97.3 2,912 07/01/90 - 09/30/90 677 47,238 98.7 924 07/01/90 - 12/31/90 617 47,855 100.0 885 10 Supervision Ratings (Form 590) Evaluation Date Development Legal Covenants Management Availability of Objectives Performance Funds 09/06/86 1 2 1 04/07/88 2 2 1 04/24/89 2 2 1 11/16/89 2 1 2 1 03/03/90 2 2 2 1 06/30/90 2 2 2 1 04/10/91 2 1 2 1 06/30/92 2 1 2 1 11 SECOND RECONsTRUCTION IMPORT CREDIT (CREDrr 1828-BO) Quarterly Disbursements Period Dates Disbursement Cumulative Percent (Historical US$ Disbursements Disbursed Eq.) 01/01/88 - 03/31/88 04/01/88 - 06/30/88 2,194 2,194 6.1 3,011 07/01/88 - 09/30/88 4,046 6,240 17.3 5,199 10/01/88 - 12/31/88 4,617 10,858 30.1 6,073 01/01/89 - 03/31/89 110 10,968 30.4 145 04/01/89 - 06/30/89 244 11,213 31.1 301 07/01/89 - 09/30/89 3,841 15,054 41.7 4,801 10/01/89 - 12/31/89 882 15,936 44.2 1,124 01/01/90 - 03/31/90 4,169 20,106 55.7 5,467 3,085/90 - 06/30/90 3,085 23,191 64.3 4,072 07/01/90 - 09/30/90 1,967 25,159 69.8 2,716 10/01/90 - 12/31/90 1,902 27,062 75.0 2,741 01/01/91 - 03/31/91 2,654 29,716 82.4 3,773 04/01/91 - 06/30/91 1,304 31,020 86.0 1,747 07/01/91 - 09/30/91 277 31,298 86.8 367 10/01/91 - 12/31/91 900 32,198 89.3 1,246 01/01/92 - 03/31/92 361 32,560 90.3 499 04/01/92 - 06/30/92 1,414 33,974 94.2 1,956 07/01/92 - 09/30/92 1,318 35,293 97.9 1,930 10/01/92 - 12/31/92 730 36,024 99.9 1,046 01/01/93 - 03/31/93 21 36,045 99.9 29 04/01/93 - 06/30/93 22 36,068 100.0 32 12 RECONSTRUCTION IMPORT CREDIT (CREDrr 1828-BO) Staff Inputs (Staff Weeks) Up to FY93 FY94 FY95 Total Preparation 9.25 - - 9.25 Appraisal 26.95 - - 26.95 Negotiations 11.68 - - 11.68 Supervision 86.05 - - 86.05 PCR - 7.45 - 7.45 Total 133.93 7.45 - 141.38 Supervision Ratings (Form 590) Evaluation Date Development Legal Covenants Management Availability of Objectives Performance Funds 12/18/87 1 1 1 04/07/88 1 2 1 04/13/89 1 2 1 11/16/89 1 1 2 1 02/26/90 2 2 2 1 06/30/90 2 2 2 1 04/10/91 2 1 2 1 06/30/91 2 1 2 1 12/04/91 2 1 2 1 06/30/92 2 1 2 1 06/30/93 2 1 2 1 13 FINANCLL SECTOR ADJUSTMENT CREDIT (CREDrr 1925-BO) Credit Position (Amounts US$ million) As of December 31, 1994 Credit Original Disbursed' Cancelled Repaid Outstanding Credit 1925-BO 70.00 66.70 0.05 0.00 73.26 Credit 1925-BO-1 11.30 11.92 0.00 0.00 13.33 Credit 1925-BO-2 9.10 9.85 0.07 0.00 10.50 Credit 1925-BO-3 14.50 13.48 0.68 0.00 14.36 Disbursed and outstanding amounts do not reconcile with original amounts due to currency fluctuations (SDR-USS). 14 Cumulative Estimated and Actual Disbursements Credit FY89 FY90 FY91 1925-0 (i) Planned 68.5 1.5 --- (ii) Actual 56.2 10.5 3.3 (iii) (ii) as % of (i) 82% 700% n.a. 1925-1 (i) Planned 11.9 --- --- (ii) Actual 11.9 (iii) (i) as % of (i) 100% --- --- 1925-2 (i) Planned --- 9.8 --- (ii) Actual --- 9.85 --- (iii) (i) as % of (i) -- 101% --- 1925-3 (i) Planned --- --- 14.5 (ii) Actual --- --- 13.5 (iii) (i) as % of (i) --- --- 93% 15 Staff Inputs (Staff Weeks) FY86 FY87 FY88 FY89 FY90 FY91 FY92 FY93 FY94 Total Preparation 42.3 54.3 --- --- --- 96.6 Appraisal --- 17.1 32.5 --- --- --- --- 49.6 Negotiations --- 3.2 --- --- --- --- 3.2 Supervision --- --- 0.1 10.3 16.2 7.3 7.2 1.5 --- 42.6 PCR --- --- --- --- --- --- --- --- 3.2 3.2 Total 42.3 71.4 35.8 10.3 16.2 7.3 7.2 1.5 3.2 195.2 *Includes select assessment of other areas of the financial sector. Project Timetable Planned Date Actual Date Preparation ---- September 26-October 9, 1986 Appraisal Mission ---- April 27-May 16, 1987 Post-Appraisal Mission ---- November 2-14, 1987 Board Approval ---- June 16, 1988 Loan Signature ---- June 24, 1988 Loan Effectiveness June 1988 September 27, 1988 Closing Date June 30, 1992 December 31, 1992 16 Mission Data Stage of Project Cycle Month/Year No. of Persons Preparation 09-10/86 1 Appraisal 04-05/87 1 Post-Appraisal 11/87 1 Board Approval 06/88 Supervision I 09/88 1 Supervision II 11-12/88 1 Supervision III 02-03/89 2 Supervision IV 03/89 2 Supervision V Supervision VI 11-12/89 1 Supervision VII 05/90-02/91 1 Supervision VIII 03/91 1 Supervision IX 05/91 1 Supervision X 08/92 1 Supervision XI Closing Date 12/92 1 Closing Date of Swedish Trust Fund Grant Agreement 06/93 17 Supervision Ratings (Form 590) Evaluation Date Development Legal Covenants Management Availability of Objectives Performance Funds 08/10/88 1 1 1 03/13/89 1 - 1 1 06/30/89 1 2 1 1 12/22/89 2 1 2 1 06/30/90 2 2 2 1 04/30/91 2 1 2 1 07/10/91 2 1 2 1 02/19/92 1 2 1 06/12/92 1 2 2 1 07/23/93 1 1 1 1  19 Evaluation Summary 1. Introduction and Background 1. Bolivia is one of Latin America's poorest, least developed countries, but has substantial untapped agricultural and mineral potential. A highly unequal pattern of development culminated in the 1952 Revolution, which introduced agrarian reform, nationalization of the major mines, and expanded access to education. But a lack of investment and repeated conflict between the Government and the miners' union undermined the goals of the reforms. 2. For more than three decades, Bolivia pursued a policy of state capitalism, including import substitution, subsidized and managed credit, public sector expansion, currency overvaluation, monopolistic rents, and price controls. Propelled by discoveries of oil and gas, and by the easy availability of foreign credit, the economy enjoyed a modest expansion between 1960 and 1980. But Bolivia's debt servicing capacity came into question, and new international lending ceased shortly thereafter. By 1985, annual inflation was running at over 20,000 percent, real per capita GDP had fallen by more than one-fifth, exports by over a third, and public sector revenues by the equivalent of over 7 percent of GDP. Moreover, high and growing intermediation costs, a rapid deterioration in lending portfolios, and inadequate prudential regulation and mechanisms for dealing with problem banks brought the financial system to the brink of collapse. 3. While the Bank and IDA did not commit or disburse development assistance to Bolivia between 1981 and 1985, they continued to monitor the economic situation and maintain a policy dialogue, particularly in the period leading to the 1985 elections. 2. RICs I and II: Objectives and Results The New Economic Program (NEP) and IDA Support 4. The just-elected Paz Estenssoro Government introduced its New Economic Policy (NEP) in August 1985, calling for a free float of the exchange rate, strict public spending controls, the elimination of most price controls, adjustment of public tariffs to international levels, streamlining and improved administration of the tax system, establishment of a Financial Administration and Control System (SAFCO), removal of credit and interest rate controls, an official moratorium on service of foreign commercial bank debt, the establishment of an Emergency Social Fund, and sweeping trade liberalization. 5. The Government issued an urgent request to IDA for financing that would focus on the urgent rehabilitation needs of Bolivia's principal public and private export sectors. This came in the form of RIC I, which was approved in May 1986 for US$64 million equivalent. RIC I was processed and approved in only seven months, reflecting IDA concerns about Bolivia's precarious external position, which was exacerbated in early 1986 by the collapse of international prices for tin and oil, the country's two leading exports. In June 1987, RIC II was approved for nearly US$48 million equivalent, added to which was co-financing from the Japanese OECF for an additional US$50 million equivalent. 20 Objectives and Design 6. Both RICs were intended to show IDA support for the NEP, and provide a vehicle for mobilizing additional aid resources and private capital finance. The situation was not yet considered ripe for a SAL-type operation, given Bolivia's history of frequent turnovers in government, the disarray in most of the country's economic and social institutions, IDA's need to refamiliarize itself with operating conditions in the country after five years of suspended lending operations, and fears that the NEP, like its seven immediate predecessors, might be a short-lived adjustment program due to strong domestic opposition. Instead, the RICS were designed to provide quick-disbursing finance with minimum conditionality to purchase priority imported equipment, spare parts, and other inputs needed to boost exports in six key sectors -- mining, hydrocarbons, power, railroads, agriculture, and industry. Four of these sectors were either exclusively or largely controlled by public enterprises. RIC II also provided technical assistance to strengthen public investment programming and management and to define policy responses to the social costs of the adjustment process. Implementation 7. The NEP was well implemented by the government and generated major benefits to the economy (see Outcome below). The RIC's support for the NEP was of high relevance to Bolivia's near and medium-term development prospects. These credits, together with other Bank and IMF operations, helped mobilize a nearly-three fold increase in the level of external donor financial support, amounting to US$800 million annually in the 1990s. Disbursement of the RICs, however, was subject to serious delays. 8. Disbursement of the RIC I took five years, instead of two, and of the RIC II four years, instead of two. A major reason was a flaw in the design of these credits, which were based on specific, financial allocations to inefficient state enterprises, and the comparatively unfavorable terms extended to the private sector. The emergency character of the credit was largely frustrated, as the largest part of the disbursement flows only became available after the early years of the NEP, when the external situation was most uncertain. Given the fungibility of resources, the inefficiencies of the public enterprises, the lack of counterpart funding, and the limited controls IDA could realistically exert over the far-flung procurement involved, an untied, quick- disbursing mechanism would have assured transfer of the bulk of RIC resources within the two- year target period for each loan while reducing costly IDA supervision inputs without any additional shortcomings. Alternatively, the credits could have incorporated conditionality aimed at ensuring a faster restructuring of the public enterprises which received the funds. While this would have also slowed down disbursements, the delays would have been due to the pacing of reforms, and not to procurement. In retrospect, it appears that a SAC or SECAC operation would have been a better choice to support the NEP. 9. Implementing Agency. The Central Bank proved to be an unfortunate choice as implementing agency. There was frequent turnover in the BCB staff monitoring the credits and serious delays in delivering required annual audits. Later intervention by the Ministry of Planning was far more effective, as the Government noted in its Part II comments on the PCR. 10. Co-financing. The co-financing agreement with the OECF called for financing of a separate list of imported spare parts and other rehabilitation requirements. Supervision reports 21 indicate that, more than one year after project approval, none of the borrowing state enterprises had yet developed specific proposals for utilizing the OECF funds, and that all showed signs of having exceeded their absorptive capacity. Disbursement of the OECF financing was completed in 1995, over two years after RIC II had closed. Outcome 11. The NEP was highly successful at stabilizing the economy, improving allocative efficiency, stimulating export growth, attracting large new volumes of capital inflows, reducing the burden of external debt, and achieved a modest recovery in the rate of economic growth. The value of timely IDA support for Bolivia's adjustment efforts was, by itself, of sufficient import to justify RICs I and II on development impact grounds, so that both are rated as satisfactory, although the relevance of providing 90 percent of the combined RIC financing to Bolivia's major public enterprises can be questioned. 12. Public Enterprise Performance. Recently-published IDA ESW cites the excessive concentration of investment in the major state enterprises-all of whom benefitted from RIC financing-and their inefficient use of these resources during the period of 1985-94 as one of the principal explanations of why GDP growth in Bolivia has yet to surpass 4 percent annually after nearly a decade of adjustment. 13. Spurring export growth, which was the major aim of the RICs, was fully achieved, but not in the way the credits envisioned. Most of the gains came from an emerging private sector export expansion in agriculture and minerals. In the meantime, state enterprise exports stagnated or declined. Exogenous factors played an important role in this failure, i.e., declining international prices and arrears in gas export receivables. But the RICs' assumption that easing the import constraint on the major public enterprises would be sufficient to achieve a major recovery of export earnings without prior structural reforms, was doubtful from the outset. 14. Moreover, had the RICs' terms of lending been more competitive with other sources of finance available at that time, private sector utilization might not have been so disappointing. Another factor was the deterrent effect public enterprise monopolies had on private sector investment demand, a problem also cited in recent ESW on Bolivia. In this sense, by contributing in however small a way toward keeping the public enterprises afloat, the RICs may have helped postpone fundamental PE restructuring and, thereby, discouraged an earlier private sector supply response. 15. Social Impact of Adjustment. In August 1985, Bolivia had urgent, unattended social needs and a Government firmly committed to address them, but lacking in know-how and resources. IDA technical assistance to establish an Emergency Social Fund began in late 1986, and a loan in support of that Fund was approved in mid-1987, nearly two years after the start of the NEP. While the Emergency Social Fund was a path-breaking project for IDA, it was somewhat delayed in terms of Bolivian priorities and needs. 16. Recent Trends. While GDP growth accelerated modestly from 1991-94 to about 4 percent annually and inflation continued to decline to single-digit levels, progress in adjustment during the early 1990s was more uneven. The fiscal deficit fluctuated between 3-6 percent of GDP, domestic savings-at 6 percent of GDP-remained low, and the current account balance-averaging 11-13 22 percent of GDP-high. In general, Bolivia's basic economic health could be considered good but fragile. 17. Of particular concern was the slow pace toward privatization of the major public enterprises. Between 1985 and 1990, the large operating deficits of these enterprises were converted into modest surpluses. But experimentation with performance contracts during 1991-92 produced disappointing results. More recently, the new Government which took office in August 1993, has brought renewed impetus to reform, led by a President who had been closely involved in the conceptualization and implementation of the NEP. An ambitious program of privatization in the oil, telecommunications, power, railroad, mining, and air transport sectors, combined with plans to decentralize governmental services and revamp education, child development, pensions and the civil service augurs well for the sustainability and deepening of the reforms supported by the RICs. 3. The Financial Sector Adjustment Loan: Objectives and Results 18. At the time the NEP was introduced, Bolivia faced a large, but latent banking crisis which originated during the years of hyperinflation, overborrowing, and prolonged interest and credit controls. To some extent, the crisis was deepened by the short-term contractionary impact of real incomes, the impact of greatly-increased real borrowing rates of interest, and the effects of strict spending controls on private sector receivables introduced by the NEP. 19. Economic policymakers were quick to recognize the gravity of the crisis, and requested outside policy advice. IDA responded promptly with a series of missions, beginning in 1986, whose conclusions were summarized in a Banking Sector Study circulated in mid-1987. The conclusions of this Study were largely adopted one month later when the Government promulgated its Reactivation Decree. 20. The Reactivation Decree focused inter alia on auditing all private commercial banks, establishing a uniform loan classification system, closing insolvent banks, imposing more stringent prudential and capitalization standards on the remaining banks, and assuming the debts of the three major state-owned banks. The Program was viewed as a continuum of measures which would lead over the medium term to consolidation of a sound, modern banking system. Shortly thereafter, the Financial Sector Adjustment Loan (1925-BO) was approved (June 1988). It provided US$70 million equivalent, with three supplemental reflow credits providing an additional US$36 million equivalent. Objectives 21. The FSAC's main objectives were to (a) increase confidence in the banking system; (b) strengthen the financial condition of banks; and (c) reduce the high cost of credit. Support of a coherent program of macroeconomic stabilization was considered a paramount means to these ends, as were the maintenance of market-determined interest rates, a strengthening of bank supervision, improvements in regulatory and accounting practices, external audits of all banks, an adequate mechanism for handling problem banks, resolution of the "dedollarization" issue, compensation of mandatory bank reserves, rehabilitation of two state-owned banks, and a strengthening of the Central Bank of Bolivia. 23 Implementation Experience 22. Implementation of the reforms started approximately one year before FSAC approval and proceeded at a swift pace. For this reason, only minor conditions of effectiveness were required. At second tranche disbursement, the Government was required to issue a Supreme Decree and enabling legislation to establish an independent Superintendency of Banks, present action plans for restructuring BAB and BANEST, and issue final regulations to resolve "dedollarization". 23. The core objective-halting the slide of the banking system into insolvency-was fully met. Bi-annual audits proved very valuable, the Superintendency of Banking, effectively led and competently staffed and trained, was established starting six months before loan approval, and tough supervisory regulations were issued and enforced. "Dedollarization" was achieved soon after FSAC approval through a series of swaps of Government dollar-denominated bonds with foreign banks in exchange for liquidation of all their claims on domestic commercial banks. However, establishment of a Financial Systems Division (GSF) in the Central Bank accomplished little of lasting value, as it suffered from a lack of financial resources and political support to carry out its intended functions, and from a battle with the Superintendency of Banks over jurisdiction of problem banks which the GSF eventually lost. Frequent and serious delays were experienced in receiving annual project audits from the Central Bank, occasioning a temporary suspension of FSAC disbursements in 1990. The audits were later received and disbursements completed. Outcome 24. All three FSAC objectives were highly relevant to Bolivia's development priorities. Moreover, the viability of the banking system has improved substantially and private sector confidence, although still fragile, has been gradually restored. The most meager results have come in the area of reducing financial spreads and the cost of credit. Borrowing costs showed little improvement during 1986-90, but have come down modestly since then. However, banking spreads have remained relatively high. On the other hand, the volume of credit to the private sector has increased in real terms by more than 20 percent annually since 1988, and bank profitability has reached high levels. 25. The reasons for persistently high real interest rates transcend financial sector policy. But account also needs to be taken of the weak competitive forces prevailing until recently in the banking sector itself. Falling regulatory barriers and the improved investment climate are expected to draw in more foreign banks, increasing competition and further reducing spreads in the coming years. 26. Efforts to restructure the state-owned banks were not successful, as the Government presented an action plan to fulfill the second tranche condition of the FSAC, but did not act on it. Instead, one year after second tranche disbursement, the Government recapitalized BANEST, which led to more bad loans. BANEST was later closed (1991) as a condition of effectiveness for the follow-on IDA SAC. 4. Conclusions, Ratings, and Lessons of Experience 27. Although the RICs and the FSAC were linked by the overriding aim of supporting Bolivia's adjustment efforts, they differed fundamentally in design and results. The RICs succeeded mainly 24 through the overt support they lent to the NEP, while failing to achieve their specific export promotion aims. On the other hand, the FSAC succeeded in advancing specific sectoral reforms, whereas its support for the overall economic program, which-by 1988 was relatively well- entrenched, became less critical. All three projects had a satisfactory outcome, and are considered to have benefits of likely sustainability. 28. Although RIC I had no institutional development objectives incorporated into its design, substantial supervision resources were expended to assist the Government in meeting IDA procurement and disbursement requirements. Therefore, the institutional development impact of this operation is rated as modest. RIC II, which provided technical assistance for improved public investment management and for designing a social safety net, had modest ID objectives, which were partially achieved. ID impact is rated as modest. Institutional development objectives were of critical importance to the success of the financial reform program. The FSAC was highly successful in supporting the establishment of the Superintendency of Banks, but unsuccessful in strengthening the Central Bank and the state-owned development banks. Overall, the ID impact is rated as substantial, given the critical role subsequently played by an effective Superintendency of Banks in helping avert a banking sector collapse. 29. IDA performance in the RICs I and 11 was mixed. Identification and design are rated as unsatisfactory in both RICs, largely because of the design flaws previously noted. Supervision missions helped reopen the dialogue on public enterprise reform but there was inadequate assessment and resolution, in RIC I, of institutional obstacles to procurement and disbursement, and laxity in enforcing timely compliance with project accounting and audit covenants in both RICs. In the FSAC, IDA deserves commendation for its major role in diagnosing and devising an integrated program of financial sector reforms, well before the FSAC was approved. Identification and preparation were rated as highly satisfactory; appraisal and supervision were rated as satisfactory. Overall IDA performance on the FSAC was satisfactory. 30. Borrower performance on RICs I and II was rated as satisfactory, largely on the basis of the Government's strong fulfillment of the terms of the macroeconomic stabilization and adjustment program. However, at the micro level, borrower preparation and implementation displayed marked deficiencies. Borrower performance on the FSAC was also rated satisfactory. 31. The outcome, sustainability and institutional development ratings for the three operations are similar to those based on the review of the PCRs. On IDA performance under the RICs, the PAR assessment is more critical than that of the PCR, particularly regarding design. Lessons of Experience RICs I and II 32. Task managers should avoid combining objectives stressing speedy resource transfer with project components that add complexity and delay. 33. Haste in preparing and appraising the RICs I and II contributed to design flaws and omissions, requiring large investments of IDA supervision resources and reducing development benefits. Conversely, investment of larger up-front resources in preparing and appraising the 25 FSAC led to proportionate savings in supervision inputs and the achievement of a more ambitious program of development benefits. 34. Financing Commercial Public Enterprises. IDA funds should not be used to finance investments in commercial public enterprises in the absence of comprehensive conditionality to restructure or privatize them. 35. Weaknesses in institutional development must be identified and addressed during preparation and appraisal, even when the operation is a rather straightforward balance-of- payments financing scheme. 36. A sound overall macroeconomic and adjustment policy environment can help achieve a project's development impact, even when its design is flawed. FSAC 37. Delays in achieving lower real interest rates and smaller financial spreads parallels the experience of other adjusting countries: significant lags often exist between the initiation of stabilization/liberalization and the arrival of a strong supply/growth response. In this case, earlier attention to the need to reduce barriers to entry might have accelerated the arrival of new entrants in the financial sector and strengthened competitive forces, thereby shortening the response time to the reforms. 38. Specific reforms of the state-owned financial institutions should have been agreed, and restructuring measures required, prior to Board Presentation so as to clarify objectives from the outset and establish clear evidence of Governmental commitment. 39. The effectiveness of technical assistance rendered under the FSAC would have been more effective, had the financial reform vested unambiguous authority in a single bank supervisory agency. 40. To facilitate timely submission of audits IDA should have (i) adopted pro-active steps to ensure that the borrowing agency, the Central Bank, was sufficiently familiar with the requirements and procedures for audit compliance prior to implementation, and (ii) provided technical assistance under the credit to the implementing agencies which lacked the requisite accounting and financial management capabilities.  27 1. Introduction and Background 1.1 With a per capita income of US$770, Bolivia is one of Latin America's poorest countries. The education level of its 6.7 million inhabitants is very limited and health indicators are among the worst on the continent. A landlocked position and mountainous terrain render transport costs high and access difficult. Internal communications and links to neighboring countries are poorly developed. Urbanization has been occurring at a relatively fast rate, with approximately 56 percent of the total population now resident in urban areas. Still, about two-fifths of the economically active population is employed in agriculture, primarily in highlands subsistence farming. Bolivia has important mineral and hydrocarbon resources, in particular tin, silver, and natural gas, but export prospects are uncertain. The manufacturing sector is small and dominated by a few agro-industrial enterprises. 1.2 Until the middle of the twentieth century, Bolivia's economy was dominated by mining and mining-related activities, with little spill-over to the rest of the economy. Profits from mining were mainly invested abroad, as a government weakened by chronic political instability was unable to tax mining activities to any meaningful extent. Thus, public investments in education and infrastructure were woefully inadequate. Over 70 percent of the population lived in a quasi- feudal rural economy, excluded from political and economic life. 1.3 The highly unequal pattern of wealth and income distribution was among the conditions which generated pressures for change, culminating in the 1952 Revolution. The Revolution introduced agrarian reform, nationalization of the major mines, and expanded coverage of primary education. But the development benefits of these reforms were diluted: inadequate investment and a lack of farmer support services prevented the agrarian reform from producing sustained and vigorous agricultural growth, while conflicts between the Government and miners led to a prolonged and destructive struggle to monopolize mining rents. 1.4 For the next 33 years, Bolivia pursued a policy of state capitalism, justified on the grounds that the private sector was unable to generate sufficient investment to ensure satisfactory economic growth. Growing state involvement was independent of the political orientation of successive governments. By the mid-1970s, some 520 public agencies had assumed control of the economy's most important activities, including 65 percent of mineral production, 100 percent of hydrocarbon output, 70 percent of energy, 70 percent of air transport, over half the assets of the banking system, and large segments of industry and agriculture. 1.5 The resulting policy picture was one common to other Latin American countries at that time: import substitution behind high tariff walls, subsidized and managed credit, an over- expanded public sector, currency overvaluation, monopolistic rents, price controls and subsidies, and a constant distributive battle fuelling inflation. Propelled by discoveries of oil and gas, and by the easy availability of foreign credit, the economy enjoyed a modest boom between 1960 and 1980, averaging real output growth of nearly 5 percent annually. But unrealistic pricing, foreign exchange, and mineral taxation policies, combined with overly optimistic expectations about future export revenue growth, led to many uneconomic and unliable investments. By the end of the 1970s, Bolivia's debt servicing capacity came into question, and new international lending ceased shortly thereafter. 28 1.6 In 1979, the government introduced a program of reforms calling for selective increases in interest rates and public sector and agricultural prices, a reduction in mining taxes, a devaluation, and the initiation of debt rescheduling discussions with foreign commercial bank creditors. The program was supported by an IMF Stand-by and a World Bank Structural Adjustment Loan (SAL), but it was interrupted by a military coup in July 1980. This would be the last Bank Group operation in Bolivia until 1986, as a series of military and civilian government started, and then aborted, six additional adjustment programs generally composed in haste and lacking convincing and comprehensive solutions. 1.7 By mid-1985, annual inflation was running at over 20,000 percent annually, real per capita GDP had fallen 22 percent, the dollar value of exports had declined by over a third, public sector revenues had shrunk to less than 1 percent of GDP, international reserves were severely depleted, and external debt service had reached unsustainably high levels. 1.8 Bolivia's bout with hyperinflation, the collapse in real output, the suspension of foreign commercial bank financing, and the failure of the adjustment program also debilitated the banking system. Concerned about the growing indebtedness of the Bolivian private non-financial sector, in 1982, the Government had ordered financial institutions to accept repayment of their US dollar- denominated loans in pesos at a highly overvalued official exchange rate. To partially offset these losses to financial institutions, dollar deposits were likewise converted to pesos at the official exchange rate. This "dedollarization" (in effect, a partial confiscation of dollar deposits) had a severe and lasting impact, making it more difficult for many years afterward to mobilize dollar deposits, even after they once again became legal. Peso denominated savings were also depressed by the lack of confidence in economic policies and in the banking system. By September 1985, banking system deposits had declined in real terms to one-tenth the level prevailing at the beginning of 1981. However, in spite of a rapid contraction in bank business, the number of branches and bank employees was not reduced. The high and growing cost of intermediation, the rapid deterioration in the quality of lending portfolios, and inadequate prudential regulation and mechanisms to handle the growing number of public and private problem banks had brought Bolivia to the brink of financial collapse. 1.9 While the Bank and IDA did not commit or disburse development assistance between 1981 and 1985, they continued to monitor the economic situation and maintain a policy dialogue. Two missions during 1984 proposed an adjustment program presented to the incoming elected Paz Estenssoro Government which assumed power in August 1985. Although not always clear on the exact nature of the measures it was proposing, the 1985 CEM' focused on Bolivia's external debt, stabilization, and long-term growth problems. In particular, it called for measures to restore export earnings quickly to the levels they enjoyed during 1979-81 via: a. a substantial real exchange rate devaluation and/or priority allocation of scarce foreign exchange to rehabilitate supporting infrastructure and production capacity in the public mining and fuel and in the private non-traditional export sectors; b. improved management of the State Mining Company (COMIBOL); 2 Economic Memorandum on Bolivia, August 2, 1985, Report No. 5680-BO. 29 c. reduction of Government regulatory restrictions on non-traditional exports; d. a multi-year rescheduling of service on the foreign debt, including non-guaranteed private sector debt; and e. a substantial real increase in Government-set retail hydrocarbon prices so as to encourage domestic conservation and generate a larger exportable surplus. To lay the groundwork for a projected increase in real output growth to an average of 5 percent annually during the period 1985-92, the CEM also advocated: f. a significant real increase in other public sector tariffs and government-controlled foodstuffs to near border parity levels to cut down on smuggling and the drain on the budget; g. modest real increases in public investment, assuming adoption of the recommended program of adjustment, combined with a weeding out of economically-unjustified projects; h. opening the mining and hydrocarbon sectors to foreign investment; i. encouraging the domestic private sector to take the lead in developing emergent sectors, such as agriculture; and j. adoption of new, stable, and consistent long-term wage agreements with the major unions that would inter alia protect the real minimum wage from further erosion through regular cost-of-living adjustments and link future real increases in other union wages to gains in productivity. 2. RICS I AND II: Objectives and Results The New Economic Program (NEP) and Bank Support 2.1 Within days of its August 1985 election, the Paz Estenssoro Government had spelled out its New Economic Policy (NEP). Among the most important steps taken were the freeing of the exchange rate and introduction of an auction system for foreign exchange, resulting in an immediate 93 percent devaluation; strict budgetary controls to contain expenditures; a tight monetary policy; elimination of most price controls; adjustment of tariffs for public services to close to international levels; a streamlining and improved administration of the tax system; elimination of most quantitative trade restrictions and a sharp across-the-board reduction in tariffs; reorganization or closure of some public enterprises; removal of credit and interest rate controls; establishment of a Financial Administration and Control System (SAFCO); alleviation of the social impact of adjustment via creation of an Emergency Social Fund; and an official moratorium on service of Bolivia's foreign commercial debt (replacing the de facto non-service of the debt since 1982). 30 2.2 In comparing the NEP with the measures IDA had advocated in its August 1985 CEM, it is apparent that there was agreement on many key points. For example, CEM recommendations a through f (para. 1.9) were adopted in one form or another. And recommendations g through i were echoed in less direct ways in the general NEP philosophy. Only recommendation j was rejected by the NEP in favor of a more ad hoc labor policy designed to confront union defiance in COMIBOL, accommodate union wage demands selectively in other sectors such as the teachers' union, and reduce government intervention generally in setting wages in the private sector. 2.3 Thus, it was logical that the NEP attracted immediate IDA interest and support, and that the Government's initial request for finance would focus on the urgent rehabilitation needs of Bolivia's public and private export sectors singled out in the 1985 CEM. Given that Bolivia's economy, and most of its institutions, were in disarray, and all recent adjustment efforts had ended in early failure, IDA staff concluded that conditions were not yet ripe for undertaking a SAL. However, IDA reasoned that an operation providing quick-disbursing finance to rehabilitate export capacity would signal the international community that Bolivia's latest adjustment efforts deserved support unless events undermined the initial thrust of the program. However, IDA was reluctant to provide this finance in the usual way, through disbursement against a positive or negative list of eligible imports, because of misgivings about the quality of the public investment program, and doubts about the Government's capacity at that time to manage and utilize resources effectively and efficiently. 2.4 The First Reconstruction Import Credit (1703-BO) for SDR 48.4 million (US$64 million equivalent) was approved on May 20, 1986, became effective on October 14, 1986, and closed December 31, 1991. Just 8 months after RIC I was declared effective, RIC II (1828-BO) for SDR 36.1 million (US$47.7 million equivalent) was approved in June 1987. In fact, RIC II was an extension of RIC I, as noted in the PCR, and is, thus being evaluated jointly with RIC I. RIC II, cofinanced by the Japanese aid agency OECF in the amount of Y$7.25 billion, was declared effective on March 28, 1988, and closed on December 31, 1992, one year after RIC I. Bolivia was declared IDA-eligible just prior to approval of RIC I. Objectives and Design 2.5 In November 1985, IDA identified RIC I, appraising it in February 1986. Bolivian foreign exchange reserves were under great pressure, due to sharp declines in international tin and energy export prices and a crushing burden of external indebtedness, so that IDA anticipated a substantial financing gap in 1986 and beyond. Although identified and brought to the Board within seven months, a short time by Bank standards, the Bolivian Government complained, nonetheless, about delays in processing, thus increasing pressures on IDA to be seen as responsive. 2.6 Reflecting the conclusions of the 1985 CEM and the concerns about management of the credit, IDA opted for a hybrid project design-part quick-disbursing credit, part sectoral investment project. The bulk of RIC I financing-63 percent-was allocated initially to meet the needs of the four major public enterprises involved in the production and transport of exports- mining, hydrocarbons, power, and railroads. Less than one-third was set aside for private borrowers in mining, in agriculture, and in agro-industrial exports. Although sectoral allocations were conceived of as flexible and capable of changing in response to revealed demand, the bulk of 31 IDA preparation and appraisal efforts were devoted to the identification of suitable rehabilitation and export-generating items needed by the four public enterprises. IDA reasoned that, at least in the short term, Bolivia's mining and hydrocarbon public enterprises, which were jointly responsible for over 90 percent of Bolivia's exports during the first half of the 1980s, held the key to a fast recovery of export earnings, which had declined by one-third in dollar terms between 1981 and 1986. An added consideration was that export royalties and taxes paid by the oil company (YPFB) supplied approximately four-fifths of all public revenues, so that restarting oil and gas exports would also provide urgently-needed revenue relief to a badly-overstretched budget. While greater private sector involvement in the economy was recognized as essential, it was considered feasible only in the medium term, after the private sector had had time to repair its precarious finances and regain confidence in the Government's economic management. 2.7 These considerations aid in understanding why RIC I was designed to be at once quick- disbursing, sectorally oriented, but with minimum policy conditionality, intended mainly to display IDA support for the NEP and serve as a vehicle to mobilize wider donor support. The loan agreement called for a review of progress on the NEP within nine months of effectiveness, a study of railroad tariffs, non-binding limits on the ratio of current rail working expenses to current revenues and total employment, and COMIBOL certification that employment by mid-1987 had been reduced by 20,000 miners. None of these conditions were tied in any way to disbursements, and deadlines were frequently extended and terms of compliance altered to match the evolving reality. 2.8 The objectives of RIC II, approved only 9 months after effectiveness of RIC I, were similar in nature, the major differences being that the number of target sectors was narrowed to the four public enterprises, in order to simplify procurement. Technical assistance components were added to strengthen public investment programming and management and to define appropriate policy responses to mounting social tensions stemming from years of economic disarray and subsequent stabilization. Implementation 2.9 The RICs' support for the NEP proved highly relevant to Bolivia's medium-term development prospects. The policy aspects of the RIC implementation proceeded smoothly, partly because conditionality was of a general nature, but mainly because the government's NEP was ambitious and radical in its conceptualization, and bold in its execution. In the space of a few years, strong execution of NEP reforms transformed Bolivia into one of IDA's premier adjustment performers. By ending hyperinflation, creating conditions for significant forgiveness of Bolivia's crushing burden of external debt, restoring moderate GDP growth, and alleviating massive unemployment, the NEP has benefitted Bolivia's population in many ways. IDA's relatively speedy response to the Government's appeal for financial support was a significant signal to other donors, which encouraged them to respond generously, increasing gross official financing flows from US$300 million in 1986 to an average of US$800 million annually in the 1990s. 2.10 However, the speed of IDA's response was not without its costs. For example, identification, preparation, and appraisal of the RIC II absorbed a relatively modest 36 staff weeks. But, as will be seen below, the loan design gave inadequate attention to problems of procurement and disbursement, which required substantial, and only partially successful, investments of IDA supervision resources (146 staff weeks) to remedy. Contrast this with the 32 experience of the FSAC, also elaborated below, which absorbed 98 staff weeks prior to effectiveness, but achieved substantially greater development benefits during implementation with far less supervision (46 staff weeks). Disbursement Delays 2.11 Actual disbursement of the RICs, however, was slow and beset by problems. As noted in the PCR, disbursement of RIC I required five years, instead of the expected two; and disbursement of RIC II four years instead of the expected two. While there were many reasons for these delays-cumbersome Governmental procurement regulations, the lack of familiarity with IDA procedures, high turnover in the civil service, and a lack of counterpart funding-the loan design was a major factor. The problems associated with RIC design include its emphasis on multisectoral financing of inefficient state enterprises, the granting of differential (and less favorable) credit terms to the private sector3, the absence of any provision to finance collateral costs such as fees for procurement services, and the inadequate assessment during preparation and appraisal of institutional obstacles to rapid implementation. 2.12 These were serious shortcomings in the sense that the "emergency" character of the credit- one of the rationales for not burdening the operation with extensive conditionality-was largely frustrated by the long period of disbursement, which reduced IDA financing at the time Bolivia most needed it, when the reform program was beset by external skepticism and internal resistance. While Bolivia experienced episodic foreign exchange crises after 1988, in early 1989 and again in 1993 during the run-up to general elections, for the most part, the period of greatest foreign exchange need was during the first three years of the NEP, from 1985 to 1988. Yet, by the end of 1988, 70 percent of RIC I had been disbursed, but only 30 percent of RIC II and virtually none of its associated OECF co-financing. 2.13 The arguments for a sector-specific approach to loan allocation had much to do with concerns about whether Bolivia would be able to prudently spend free foreign exchange, due to well-known weaknesses in public expenditure controls and doubts about the relevance of the public investment program as then defined. At the initiating memorandum stage, it was argued that tying RIC II disbursements to IDA approval of the 1987-88 investment programs would directly address the issue of weak resource management'. Also, it was hoped that IDA's technical assistance (to identify critical public enterprise maintenance needs and production bottlenecks) might increase the likelihood the funding would be applied to productive ends. But, given the fungibility of resources', the inefficiencies of the public enterprises, the lack of I In general, private sector imports were financed for a maximum term of one year at annual interest rates in dollars of between 13.5-15.5 percent, while state enterprises received credits for up to 15 years maturity at interest rates five percentage points below the rates on the private sector lines of credit. 'Division Chief, LCPIt, memorandum to files on Proposed Financial Sector Adjustment Credit, 1/30/87. YPFB alone reported receiving funding from over 15 different foreign donors during the years of the RICs. 33 counterpart funding', and the limited controls IDA could realistically impose over such a vast and complicated program of procurement, there was acknowledgment, even at the time, that this approach was highly questionable. 2.14 An untied, quick-disbursing mechanism would at least have assured transfer of the bulk of the RIC resources within the two-year target period and concomitantly reduced costly IDA supervision inputs'. Alternatively, the credits could have incorporated conditionality and tranching linked to faster restructuring of the public enterprises. While this would have also involved the risk of slowing disbursements significantly, it would have been because of policy conditionality and not procurement delays. In retrospect, knowing that (a) a supply response often takes place only several years after a macroeconomic track record has been established, meaning a significant lag between adjustment and growth is likely, and (b) that these two resource-transfer operations without conditionality took longer to disburse than most adjustment operations, it appears that a SAC or SECAC operation would have been a better choice to support the NEP'. 2.15 IDA staff point out that the sectoral/enterprise character of the RICs provided a convenient framework for engaging the Government in a wide-ranging dialogue about reforms of the mining and energy laws, about restructuring the major PEs, about reordering long-term public investment priorities, and about devising improved sectoral strategies. While this is plausible, there was an ample range of operations available', as well as ESW opportunities, to carry forward this process without the assistance of the RICs. In the event, it does appear that the regular supervision visits occasioned by the two credits served as a useful "door opener" to renew and widen the dialogue with the key state enterprises, a dialogue which had been interrupted for more than five years after the Bank suspended all operations in 1980. Borrower/Implementing Agency Performance 2.16 Some problems surfaced in the implementing agency's support for the project, although this was largely beyond the Government's control, given the dearth of trained staff, high turnover, and unfamiliarity with IDA procedures. Notwithstanding a President who played a leading role in the NEP reforms, the Central Bank as an institution proved to be an unfortunate choice as the financing and supervisory agency for the RICs. The BCB suffered from politicized personnel policies, high turnover, a centralized decision-making structure which hampered timely resolution ' Borrowers such as the Railroad Company (ENDE) found their capacity to procure severely constrained by the lack of counterpart funding to cover the costs of import taxes and the fees collected by the private external procurement agents required by Government policy after 1987. No provisions were made in either credit to find a suitable source of financing for this counterpart, the lack of which greatly added to procurement delays. 'From 1986 to 1989, RICs I and 11 absorbed about 40 staff-weeks annually in supervision, much of it spent on procurement issues. 'The RICs were prepared before announcement of the Brady Plan, and, thus, did not factor debt forgiveness into their long-term projections. In Bolivia's case, debt forgiveness played a critical role in closing what, from the perspective of 1985-86, appeared to be a quasi-permanent and unsustainable burden of debt. * During preparation and implementation of the RICs, the Bank pursued an active lending program in Bolivia, averaging three new operations yearly, including various technical assistance loans in support of public sector management and restructuring, two follow-on adjustment operations, a mining sector investment loan, three social investment fund projects, funding for municipal finance, and for expansion of gas production. 34 of day-to-day problems, weak accounting and financial controls with limited accountability, and a hazy definition of its basic roles and functions. The numerous problems encountered with BCB administration of the credits include: a. Within six months of effectiveness of RIC I, the Central Bank staff responsible for the loan was dismissed. b. The Project Coordinating Committee was staffed exclusively by members of the Central Bank Board, excluding representatives from other participating agencies. It played a negligible role in project monitoring. c. In early 1989, an incoming Administration fired virtually all the BCB staff working on RICs I and II. The Planning Ministry had to assume a coordinating role in order to re-establish effective contact with the borrowing enterprises, and take stock and resolve numerous accumulated procurement and other problems. By all accounts, the Planning Ministry provided effective liaison for the two projects. d. The audits performed by the Central Bank fell more than three years overdue, and contained serious accounting deficiencies, including a failure to keep separate accounts of disbursements by credit. However, all audits were eventually delivered in a form, which, however imperfectly, enabled the Association to reconcile its disbursement records with the Government's. Co-financing 2.17 Under an Administration Agreement between the Government of Japan and IDA, co- financing of RIC II in the amount of Y$7.2 billion (approximately US$50 million equivalent) was provided. The agreement called for development of a separate list of imported spare parts and other rehabilitation requirements by joint agreement between IDA, the designated state enterprise beneficiaries, and the Government. However, loan records indicate that no clear idea for the uses of the OECF funds had been developed at the time of the Agreement. A supervision mission visiting Bolivia more than one year after RIC II approval reported that the OECF funds were straining the absorptive capacity of the four designated state enterprises, and that none of the enterprises had developed a detailed list of needs against which procurement and draw-down of the co-financing could begin. 2.18 The Government and IDA argued that the co-financier's procurement and disbursement requirements were cumbersome, requiring a "no objection" from both IDA and the OECF, often with many months of delay, before procurement could be initiated"o. The delays over procurement issues, and the substantial IDA overhead associated with supervision of the co- financing disbursement arrangements, were key reasons why the two credits became something of bureaucratic "orphans", particularly after 1989. The OECF co-financing did not fully disburse until 1995, over two years after RIC II was closed. as Letter to OECF Washington Representative of 3123/90, from the Division Chief, LATIE. 35 Outcome 2.19 The adjustment program was highly successful in rapidly stabilizing the economy and restoring internal and external balances, despite severe terms of trade losses, arrearages on receivables from natural gas exports, and significant crop failures during the early years following introduction of the NEP. Between 1987 and 1990 (see Annex, Figures 1-4), inflation averaged 16 percent and real export growth 18 percent. The consolidated fiscal deficit was sharply reduced from 1984 to 1990. Substantial progress was made in three Paris Club reschedulings to restore relations with external creditors. Repurchases of two-thirds of Bolivia's commercial bank debt at 11 cents to the U.S. dollar, using funds provided by official donors and significant write-offs of bilateral debt largely resolved the country's external debt problems. However, output recovery was comparatively slow, averaging only 2.8 percent annually in real terms during 1987-90, barely sufficient to cover Bolivia's rate of population growth. 2.20 The value of timely IDA support for Bolivia's adjustment efforts through RIC I and RIC H was, by itself, sufficient to justify the development impact of these credits. Thus, the outcome of the two credits is rated as satisfactory. On the other hand, the decision to provide import finance predominantly to Bolivia's major public enterprises can be questioned on several grounds. First, there was considerable reason to question, even in late 1985, how efficiently the state enterprises would apply such resources. They had been identified by the Bank's ESW" as partly responsible for in the failure of the economy to achieve stabilizing growth. Most had displayed a notorious inability to execute external procurement rapidlyl2 and registered dismal export performances, while claiming huge shares of public investment resources and foreign exchange. The assumption that the deterioration in state enterprise export performance could be reversed largely by relieving the import constraint was unduly simplistic, and contradicted by subsequent experience. 2.21 After declining in 1987, real exports did increase-by an average of nearly 8 percent annually from 1988-92-a performance which was all the more impressive since it was accomplished in the face of sharp declines in international fuel and minerals prices and agricultural shortages induced by drought. However, it was non-traditional exports, mainly from the private agricultural sector (soybeans, sugar, and timber), and from precious metals (gold and silver) produced from private mines, which furnished the most dynamic contributions to overall export growth during this period. Since 1992, the export base have continued to diversify, but in directions which have virtually nothing to do with public enterprises, as evidenced by the emergence and strong growth of cotton, clothing, chestnuts, arts and crafts, footwear, and alcohol. Meanwhile, the combined share of exports from the fuel and mining state enterprises has declined sharply from 95 percent in 1985 to 60 percent in 1993. "See, for example, the 1985 Economic Memorandum on Bolivia. 2 There was nearly US1 billion outstanding in undisbursed external funding to Bolivia in early 1986, much of it directed to the public enterprises. 36 Public Enterprise Performance 2.22 IDA's most recent Country Economic Memorandum on Bolivia" singles out misallocated and inefficient public investment as one of the two principal obstacles to faster growth."' In particular, the Report notes: " Over the last decade in Bolivia, substantial public investment resources-equivalent to 4 percent of GDP-have been directed toward public sector enterprises, which for the most part have been inefficient. For example, public investment in YPFB has grown by 2 percent annually, accounting for an average of 25 percent of total public sector investment during the last 10 years...such an increase in capital should have resulted in output growth greater than 3 percent per year. Instead, during this same period, output growth from the sector - of which, YPFB represents 95 percent - has remained low - 1.2 percent annually." YPFB was the principal state enterprise recipient of funding from RICs I and II. While IDA's lending program has increasingly supported state enterprise restructuring and privatization, Bolivia's first major public enterprise is scheduled to be privatized in 1995, ten years after the start of the NEP. 2.23 The disappointing private sector demand for RIC I, only about half what had been originally anticipated, appears to have been affected not only by its comparatively unfavorable financing terms", but also by the deterrent effect public enterprise monopolies had on private sector investment demand generally". In this sense, by contributing in a small way toward keeping these enterprises afloat, RICs I and II may have helped postpone fundamental PE restructuring and discouraged an earlier private sector supply response. "Bolivia: Structural Reforms, Fiscal Impacts and Economic Growth (Report No. 13067-BO) of October 14, 1994. " The other was Bolivia's low rate of human capital accumulation, which, indirectly, relates to inefficient public investment patterns. See pp. 6-9. " The PCR argues that overborrowing and lack of private sector confidence in the new policy climate were the key reasons for the shortfall in private sector demand, which ultimately took up less than one-fifth of RIC 1 and none of RIC II. But, in its Part II comments, the Government notes that private sector interest was initially high, but soon disappeared when other, more attractive sources of financing from the IDB and elsewhere became available and RIC I did not adjust its terms. One of these new sources (see discussion of the Financial Sector Adjustment Loan below) was the Government itself, which, starting in 1987, supplied long-term credit (seven years and up) in dollars to the private sector at a highly-preferential rate of LIBOR + 5 percentage points. Such terms were obviously more attractive than RIC I and II's maximum of one-year maturity and interest rate of LIBOR + 13 percentage points. There is no record during supervision of RICs I and II of any IDA efforts to resolve these discrepancies, so as to remove this disincentive to private sector utilization of the credits. The October 1994 CEM, Bolivia: Structural Reforms, Fiscal Impacts, and Economic Growth (Report No. 13067-BO) notes: "Private sector investment has been and remains slugish for the following reasons:... (d) Public sector dominance and the eisting institutional framework -- including legal, regulatory and pricing policies -- has restricted private sector entry into key economic sectors -- primarily mining, hydrocarbons, telecommunications and electricity..." These are, of course, the four leading state enterprise sectors targeted by RICs I and II. 37 2.24 Signs of absorptive capacity problems in the public enterprises became increasingly apparent from early 1987 onward, as evidenced by the growing backlog of procurement, the increase in parallel financing available to the public enterprises from other aid donors, the inability of the public enterprises to identify financing needs to absorb the Japanese OECD loan which co-financed the RIC II until long after it had been approved, and the pleas by Government officials starting in 1989 to shift RIC I and II funding away from the public enterprises financed by the RICs, which "had more resources than they could use wisely, at present, while the Central Government had to use its own scarce foreign exchange to priority imports of ... other [public] agencies and entities" which were less well-financed". Hence, the relevance of the enterprise- specific financing, which eventually absorbed nearly all of the RIC financing, must be considered moderate at best during the 1986-88 period, and low thereafter. Social Impact of Adjustment 2.25 At the time of the NEP, Bolivia had urgent unmet social needs, including a poverty ratio in excess of 70 percent, an educational system reaching less than three-fifths of urban children at the elementary level, and less than 30 percent in rural areas, life expectancy in the mid-50s, and a majority of inhabitants living in housing without access to sanitation facilities and safe water. As the economy deteriorated, per capita incomes had declined and the provision of basic services to the poor had deteriorated. 2.26 In August 1985, i.e., three months before RIC I was identified, the Government attempted to establish a Social Emergency Fund, an initiative which the President considered one of his highest priorities. This attempt, like several related anti-poverty initiatives undertaken over the following 15 months, failed for lack of clear leadership within the government and because of institutional and funding inadequacies. During the mission which identified RIC II in November 1986, the Task Manager reported that Government officials were unanimous in naming establishment of a Social Emergency Fund as Bolivia's top funding priority (along with reactivation of private sector investment through financing of working capital and trade and intensification of the war on drugs). Financial support for the public investment program was listed as, at best, a subsidiary objective by most officials, except the Minister of Energy, who argued that state enterprises should continue to receive direct allocations from the future credit, lest their incentive to carry out further reforms be weakened". As a result, the Government prevailed on IDA to shift SDR$10 million from RIC II to the financing of the Emergency Social Fund Project, which was being processed on a parallel track with RIC II. 2.27 IDA technical assistance to assist the Government in establishing such a fund did not begin until late 1986, i.e., more than a year after the first Governmental attempt to create a social fund. And the first IDA loan for an Emergency Social Fund went to the Board in mid-1987, nearly two years after the Government's first initiative in this area had gone awry. While the Emergency Social Fund was the first of its kind in IDA and achieved satisfactory results, from a Bolivian perspective, its arrival was somewhat delayed. " Memorandum of Task Manager, RICs I and II, to LA3 Department Director, 2/6/89. The memorandum does not identity what public agencies and entities the Bolivian Finance Minister had in mind. " Back-to-Office Report of December 11, 1986. 38 Recent Trends 2.28 In the early 1990s, further progress toward stabilization and adjustment has been uneven: the fiscal deficit rose to over 6 percent of GDP in 1993 (and then declined to about 3 percent in 1994 in the first full year of a new Government); the current account balance-with a deficit equivalent to 13 percent of GDP in 1993-remained weak; domestic savings-at 6 percent of GDP-remained low; and reliance on external donor flows-at 3 percent of GDP net-remained unsustainably high. Average real GDP growth accelerated to 4 percent annually during 1991-93, but this was still below expectations for growth formulated at the time the NEP was first announced. At the same time, the pace of structural reforms slowed down. In general, Bolivia's basic economic health during this time remained good, but fragile. 2.29 Of particular concern was the cautious pace of privatization of Bolivia's most important state enterprises, which dominate the key sectors of the economy. During the early years of the reforms, the imposition of hard budget constraints had been successful in forcing the closure of a sizeable number of unprofitable mining and a smaller number of non-mining operations accompanied by significant reductions in enterprise employment. Between 1985 and 1990, large operating deficits had been converted into modest overall surpluses. However, experimentation with performance contracts during 1991-92 was disappointing, yielding relatively meager improvements in public enterprise investment and operating efficiency. 2.30 The new Government that took office in August 1993 has generated renewed impetus toward reform. The President (who served as Minister of Planning during the period of the NEP) has launched an ambitious privatization program in the oil, telecommunications, power, railroad, mining, and air transport sectors. Combined with plans for decentralizing governmental services and revamping education, child development, pension and civil service programs, the new Government appears well-placed to sustain and deepen the benefits derived from the NEP. 39 3. The Financial Sector Adjustment Loan: Objectives and Results 3.1 The Financial Sector Adjustment Credit (1925-BO), in the amount of SDR 50.6 million (US$70 million equivalent), was approved on June 16, 1988, became effective on September 27, 1988, and closed on December 31, 1992. The Credit, including three subsequent supplemental credits (from IDA reflows) for US$11.9 million equivalent, US$9.8 million equivalent, and US$14.5 million equivalent, was nearly fully disbursed by October 10, 1991, leaving only a small amount (SDR 581,000) to be cancelled. The Banking Crisis 3.2 Bolivia faced a large but latent banking crisis at the start of the NEP reforms, typical of countries emerging from prolonged periods of hyperinflation, overborrowing, and prolonged credit and interest rate controls. The NEP had only a limited focus on banking and financial sector reforms. Thus, it proved relatively ineffectual in rolling back the danger of a generalized banking collapse, which had been mounting rapidly since 1982. Indeed, greatly increased real interest rates, the contraction of real incomes, and the effects of strict public spending controls on private sector receivables were by-products of the NEP which ultimately exacerbated the already- weakened condition of the banks. 3.3 The President of the Central Bank and other members of economic cabinet were quick to recognize the gravity of the crisis, requesting policy advice from IDA, the IMF, the IDB, USAID, and other outside experts. IDA responded promptly with a series of missions composed of staff and consultants having considerable personal experience in dealing with banking crises. The Green Cover Banking Sector Study" of June 1987 summarized their views on an agenda for banking sector reform which was largely adopted by the Government when it issued its Reactivation Decree one month later. The Reactivation Decree of 1987 3.4 The Reactivation Decree re-established a Superintendency of Banking independent of the Central Bank, created a Central Bank Financial System Department charged with managing rehabilitation or liquidation of problem banks, made bi-annual external audits of all commercial banks mandatory, closed three insolvent private banks, established a uniform loan classification system based on capacity to repay as well as the cash value of collaterals, imposed more stringent regulations on loan provisions and interest accrual on overdue loans, modified leverage and minimum capital requirements to strengthen the capital base of banks, prohibited lending to finance shareholders' recapitalization of their banks; introduced limits on loan concentration, and increased requirements for information disclosure. The debts of three major state-owned banks were also assumed by the public sector in order to stave off impending bankruptcies, and a fourth public bank was liquidated. 3.5 The Government's Financial Sector Adjustment Program, which was launched as part of the Reactivation Decree and was explicitly supported by the FSAC, gave priority to confronting the immediate problems of a large number of public and private banks on the brink of insolvency. " Later published as the Bolivia Banking Sector Study (Report No. 6765-BO) of November 18, 1988. 40 About one-third of all banks required recapitalization, the volume of lending transactions had shrunk by over two-thirds between 1982 and 1986, portfolios were crippled by unrecoverable and overdue loans, excessive investment in fixed assets had led to rising and unsustainable operating costs, and the foreign currency obligations left unpaid following the 1982 "dedollarization" measures, at US$65 million, now amounted to three times the joint capitalization of all private commercial banks. The emergency program measures of 1987 were viewed as part of a continuum of steps which would lead over the medium-term to the consolidation of a resilient, solid, and efficient financial system. FSAC Design and Related Operations 3.6 The FSAC was the second of at least four externally-financed operations designed to support various aspects of the longer-term Financial Sector Adjustment Program. First, the Public Financial Management Operation (PFMO), approved by IDA in 1987, provided technical assistance to formulate proposals for restructuring the Agricultural Bank (BAB) and the National Development Bank (BANEST), as well as to assist in the establishment of an autonomous Superintendency of Banks (SBEF). Coincident with approval of the FSAC, an IMF Enhanced Structural Adjustment Facility (ESAF) provided important technical assistance in three areas covered by the FSAC: formulation of the Banks and Financial Entities Law, proposed in 1990 and eventually approved by the Bolivian Congress in April 1993, adoption of SAFCO, and restructuring of the state-owned banks. A Structural Adjustment Credit, approved in August 1991, has a large financial sector component building on the actions started under the PFMO and the FSAC, including closure of insolvent public banks, improvement of allocation of externally- financed development credit, strengthened supervision of banks and other financial intermediaries, and removal of impediments to capital market development. 3.7 The main objectives of the FSAL were to (a) increase confidence in the banking system and in resource mobilization; (b) strengthen the financial condition of banks and (iii) reduce the high cost of credit. These objectives would be achieved by (i) maintaining a coherent program of macroeconomic stabilization; (ii) maintaining market determination of interest rates; (iii) strengthening bank supervision; (iv) improving bank regulations and accounting practices; (v) requiring external bank audits; (vi) establishing an adequate mechanism for handling problem banks; (vii) resolving the "dedollarization" issue; (viii) compensating banks for their reserve requirements; (ix) rehabilitating or restructuring the state-owned banks; and (x) strengthening the Central Bank of Bolivia (BCB). Implementation Experience 3.8 Implementation of the reforms started approximately one year prior to loan approval, and proceeded at a swift pace. Taking this into account, the only condition of effectiveness of this two-tranche, quick-disbursing operation was that the Government staff the new Financial System Department of the BCB and nominate its Acting Vice President. Second-tranche conditionality included requirements for (a) a Supreme Decree and enabling legislation to legally establish an independent Superintendency of Banks; (b) establishing a high-level policy committee to prepare and present to IDA action plans and implementation schedules for the restructuring of BAB and BANEST; and (c) the issuance of regulations giving Final resolution to the dedollarization problem through a swap of dollar-denominated bonds against the peso accounts deposited by the commercial banks. 41 3.9 The core objective of the FSAC, halting the slide of the banking system toward insolvency, was fully met. The bi-annual external audits of the banks have proven invaluable in identifying the banks in greatest difficulty and the key problems needing attention. The Government negotiated a resolution of the "dedollarization" problem with foreign creditors, resulting in the issuing of dollar-denominated bonds equivalent to US$0.11 cents for every US$1 of face value of claims, liquidating US$65 million in commercial bank debt. The Superintendency of Banking was organized very quickly by December 1987, six months before the FSAC was approved. A charismatic, highly-effective Superintendent, with full support of the President of the Republic, was named, and proceeded to move quickly to hire competent staff, train them, promulgate tough regulations on self-dealing, provisioning for bad loans, adopting uniform accounting standards, establishing a system of central filing of financial information, and a computerized system of credit risk analysis. 3.10 After an initial flurry of forced bank closures during 1987, no further banks were closed until early 1995, when two additional banks were liquidated and two others intervened. The evidence suggests that at least some of these insolvent banks were allowed to remain open, even after awareness of their inviability had become more widely appreciated. While there may have been several good reasons for this slow response, including concerns about the contagion effects on public confidence in other banks, an additional factor may have been a lingering dispute between the SBEF and the Central Bank about jurisdiction over financial sector policy. This dispute ended up affecting the design of the FSAC, which sought to create an independent SBEF, and, at the same time, a Financial Systems Management Division ( GSF) in the BCB which was to have assumed responsibility for dealing with problem banks. The GSF was never able to define for itself a role separate from the SBEF, lacked financial resources and political support to carry out its supposed functions, and soon succumbed to long-standing institutional weaknesses endemic to its host agency, the BCB. The 1993 Law on Financial Entities formally transferred most of the GSF's functions to the SBEF, which has since shown renewed vigor in dealing with problem banks. Outcome 3.11 All three of the key FSAC objectives-dealing with problem banks, strengthening banking capacity to mobilize savings, and lowering the cost of credit-were highly relevant. The Government requested IDA attention to failing banks because it correctly perceived the devastating impact that an implosion of the banking system would have had on the NEP. Secondly, the ravages of hyperinflation and financial controls had so distorted and reduced the dimensions of the banking sector that it clearly could not, in its condition prior to adoption of the 1987 Program, mobilize savings or efficiently intermediate more than a trickle of the lendable resources required to hasten the real sector adjustment. Lastly, with real interest rates in excess of 25 percent annually, a reduction in the high cost of credit was a sie Qua non of economic recovery. IDA and the Government's early recognition of the primacy of financial adjustment in the overall stabilization process deserves high praise. 3.12 The viability of the banking system has substantially improved in recent years. The proportion of non-performing loans for all commercial banks declined from 10.2 percent at the end of 1988 to 5.3 percent at the end of 1992. The growth of bank credit to the private sector accelerated in real terms from 21 percent on average in 1989-90 to 29 percent in 1991 and 32 percent in 1992, before slowing to 23 percent in 1993. Banks have limited their currency risk by 42 roughly matching the currency composition of assets and liabilities, and raised their minimum capital-to-assets ratio from one-to-twenty to one-to-twelve. Banking profitability has soared. Since 1994, the authorities are opening the sector to greater competition by reducing and simplifying requirements for the establishment of banks. 3.13 Confidence in the banking system has been gradually strengthened, but remains fragile. While the volume of deposits tripled in the period 1989-91, and continued to grow rapidly thereafter, a growing percentage of these deposits has been denominated in foreign currency (from 85 percent at the end of 1989 to 96 percent at the end of September 1993), an indication that fears of sudden devaluation or other abrupt policy shifts have not significantly abated. 3.14 The most meager results have come in the areas of reducing credit costs (see Annex, Figures 5 and 6), and restructuring the state-owned banks. Real lending rates in dollars, which for all practical purposes is the only currency in which credit is denominated, declined by nearly 4 percentage points between 1987 and 1993, but this was more a reflection of falling international rates, than of significant increases in the efficiency of intermediation. In some respects, the reasons for persistently high real interest rates transcend financial sector policy, having as much or more to do with the tight monetary policies and the shift from monetary to debt-financing of the fiscal deficit and uncertainties about the consistency of macroeconomic policy. 3.15 A related area where results fell short of expectations was in the reduction of interest rate spreads, which have declined slightly, but, as of 1993, remained well above the 5 percentage-point benchmark established as an FSAC objective. The lack of adequate competition from new entrants appears to have been one of the factors explaining the persistence of high spreads. However, this situation appears about to change rapidly, as regulatory barriers were recently lowered and more favorable macroeconomic and profit opportunities are beginning to draw in more foreign bank subsidiaries. 3.16 Even in this area of relatively weak FSAC results, the fact that IDA was able to convince the Government throughout the period of FSAC preparation and implementation to resist intervening to repress high interest rates, despite strong political pressures to do so, should be counted as an important accomplishment of the operation. 3.17 With respect to the restructuring of the state-owned banks, the FSAC, like its predecessor, the PMFO, largely failed in its objectives. Although IDA received a plan of action to restructure BAB and BANEST, it appears that compliance was pro-forma. The Government allowed the heads of the public banks, who had an obvious conflict-of-interest, to formulate the plans, which violated the provision in the FSAC legal agreement requiring this task to be turned over to a Restructuring Commission. Nor did the Government seriously act to implement the action plans following second-tranche disbursement. Indeed, one-year after the FSAC was approved, the Government recapitalized an unrestructured BANEST, which proceeded to issue more unrecoverable loans until it was closed (along with BAB) as a condition of effectiveness for the SAC in 1991. 3.18 Frequent and serious delays were experienced in receiving from the Central Bank the annual project audits. In 1990, disbursements against statements of expenses were suspended because of repeated failure to produce timely audits acceptable to IDA. 43 4. Conclusions, Ratings and Lessons of Experience 4.1 Although the RICs I and II and the FSAC were linked by their overriding emphasis on supporting Bolivia's adjustment efforts, in reality they were fundamentally different kinds of operations, with very different effects. The RICs succeeded mainly at the level of the support they provided to a general economic program, while failing to achieve their more specific project aims. On the other hand, the FSAC was mainly successful in promoting financial reform, while its support for the NEP, by 1988 relatively well-entrenched, was less important than in the cases of the RICs. RIC Ratings 4.2 Despite lackluster results in promoting state enterprise exports, the RICs played a valuable role in providing early signals of IDA support which effectively mobilized large volumes of external resources in support of Bolivia's historic stabilization and adjustment Program. It is on these grounds that both RICs I and II are rated as satisfactory in outcome. The efficacy of both operations is considered substantial, largely on the basis that macroeconomic stabilization, a key objective of the NEP supported by the RICs, was achieved with a high degree of success, as was the credits' objective of mobilizing large volumes of additional external resources during the period of the operations. However, the efficiency of these credits was rated as modest, given longer-term evidence of sub-optimal use of investment resources by the principal beneficiaries, high staff supervision costs, and a poor state enterprise exports response. 4.3 RIC I had a negligible beneficial impact on private sector development through lines of credit to mining and agriculture which had very little demand. No other thematic incidences were present. RIC II substantially achieved its poverty-related goal of financing technical assistance in support of establishing a Social Emergency Fund to alleviate the adverse social effects of the NEP. No other thematic incidences were present. 4.4 Both credits are rated of likely sustainability, on the grounds of strong governmental commitment to the NEP supported by operations, a favorable policy environment, and marginally acceptable economic viability from the standpoint of the specific uses of the funds at the state enterprise level. Both projects benefitted from follow-on projects intended to support continuation of the NEP, promote public enterprise reform and privatization, and alleviate the social costs of adjustment. 4.5 Institutional development objectives were not specified in RIC I. However, RIC II's objective of providing technical assistance for the improvement of public investment management and for designing a social safety net were highly relevant to Bolivia's ongoing adjustment needs. Important improvements in procurement procedures stemmed from studies and mission technical assistance financed in part by RIC II. Improvements in public investment management technology and monitoring were modest. On the other hand, assistance for the establishment of a Social Emergency Fund short-lived and relatively inconsequential. In the latter two areas, institutional development components of much greater impact were supplied by projects financed by multilateral and bilateral donors, including IDA. 4.6 Largely on the basis of the flaws noted earlier in the design of RICs I and II, i.e., targeted on public enterprises but with little conditionality, the delayed response to Bolivia's urgent social 44 needs (RIC I only), the inadequate assessment of institutional obstacles to satisfactory procurement and disbursement (RIC I only), the poor choice of an implementing agency (i.e., the Central Bank rather than the Planning Ministry), and inadequate attention to the likely development impact of the credits, given inefficient utilization by the state enterprises. Bank performance identification is rated as unsatisfactory in both operations. Performance during implementation was mixed; the supervision missions helped reopen the dialogue on public enterprise reforms but the Bank did not enforce in a timely fashion loan covenants on project accounting and audit delivery. 4.7 Borrower performance is rated as satisfactory, largely on the basis of the Government's strong fulfillment of commitments to macroeconomic stabilization and adjustment which formed the main justification for the RICs satisfactory outcome and sustainability. On the other hand, at the micro level of the project, borrower preparation, particularly with respect to the institutional requirements of the credits proved highly unsatisfactory, although, as mentioned previously, many of these shortcomings reflect a real dearth of skilled staff and management rather than a basic indifference or lack of commitment to the credits' objectives. Similarly, borrower implementation showed marked deficiencies in management quality and continuity, agency staff quality and quantity, and the amount and timeliness of counterpart funding. FSAC Ratings 4.8 As for the FSAC, the creation of an effective Bank Superintendency, accompanied by the complimentary reforms to strengthen prudential oversight and increase capitalization, forestalled what could easily have been a grave and prolonged banking crisis. The delays in closure of the state-owned banks are likely to have little adverse impact in the medium term, and the move to expand competition in the private banking sector is further affirmation of a fundamental shift toward market-based banking. These results alone would have amply justified the FSAC. Although borrowing costs and bank spreads remain high in real terms, the volume of credit has burgeoned, and the efficiency of allocation appears to have improved. Also, the overall macroeconomic framework, which the FSAL supported, continues to consolidate its dramatic benefits to the Bolivian economy. On these grounds, the FSAC is rated as satisfactory. 4.9 The FSAC's efficacy is considered substantial, given the high degree of achievement of overall macroeconomic and financial stabilization objectives, the signal success in creating an effective Superintendency of Banking from scratch, and more modest achievement of the goals of restructuring the publicly-owned banks and strengthening the Central Bank. Halting financial disintegration and sustaining a sweeping program of reforms for US$50 million would have been a bargain at twice the price, given the historical significance of the NEP for Bolivia's own development prospects, and the positive example it has lent to other parts of Latin America and the developing world. Efficiency is rated as high. 4.10 The FSAC had a substantially positive effect on Private Sector Development. The growth and diversification of the non-traditional sectors would have been well-nigh impossible without the increased financial intermediation and savings mobilization which the Financial Sector Adjustment Program made possible. Financial deepening has now reached nearly 45 percent of GDP in Bolivia, one of the many indicators that Bolivia's financial sector is stepping up to a more sophisticated level of development. However, the Governmental attempts to refinance bad loans, provide rehabilitative finance to troubled banks, and provide subsidized long-term credits to the 45 non-financial private sector had, at best, modestly favorable effects, when they did not fail altogether. No other thematic components were present in this operation. 4.11 The NEP supported by the FSAC remains on track. The government's market-friendly approach, in financial sector policy as well as the economy at large, is no longer at issue in public debates. The independence and budgetary autonomy of the Superintendency of Banks was consolidated with passage of the 1993 Banking Entities Law, which strengthened its regulatory powers and greatly reduced the scope for Executive Branch backtracking. The BCB is pressing for a restoration of its normative role in fixing commercial bank norms, which could lead to a weakening of the Superintendency, but such an outcome is speculative at present. BAB and BANEST are now being liquidated, along with the state mining bank. As part of a proposed Charter for the Central Bank, intermediation of external credits would be turned over to a private institution, thus completing the withdrawal of public institutions from financial intermediation with the non-bank private sector. While this privatization process could be reversed, there are no strong political pressures to start what would be a costly process of reversal. However, efforts to strengthen the GSF and the BCB proved unsustainable. On balance, the FSAC is rated as of likely sustainability. 4.12 Institutional development objectives were of critical importance in building up a strong prudential oversight capacity. Technical assistance of US$2.4 million was allocated mainly to the SBEF (US$1.6 million), and proved highly effective. Critical to the success of this endeavor was the Government's commitment to establishing a strong authority, the President's appointment of a decisive, charismatic Superintendent with direct access to him on key decisions, the purging of unionized employees inherited from the Central Bank and their replacement by young university graduates and professionals from other disciplines who were readily trainable, but not "stuck in their ways"; IDA's appointment of an experienced, highly competent lead consultant who remained for three years with the program; and the weakness of other institutions in competing for bank oversight responsibilities. 4.13 By contrast, efforts to strengthen the Central Bank institutionally were almost totally ineffectual. The GSF attempted to duplicate functions already assumed by the Superintendency. In early 1989, all the GSF staff trained by IDA had been dismissed by an incoming administration. There was widespread misapprehension, including in the Bolivian Congress, about investing the Central Bank with such an important crisis management function, given its dismal past record of supervising commercial banks. 4.14 Technical assistance to restructure the state banks experienced modest success. The study of BANEST done by IDA consultants proved valuable when the decision to liquidate the bank was adopted in 1991. However, the work with BAB was essentially wasted. 4.15 IDA staff deserve commendation for the extraordinary services rendered to the Bolivian Government in diagnosing and devising an integrated set of policy solutions during the time of preparation of the FSAC. Appraisal was satisfactory, with appropriate emphasis on up-front policy reforms, emphasis on strengthening institutional oversight of the banks, and reduction or elimination of the credit allocation role of the state-owned banks. However, there was inadequate appreciation at the Government's ambivalence about liquidating the state banks, a fact which became readily apparent during implementation of the earlier PFMO. And efforts to strengthen the Central Bank might better have been directed at restoring its basic accounting and 46 management functions, and divesting the BCB of its remaining development credit allocation functions, rather than promoting banking sector management functions which operated at cross- purposes with the SBEF and were too demanding for the BCB's debilitated capabilities. Supervision could be faulted mainly for having accepted the pro-forma action plans for state bank restructuring as genuine indicators of Government commitment at second tranche disbursement. 4.16 The Borrower merits high praise for the alacrity of its response to the impending financial crisis, its steadfastness in resisting the temptation to re-introduce interest rate controls, and its maintenance of a supportive macroeconomic climate. However, failure to follow through in restructuring the state-owned banks strongly suggests the Government did not share IDA's interest in achieving this goal; in these circumstances, the Government should have resolved upon a firm strategy of restructuring, or, if an internal consensus was not achievable, requested IDA to drop this item from the FSAC's list of conditions. Implementing agency performance was mixed, with the SBEF doing very well, and the GSF proving a disappointment. The Government's decision to dismiss all the GSF staff trained by IDA dealt this component a severe setback. And the inability to provide adequate. timely audits was a persistent problem. Overall, borrower performance is rated as satisfactory. Lessons RICs I and II 4.17 Means Incompatible With Objectives. Task managers should avoid combining project objectives which have an overriding resource transfer objective, such as emergency reconstruction, with project components that are likely to add complexity and delay to the procurement and disbursement process. In the case of RICs I and II, it would have been preferable to provide financing against, say, a negative list of imports from the public or private sector, trusting that the source for most of the measures intended to ensure a pro-development impact will come perforce from the well-designed and implemented stabilization program the credits support, i.e., raising interest rates to positive real levels, eliminating exchange rate and capital control distortions, removing trade barriers, etc., rather than from any specific project spending controls. 4.18 Haste Makes Waste. Haste in preparing and appraising the RICs I and II contributed to design flaws and omissions, requiring inordinate investments of IDA supervision resources and less-than-optimal development benefits. Conversely, investment of larger up-front resources in preparing and appraising the FSAC led to proportionately smaller supervision inputs and achievement of a more ambitious program of development benefits. 4.19 Financing Commercial Public Enterprises. IDA funds should not be used to finance investments in commercial public enterprises in the absence of comprehensive conditionality to restructure or privatize them. 4.20 Strengthening Institutional Development. It is apparent that weaknesses in institutional development can play havoc with even the simplest of program loans by impeding disbursement, delaying the delivery of crucial audit information, etc. This suggests that, as a matter of course, preparation should include a more comprehensive, in-depth look at economic and financial capacity prior to, and during, appraisal. Such efforts might have uncovered a more timely, viable solution to the procurement difficulties and a better choice of implementing agency. 47 4.21 Importance of Sound Overall Policy Environment. Despite significant weaknesses in design and implementation, a sound, well-executed, sustained adjustment effort allowed the development impact of these operations to be achieved. Financial Sector Adjustment Credit 4.22 Removing Barriers to Entry to the Banking System. Significant delays in realizing lower real interest rates and smaller financial spreads parallels the experience of other adjusting countries where significant lags often exist between the initiation of stabilization/liberalization and the arrival of a strong supply/growth response. In this case, earlier attention to the removal of barriers to entry might have accelerated the arrival of new entrants and strengthened competitive forces, thereby shortening the response time to the reforms. 4.23 Up-Front Agreement on Purposes of State Bank Reform and Initial Reform Measures. Specific reforms of the state-owned financial institutions should have been agreed, and restructuring measures required, prior to Board Presentation so as to clarify objectives from the outset and establish clear evidence of Governmental commitment. 4.24 Unitary Responsibility for Banking System Oversight. The effectiveness of technical assistance rendered under the FSAC would have been more effective, had the financial reform vested unambiguous authority in a single bank supervisory agency, thereby obviating prolonged bureaucratic in-fighting and speeding effective regulatory action. 4.25 Pro-Active IDA Assistance to Strengthen Financial Audit Capacity. Timely submission of audits requires (i) pro-active IDA steps to ensure the borrower is sufficiently familiar with the requirements and procedures for audit compliance prior to implementation, and (ii) technical assistance under the credit targeted to those project entities lacking the requisite accounting and financial management capabilities.  49 Annex 1 Inflation Rate 240 200 160 120 80 40 0 - Note: the inflation rate for 1985 was 11749% In domestic currency II I 00 00 I 00 00 T 00 00I , I -II +, I 51 Annex III Fiscal Balance as a Percentage of GDP 10 0 -- -- ~ -20 ------------- - - --- - -30 ------------------ --------- -- --- - - -40 151 -40 19ý3 19ý5 i47 -199 i4 19 3 52 Annex IV External Balance & Capital Inflows 30 - 20 -- -- -- 10 0 - -10 --- - - -20 19 0 1992 1994 196 19k8 19b0 19 -a- Current account balance -m- Capital inflows Source: IMF 53 Annex V Real Interest Rates 25- 2 0- - - - - - - - - 15 --------- 10 - -- - - - - - 5 1986 1987 1988 1989 1990 1991 1992 1993 -m- Lending rate -w- Deposit rate -w- Spread 54 Annex VI Nominal Interest Rates 30 2 5 - - - - - -- - - - - - - - - - - - - - - - - - - - - - - - - ---- - - - - - - - 20 ----------------------- -- ---- 10 - - - - - - - - - - --------- - -- - - -- - - -- - 15 1986 1987 1988 1989 1990 1991 1992 1993 -m- Lending rate -- Deposit rate -e- Spread 55 Annex VII Republic of Bolivia Ministry of Finance National Secretariat of Finance La Paz, 9 June 1995 DIFEM/1687/95 Mr. Manuel Penalver Division Chief Country Policy, Industry, and Finance Operations Evaluation Department Re: Draft Performance Audit Report on Reconstruction Import Credit I and II and Financial Sector Adjustment Credit (Credits 1703-BO, 1828-BO, and 1925-BO) Dear Sir: I acknowledge receipt of your letter dated May 24 requesting this Secretariat to comment on the above-mentioned draft report. I am pleased to express, in representation of the Bolivian Government, my agreement with the terms mentioned in that document. Moreover, since the Ministry of Finance, from which this Secretariat depends on, took part in the preparation of the Final Evaluation Report of Reconstruction Import credits, I consider that the degree of compliance with each of its components is satisfactory. Cordially yours, (signed) Lic. Marcelo Machicao P. Undersecretary of Public Investment and External Finance National Secretariat of Finance s 57 Document of THE WORLD BANK FOR OFFICIAL USE ONLY PROJECT COMPLETION REPORT BOLIVIA RECONSTRUCTION IMPORT CREDITS (CREDITS 1703-BO AND 1828-BO) June 28, 1994 Department H Infrastructure Division Latin America and the Caribbean Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise be disclosed without World Bank authorization. 58 FISCAL YEAR January 1 to December 31 CURRENCIES Currency is expressed in US Dollars (US$). Credit financing is expressed in Special Drawing Rights (SDR) whose rate of exchange versus the dollar is variable. FISCAL YEAR January 1 to December 31 Abbreviations and Acronyms IBRD International Bank for Reconstruction and Development. ICB International Competitive Bidding OECF The Overseas Economic Cooperative Fund (Japan) COMIBOL Corporacion Minera de Bolivia. ENFE Empresa Nacional de Ferocarrfles, National Railway Company. YPFB Yacimientos Petrolfferos Fiscales Bolivianos, Bolivian Petroleum Corporation. BAMIN Banco Minero - Bolivian Mining Bank CB Central Bank of Bolivia ENDE Bolivian Power Company - Empresa Nacional de Energfa E16ctrica IDB Inter-American Development Bank. Banco Interamericano de Desarrollo NEP New Economic Policy RIC Reconstruction Import Credit GDP Gross Domestic Product DCD Development Credit Division CPCD Currency and Publication Credit Division IDA International Development Association 59 PREFACE This is the Project Completion Report (PCR) on the two Reconstruction Import Credit Projects in Bolivia financed under Credits 1703-BO for SDR 48.4 million (US$55 million equivalent) and Credit 1828-BO for SDR 36.1 million (US$47. 1.0 million equivalent). Credit 1703-BO was approved on May 20,1986 and made effective on October 14, 1986; the original closing date, June 30 1988 was subsequently extended three times to December 31, 1991. Credit 1828-BO became effective on March 28, 1988, and its Closing Date, June 30, 1990, was extended three times to December 31, 1992. RIC II was cofinanced by OECF (Loan BV-C1, Yen 7,250,000,000 signed on December 12, 1988, whose original closing date of March 27, 1991 was extended to March 27, 1995. The PCR was prepared by the Infrastructure Division Country Department III, Latin America and the Caribbean Regional Office. It is based on the "Report and Recommendation of the President, April 1986" which was presented to the Bank's Board regarding Reconstruction Import Credit Project (Credit 1703-BO); the "Report and Recommendations of the President of June 1987" in support of the Second Reconstruction and Import Credit Project (Credit 1828-BO); the respective Development Credit Agreements and the Project Agreements; materials in project files, and/or obtained from the staff of the Bank Resident Mission in La Paz, who were associated with the project. This report contains Part I and II prepared by the Bank and Part I prepared by the Borrower. Part II reflects the Borrower's perspective of the project's implementation achievements and difficulties. Given that the Second Imports Credit (RIC II) was a, de facto, extension of RIC I, whose implementation was initiated while RIC I was being implemented, it was agreed that a joint PCR should be prepared for RIC I, and RIC H.  61 EVALUATION SUMMARY A. Objectives i. RIC I was designed to provide emergency assistance in support of the stabilization and structural adjustment program (New Economic Policy, NEP) that Bolivia imposed itself in August, 1985. Prior to the Paz Estenssoro Government, taking office in August, 1985, the Bolivian economy was characterized by hyper inflation (up to 24,000 % annually), high debt burden and negative GDP growth. RIC I was the first operation since the Bank suspended its operations in 1981. Specifically, the Project aimed at: (a) rebuilding private and public production base through the provision of financing for necessary imported goods, (b) restructuring the key sectors of the economy consistent with the new role of the state stipulated in NEP; and (c) achieving macroeconomic stability and economic growth. ii. RIC II complemented the objectives and activities of the RIC I, and was considered a centerpiece of IDA's operational strategy in Bolivia. The overall objective was to maintain the momentum of the reforms at the macroeconomic and sectoral level, and to provide critical financing to restore economic growth. In addition the project included two important objectives, namely: (a) strengthening of public investment programming and management; and (b) a definition of an appropriate policy response to the social problems associated with the adjustment process. B. Implementation Experience iii. The most innovative feature of the projects was that they were conceived as something between an investment project and an adjustment operation. The quick-disbursement against imports and periodic review of the macroeconomic as well as sectoral reform programs are essential elements of an adjustment operation. There was, however, no Letter of Development Policy or its equivalent. Disbursements were not tied to policy conditionalities. On the other hand, the projects financed specific needs of the public and private enterprises, although the resources were not directed to a specific investment project of these enterprises. The projects' 62 targeted financing resulted in a more restrictive use of the resources but ensured the flow of funds to priority sectors. iv. Although both Projects were to be quick-disbursing, disbursements took much longer than expected. The RIC I credit was to be disbursed within a period of one to two years after credit effectiveness in 1986; instead, disbursements took four years after three extensions of the closing date. Similar problems occurred with the RIC II project that was to be completed in two years, by 1989, but was actually completed by the end 1992, after three formal closing date extensions. v. One of the reasons for the slower than expected disbursements was the restructuring process undertaken by some of the most important public enterprises such as COMIBOL and YPFB. Strikes by unions against drastic personnel reduction, for example, disturbed companies operations. Inappropriate procurement procedures used for public sector purchases were cause of substantial implementation delays. The procedures were cumbersome, involving, at times, discretionary decisions from higher authorities of the Central Government. On average, the bidding process to arrive at a final decision could take two years. Lack of familiarity with the Bank's procurement Guidelines further delayed IDA's disbursements. vi. The major risk for the projects was the possibility that the Government might not be able to keep on track the reform program, in a potentially conflicting social environment. The relative stability of the economy achieved early in the development of the program helped to control social unrest. The establishment of an emergency social program improved further the chances of the Government to succeed in its efforts. C. Project Results vii. Notwithstanding implementation delays, overall, the projects achieved their specific objectives. The stabilization program succeeded and inflation was brought under control during project implementation. Economic growth resumed in 1987 with 2.6% to an average of 3.2% between 1988 to 1992, therefore modest real growth in per capita GDP was achieved. Important contributions for GDP growth came from the public enterprises supported by the credits. viii. The hydrocarbons sector led by YPFB, contributed with a 2.4% real growth, on average, between 1987 and 1992 despite important reductions of the price for the natural gas exported to Argentina. The power sector also contributed to GDP growth, through ENDE. Average growth in the sector was 3.9% for the 1987-92 period. Transportation, including the railways component contributed with an average growth of 3.5% for the same referred period. The mining sector's contribution to growth in these years came mostly from the private sector given that most COMIBOL mines were either non-operating, closed or the ones remaining opened confronting historical low prices for the minerals the company produced. Despite a large decline in COMIBOL production, overall, the mining sector grew at 13.3% for the period 1987-1992. 63 ix. Private sector contribution to GDP growth came basically from export oriented sectors. Non-traditional agriculture responded relatively quickly to the NEP incentives. A modest annual average growth of 1.5% for the agriculture sector, was mainly due to poor results with traditional highland crops, which diminished the positive impact of export oriented crops in the lowlands, mainly soybeans. Manufacturing sector grew at 5.1% annually during the same period after having adjusted to the new incentives framework established by the NEP and the increased competition in local markets. x. There was not an explicit rate of return calculated at the time of appraisal for both projects. It was generally accepted that the returns on investments made with the proceeds of the IDA Credits by public enterprises were largely positive and justified. The RIC Credits were to be evaluated in light of their contribution to the overall economic stabilization and adjustment program. D. Project Sustainability xi. The projects helped the implementation of the NEP in its crucial phase of tight fiscal and monetary policies, allowing at the same time application of resources for crucial investments by the public enterprises, basis for economic recovery. The recovery of production of most public enterprises helped to preserve the credibility of the reform program which, by end-1987, had stabilized the economy and promoted modest growth. The foundations of a sound economic policy laid-out by the NEP and supported by the projects, have since continued to prevail in Bolivia, after two democratic changes of Government. E. Lessons Learned xii. The main lessons learned can be summarized as follows: (a) The combination of a quick-disbursing operation with sector specific investments was unique and could be useful in response to the urgent needs to reconstruct an economy in circumstances similar to those of Bolivia at that time; (b) Continued commitment by the Government to the economic stabilization program it had designed upfront was the key to the success of the Projects; a potential risk which did not occur was that the Bank had little control on disbursements of the loans if Government committment had waivered; (c) The timing of this type of operation is critical in order to meet emergency needs of financing imported goods essential for economic growth and export resumption; 64 (d) The high quality and well focussed technical assistance in macroeconomic and sector restructuring provided by IDA was instrumental not only to implement the Projects but also to rebuild the IDA lending program; (e) By itself the project may not have had the same success if it had not been for the social adjustment projects (Emergency Social Fund) which helped during the adjustment period to ease political pressure against the Government's painful reforms; (f) Lack of familiarity with the Bank's procurement guidelines was one of the reasons for disbursement delay. For countries where the Bank has not worked before or lending operations have been suspended for some time, intensive training on procurement and disbursement at project start-up is essential to avoid unnecessary implementation delay; and (g) Attention to detail in the design and implementation of the socially sensitive program which required a lay-off of thousands of public sector workers was an important complementary action for the success of the NEP program. (h) Intensification of reform was heightened by focusing on fewer sectors (in RIC II) 65 PART I. PROJECT REVIEW FROM BANK'S PERSPECTIVE A. Project Identity Project Name: Reconstruction Import Credit I and II Credit Number: 1703-BO and 1828-BO RVP Unit: Latin America and Caribbean Region Country Department III Country: Bolivia Sector: Multisectoral B. Background 1. Policy Context. The Bolivian economy grew at a rapid pace during the 1970s, supported by an infusion of external capital attracted by rising prices of mineral and petroleum exports. Subsequent use of most credit funds in projects of marginal value and the capital flight led, in 1979, to a situation in which the debt burden exceeded the absorptive capacity of the economy and as a result net foreign lending was halted. Growing political instability was noted since 1978 and by early 1980s severe internal and external imbalances became apparent; GDP started to contract and external financing of private sources dried up. Internal revenues from tax collections and tariffs were rapidly eroding by rising inflation. Furthermore, with authorities trying to maintain or increase real wages in the public sector, the fiscal deficit supported by domestic credit expansion increased. By August 1985 inflation reached 24,000% on annual basis. 2. The New Economic Policy (NEP) introduced by the Paz Estenssoro Government in August 29, 1985, was designed to stabilize the economy and to introduce structural reforms that were to put Bolivia back on the path of economic growth. Stabilization was to be achieved by introduction of a managed float of the exchange rate through an auction system, which immediately devalued the local currency by 93% against the American dollar. Furthermore, a sharp reduction of the fiscal deficit was to be achieved through the elimination of Government subsidies, a drastic rise in the Government regulated prices of hydrocarbons derivatives, elimination of Central Government's transfers to public enterprises and a restoration of fiscal revenues. The latter was to be brought about by returning economic activities to formal channels as a consequence of the elimination of the gap between foreign exchange in the official and parallel markets and elimination of price controls. The measures also included phasing out Central Bank financing of the Treasury; the introduction of a tax reform to increase government revenues; and controls over public sector revenues by centralizing all public sector accounts in the Central Bank. 3. The Structural Reform measures consisted of freeing prices across the economy (in the financial, goods and labor markets), and using economic criteria to set those prices that, inherently, were not market determined. External trade was liberalized and import tariffs were 66 to be reduced to a flat 10% of the CIF price, except for capital goods for which the import tariff was reduced to 5%. The reorganization and decentralization of major public enterprises (e.g. COMIBOL and YPFB) were initiated to improve their efficiency. The Central Bank and the Finance and Planning Ministries were to initiate monetary and tax reforms consistent with the NEP. The overall structural reform effort was aimed at reducing Government intervention, establishing market prices, and restoring incentives for private sector activity to increase the efficiency of the Bolivian economy. 4. In response to the Government's urgent request, IDA identified the project in November 1985, and appraised it in February 1986. The first Reconstruction Import Credit (RIC I) was approved by the Executive Directors on May 20, 1986. It was the first Bank/IDA operation for Bolivia since 1980. The Credit, for SDR 48.4 million (US$55 million equivalent at the time of Credit approval), was designed as an emergency operation to help reactivate the economy after almost five years of economic decline, and to rebuild export capacity by providing financing for imported and locally produced inputs for both public and private enterprises. The operation was developed in support of the stabilization and adjustment measures introduced by the Government in August 1985, and was closely associated with the IMF Standby Operation approved on June 19, 1986. RIC I was signed on June 2, 1986 and became effective on October 14, 1986. The original Closing Date was June 30, 1988. 5. The second Reconstruction Import Credit (RIC II) for SDR 36.1 million (US$47.1 equivalent at the time of the Credit approval) was approved on June 23, 1987, signed on July 31, 1987 and became effective on March 28, 1988. The operation followed closely the RIC I credit and was designed to help maintain the momentum of the stabilization and adjustment measures introduced by the Government in August 1985. The RIC II was cofinanced with OECF. The OECF Loan of Yen 7.25 billion was signed on December 12, 1988. Its original closing date was March 27, 1991. C. Project Objectives and Description 6. Project Objectives. RIC I was designed to provide emergency assistance in support of the stabilization and structural adjustment program that Bolivia imposed itself in August, 1985. More specifically, the Project aimed at: (a) rebuilding private and public production base through the provision of financing for necessary imported goods; (b) restructuring the key sectors of the economy consistent with the new role of the state stipulated in NEP; and; (c) achieving macroeconomic stability and economic growth. 7. RIC II complemented the objectives and activities of the RIC I, and was considered a centerpiece of IDA's operational strategy in Bolivia. The overall objective was to maintain the momentum of the reforms at the macroeconomic and sectoral level, and to provide critical financing to restore economic growth. In addition, the project included two important 67 objectives, namely: (a) strengthening of public investment programming and management; and, (b) a definition of an appropriate policy response to the social problems associated with the adjustment process. 8. Project Components. The RIC I Project was to focus on financing critical imports for seven key sectors for economic recovery and export resumption. The operation was to be quick-disbursing. Most actions provided under the Credit were linked to the specific sectors. The initial allocation for the sectors supported by the credit was: (a) Mining (US$21 million) comprising (US$14.5 million) for COMIBOL, the state mining company, subject to substantial progress in restructuring its operations, and (US$6.5 million) for private mining enterprises; (b) Hydrocarbons (US$11 million) for critical imports for the state petroleum company (YPFB); (c) Power (US$1.8 million) for the state power company (ENDE), subject to conditions on ENDE's tariffs and capital improvement program; (d) Transport (US$4.5 million) for the state railway company (ENFE), for critical imports, subject to action on cost and tariff studies; (e) Agriculture (US$7.2 million) for imports of agricultural inputs for private farmers and traders; and (f) Industry (US$4.5 million) for manufacturing and agro-based industry, providing financing for inputs needed by qualified industrial exporters. Unallocated funds (US$5 million) provided also some flexibility to take into account different progress rates to allow program modification in the event of deviation from the overall program. 9. The RIC II Project was designed to cover initially: (a) priority equipment, spare parts, supplies, materials and other imported inputs needed by three public enterprises, namely YPFB (US$13 million), ENFE (US$7 million), and the National Road Service (SNC) (US$3.6 million); (b) foreign exchange needed by the importers of inputs for the agriculture sector (US$8 million); (c) working capital requirements of private producers and exporters (US$7 million); (d) technical assistance to facilitate the restructuring and rehabilitation of the railway subsector (US$0.5 million); and (e) the procurement management contracts resulting from the public sector import requirements (US$1 million). Unallocated funds (US$7 million) provided the mechanism needed to facilitate reallocation of funds to sectors which proved to be most efficient in using resources as the operations progressed. Credit allocation to each of the sectors was based on an analysis of specific import needs based on production and efficiency targets and priorities for short-term recovery. The Credit proceeds were to be on-lent by the Central Bank through financing agencies to YPFB, ENFE and the private sector producers and exporters, thus helping ease their shortage of own funds or local credit for the purchase of imports and local inputs. In the case of agriculture, foreign exchange funds were to be disbursed by the Central Bank on the basis of documented import payments. Finally, the funds needed by the SNC for emergency road rehabilitation works were to be transferred as a grant. 68 D. Project Design and Organization 10. The most innovative feature of the projects was that they were conceived as something between an investment project and an adjustment operation. The quick-disbursement against imports and periodic review of the macroeconomic as well as sectoral reform programs are essential elements of an adjustment operation. There was, however, no Letter of Development Policy or its equivalent. Disbursements were not tied to policy conditionalities. On the other hand, the projects financed specific needs of the public and private enterprises, although the resources were not directed to a specific investment project of these enterprises. The projects' targeted financing resulted in a more restrictive use of the resources but ensured the flow of funds to priority sectors. 11. The Projects were designed as a group of separate and independent sectoral subprojects. This design feature allowed each sector component to advance independently of the others. This resulting flexibility was useful because it was difficult to anticipate the pace of implementation in each sector. 12. The project design of RIC II incorporated the implementation experience and lessons learned from RIC I. Firstly, the number of sectors covered was reduced from 7 to 4 in order to intensify implementation of sector reform programs. Secondly, mechanisms to allocate credits were simplified, taking advantage of the on-lending agreements and coordinating mechanisms already established under RIC I. Thirdly, interim procedures for public procurement were established, mandating the use of external procurement agents and eliminating cumbersome Government regulations. Lastly, clear lines of responsibility and accountability were established within the principal implementing agencies. 13. The scope of the projects was appropriate given the urgent need for financing imported inputs. Production levels of both public and private sectors were falling continuously in the first half of the 1980s, following political and economic instability. External shocks generated by drastic reduction of tin and petroleum prices in 1985 and 1986 further deteriorated the Government's foreign exchange earnings. The IDA Credits helped to provide about 10% of Bolivia's annual import requirements, to rebuild private sector confidence in public enterprises' ability to comply with their financial commitments and to generate additional resources from bilateral donors. Through annual Consultative Group meetings for Bolivia, donors have contributed to the reforms with grants and concessional credits starting with US$300 million at the end of 1986 to an average of US$800 million in commitments for the first years of the 1990s. 14. As part of the policy dialogue, the Bank helped the Government to put together a medium term development program as well as rehabilitation plans for the public enterprises which received financing under both operations. This provided the basis for further complementary operations in support of the Government's stabilization and structural adjustment program. 69 15. The timing of both projects was appropriate to meet Government needs for hard currency and critical imports, and to involve the Bank from the early stages of NEP's implementation. The approval of a follow-up operation only a year after the first RIC's approval shows IDA's readiness to help the Government recover macroeconomic stability. 16. The Ministry of Finance and the Central Bank shared overall responsibility for the implementation and administration of the Credit. Credit proceeds were made available to the Central Bank under a subsidiary agreement with the Government. Funds were on-lent by the Central Bank to COMIBOL, YPFB, ENFE, and ENDE under separate financing agreements. Under Credit 1703-BO, beneficiaries included: State enterprises, private mining, industrial and agricultural producers and traders. Standard IDA terms applied. Relending terms under Credit 1703-BO were the following: (i) State enterprises: 14.5%, 10 years with 3 years of grace; and (ii) private sector: 14.5%, maximum of 1 year with 3 months of grace. Under Credit 1828-BO beneficiaries included: State enterprises; private sector producers and exporters in agriculture, agro-based industry and manufacturing. Standard IDA terms applied. Relending terms were: (i) State enterprises: 8.5%, 15 years and 3 years of grace; and (ii) Private Sector: up to 13.5%, maximum of 1 year with 3 months of grace. For most components, the approach comprised preparation of a list of authorized imports, and the use of appropriate procurement procedures for their acquisition. 17. The Central Bank performed its role of on-lending agent through two of its Divisions: the Currency and Public Credit Division (CPCD), in charge of allocating credits to public enterprises, and the Development Credit Division (DCD), in charge of administering the credits to the private sector. This arrangement called for a closer coordination role of the Ministry of Planning, which took over from the Ministry of Finance the role of monitoring the use of the credit. As bottlenecks or implementation problems were identified, necessary actions were taken to redress those situations, including discussions with the Bank to reallocate resources, as needed. 18. The centralization of the credits under the Central Bank authority provided for better monitoring and control of the use of the credits. The management capacities of most of the public enterprises were yet too weak, at the time, to take on the responsibility of administering credits. Before the NEP Decree was issued, public enterprises were contracting financing for their projects directly, and that practice generally resulted in mismanagement, cost over-runs, and dubious quality of goods and services purchased. The NEP Decree mandated the public enterprises to first receive formal authorization from the Ministry of Planning before engaging in any discussion over possible credits, and to sign a credit agreement with the Central Bank to have access to the proceeds of the credit. With those rules in place, public enterprises were obliged to use, as efficiently as possible, their share of the RIC credit resources. E. Project Implementation 19. Legal and financial covenants for both projects were, generally, complied with despite some delays. The RIC I credit was to be disbursed within a period of one to two years after 70 credit effectiveness in 1986, instead, disbursements took four years after three extensions of the closing date. Similar problems occurred with RIC II project that was to be completed in two years, by 1989, but was actually completed by the end 1992, after three formal closing date extensions. 20. One of the reasons for the slower than expected disbursements was the restructuring process undertaken by some of the most important public enterprises. COMIBOL laid-off more than 20,000 miners in the first 18 months of the Paz Estenssoro Government's tenure, and closed most of its unprofitable mines. YPFB also reduced its personnel and suffered, as a result, from strikes organized against it by its unionized workforce, which affected the company's efficiency. 21. Inappropriate procurement procedures used for public sector purchases were cause of substantial implementation delays. The procedures were cumbersome, involving, at times, discretionary decisions from higher authorities of the Central Government. On average, the bidding process to arrive at a final decision could take two years. Lack of familiarity with the Bank's procurement Guidelines further delayed IDA's disbursements. RIC II was cofinanced with OECF with a loan totalling Yen 7.25 billion. OECF requested IDA to review and give no- objection to bidding documents and bid evaluation for goods and services to be financed under the OECF loan. In the beginning, disbursements of OECF loan was delayed by the lack of understanding of procurement arrangements among the Government, IDA and OECF's loan which was extended to March 27, 1995. 22. Modification of the existing procurement system for the public sector was necessary and beneficial for the project implementation. In an effort to streamline procurement procedures, the Government issued the Supreme Decree 21660 in mid-1987, which made mandatory the use of external procurement agents for major public sector purchases of goods and services. The new Decree improved the procurement system, both in terms of the time required and associated costs, notwithstanding the initial delays caused by the need of those involved in public sector procurement to adapt to the new system. 23. The initial slow response by the private sector to the availability of import credit lines was not completely foreseen and slowed down disbursements. The lines of credit established through both projects were intended to alleviate shortage of funds available to the private sector. Under the credit system in practice at the time, the Central Bank (through the DCD) provided re-discounting facilities to the private banking sector with resources coming from multilateral or bilateral organizations. In general, rediscounting rates were lower than market-prevailing interest rates. Nevertheless, the financial situation of both banking and productive private sectors after the high inflation and during the first years of the stabilization program was very difficult. Excessive indebtness to private banks by private companies, combined with a high exposure and associated insolvency risks were some of the reasons for the private sector's inability to take advantage of available credit funds. 71 24. Expectations about the private sector's response to the new incentives framework provided by the NEP were not completely fulfilled. The private sector was doubtful about the ability of the NEP to stabilize the economy, resulting in the private sector's "wait and see" attitude. Clearly, from the private sector's perspective the enactment of the NEP Decree was not sufficient to put at risk any additional investments or to increase the level of production at the prevailing interest rates. 25. The major risk for the projects was the possibility that the Government might not be able to keep on track the reform program, in a potentially conflicting social environment. The relative stability of the economy achieved early in the development of the program helped to control social unrest. The establishment of an emergency social program improved further the chances of the Government to succeed in its efforts. 26. An important action which positively affected project implementation was the Government's decision to engage in an effort to restructure the financial sector. With the support of the IDA credit 1925-BO the Government started the Financial Sector Adjustment Program that was designed to confront problems which affected a large number of financial institutions. The Government used some of the counterpart funds of the Adjustment Credit to support a rediscounting scheme which aimed to extend maturity terms and lower interest rates of the existing loans. The aim was to assist private banks and their clients to resume operations under better working conditions, including the extensive use of credit lines provided by the RIC Projects. F. Project Results 27. Notwithstanding implementation delays, overall, the projects achieved their specific objectives. The stabilization program succeeded and inflation was brought under control during project implementation. Economic growth resumed in 1987 with 2.6% to an average of 3.2% between 1988 to 1992, therefore, modest real growth in per capita GDP was achieved. Important contributions for GDP growth came from the public enterprises supported by the credits. 28. The hydrocarbons sector led by YPFB, contributed with a 2.4% real growth, on average, between 1987 and 1992 despite important reductions of the price for the natural gas exported to Argentina. An increase in crude and gas production was made possible by the financing provided for spare parts, chemical products, machinery and technical assistance provided by the credits. YPFB generated more revenues for the Treasury both from foreign and domestic market sales. 29. The power sector also contributed to GDP growth, through ENDE. Average growth in the sector was 3.9% for the 1987-92 period. After agreement with the IDA on the least-cost alternative for its expansion plan, ENDE, increased its power generation by investing in a thermal plant (financed by RIC I project), which, in turn, increased the reliability of power supply and allowed many productive sectors to receive adequate level of energy for their use. 72 30. Transportation, including the railways component contributed with an average growth of 3.5% for the same referred period, largely due to the increased capacity of freight transportation of ENFE, restructuring of its tariffs structure and initiation of the implementation of the action plan to improve financial control of the company. The Credits provided financing for the purchase of spare parts and equipment necessary to continue operations to satisfy the growing demand for railway transportation derived from exports generated by private mining activities in the highlands and non-traditional agriculture crops of the lowlands. 31. The mining sector's contribution to growth in these years came mostly from the private sector given that most COMIBOL mines were either non-operating, closed, or the ones remaining opened confronting historical low prices for the minerals the company produced. Despite a large decline in COMIBOL production, overall, the mining sector grew at 13.3% for the period 1987-1992. Part of this success was related to the financing provided to private mining activities by the private banking system after the restructuring effort supported by the Bank. 32. Private sector contribution to GDP growth came basically from export oriented sectors. Supported by credit facilities made available initially by the RIC projects and then followed with other lines of credit from foreign donors, non-traditional agriculture responded relatively quickly to the NEP incentives. A modest annual average growth of 1.5% for the agriculture sector, was mainly due to poor results with traditional highland crops, which diminished the positive impact of export oriented crops in the lowlands, mainly soybeans. Manufacturing sector grew at 5.1% annually during the same period after having adjusted to the new incentives framework established by the NEP and the increased competition in local markets. As a result, non traditional exports coming from both sectors increased from US$105 million in 1987 up to more than US$205 million in 1992. 33. Although some important changes in the allocation of credits' proceeds occurred during the implementation phase, they did not change the main objectives of the projects. The changes in allocation were anticipated during project preparation to be responsive to different implementation capacity of different beneficiaries, and to the fine-tuning of the NEP process. Addition of beneficiaries to the program took place, again in response to emerging needs from key sectors. The emergency character of the operation was always borne in mind when discussing proposed modifications by the Government. Even though the time required for the completion of the two Credits was twice as long as expected, it did not influence the overall positive impact that the credits had in achieving the expected results 34. There was not an explicit rate of return calculated at the time of appraisal for both projects. It was generally accepted that the returns on investments made with the proceeds of the IDA Credits by public enterprises were largely positive and justified. The RIC Credits were to be evaluated in light of their contribution to the overall economic stabilization and adjustment program. 73 35. The Credits had indirect effects on poverty alleviation and income distribution. The Credits contributed to increases in production and productivity, which, in turn, helped to improve employment opportunities and income for workers. Since IDA Credits targeted improvements in commercial agriculture, they did not benefit the poor subsistence farmers in the highlands. G. Project Sustainability 36. The projects helped the implementation of the NEP in its crucial phase of tight fiscal and monetary policies, allowing at the same time application of resources for crucial investments by the public enterprises, the basis of economic recovery. The recovery of production of most public enterprises helped to preserve the credibility of the reform program which, by end-1987, had stabilized the economy and promoted modest growth. The foundations of a sound economic policy laid-out by the NEP and supported by the projects, have since continued to prevail in Bolivia, after two democratic changes of Government. H. Bank Performance 37. The main strength of Bank's performance on the projects was its ability to provide high quality technical assistance by Bank staff and consultants with expertise in different areas. The macroeconomic dialogue regarding the overall program was conducted by Bank staff always bearing in mind the long-term objectives of the reform program. The Bank often played a constructive role as a mediator between the Government's position and IMF recommendations that have not always been followed by the Government. Sectoral Bank experts engaged in comprehensive sectoral restructuring efforts, and later facilitated identification of specific operations supporting the Government's reform program. 38. The Bank played the role as a coordinator of multilateral and bilateral donors which helped the Government identify entities having potential interest in supporting reform programs and make pledges for concessional resources and grants to support the country's efforts. The Consultative Group meetings resumed in 1986 sponsored by the Bank and have since been instrumental in persuading the Government to prepare and to follow consistent economic policies, together with public sector investment proposal that donors have regularly agreed to finance. 39. Intensive supervision was provided for the overall economic program and for sectoral reforms during the life cycle of the projects. Although the overall responsibility for the supervision of the project was vested in the Bank's infrastructure division, other Bank divisions provided on demand, technical resources in areas of their expertise, to supervise implementation of the reform program affecting public enterprises. The Bank also intensified technical assistance and close supervision of the program by resident Bank staff. A decision was made to base two full-time Bank staff at the Ministry of Planning to closely monitor the program. Later on the Bank decided to increase the size and the role of the Resident Mission in Bolivia, in 74 support of a larger involvement in the stabilization and adjustment program and a larger portfolio of credits. 40. However, the Bank could have provided more support on procurement issues created by inadequate compliance with Bank Procurement Guidelines whose use was covenanted in the Credit Agreements. Procurement difficulties created problems for the timely implementation of the projects. Eventually these difficulties were resolved when the Government issued the Supreme Decree 21660 requiring mandatory use of independent procurement agencies for Government-financed procurement, since 1987, for the procurement of goods and services whose value exceeded US$40,000. 41. The Bank's work to identify and prepare the projects was appropriate. Extensive economic and sectoral work for most critical sectors of the economy started during the preparation phase of the projects to assess the most critical areas in which reforms required support. The second RIC, already benefitted from sectoral work started in the mining, financial, and social sectors. 42. The appraisal process was successful. The Bank reviewed import requirements for critical sectors, identified priority requirements to reactivate private sector activities, agreed on implementation arrangements including administrative set-up, on-lending procedures for public and private enterprises, and for procurement and disbursements guidelines. Specific action plans for the public enterprises that were to benefit from the credits were developed to ensure their commitment to the rules established by the NEP. Both credits became effective in accordance with the agreed schedules. 43. The particular design of these projects, being half way between adjustment and investment project, helped the Government and the Bank to support the economic reform program effectively both with financing and technical assistance. This type of credits were not common in previous Bank operations. Given their effectiveness to support important economic program it might lend itself to being replicated in countries affected by economic problems similar to those which were faced in Bolivia. I. Borrower Performance 44. The main strength of the Borrower was its commitment to the overall economic program that was the foundation for the successful stabilization and economic growth. That commitment was strengthened by RIC projects. The main weakness of the Government was the limited number of qualified people who had to carry out the program and the associated projects (including the RIC projects). The Government had to make many painful decisions during the projects cycle, including the layoff of more than 20,000 miners between 1986 and 1989, and a significant reduction of overall public employment and wages. This social hardship was partially alleviated by the creation of emergency programs that generated employment for an important number of unemployed miners. The resumption of economic growth in later years helped also to increase opportunities for employment for dismissed workers. 75 45. The Borrower provided all information needed to prepare efficiently the program and engaged high level officials to speed up the project preparation process. The appraisal and negotiations of the projects involved participation of officials, including the President of the Central Bank and the Ministry of Finance officials, and presented no major problems or differences of view between the Bank and Government in the design, scope and objectives of the project. 46. Taking into account the important shortage of qualified professionals and the number of areas that they had to cover, the overall performance was good. A particular area in which the Borrower did not perform strictly according to legal agreements was the timely submission of independent annual audit reports for the Credits. The reports were invariably submitted with considerable delays after formal reminders were sent by the Bank. Through those audits it was learned that the Central Bank's accounting system was not keeping separate accounts for the Credits, although the information on disbursements was in agreement with Bank records. 47. Initially the Borrower established a Project Coordination Committee, but the Central Bank staff took over the follow up on the credits through DCD and CPCD. Given the number of different agencies involved in the project, and expressions of concerns made by the Bank about the pace of projects implementation, the Ministry of Planning took over the role of program coordinator through its foreign financing unit and helped to improve project implementation and compliance with Bank requirements. The Ministry established periodic meetings with agencies involved in the projects and requested from them mandatory progress reports. J. Bank-Borrower Relationship 48. A fruitful Bank-Borrower relationship helped the projects to succeed and to achieve its objectives. Consultations were held on a regular basis to resolve problems arising during implementation. When judged appropriate, the Bank agreed with the Government to reallocate funds to those categories that proved to be more efficient in the use of the funds. K. Consulting Services 49. Initially the Credits involved limited financing for consulting services. Nevertheless, some public enterprises requested support to develop their restructuring plans. The Bank approved those requests, given their close linkage with the sectoral reform programs under preparation. ENFE and YPFB consultancies were of good quality and useful to resolve specific problems. Technical assistance to the Ministry of Energy was more erratic specially with local consultants. The high turn-over of the consultants provided under the credit did not help to improve significantly the quality of the overall management in the energy sector. 76 L. Project Documentation and Data 50. The legal agreements incorporated the necessary conditions and covenants to ensure that the projects were implemented according to agreements. Inclusion of sectoral specific covenants helped to focus Government's attention on the necessary reforms that had to be pursued in order to receive the benefits from the application of Credit funds. 51. No separate staff appraisal reports were prepared in addition to the Reports and Recommendation of the President, which comprised all relevant information needed for a detailed follow-up during the implementation phase. 52. Overall, sufficient data were available for the preparation of the PCR. The last supervision mission prepared a questionnaire that was forwarded to all beneficiaries of the Credits, to provide pertinent information on the results of the projects. Public enterprises and the Central Bank provided information on disbursements and their own evaluation of performance achieved with the use of the credits' proceeds. This information was timely and useful. M. Lessons Learned 53. The main lessons learned can be summarized as follows: (a) The combination of a quick-disbursing operation with sector specific investments was unique and could be useful in response to the urgent needs to reconstruct an economy in circumstances similar to those of Bolivia at that time; (b) Continued commitment by the Government to the economic stabilization program it had designed upfront was the key to the success of the Projects; a potential risk which did not occur was that the Bank had little control or disbursement of the loans if Government committment had waivered; (c) The timing of this type of operation is critical in order to meet emergency needs of financing imported goods essential for economic growth and export resumption; (d) The high quality and well focussed technical assistance in macroeconomic and sector restructuring provided by IDA was instrumental not only to implement the Projects but also to rebuild the IDA lending program; (e) By itself the project may not have had the same success if it had not been for the social adjustment projects (Emergency Social Fund) which helped during the adjustment period to ease political pressure against the Government's painful reforms; 77 (f) Lack of familiarity with the Bank's procurement guidelines was one of the reasons for disbursement delay. For countries where the Bank has not worked before or lending operations have been suspended for some time, intensive training on procurement and disbursement at project start-up is essential to avoid unnecessary implementation delay; and (g) Attention to detail in the design and implementation of the socially sensitive program which required a lay off of thousands of public sector workers was an important complementary action for the success of the NEP program. (h) Intensification of reform was heightened by focusing on fewer sectors (in RIC II).  79 PART II. PROJECT REVIEW FROM BORROWER'S PERSPECTIVE Republic of Bolivia Ministry of Finance and Economic Development Secretariat of Finance WORLD BANK FINANCING AGREEMENTS FOR RECONSTRUCTION IMPORT CREDITS RIC I AND RIC II Following a five-year period during which Bolivia was not deemed creditworthy by the financial agencies, the Government of Bolivia concluded with the International Development Association two Reconstruction Import Credits, as a stop-gap measure in the spiraling inflation that was taking a toll on the country's economy (RIC I 1703-BO and RIC II 1828-BO), with the following general characteristics: CREDIT RIC I RICH AMOUNT: SDR 48.4 MillionSDR 36.1 Million US$64.0 Million US$47.7 Million ALLOCATION: Public Sector SDR 37.1 MillionSDR 24.6 Million Private Sector SDR 11.3 MillionSDR 11.5 Million SUBSCRIPTION: June 2, 1987 July 31, 1987 The credits were to assist public and private enterprises identified under the Economic Recovery Project in the country's productive sectors and specifically aimed at increasing and improving the production of the final beneficiaries. The beneficiary enterprises under the credits were YPFB, ENDE, ENFE, COMIBOL, SENAC, AASANA, an institution building component for the former Ministry of Energy and Hydrocarbons and a line of credit to promote exports and imports within the private sector. The original allocations were revised several times, owing to the slowness in execution and utilization of funds. This was the case with the allocation to COMIBOL which, because of delays in the procurement process, had to be reallocated to YPFB and ENDE. In the case of the allocation to the private sector, the original target could not be achieved, since because of the above-mentioned delays, by the end of the implementation period for the project other credits under more favorable conditions had become available, and the unutilized funds were subsequently channeled towards the public sector. 80 RIC I (CREDIT 1703-BO) The main objective of RIC I was economic stabilization and support for the Structural Reform Program begun in 1985. It was also intended to reduce the demand for foreign exchange for imports of equipment, machinery and other priority inputs. In this sense, it represented the first stage in the rehabilitation of the beneficiary public enterprises (over the medium run). Initially, 60% of the credit proceeds were to go to the public sector and the rest to the private sector. However, the allocations were revised to reflect the quick-disbursing nature of the financing of each beneficiary enterprise. RIC II (CREDIT 1828-BO) RIC II was approved to continue providing support to economic growth and financing the country's productive sector. The disbursement mechanism was similar to that under RIC I and its utilization was also intended for imported equipment, machinery and other inputs in the sectors of energy, transport, agriculture and manufacturing (the latter in order to foment development in the private sector). IMPACT ON THE BENEFICIARY ENTERPRISES A. PUBLIC SECTOR YPFB The import programs of both credits aimed at supporting the requirement of inputs to continue field operations, maintain the production of liquid products needed by the domestic market and boost gas exports. The enterprise's production volume was consequently maintained, which made it possible to guarantee the return on the funds required by the National Treasury within the guidelines of the then current economic policy. Likewise, with the importation of equipment, the drilling of new fields increased, which subsequently resulted in an increase in production. ENDE The credit proceeds allocated to ENDE enabled it to purchase spare parts, supplies for its facilities and equipment for operations and maintenance of its Corani and Santa Isabel hydroelectric plants and the Santa Cruz and Villamontes thermal plants, and to acquire a seventh gas turbine. The import program made it possible to satisfy the rise in demand that had direct implications for urban, industrial, commercial, agricultural, etc., growth in the departments of Santa Cruz and Cochabamba. ENFE ENFE's import program covered imported materials, spare parts and track equipment needed to improve the western and eastern railway networks and to provide technical assistance for the restructuring and implementation of freight tariffs. With these assets, the company's productivity was 81 maintained at an acceptable level, although the return was not as great as expected owing to labor union and political issues. COMIBOL The allocation to the Corporaci6n Minera de Bolivia was made to purchase supplies such as chemical products, technical inputs and equipment, with a view to a reactivation of production. The program facilitated in the replacement of ore extraction equipment, ensuring normalcy of production. SENAC The acquisition of machinery and spare parts resulted in an increase in the operating capacity of the National Roads Service, which helped to ensure satisfactory road maintenance and rehabilitation, thereby producing significant savings in the wear and tear of transport vehicles and in the related operating costs. B. PRIVATE SECTOR The objective of the line of credit to the private sector was to support the Government of Bolivia in the reactivation of exports, through the financing of equipment, spare parts and other products intended for use by the mining, agricultural, industrial, etc., sectors and to finance national capital goods required by the industrial exporters. Initially, this line of credit had strong demand from the productive private sector. However, to the extent that the growth process was stabilizing and other financing was available from other agencies, demand eventually fell to zero owing to the more favorable conditions associated with other credit available. The export of many products was promoted, including coffee, soybean, wood, leather, cotton, chestnut, etc., and raw materials were imported for agriculture, heavy engineering, chemical textiles, and the like. RELATIONS WITH THE BCB AND THE FORMER EX-MPC The experience gained during execution of RIC I and RIC II for the Central Bank of Bolivia was positive and satisfactory. Some problems arose in the implementation of the credits, owing to a lack of knowledge about credit procedures on the part of the beneficiary enterprises. Use of the Special Account facilitate with disbursement flow. However, the "historical balance* entry of the Special Account did not clarify in time that the transactions were to be made in dollars and not SDRs. This transaction which reduced the amount of the overall credit, was prorated among the beneficiaries. 82 On certain occasions, overdrafts occurred because the World Bank had accepted direct requests from the beneficiaries that did not have authorized signatures or control over the total allocated. These problems were solved following an agreement with World Bank. Exchange-related differences caused delays and differences in the subloans from the Government of Bolivia to the beneficiary enterprises, which were made in dollars, whereas at the same time the World Bank's credit to the Republic of Bolivia was denominated in SDRs. These difficulties were subsequently absorbed by the National Treasury. In general, close coordination was maintained between the Central Bank of Bolivia, the World Bank and the MPC, which made it possible to resolve the difficulties that arose in a timely manner. The Government of Bolivia considers that the presence of the MPC as a liaison entity between the main executing agency (BCB) and the financing entity (IBRD) was an important link that helped resolve problems and facilitate disbursements. 83 PART M. STATISTICAL INFORMATION CREDIT 1703-BO QUARTERLY DISBURSEMENTS RECONSTRUCTION IMPORT CREDIT Period Datea Disbursement Cum. Percent Disbursed (Historical USD Disbrusements EQ) 10/1/86 - 12/31/87 8,865 8,865 18.5 10,542 01/04/87 - 03/31/87 8,865 18.5 04/01/87 06/30/87 5,393 14,259 29.8 7,058 07/01/87 - 09/30/87 6,070 20,329 42.5 7,634 10/01/87 - 12/31/87 4,040 24,370 50.9 5,372 01/01/87 - 03/31/88 2,872 27,242 56.9 3,972 04/01/88 - 06/30/88 3,898 31,141 65.1 5,344 07/01/88 - 09/30/88 1,541 32,683 68.3 1,996 10/01/88 - 12/31/88 1,685 34,369 71.8 2,257 01/01/88 - 03/31/89 3,319 37,688 78.8 4,371 04/01/89 - 06/30/89 251 37,940 79.3 313 07/01/89 - 09/30/89 273 38,213 79.9 344 10/01/89 - 12/31/89 5,120 43,334 90.6 6,625 01/01/90 - 03/31/90 1,018 44,352 92.7 1,343 04/01/90 - 06/30/90 2,208 46,561 97.3 2,912 07/01/90 - 09/30/90 677 47,238 98.7 924 07/01/90 - 12/31/90 617 47,855 100.0 885 84 CREDIT 1828-BO QUARTERLY DISBURSEMENTS SECOND RECONSTRUCTION IMPORT CREDIT Period Dates Disbursement Cum. Disbrusements Percent Disbursed (Historical USD EQ) 01/01/88 - 03/31/88 04/01/88 - 06/30/88 2,194 2,194 6.1 3,011 07/01/88 - 09/30/88 4,046 6,240 17.3 5,199 10/01/88 - 12/31/88 4,617 10,858 30.1 6,073 01/01/89 - 03/31/89 110 10,968 30.4 145 04/01/89 - 06/30/89 244 11,213 31.1 301 07/01/89 - 09/30/89 3,841 15,054 41.7 4,801 10/01/89 - 12/31/89 882 15,936 44.2 1,124 01/01/90 - 03/31/90 4,169 20,106 55.7 5,467 04/01/90 - 06/30/90 3,085 23,191 64.3 4,072 07/01/90 - 09/30/90 1,967 25,159 69.8 2,716 10/01/90 - 12/31/90 1,902 27,062 75.0 2,741 01/01/91 - 03/31/91 2,654 29,716 82.4 3,773 04/01/91 - 06/30/91 1,304 31,020 86.0 1,747 07/01/91 - 09/30/91 277 31,298 86.8 367 10/01/91 - 12/31/91 900 32,198 89.3 1,246 01/01/92 - 03/31/92 361 32,560 90.3 499 04/01/92 - 06/30/92 1,414 33,974 94.2 1,956 07/01/92 - 09/30/92 1,318 35,293 97.9 1,930 10/01/92 - 12/31/92 730 36,024 99.9 1,046 01/01/93 - 03/31/93 21 36,045 99.9 29 04/01/93 - 06/30/93 22 36,068 100.0 32 85 1. Related IDA Credits Amount (less Loan/Credit Fiscal cancellations) Number Year Purpose Bank IDA 20120 1989 Export Corridors 37.0 23950 1992 Road Maintenance 80.0 86 2. Pfect ThdaNe: RIC I, CREDIT 1703-BO Benchmarks Dt Planned Actu Identification Nov. 1985 Nov. 1985 Preparation Mission Nov.85-Feb 1986 Nov.1985 to Feb. 1986 Appraisal Mission Feb. 3, 1986 Feb. 3, 1986 Loan Negotiations Apr.14, 1986 Apr.14-18, 1986 Board Approval May 20, 1986 May 20, 1986 Loan Signature June 2, 1986 June 2, 1986 Loan Effectiveness October 1986 Oct. 14, 1986 Project Completion Dec. 31, 1987 Dec. 31, 1990 Loan Closing Jun. 30, 1988 Dec. 31, 1990 RIC 11, CREDIT 1828-BO Benchmarks Daa Planned Ai_ Identification Oct./Nov. 1986 Preparation Mission Nov. 1986 Nov. 1986 Appraisal Mission Feb. 1987 Feb.3, 1987 Loan Negotiations May 1987 May 28, 1987 Board Approval June 1987 June 23, 1987 Loan Signature July 1987 July 31, 1987 Loan Effectiveness March 1988 March 28, 1988 Project Completion Dec. 31, 1989 June 30, 1990 Loan Closing June 30, 1990 Dec. 31, 1992 87 Document of THE WORLD BANK FOR OFFICIAL USE ONLY PROJECT COMPLETION REPORT BOLIVIA FINANCIAL SECTOR ADJUSITMENT CREDIT (CREDIT 1925-BO) June 24, 1994 Trade, Flanace, ladustry and Energy Division Country Department IH Latin America and the Caribbean Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise be disclosed without World Bank authorization. 88 CURRENCY EQUIVALENTS Currency Unit = Boliviano (Bs) US$1.00 = Bolivianos 4.56 (March 30, 1994) FISCAL YEAR OF BORROWER January 1 to December 31 ABBREVIATIONS AND ACRONYMS BAB - Banco Agricola de Bolivia BAMIN - Banco Minero BANEST - Banco del Estado BCB - Banco Central de Bolivia CPI - Consumer Price Index ESAF - IMF Enhanced Structural Adjustment Facility FSAC - Financial Sector Adjustment Credit GD - Gerencia de Desarrollo (Development Credit Department - Central Bank) GDP - Gross Domestic Product GSF - Gerencia Principal del Sistema Fnanciero (Financial System Department - Central Bank) IDA - International Development Association IDB - Inter-American Development Bank IMF - International Monetary Fund LIBOR - London Interbank Offering Rate LDP - Letter of Development Policy OECF - Overseas Economic Cooperation Fund PFMO - Public Financial Management Operation PPF - Project Preparation Facility SAC - Structural Adjustment Credit SAFCO - Financial Administration and Control System SBEF - Superintendency of Banks and Financial Entities SDR - Special Drawing Rights SOE - Statement of Expenditures UNDP - United Nations Development Programme 89 PREFACE This is the Project Completion Report (PCR) for the Financial Sector Adjustment Credit in Bolivia, for which Credit 1925-BO in the amount of SDR 50.6 million (US$ 70 million equivalent) was approved on June 16, 1988. Three subsequent reflow amending agreements were signed for a total of US$ 34.9 million equivalent. The Credit was closed on December 31, 1992. The Credit, including the three subsequent reflow amending agreements was not fully disbursed and an undisbursed balance of SDR 581,001 was cancelled. The last disbursement for Credit 1925-BO-0 was for US$ 1.4 million on September 29, 1989 and for Credit 1925-BO-3 was for US$ 5.4 million on October 10, 1991. The PCR was prepared by the Trade, Finance, Industry and Energy Division of the Latin America and the Caribbean Regional Office (Preface, Evaluation Summary, Parts I and I). The Borrower sent a draft of Part II to IDA on January 28, 1994 and a letter of April 20, 1994 indicating basic agreement with the presentation in the Preface, Parts I and III. Preparation of this PCR was started during IDA's final supervision of the project in 1992, and is based, inter alia, on the Memorandum to the President; the Development Credit Agreement, including amendments; supervision reports; correspondence between IDA and the borrower; and internal IDA memoranda.  91 EVALUATION SUMMARY i. Background. The Financial Sector Adjustment Credit (FSAC) was developed to support the Financial Sector Reform Program established by the Government in early 1987 with IDA support. Following an IDA report, "Bolivia Financial Sector Study" presented in July, 1987, a Reactivation Decree was issued incorporating many of the report's recommendations, and discussions were held of an IDA credit to support the reforms. The main issues identified as affecting Bolivia's financial system were: (i) its shallowness resulting from lack of confidence in medium- and long-term economic performance and in the soundness of financial institutions; (ii) the weak financial condition of several banks; (iii) the high cost of financial intermediation; and (iv) the high interest rates in real terms for both deposits and loans. While it was recognized that significant measures had been taken in the Economic Recovery Program to liberalize the financial system, further measures were needed to improve regulation and supervision, remove select impediments for financial market efficiency and reduce the State's role as an owner of financial intermediaries. ii. With the 1987 reactivation decree and prior measures, the Government had taken actions to maintain fiscal and monetary programs conducive to stability, liberalization of the exchange regime, and liberalization of interest rates. The FSAC was designed to support Bolivia's medium-term adjustment program for 1988-1989. This program was aimed at consolidating the initial stabilization efforts and shifting the focus of economic policies toward the achievement of a sustainable rate of growth and viable balance of payments through export diversification, higher domestic savings and price stability. The program was designed with the immediate intent of confronting the problem of the large number of financial institutions with solvency problems within the context of a medium-term program to develop a resilient, solid and efficient financial system. Measures included under the FSAC were understood to be the first stage of a longer term reform program and, as such, establish the basis for resuming credit operations on a significant scale and thus play an essential role in the resuscitation of private investment. The program therefore established measures to improve financial institution regulation and solvency and help sustain a stable macroeconomic framework. Evaluation of Measures Supported - Measures Largely Successful iii. Macroeconomic Stabilization and Growth. Most of the macroeconomic objectives of the program were realized. Stable economic conditions were achieved and, albeit somewhat belatedly, a growth process was restarted with real GDP growth increasing at approximately 4% for 1991-1993. While inflation rates exceeded expectations, inflation was kept under control. The fiscal deficit declined steadily during the period of the Credit, although did increase in 1993 prior to national elections. Gross domestic savings exceeded targets set from 1988-90, then fell short of the targets from 1991 afterwards. While public fixed investment remained at between 8-11% of GDP from 1988-1992 (exceeding target levels), private investment remained at only 4.1-4.5% of GDP from 1988 to 1991 before increasing to 5.9% in 1992 and 6.1% in 1993. Private investment therefore did not increase as quickly as anticipated, although it did increase to expected levels by 1992, three years later than expected. The Balance of Payments position remained weak as a result of persistent trade deficits since 1988. The current account deficit did remain at about 11-12% of GDP from 1987 to 1988, but then declined to 8.5% in 1989 and 8.3% in 1990 before increasing to 9.5%, 11.9% and 12.9% in 1991, 1992 and 1993 92 respectively. A sharp decline in the terms of trade--partially mitigated in 1992 by a depreciation of the real exchange rate--contributed to the fall in the value of exports. Current account deficits since 1991 have been financed largely by an accelerated rate of concessional loan disbursements from multilateral organizations and bilateral creditors, and by larger than anticipated inflows of private capital. The level of remonetization was much greater than anticipated. As a result of high real interest rates and stable economic conditions, total banking deposits grew in US$ terms by 35%, 48%, 31% and 29% for 1990, 1991, 1992 and 1993 respectively. iv. Prudential Regulation and Supervision. An important and enduring result of the program supported by the Credit is the establishment of strong banking prudential regulations and strong supervision through an independent Superintendency of Banks (SBEF). More stringent prudential regulations were established under the Credit. Developing implementing regulations and institutional capacity was supported by technical assistance funds under the Credit, including assistance for external audits of banks. While a draft Banking Law was submitted to Congress in 1989, the legislation was only ultimately passed in April, 1993, to meet the second tranche condition in the subsequent Structural Adjustment Credit (SAC). The latter suggests that there was limited commitment by the Government to such a legal change. v. Dedollarization and Reserve Requirements. The Government took measures to resolve the dedollarization issue and did reduce and remunerate reserve requirements. Since such measures were taken, the Central Bank did further develop its facility with open market operations through Central Bank certificates of deposit. These measures appear to be of lesser importance than other issues addressed by the operation, but were largely successful in their outcome. Largely Unsuccessful Measures vi. Reform of State-owned Banks. The most important failure of the design of the program supported by the Credit was of measures contemplated for restructuring the Banco Agricola (BAB). Banco del Estado (BANEST) and Banco Minero (BAMIN). While the Government presented to IDA restructuring plans for BAB and BANEST prior to second tranche release, these plans were never effectively carried out and the Government thereafter decided to reevaluate the role of the public sector in the financial system before embarking on the restructuring of specific institutions. The role of BANEST and BAB remained uncertain until the Government complied with Board Presentation conditions of the subsequent Structural Adjustment Credit (SAC) in July, 1991, closing BAB and beginning its liquidation, and redefining the functions of BANEST, including the elimination of its lending functions, initiation of measures to transfer select responsibility as fiscal agent to the private sector and initiating an evaluation of the cost-effectiveness of its branch network. Between July 1991 and June 1992, BANEST relieved from duty most of its staff, eliminated its deposit-taking functions, transferred its special fiscal agent functions to the private sector, began select auctions of assets received in loan foreclosures and rented most of its branches to a private bank. With respect to BAMIN, no explicit measures were required in the Credit in light of restructuring measures supported by the then-advanced Mining Sector Development Credit, including technical assistance. Measures initiated in BAMIN prior to the Board Presentation of the FSAC never had their intended result of putting BAMIN on a sound financial footing. Only in accordance with the IDA SAC, was BAMIN's liquidation initiated in October of 1991. 93 vii. Central to the lack of progress in reaching these objectives was a flaw in the design of the conditionality: (i) it was unrealistic to expect that BAB could have become an autonomous and viable financial institution in light of its highly political nature, nor could it have attended its same intended clientele (small farmers) unless it radically changed its credit and its interest rate policy so as to compensate for administrative costs and risk; (ii) while the objective of restructuring BANEST to become an operationally and financially viable development bank was not impossible, the Government and IDA should have anticipated that this would have been extremely difficult to achieve given its history and the lack of consensus as to its transformation both in the Bolivian Government and in BANEST's management. Fundamental to successful set of measures would have been a clear vision and very strong commitment to significant transformation, both of which did not exist; and (iii) evidence was not provided in the Letter of Development Policy of a clear vision for the future of BAMIN whereby the initial measures taken would lead to a specific result--ie. the full privatization or liquidation of the institution. Moreover, conditions were never established in the Credit supporting such a result. Further, no specific conditionality, other than that embodied in the Letter of Development Policy (LDP), addressed BAMIN's needed restructuring. While further diagnostic work and formulation of revised operating procedures was to be supported under the PPF of the proposed IDA financed Mining Sector Development Project, there was no way to ensure that the diagnosis would be translated into required actions to transform the bank. viii. Prior to second tranche release, key to the preparation of action plans to restructure the State-owned banks was for the Government to develop a clear idea of the role of each institution. The restructuring plans (including their implementation) should have depended on the Restructuring Commission and not on the presidents of these banks whose interest differed from that of the Government. While the action plans agreed-to had been certified as satisfactory, the conditionality did not require that the initial steps be taken to achieve the objectives of such plans. Indeed, the Credit did not require that the most difficult restructuring measures be taken prior to second-tranche release. As a result, with limited borrower commitment and no specific incentive to implement the restructuring plans, such plans languished over the following two years. ix. Central Bank Strengthening and Establishment of an Adequate Mechanism to Handle Problem Banks. Measures to strengthen the Central Bank were largely unsuccessful, in spite of a commitment in the LDP and technical assistance support from IDA, the International Monetary Fund (IMF) and The Inter-American Development Bank (IDB). In particular, measures to establish an adequate mechanism to handle problem banks were largely unsuccessful. While the Gerencia Principal del Sistema Financiero (GSF) of the Central Bank was created in order to try to anticipate banking crises and provide financial assistance to problem banks when liquidation was not desirable or assist in liquidation in collaboration with the SBEF, the GSF was never able to effectively act upon its mandate and within two years after its establishment, lost most of its capacity entirely. Other Measures Supported x. Maintenance of Market Determined Interest Rates and Reducing the High Cost of Credit. Restrictions on interest rates had been removed with the August 1985 Reactivation decree and were not reinstituted during the period of the Credit. While the Government felt significant pressure to reinstate interest rate controls to reduce the high cost of credit so as to try to jump-start economic activity, it agreed under the Program to maintain the market 94 determination of interest rates. The Government accepted IDA's view that indirect measures, together with a more adequate and stable macroeconomic policy, would help reduce the cost of credit. Measures aimed at reducing the average operating costs of banks were thus viewed as helping to reduce credit costs. The Economic Reactivation Decree did however, stipulate that the annual interest rate to the final borrower on dollar-linked development credits channeled through the Central Bank would be at a rate of LIBOR + 5%. Although positive in real terms, this rate was subsidized--slightly below rates paid by banks on their dollar-linked deposits. The Government indicated that this intervention was needed to provide a source of credit to the private sector in a transitory phase, and would phase out such special treatment of development credits. While interest rate controls were not reimposed, restrictions on the rates charged for development credits to final borrowers were not eliminated until an auction system for such credits was put into place in October 1990. With such an auction and liberalization of restrictions on spreads, resulting rates increased considerably. Access, however, was said to improve for final borrowers, as banks no longer had the prerogative to allocate credit to borrowers at below market rates. xi. Interest rates did decrease gradually yet significantly from 1987-1993 reflecting economic stabilization, an increase in depositor confidence and a reduction in international rates. Spreads did decline moderately from 8.6% in 1988 to 7.0% in 1992, although increased somewhat in 1993. Efficiency indicators also did improve in the banking system in terms of portfolio arrears and administrative costs. The desired goal of reductions in spreads of over 5% however, was not realized. As Bolivia's financial markets become increasingly efficient and competitive, it is expected that a further reduction in spreads will be realized. xii. One way that the Government aimed to address the problem of high lending rates and limited credit to the productive sectors was through a mechanism through which the Central Bank would refinance a portion of the outstanding commercial bank liabilities, thus providing short-term relief. The credit refinancing line was therefore aimed at stimulating real sector investment and stabilizing interest rate conditions. While in the period 1987-1989 interest rates did decline and stabilize, it is impossible to isolate the effects that this refinancing line had on such a result. Further, while portfolio quality of banks did improve somewhat during this period, it is impossible to determine the degree to which the refinancing line provided the breathing space for productive credits which otherwise would have gone sour. Indeed, the ratio of bad loans to total assets and equity fell in part simply because the financial depth increased so markedly. Role of IDA -- Cofinancing-Trust Funds, Disbursements, Records and Audits xiii. The Credit had three reflow amendments disbursed in the period 1989-1991, resulting in additional commitments of US$34.9 million. A Trust Fund of US$ 855,505 (Swedish Kroner 5.0 million equivalent) was established in February, 1992, administered by IDA in connection with the Credit, earmarked to repay IBRD debt and connected with the FSAC. While, in general, disbursement proceeded without difficulty, severe problems in the prompt delivery of audit reports, and, in particular, delivery of a separate auditors' opinion of the Statement of Expenditures (SOE) resulted in the suspension of the SOE procedure in 1990. The imposition of a full documentation requirement made disbursement of some reflows more difficult and thus some funds were ultimately not disbursed under the third reflow Credit. 95 Lessons Learned xiv. Lessons learned can be summarized as follows: * The Lag Between Adjustment and Growth. While most macroeconomic targets established under the Credit were met, private investment and per capita GDP growth did not increase significantly until 1992 and 1993, seven years after the initiation of liberalization measures. This indicates that a supply response of investment funding can take years after a macro- economic track record has been established. * Adjustment and the Reduction of Real Interest Rates. The time taken for real interest rates to decline significantly lagged the initial period of adjustment. The country risk premium required to attract public deposits and investment financing was affected by monetary policy objectives and perceptions of risk that lingered throughout the period under the Credit. Deposit rates came down only gradually, impacted more by reductions of international rates than reductions in country risk premia. The process of reducing the risk perceived of systemic threats or that of individual institutions lagged liberalization of economic policies. * Reductions in Spreads. The degree to which financial spreads would nW decrease due to increases in volume and efficiency of financial intermediation was not fully appreciated when the Credit was designed. The expectation was that reductions in costs would be translated into reductions in spreads rather than the increase in profitability observed. This suggests that it may take time for existing or new entrants to respond in a competitive way to efficiency gains or that barriers to entry in banking continue to exist, even if legal entry procedures appear not restrictive. * The Limited Utility of Sub-Loan Refinancing to Increase Economic Activity and Reduce Interest Rates. The effects of the loan repurchasing mechanism established (at subsidized rates) are unclear with respect to increasing economic activity as well as in reducing interest rates. While loan portfolios did improve during the period, it is impossible to evaluate the effect, if any, of the repurchase scheme on banks' balance sheets on a sustainable basis. * Rehabilitation and Liquidation of Insolvent Financial Institutions. The experience of the Central Bank Financial System Department (GSF) supported under this project suggests that technical capacity and professional management is a necessary yet not sufficient condition to take expeditious measures for the restructuring and/or liquidation of financial institutions in crisis. The institution charged with such tasks must also have the political will and technical autonomy to carry out its mandate, both not the case in Bolivia where during the period supported by the Credit, no private institutions were rehabilitated, intervened or liquidated. * Restructuring of State-owned Banks. The experience of this project suggests that: (i) The objectives of State-owned financial institutions should be clearly established and such objectives should serve as a basis for proceeding with any restructuring plan. In Bolivia, these key questions were not addressed; and (ii) if modification of the State's role as an owner of financial institutions is determined and justified (through financial institution restructuring, privatization and/or liquidation) and if such restructuring is central to the objectives of the operation, restructuring measures should be required to be taken prior to Board Presentation so as to demonstrate the clarity of the objectives at the outset and to ensure the commitment to the measures involved. A clear definition of the objectives and up- 96 front measures reflecting the required commitment can make the process easier and lead to a greater chance of success than was the case in Bolivia. * Institution Building and Technical Assistance. The success of technical assistance support under the Credit depended upon the clarity of the objectives of the measures supported and the commitment of the Government to building strong and capable institutions. Institution- building proved integral to achieving the policy objectives supported. While in the case of the Banking Superintendency, a strong commitment to institution-building had a symbiotic relationship with a commitment to strong banking institutions and thus a positive result from the use of technical assistance, in the case of the Central Bank Financial Systems Department, an unclear objective and a commitment which was not sustained led to institution-building becoming mired. The experience of support to State-owned banks also suggests that a commitment and clarity of purpose is critical to institution-building measures. * Financial Covenants and Audit Compliance. The experience under the Credit with respect to timely audit submission suggests that: (i) the financial management of the counterpart entities being audited need be sufficiently developed or supported so that a timely and accurate audit can be carried out; and (ii) the borrower need be familiar with the requirements and procedures for audit compliance, including audit requirements for Statements of Expenditure. Sustainability xv. In general, most measures taken under the Credit are expected to be irreversible and have a sustainable impact: (i) the commitment to macroeconomic framework established by the 1985 reactivation decree (including market determination of interest rates) has since been consistently sustained. The broad parameters of the economic model being pursued are generally not debated. Moreover, fiscal discipline and monetary management have been and continue to be supported by IMF ESAF arrangements; (ii) in banking regulation and supervision, with the passage of the 1993 Banking Law, most prudential regulations could only be changed by presenting amendments to Congress. While this is possible, amendments under consideration, in general, are only to strengthen prudential regulations rather than to weaken them. Further, although the Superintendent of Banks has the authority to modify circulars, the legal autonomy of the Superintendent shields him or her from pressures to relax prudential standards. In the same way, while the institutional capacity of the SBEF could be weakened, such is unlikely given the political and budgetary autonomy of the institution; (iii) all State-owned Banks have been closed and are in the process of liquidation. While new institutions could be created, it would be legally costly and difficult to reverse the process already well-advanced; (iv) as indicated, in the case of the Central Bank, measures taken to establish a unit to manage bank crises had very limited success and the functions of the Financial Systems Department have since been curtailed and refocused. Whether this Department's functions prove sustainable is not material since its functions are so limited to begin with. 97 PART 1: IDA's ASSESSMENT Project Identity Name: Financial Sector Adjustment Credit Credit Number: 1925-BO' RVP Unit: LAC Region Country: Bolivia Sector: Financial Sector I. Introduction 1. Background - Emergence of an Economic Crisis and Stabilization Measures Taken. The Bolivian economy grew at a rapid pace during the 1970's, supported by an infusion of external capital which was encouraged by rising prices of mineral exports. Net foreign lending halted in 1979-1980 when it became obvious that the debt burden had become excessive and much of it for projects of dubious value. By the early 1980s, severe internal and external imbalances became apparent and savings, investment and GDP began to contract and external finance began to dry up. As tax collections dropped off, rapidly rising inflation eroded the tax base. With authorities trying to maintain the size and wage levels of the public sector, widening deficits were fueled by domestic credit expansion, pushing inflation up to 24,000% during the 12 month period preceding September 1985. 2. The New Economic Policy, enacted in late 1985, established a series of long-term adjustment measures including a freeing of the exchange rate through an auction system, strict budgetary controls, elimination of most price controls, increasing of prices for gasoline, electricity and transport to near international levels, far-reaching reform of the tax system, liberalization of the trade regime, and steps to reorganize some public enterprises and abolish or reduce others. An important start was made to improve public sector administration by establishing the Financial Administration and Control System (SAFCO). The financial system was also liberalized, removing regulatory constraints on financial transactions and freeing the determination of interest rates. 3. In early 1987, the Government launched an ambitious program to alleviate the impact of the economic crisis on the poorest groups through the Emergency Social Fund, which supported small sub-projects to generate productive employment and social assistance efforts (e.g. maternal health care and school feeding). The Government sustained the adjustment program in the face of the collapse of the international tin price in 1985/86 and difficulties caused by continuous delays in paymeit by Argentina for Bolivian gas shipments. The new policy stance succeeded in quickly restoring macroeconomic stability and inflation fell dramatically and remained at levels between 10% and 20%. 1/ Three amending agreements were signed under the Credit to enable credit reflows. These reflow amending agreements were credits 1925-BO-1, 1925-BO-2 and 1925-BO-3. 98 4. History of the Credit and Reform Program. The Financial Sector Adjustment Credit (FSAC) was developed to support the Financial Sector Reform Program established by the Government in early 1987 with IDA support. During FY86, recognizing the difficulties faced by the financial system for mobilizing deposits and the delivery of credit to support stabilization efforts, the Government requested IDA assistance to study and support a program of reforms in the financial sector. IDA undertook a study of the financial sector and in June, 1987, issued a Green Cover report entitled "Bolivia Financial Sector Study". Concurrently, early in 1987, IDA began preparation of the Financial Sector Adjustment Credit (FSAC). In July, 1987, a Reactivation Decree was issued incorporating many of the recommendations of the report, and discussions of an IDA credit to support the reforms were concluded. 5. The FSAC was designed to support Bolivia's medium-term adjustment program for 1988-1989. This program was aimed at consolidating the initial stabilization efforts and shifting the focus of economic policies toward the achievement of a sustainable rate of growth and viable balance of payments through export diversification, higher domestic savings and price stability. The Credit aimed to complement the Second Reconstruction Import Credit (RIC-II) which provided quick-disbursing assistance for imports to critical sectors having an emergency character. As such, while based on the Government's overall stabilization and adjustment program, RIC-II did not focus on macroeconomic policy actions but on specific sectoral programs. 6. Subsequent Economic Developments and Reform Measures (1989-1993). In late 1989, preliminary discussions were held between IDA and the Government on the possibility of a second adjustment operation which would expand the breadth of structural reforms both in the financial sector and support complementary reforms in other sectors. A Structural Adjustment Credit (SAC) was prepared in late 1990 and early 1991 and presented to the Board of IDA in August 1991. The SAC has sought to serve as a bridge from stabilization to growth. The Credit has a large financial sector component which builds upon the actions started under the FSAC to: improve the allocation of savings through the financial system by closing public banks that have incurred substantial losses and misallocate scarce investment resources; improve the allocation of development credit financed by external donors; continue to strengthen supervision of the banking system and other financial intermediaries; and, remove impediments to capital markets development. Outside of the financial sector, the Credit supports the Government's efforts to strengthen major public enterprises that provide key public services, increase private sector investment in mining and hydrocarbons, privatize public enterprises operating in other competitive markets, streamline trade and registration procedures to facilitate trade and remove bureaucratic impediments impairing investment, strengthen public sector investment, and increase the targets for current expenditures to primary health and basic education. 7. As indicated in Section III below, during the period from 1989 to 1993, the process of adjustment continued and some transition to growth was achieved. Real GDP growth, which had averaged 2.8% in 1988-1990 (in large part due to the limited investment response of the private sector), increased to 4.1% and 3.8% in 1991 and 1992 respectively and is estimated at 4% for 1993. Increased private investment contributed to the economic growth observed, with private investment amounting to around US$ 400 million in 1992, a 20% increase over 1991, yet still only 5.4% of GDP. Financial depth and monetization also continued to increase significantly during these four years, buoyed by low inflation (10.5% in 1992 and 10% in 1993) and capital inflows resulting in part from high real interest rates. 99 II. The Financial Sector Adjustment Program and its Justification 8. As above, the Financial Sector Adjustment Program was developed to address the issues identified the July, 1987, Financial Sector Study and subsequent policy discussions held over the constraints to growth. The principal justification was that difficulties in the solvency and efficiency of the financial system posed a constraint to efficient financial intermediation and mobilization of savings for investment. 9. Financial Sector Adjustment Issues and Efforts. The main issues identified in project preparation as affecting Bolivia's financial system were: (i) its shallowness resulting from lack of confidence in medium- and long-term economic performance and in the soundness of financial institutions; (ii) the weak financial condition of several banks; (iii) the high cost of financial intermediation; and (iv) the high interest rates in real terms for both deposits and loans. While it was recognized that significant measures had been taken in the economic recovery program to liberalize the financial system, further measures were needed to improve regulation and supervision, remove select impediments for financial market efficiency and reduce the State's role as an owner of financial intermediaries. With the 1987 reactivation decree and prior measures, the Government had taken action to maintain fiscal and monetary programs conducive to stability, liberalization of the exchange regime, and liberalization of interest rates. 10. Design of the Financial Sector Adjustment Program. The Program was designed with the immediate intent of confronting the problem of the large number of financial institutions with solvency problems within the context of a medium-term program to develop a resilient, solid and efficient financial system. Measures included under the FSAC were understood to be the first stage of a longer term reform program and, as such, establish the basis for resuming credit operations on a significant scale and thus play an essential role in the resuscitation of private investment. As such, the program established measures to improve financial institution regulation and solvency, and help sustain a stable macroeconomic framework. 11. Appropriateness of the Program Design to Achieve the Desired Results. The program design was, in general, sufficiently comprehensive yet focused to achieve its desired results. Principal elements identified in the Financial Sector Study were addressed in the operation. Measures were designed to: (i) support the agreed-upon macroeconomic framework; (ii) establish a liberal economic framework for the financial system by further rationalizing reserve requirements; (iii) strengthen financial institution regulation; (iv) establish mechanisms to attempt to resolve the issues surrounding weak and potentially insolvent financial intermediaries; and (v) establish means to restructure and improve the efficiency of State-owned banks. III. Implementation of the Financial Sector Reform Program and Macroeconomic Performanc Macroeconomic Framework 12. Measures and Objectives. The Credit supported the medium-term adjustment program from 1988-89 aimed at consolidating stabilization efforts and shifting the focus of economic policies toward the achievement of a sustainable rate of growth and viable balance of payments through export diversification, higher domestic savings and price stability. The targets indicated in the President's Report were GDP growth of 3-4% per annum, inflation at around 100 10% per year, a fiscal deficit at 4-5% of GDP by 1991 and a monetary and foreign exchange policy aimed at retaining reserves. Gross domestic savings was assumed to rise from 3.4% of GDP in 1986 to 8.3% in 1990. To support the rate of growth and assist in diversification away from tin mining, both public and private investment would have had to increase sharply over three years. To achieve the rise in public savings while maintaining essential services would have required a major resource mobilization effort. A major portion of the public investment program was assumed to be financed from abroad for the foreseeable future and the current account deficit projected to remain at about 11 % of GDP. At the time of Board approval, the Bolivian Government was working on an agreement with the IMF on an Enhanced Structural Adjustment Facility (ESAF), which was approved on July 27, 1988. 13. Evaluation. An examination of economic results evaluated against the expectations of the adjustment program reveals the following highlights: o Real GDP growth increased more slowly than expected. While in 1989 and 1990, real GDP growth was 2.8% and 2.6% respectively, it increased to 4.1%, 3.8% and 4.0% respectively for 1991, 1992 and 1993. Growth since 1991 represented the first significant real increases in per capita GDP in more than a decade. Increased private investment contributed to such economic growth. In 1992, private investment increased to 5.9% of GDP and in 1993 was 6.1 %. Thus, while real GDP did not reach the growth targets in the first three years of the program--1988-90, such targets were reached in 1991 and 1992, even though close to zero in per capita terms until 1991. The slow GDP growth is attributed in large part to the lagged investment response of the private sector. o Inflation also exceeded the 10% expectation, although not by a large margin, with period average CPI increases being 15.2%, 17.1%, 21.4% and 12.1% for 1989, 1990, 1991 and 1992. In 1993, however, inflation declined to 8.4%, therefore below the 10% target. o Between 1988 and 1991, the overall fiscal deficit of the public sector declined steadily from 6.5% to 3.8% of GDP but increased to 4.7% in 1992 and increased still further to 6.6% in 1993, as expenditures were increased prior to the presidential and congressional elections in June. The deficit was attributable to large increases in current and capital expenditures. However, by end-1993 the new government had begun to take corrective measures and had reduced the rate of spending. None of the fiscal targets projected in 1988 were realized. o Gross domestic savings exceeded the targets projected from 1988-90, then fell short of the targets from 1991 afterwards. Domestic savings was expected to reach 8.3% of GDP by 1990 (increasing in proportion of GDP thereafter), and such savings rates indeed reached 9.3% in 1990, yet declined to 8.7%, 9.0% and 7.0% for 1991, 1992 and 1993 respectively. Limited gross domestic savings mobilization was compensated for by external borrowing. o While public fixed investment remained from 8.1-10.1% of GDP from 1988-1992, priva investment remained at only between 4.1% and 4.5% of GDP from 1988 to 1991 before increasing to 5.9% in 1992. Estimates indicate a further increase to 6.1% in 1993. Private investment therefore did not increase as quickly as anticipated, although it did increase by 1992, three years later than expected. 101 o The Balance of Payments position remained weak as a result of persistent trade deficits since 1988. The current account deficit (before official transfers) did remain at about 11- 12% of GDP from 1987 to 1988 as expected, but then declined to 8.5% in 1989 and 8.3% in 1990 before increasing to 9.5%, 11.9% and 12.9% in 1991, 1992 and 1993 respectively. Relative to the period 1988-1990, the trade balance since 1990 further deteriorated due to both falling exports (including non-traditional exports, especially in 1992) and rising imports. A sharp decline in the terms of trade--partially mitigated in 1992 by a depreciation of the real exchange rate--has contributed to the fall in the value of exports. Current account deficits since 1991 were financed largely by an accelerated rate of concessional loan disbursements from multilateral organizations and bilateral creditors, and by larger than anticipated inflows of private capital. o Rapid remonetization, mostly due to important capital inflows continued during the period from 1988 to 1993. As a result of high real interest rates and stable economic conditions, total banking deposits grew by 35%, 48%, 31% and 29% for 1990, 1991, 1992 and 1993 respectively. The average term of time deposits increased from 65 days at end-1988 to 185 days at end-February, 1994. Marginal spreads' in US$ terms did decrease from 8.6% at end-1988 to 7.0% at end-1992 and further decreased by early 1994 to approximately 6.0%. Table 1: Select Macroeconomic Indicators21 Act. set. Projected in President's Report Actual Prel. Projected 1965 1986 1987 1986 1989 1990 1991 1995 1967 1988 1969 1990 1991 1992 1993 1994 1995 1996 Real GDP Growth -1.3 -2.9 2.4 4.2 4.4 4.1 4.0 4.0 2.6 2.9 2.6 2.6 4.1 3.6 4.0 4.0 4.0 4.5 Real Per Capita GDP Growth n.S. n.a. n.S. n.a. n.S. n.S. n.s. n.. 0.1 0.5 0.4 0.1 1.6 1.2 1.5 1.5 1.5 2.1 Inflation (Period Avg. CPI) n.S. n.. n.a. U.S. n.S. n.S. n.s. n.e. 14.6 16.0 15.2 17.1 21.4 12.1 6.4 8.5 5.2 5.5 Fiscal Budget Surplue (Def)/GDP -7.5 6.4 1.1 1.9 2.3 2.3 2.1 2.6 -7.7 -6.5 -5.5 -4.1 -3.8 -4.7 -6.6 -3.1 -4.2 -5.9 Damestic Savings/GDP 16.1 3.4 2.3 5.7 7.0 8.3 9. 12.2 4.8 6.6 6.5 9.3 6.7 9.0 7.0 9.7 7.9 9.3 Public Fixed lovetuent/GDP 3.5 4.7 5.4 7.0 7.4 7.8 6.0 6.6 6.2 8.1 8.6 8.9 9.3 10.9 10.0 8.9 8.1 6.9 Private Investment/GDP 3.6 4.9 4.9 5.4 5.8 6.1 6.4 6.7 4.0 4.2 4.1 4.3 4.5 5.9 6.1 6.5 6.9 8.1 Cur. Acct. Dal./GDP (Bef Tranefre)-7.2 -10.5 -13.1 -11.9 -11.1 .10.1 -9.1 -7.4 -11.8 -11.1 -8.5 -6.3 -9.5 -11.9 -12.9 -11.0 -11.1 -13.0 Reconciliation / Difference Real GDP Grovth 0.2 -1.3 *I, -.5 0.1 0.0 Fiscal Budget Deficit/GDP -8.6 -8.4 -7.8 -6.4 -5.9 -6.8 Domestic Saving*IGDP 2.5 0.9 1.5 1.0 -0.7 -4.3 Public Fixed Investment/GDP 0.8 1.1 1.4 1.1 1.3 -0.5 Private Investment/GDP -0.9 -1.2 -1.7 -1.8 -1.9 0.2 Current Account Balance/GDP 1.3 0.6 2.6 1.6 -0.4 -3.7 Sources FSAC Presidents Report; IDA Staff Estimates. Broadly speaking, macroeconomic performance has been consistent with expectations when the FSAC was approved, although growth rates increased only with a lag. Institutional Strengthening 14. Actions Required and Taken. In accordance with the effectiveness conditions under the Credit and with funding assistance from IDA's PFMO credit, in November 1987 the Government reestablished an independent Banking Superintendency, assuming the supervisory functions previously performed by the Banking Supervision Department of the Central Bank'. The new Superintendent was also named in November 1987. In accordance with the second 2/ Average lending rate minus average time deposit rate. I In order to perform an effective supervisory role, the President's Report indicated that the new Superintendency would be assigned the following functions: (i) grant licenses to banks to operate in the market, (ii) promulgate norms and rules with regards to loan portfolio classification, accrual of interest, provisioning, and loan concentration; (iii) enact minimum capital regulations; (iv) implement a system of fines and sanctions for lack of compliance with regulations, and (v) establish an accounting plan and manual. A comprehensive organizational and regulatory framework was also developed for the Superintendency. 102 tranche release conditions, the Government in May 1989 issued a Supreme Decree (agreed upon by IDA) establishing the status of the Superintendency of Banks (SBEF), strengthening the position of the Superintendency and guaranteeing its financial autonomy (See paras 16-20 below). Reinforcing the policy decision to establish and strengthen an independent SBEF was significant support of institutional strengthening by technical assistance funds under the Credit. Support was provided in the development of SBEF resolutions and circulars, on-the-job and external training of inspectors and financial analysts, audits of banks and computer equipment. 15. Evaluation. The establishment of an independent SBEF and the further development of specific regulatory functions and institutional capacity was an important achievement under the FSAC and proved fundamental to establishing a firm basis for banking regulation. The independent SBEF was bolstered, in general, by a professional Superintendent and strong approach to regulation in the face of considerable opposition. The organizational design of the SBEF generally worked well, with timely support from technical assistance funds. The result was a strong and capable SBEF, with considerable budgetary and political autonomy. Improving Banking Regulations and Accounting Practices 16. Actions Required and Taken. The 1987 Reactivation Decree established more stringent banking regulations with respect to, inter alia, loan loss provisions, interest accrual on overdue loans, leverage and minimum capital requirements, loan concentration limits, and requirements for information disclosure. Further, in connection with a Credit condition, in December 1987 the SBEF modified the norms with regard to loan loss provisions and interest accrual, to take into consideration the actual quality and recovery risk of loans. The Government, recognizing that the General Law of Banks of 1928 was too vague concerning recapitalization, included in the Reactivation Decree an article which established limits on the credits which a bank can grant to finance investors, including own shareholders to recapitalize the bank. These credits could not exceed 50% of the audited net worth of a bank. The decree also indicated that these credits would only be provided if the borrower obtains a guarantee from a different bank. The SBEF also issued a resolution indicating that Article 82 of the Reactivation Decree was a complement to Article 141 of the General Law of Banks, rather than a substitute, thereby improving the definition of financial conglomerates and making more restrictive the rules on lending to related parties so as to reduce the room for evading loan concentration regulations. 17. As a condition of second tranche release, the Government issued a Supreme Decree eliminating the possibility of recapitalization through lending to shareholders. The SBEF also issued regulations requiring banks holding related-party loans to achieve punctual loan collection. and prohibiting the refinancing, rescheduling or renewing of such credits. L=an concentration rules were also tightened to limit credit granted to a single borrower to no more than 20% of a bank's capital and reserves, regardless of the maturity of the loans. Also as a second tranche condition, the Government in 1989 submitted to Congress a draft Banking Law. Such legislation would have allowed the SBEF to permit an intervened bank to continue functioning, and enhanced the SBEF's powers to apply severe sanctions and fines to banks not complying with norms and regulations. 18. Evaluation. Prudential regulation provisions under this component of the Credit, including those enacted under the Reactivation Decree, subsequent supreme decrees and SBEF resolutions, proved critical to establishing a strong regulatory framework for banking 103 supervision. Establishing minimum loan classification and arrears standards, provisioning guidelines, loan concentration limits, limits on related-party lending, maximum leverage and minimum capital requirements established the basis for a stronger regulatory framework and, ultimately, the basis for stronger banking risk management and thus depositor confidence. Moreover, concomitant with the strengthening of prudential regulations was improvement in the capacity of the SBEF to enforce such regulations. 19. Draft legislation submitted to Congress was not acted upon during the period supported by the Credit. Rather, such draft legislation was significantly modified and only ultimately passed in April, 1993, to meet the second tranche condition in the subsequent SAC. The latter suggests limited commitment by the Government to such a legal change. The legislation was ultimately passed in a form which was significantly modified from that submitted in accordance with the Board Presentation condition of the SAC. Further, the new Government in December 1993 decided that it would draft substantial amendments to the new legislation and incorporate elements modifying prudential regulations into the draft Central Bank Organic Law. 20. It is also important to note the more enduring structure created by the 1993 Banking Law as compared with supreme decrees enacted within the framework of the previous Banking Law of 1928. While both a revised law and supreme decrees have the force of law, law have proved much more difficult to amend and supersede (partially because they require approval by the legislature) and thus have often provided a more stable framework. Indeed a supreme decree was enacted in 1989 which loosened capital adequacy requirements, thereby undercutting some of the improvements made in banks' capital adequacy during the previous two years of measures supported by the Credit. It thus appears that a law appears as a desired modality to the degree that regulations which are difficult to change are desired results and also to the degree that it is possible to enact such a law. Maintaining Market- Determined Interest Rates 21. Actions Required and Taken. Restrictions on interest rates had been removed with the August 1985 decree (except for term credits which were subsequently removed) and were not reinstituted during the project implementation period. During the period from 1987 through early 1988, the Government felt significant pressure to reinstate interest rate controls in order to reduce the high cost of credit to the private sector so as to try to jump-start economic activity. In particular, in 1987, US$ lending rates approached 25% in real terms, largely due to continuing uncertainty over the stability and sustainability of economic policies. Such rates not only proved a deterrent to new investment, they also created a debt burden for accumulated debt outstanding which most businesses could not service. The Government was concerned that the persistence of high real interest rates, despite two years of macroeconomic adjustment, posed a serious danger to maintenance of the productive sectors of the economy, and consequently to the health of the portfolio of the banking system. The severe shrinkage in the volume of commercial bank operations (resulting from the demonetization process which lasted through mid-1985) had led to high spreads between interest rates on deposits and loans, as banks attempted to cover their operating costs and non-performing portfolios. While stabilization measures greatly reduced the macroeconomic distortions and interest rates somewhat declined, high interest rates still constrained the revival of economic activity and weakening the financial condition of the productive sector. 104 22. In spite of these difficult conditions, it was agreed under the Program to maintain the market determination of interest rates--that attempts to control interest rates (either absolute limits on rates or on spreads), rather than attacking the causes of high interest rates, would be counterproductive. The Government accepted IDA's view that indirect measures such as strengthening banking supervision, stringent banking regulations, resolution of the "dedollarization issue" and improving the mechanism to handle ailing banks, together with a more adequate and stable macroeconomic policy, would help reduce the cost of credit. IDA also indicated that attempts to limit spreads at that time, when they reflect high costs of intermediation, could lead to additional financial pressure on the banking system, already then under financial stress. To the extent that spreads depend on the efficiency of intermediation, measures aimed at reducing the average operating costs of banks--such as reducing the number of intermediaries, remunerating reserve requirements and increasing lending volume to reduce the relative level of fixed operational costs--should have helped reduce the high cost of credit. Preliminary IDA estimates indicated that when fully implemented, the banking sector reforms could have resulted in a reduction in spreads ranging from 5% to 8%. Table 2: BOLIVIA Commercial Bank Interest Rates (Percent, End of Year) I. Nominal Rate Nov 26 Proj 1986 1987 1988 1989 1990 1991 1992 1993 1994 Bolivianos Lending Rate 3/ 64.8 43.2 39.6 39.4 38.9 38.1 58.8 30.8 Borrowing Rate 4/ 33.4 32.7 27.8 20.8 20.5 19.0 24.0 18.7 Spread 31.4 10.5 11.8 18.6 18.4 19.1 34.9 12.1 US$ Lending Rate 3/ 22.0 28.5 24.4 24.4 22.2 19.1 18.6 16.5 Borrowing Rate 4/ 14.9 17.8 15.8 16.1 14.4 11.4 11.7 9.9 Spread 7.1 10.7 8.6 8.3 7.8 7.6 7.0 6.6 Bol Inflation Rate (Prior Year) 66.0 10.7 21.5 16.6 18.0 14.5 12.1 8.4 9.5 US$ Inflation Rate (Period Average) 3.7 4.0 4.8 5.4 4.3 3.0 3.0 3.0 II. Real Rates 2/ Bolivianos Lending Rate 3/ 48.9 17.8 19.7 18.2 21.3 23.2 46.5 19.5 Borrowing Rate 4/ 20.5 9.2 9.6 2.4 5.2 6.2 14.4 8.4 US$ Lending Rate 3/ 17.6 23.5 18.7 18.1 17.2 15.6 15.2 13.1 Borrowing Rate 4/ 10.8 13.3 10.5 10.2 9.7 8.2 8.4 6.7 III. US$ Rates in USA US$ Rates in US (Period Average) Certificate of Deposit 6.52 6.86 7.73 9.09 8.16 5.84 3.68 3.14 LT Govt Bond Yield 7.68 8.38 8.85 8.5 8.55 7.86 7.01 6.02 1/ December 1987 and 1988 rates are anticipated (marginal rates) and others are effective rates. 2/ Deflated by CPI of subsequent one year period (with projections indicated for inflation for 1994). 3/ Rate is the Weighted Average Lending Rate (weighted by loan amount). 4/ Weighted Average Time Deposit Rate. Source: Central Bank, Superintendency of Banks, International Financial Statistics. 105 23. The Economic Reactivation Decree did however, stipulate that the annual interest rate to the final borrower on dollar-linked development credits channeled from foreign sources through the Central Bank would be at a rate of LIBOR + 5%. Although positive in real terms, this rate was subsidized--well below market lending rates and even slightly below rates paid by banks on their US$ and dollar-linked deposits. The Government indicated in the LDP that this intervention was needed to provide a source of credit to the private sector in a transitory phase, and would phase out such special treatment of development credits. 24. Evaluation. While interest rate controls were not reimposed, restrictions on the rates charged for development credits to final borrowers (LIBOR + 5%) were not eliminated until an auction system for such credits was put into place in October 1990. As indicated in the section on reducing the high cost of credit below, real interest rates did decrease gradually yet significantly from 1987-1993 reflecting economic stabilization, an increase in depositor confidence and a reduction in international rates. While high market-determined interest rates may have discouraged some private investment, such market determination proved fundamental to efficient resource allocation, maintaining depositor confidence and thus long-term savings mobilization. When rates on development credits began to be auctioned in October 1990, many business associations complained bitterly over the resulting rates which were considerably higher than LIBOR + 5%. Access, however, was said to improve for final borrowers with the introduction of the auction system, as banks no longer had the prerogative to allocate credit to borrowers at below market rates. 25. As Table 2 above indicates, spreads on dollar denominated loans quickly reflected modification in reserve requirements (see below) decreasing from 10.7% in 1987 to 8.6% in 1988 and further declined to 7.8% in 1990 and 7.0% in 1992. Over the period supported by the Credit, efficiency indicators improved in the banking system in terms of the level of administrative costs as a percent of average assets. However, spreads fell less than 1 % for the period from 1988-1993 and remained high by regional standards, given Bolivia's level of economic regulations. The desired goal of a reduction in spreads of over 5% was therefore not realized. While high spreads in the initial period reflected high levels of arrears and administrative costs (relative to asset levels), as time progressed in project implementation, the asset volume increased and administrative costs reduced somewhat in relative terms. In this way, maintenance of high spreads was increasingly translated into profitability. While artificial barriers have not been introduced since 1988 (other than reasonable minimum capital requirements), it remains important to allow for continued free entry by serious investors. In this way, with new entrants and increasing competition from within Bolivia and abroad could bring pressure upon profitability in such a way as to reduce spreads to more competitive levels. 26. Also indicated in Table 2, US$ borrowing and lending rates fell in Bolivia by over 5% from end-1989 to June 30, 1993. This reduction is attributable not just to improvement in economic conditions in Bolivia and the effect of the measures supported by the program, but also decreases in international rates--certificate of deposit rates in the United States fell by almost 6% over the same period. Continued high real deposit rates suggest that economic conditions in Bolivia (including conditions specific to financial markets) have not yet developed to a point where depositor risk perceptions and hence the country risk premium demanded has been reduced significantly. 106 Reducing the High Cost of Credit - The Central Bank Refinancing Line 27. Actions Required and Taken. The Government designed a direct mechanism through which the Central Bank would attempt to address the problem of high lending rates and limited credit to the productive sectors by refinancing a portion of the outstanding liabilities of the productive sectors, thus providing short-term relief. Such a measure, while indicated in the President's Report, was not a condition of the Credit. The aim was to decrease rates, extend maturities, and reduce corporate debt service from a level of US$150 million per year to US$40 million. This would purportedly have enabled productive sector to finance its working capital needs and contribute to the reactivation of industry4. 28. Evaluation. The financial analysis of the refinancing line suggests that, while it was unprofitable for a bank to refinance credits that were current, the benefits of refinancing a non-performing credit were considerable. Indeed, it would have been beneficial for a bank to refinance a current loan only if the bank received a separate benefit from the borrower. In some cases of non-performing loans, this type of refinancing could have thus amounted to throwing good money after bad and deferring recognition of losses for the period during which the loans were refinanced. While the volume of non-performing loans may have been reduced, the broader objective of financing the most efficient industrial credit users would not have been achieved. A further anomaly was that since only non-performing debts would be refinanced, there was an incentive for debtors to let their loans become overdue in order to make them attractive for refinancing. This could therefore increase rather than decrease the volume of overdue loans. During supervision it was pointed out that credit refinancing should have been prohibited unless the GSF believed in the soundness of a bank's management and Board of Directors, to avoid a repetition of bad lending practices. This was borne out by actual experience, as the volume of overdue loans practically remained at the same level during 1989 despite the Central Bank (BCB) having refinanced almost 10% of the private national banking system's total loan portfolio. 29. The medium-term results of the refinancing line are difficult to segregate from the effects of other causes on the financial system and real sector. As a result, each conclusion below is subject to a caveat: (i) while interest rates were reduced for banks and individual borrowers of such loans, it is impossible to isolate the effects of this line in the overall secular change in interest rates in the economy in order to determine if such subsidized rates had any effect on overall rates; (ii) it seems unlikely that there was much of a net increase in the flow of credit to the productive sectors from this line because incentives of the Credit were to refinance bad debts. It is possible however, that without the line, businesses could have failed for lack of ability to service debt; and (iii) while portfolio quality of banks did improve somewhat during this period, it is impossible to isolate the effects of the refinancing line from 4/ The mechanics of the line were as follows: (i) BCB rediscounted a credit from a commercial bank with the bank retaining the credit risk, using the credit as collateral for new financing; (ii) from the rediscount, the bank would receive two loans from BCB: the first 1/2 would be based on a cash disbursement with a rate of 3 month LIBOR and a repayment period of five years (one year grace). The second 1/2 was disbursed in Central Bank CDs (CEDES), with maturities from 15 to 60 months (the credit was divided into equal installments based on a scheduled amortization), with interest paid every quarter. Beginning in 1989 the Central Bank provided only CEDES and not cash; (iii) the borrower received new financing from the bank (refinancing of an existing credit) at LIBOR + 5%, 5 year maturity, one year grace. One half of each loan was refinanced in Bolivianos indexed to US$ and the other 1/2 in was in the same currency as original credit; (iv) only banks in good standing with the SBEF and approved by the Central Bank Board of Directors had access to the line; and (v) while the line was intended to be for US$ 120 million ($60 million from the counterpart funds of the FSAC and $60 million financed from CEDES), only USS74 million of this amount was ever committed and disbursed. 107 the effects of greater financial discipline by banks and the growth in portfolios during the period. Indeed, the ratio of bad loans to total assets and equity fell, in part, simply because the depth of the financial system increased so markedly. External Audit of Banks by Qualified Auditors 30. Actions Required and Taken. In order to facilitate the assessment of the financial situation of banks, the Central Bank made comprehensive biannual audits of all banks mandatory by qualified external auditors contracted by the SBEF. Initial audits were carried out in respect of banks' financial statements as of July 31, 1987. Technical assistance from the Credit was used to finance special external audits based on the June 30, 1988 financial statements, giving special attention to the status of loan portfolios. 31. Evaluation. Audits conducted provided assistance in the assessment of the financial condition of banks as well as assisted in developing the institutional capacity of the SBEF. The audits provided a comprehensive snapshot of the status of financial institutions and enabled the nascent SBEF to establish its priorities and focus its efforts on the weakest institutions. Establishing Adequate Mechanisms to Manage Problem Banks 32. Actions Required and Taken. In 1987, with limited mechanisms to manage ailing financial institutions, the Central Bank liquidated three banks. In order to expedite a solution to both the overdimensioning and the widespread solvency problems affecting the banking system, in the most cost-effective way, the Government in December 1987 established the Gerencia Principal del Sistema Financiero (GSF) of the Central Bank. The aim of the GSF was to anticipate banking crises and provide financial assistance to problem banks when liquidation was not desirable or assist in liquidation in collaboration with the SBEF. The GSF was to be run by experienced professional management in charge of bank rehabilitation, and of regulating and promoting open market operations respectively. The GSF was also to manage a refinancing line (See para below). From 1989-1993, the GSF was assisted by technical assistance from the FSAC and SAC and received special assistance from technical assistance missions of the IMF. 33. In accordance with the Credit effectiveness conditions and as part of its efforts to rehabilitate banks, a supreme decree authorized the Central Bank to purchase assets from commercial banks, subject to an obligation of such banks to repurchase such assets, at par plus interest. This refinancing line (separate from the Line indicated in paras. 27-29 above) had the objective to improve a systemic problem in the financial system by reducing the level of non- performing loans in the financial system and provide a breathing cushion over a period of five 108 years for banks to rehabilitate. In this way, the aim was to improve the equity position of the systems. Funds were never actually committed under this refinancing line. 34. Evaluation. With the support of technical assistance funds (US$ 626,000), the GSF began functioning more or less as intended. The Government complied with its commitment to appoint a professional manager of the unit and staff was provided with extensive training. Coordination with the SBEF in general functioned poorly, with competition emerging between the two institutions due to their real and perceived overlapping authorities. Following the entry of a new Government in August of 1989, a large proportion of the staff of the GSF was either fired or resigned, and many of the members of the team of consultants left thereafter. With the depletion in morale and in the quality of the GSFs personnel, the GSF found itself less and less able to accomplish its purported goals. By early 1990, funds for technical assistance had been largely depleted and most trained individuals had left. Relations with the SBEF continued to sour and communication was limited. 35. The nature of establishing and administering an early warning system became more and more an elusive goal for the GSF because: (i) the objective of managing banks in crisis became increasingly unclear as the BCB Board never provided the GSF the authority to fully carry out its mandate and as draft versions of the Financial Institutions Law then before Congress (passed in 1993) legally removed such authority from the Central Bank; (ii) the staff of the GSF had neither the information nor the capability to undertake the macro-financial analysis and financial analysis of banks necessary in order to foresee neither systemic threats nor individual bank crises; and (iii) the GSF had an increasingly unclear sense of purpose since the interpretation of managing banking crises was increasingly confused with interventionist concepts of supporting types of institutions or directing credit to specific sectors. 36. In late 1993, measures were initiated to restructure the Central Bank, including a restructuring and reorientation of the GSF. Many of the functions performed by the GSF were removed (including some financial system analysis) and a system of entry examinations were instituted resulting in a change in GSFs staffing. Most importantly, the objectives of the GSF were and are being redesigned in accordance with the 1993 Banking Law, the draft Central Bank Organic Law submitted to Congress in April, 1994 and in light of proposed Banking Law amendments. 37. The refinancing line never functioned as intended. While the GSF did undertake analysis of individual institutions and developed work-out programs, actual funding of rehabilitation programs through the line was never undertaken. Action plans for individual institutions became linked to liquidity financing, which became very important in October 1989 '/ The mechanics of the line were designed to be as follows: (i) The Central Bank would purchase assets (loans) from banks which were registered as in arrears and considered not viable as of September 26, 1988; (ii) The Central Bank would purchase principal and interest of such loans based on book value of June 30, 1988; (iii) BCB would purchase an amount of assets no more than the amount of equity of the bank; (iv) The form of repurchase was to be a two year credit with a rate of LIBOR. In addition, BCB was to receive some of profits of the rehabilitated bank for five years, in accordance with mutual agreements, but such would never be less than 10% of net income, 2 years after the contract; (v) Assets were to be administered by BCB on a trustee basis, with account administration remaining with each bank; (vi) Participating banks were to have entered into an acceptable financial and administrative rehabilitation plan and such plan would have to have been approved by the BCB Board. The plan was required to project the financial and operating position of the bank for a period of five years, including an indication of institutional objectives, financial objectives and reorganization measures. The GSF was to evaluate progress against such plans on a quarterly basis; (vii) Banks were to submit details of the financial assets to be repurchased; and (viii) USS 65 million was allocated for the line. 109 when uncertain election results resulted in a reduction in deposits in the financial system. Further, as the draft Banking Law was revised during the period 1991-1993, the function of the Central Bank in actively rehabilitating banks was increasingly viewed as unimportant and not provided for under such legislation, except for the purposes of facilitating a merger. Restructuring of the Banco Minero. Banco Agricola and Banco del Estado 38. Actions Required and Taken. Due to their poor financial and operational condition, the three major public sector banks (Banco Agricola - BAB, Banco del Estado - BANEST, and Banco Minero - BAMIN) were identified as needing basic restructuring which the Government agreed to support in the LDP. BAB and BANEST were to be restructured as conditions of second tranche. 39. No explicit measures were required in the Credit with respect to BAMIN in light of restructuring measures supported by the then-advanced Mining Sector Development Credit, including technical assistance. The Government at that time had initiated the partial privatization of BAMIN, whose Board it was hoped would lead to majority private participation which would acquire majority ownership over time. Further, several commissions were created to plan and implement BAMIN's reorganization. Finally, the Government assumed all of BAMIN's foreign debt so that the expected "new" bank would start from a more solid base. These measures, which were initiated prior to the Board Presentation of the FSAC, never amounted to the intended result of putting BAMIN on a sound financial footing. Only later, in July 1991, in accordance with a Board Presentation condition of the subsequent SAC, was BAMIN closed and its liquidation initiated in October of 1991. 40. The Public Financial Management Operation (PFMO), approved by IDA in 1987, provided technical assistance to review and recommend proposals to restructure BAB and BANEST. The Government also agreed in the LDP to create a policy group composed of high level Government officials to guide the needed restructuring of each bank. It was indicated that BAB would be restructured into an institution that was autonomous and financially viable with a focus on providing a full range of financial services to areas not served by commercial banks. 41. The Government indicated that it had decided to limit BANEST's role to the provision of services to the public sector, eliminating its commercial lending. As agreed under the PFMO, BANEST was to be restructured to become an operationally and financially viable development bank. However, the Bolivian Congress subsequently decided to maintain the commercial banking functions of BANEST and added additional functions so that the bank would serve as a development bank and banker of the public sector. Given the fundamental lack of consensus within the Government as to BANEST's size and mandate, for some time no assistance under the PFMO could be provided to formulate a realistic proposal for BANEST's restructuring. The FSAC did ultimately proceed in supporting the design of an action plan to address the bank's main problems, ostensibly to make it a viable credit institution, including recapitalization. 42. The Government created a senior policy group and, in accordance with the second tranche condition, presented restructuring plans for BAB and BANEST, including 110 implementation schedules'. The December 1989 Supervision mission noted that not only was progress in carrying out these action plans behind schedule, the Government had also decided to reevaluate the role of the public sector in the financial system before embarking on the restructuring of specific institutions. In May 1991 it was noted that the role of the institutions continued to remain uncertain, having spent considerable funds on consultants hired to develop strengthening measures. 43. The role of BANEST and BAB each remained uncertain until the Government complied with the Board Presentation conditions of the SAC in July, 1991, by closing BAB and beginning its liquidation, and issuing a supreme decree redefining the functions of BANEST, including the elimination of its lending functions, initiation of measures to transfer select responsibilities as fiscal agent to the private sector and initiating an evaluation of the cost- effectiveness of its branch network. While a subsequent decree in early 1992 left some ambiguities as to BANEST's role, between July 1991 and June 1992, BANEST relieved from duty most of its staff, eliminated its deposit-taking functions, transferred its special fiscal agent functions (eg. to receive tax contributions of large contributors) to the private sector, began select auctions of assets received in loan foreclosures and rented most of its branches to a private bank. However, no concrete measures were taken to renegotiate or liquidate BANEST's portfolio, most assets received in loan foreclosures remained in BANEST's accounts, and significant legal and financial issues remained unsettled between the Central Bank and BANEST. In December, 1993, the Government agreed to liquidate BANEST and in early 1994 was in the process of developing a Supreme Decree providing the framework and procedures for such liquidation. 44. Evaluation. In general, the objectives in restructuring State-owned banks indicated in the President's Report and in the LDP were not achieved in the course of the Program supported by the Credit. Central to the lack of progress in reaching these objectives were flaws in the design of the conditionality: (i) With respect to BAMIN, no explicit restructuring measures were required in the Credit (other than that embodied in the LDP) in light of restructuring measures supported by the then-advanced Mining Sector Development Credit. While further diagnostic work and formulation of revised operating procedures was to be supported under the PPF of the then proposed IDA-financed Mining Sector Project, there was no requirements under the FSAC to ensure that the diagnosis would result in concrete actions to transform the bank. Measures initiated in BAMIN prior to the Board Presentation of the FSAC never achieved their intended result of putting BAMIN on a sound financial footing. Only in accordance with IDA SAC conditions was BAMIN's liquidation initiated; '/ The plans of action for both banks were supposed to cover the following aspects: (i) autonomy of the management and board of the institutions from political influence (particularly regarding credit allocation); (ii) description of [revised] functions; (iii) new collection policy and plan to accelerate collection of past due loans; (iv) new lending policies; (v) a program for the recapitalization of the respective banks; and (vi) rehabilitation program and implementation schedule aimed at achieving the financial viability of the institutions. Long delays occurred in preparing the restructuring plans for BAB and BANEST and in carrying out the restructuring plans. According to PFMO credit documents, plans were supposed to be carried out early in 1988. In late 1988, there was a disagreement between the general manager of BANEST and the Government on the future of the institution. 111 (ii) It was unrealistic to expect that BAB could have become an autonomous and viable financial institution in light of its highly political nature, nor could it have attended its same intended clientele (small farmers) unless it radically changed its credit and interest rate policies so as to manage its risks and compensate for its administrative costs; and (iii) While the objective of restructuring BANEST to become an operationally and financially viable development bank was not impossible, IDA should have anticipated that such would have been extremely difficult to achieve given its history and the lack of consensus as to its transformation both in the Bolivian Government and in BANEST's management. While examples exist in other countries of converting Government-owned development banks into solvent and viable entities, the requisite conditions of a clear vision and very strong commitment to radical transformation did not exist in Bolivia. 45. As indicated during project supervision prior to second tranche release, key to the preparation of action plans for restructuring BANEST and BAB was for the Government to have developed a clear idea of the role of each institution. The restructuring plans (including their implementation) should have depended on the Restructuring Commission established and not on the presidents of the banks whose interest differed from that of the Government. While the action plans were found by IDA to have been satisfactory", the conditionality did not require that the initial steps be taken to achieve the objectives of such plans. Most important, the Credit did not require that the most difficult measures be taken prior to second-tranche release, and, as a result, with no more pressure to implement the restructuring plans, they languished for the following two years. Strengthening the Central Bank 46. Actions Required and Taken. With commitment in the LDP and technical assistance support from IDA, IMF and IDB, the Government in 1987 began a comprehensive program to strengthen the Central Bank. The program aimed to strengthen multiple areas including accounting controls, management information systems, the economic studies department, staffing and training. With specific assistance from the IDB, the Development Credit Department (Gerencia de Desarrollo - GD) was strengthened to remedy problems associated with the channeling of credits from international agencies. The new administration which assumed power in June, 1993 initiated measures to restructure the BCB, including the initiation of examination entry requirements and promotion criteria. It is currently revamping the BCB's accounting and management information systems, and measures are being taken to establish an independent, autonomous, second-tier financial institution to replace the functions of the GD. 47. Evaluation. Measures to strengthen the institutional capacity of the Central Bank were not fully successful in large part due to the following reasons: (i) while the Government had been firm in its commitment to downsize the staffing at the Central Bank in 1987, its commitment was less firm with respect to developing a cadre of able and committed Central Bank professionals. BCB never developed a system of professional entry through examinations 7/ The Action Plans were supposed to contain: (i) strategic objectives of the institution; (ii) a description of principal problems; (iii) an operational program to resolve those problems; and (iv) a write-off plan to for lost loans and recapitalization. 112 or explicit criteria for advancement and promotion. This compounded the institutions heavily politicized nature, with individuals fearing job security on political grounds, and limited the sustainable results of technical assistance; (ii) the level of centralization in BCB's decision- making at the Board level, when combined with its politicized nature, meant that few day-to-day decisions could be taken on technical grounds; (iii) accounting and financial control remained decentralized, with limited accountability; and (iv) the basic role and functions of the Central Bank had been unclear. Such definition was lacking in a Central Bank Act and there was confusion by management and staff resulting from the integration of monetary policy and developmental objectives in the Central Bank in prior years. The restructuring currently under consideration may, however, overcome these problems and achieve the required strengthening of BCB needed to effectively carry out the principles contained in the draft Central Bank organic law, now before Congress. Resolution of the Dedollarization Issue 48. Actions Required and Taken. The problem of "Dedollarization" arose in the period after November 1982 when US$-denominated liabilities and assets in the banking system (principally deposits and loans) were frozen and converted to Bolivian Pesos at the overvalued official exchange rate. Two phenomenon led to commercial bank losses from this measure: (i) as loans and deposits were converted from US$ to Pesos, banks found themselves mobilizing deposits at rates which exceeded their return on their loans because of the mismatch in maturities. Such negative spreads were high, given the premium depositors required in light of the risk of further devaluations; and (ii) banks had made Bolivian currency deposits in the BCB (at the official exchange rate) with the understanding that such deposits would be used by the BCB to make foreign debt-service payments of such institutions. The use of a series of decrees and devices to avoid accepting these deposits and hence to avoid responsibility for providing dollars to service foreign debts resulted that several banks had no effective mechanism to service their creditors nor to cover their foreign exchange losses. Such losses were estimated in 1987 at US$60 million, more than three times the capital and reserves of the private banking system. This level of losses would have rendered most institutions insolvent. 49. Under the Reactivation Decree, the Government agreed to issue dollar denominated bonds that banks could exchange for the Bolivian currency deposits made at BCB in 1982, to be used to repay their obligations to foreign banks. Every US dollar of original debt was exchanged for US$0.11 in bonds, with the rate arrived at in external debt renegotiations. The Government issued the regulations necessary to make effective this solution early in 1988, when it reached an agreement with foreign creditors on the repurchase of Bolivian debt at discount. In 1989, the SBEF issued regulations requiring banks to either accept dollar-denominated bonds in exchange for Boliviano deposits of such banks in the Central Bank in accordance with Articles 49 and 50 of the Reactivation Decree or take other necessary or appropriate action with respect to such deposits. All private national banks participated in the program whereby of the US$ 40 million fraction of debt in deposits at the BCB, US$ 35 million was exchanged for bonds. The remaining amount was exchanged as banks settled with their foreign creditors. With the parallel objective of promoting local investment, a mechanism was also devised whereby the holders of the bonds could receive a bonus equal to 50% of the present value of the bonds if invested in banks or private companies. 50. Evaluation. By most accounts, measures taken to resolve the dedollarization of 1982 were successful. As a prudential matter, some banks were provided a 10 year amortization 113 of related exchange losses. This provision enabled some institutions breathing space while others, who had recovered from such losses or never suffered from them to begin with, were relatively disadvantaged in the marketplace by such treatment. Considerable controversy arose with respect to the mechanism whereby bondholders received bonuses for the investment of such bonds in banks or private companies. The 50% premium was in some cases provided to bondholders in such a way as not resulting in an increase in new investment and thus resulting in a windfall for the beneficiary. The program was abolished in 1991. Remuneration of Reserve Requirements 51. Actions Required and Taken. In July 1987, the Government modified the reserve requirement structure to eliminate the bias against peso deposits as compared to dollar denominated accounts, and to reduce the level of reserve requirements which affected demand deposits (from 40% to 20%). The objective was to introduce a new structure which would have a neutral impact on the monetary supply and on the lending capacity of the banks. However, due to an increase in the ratio of dollar deposits to total deposits, the new structure increased total reserves, negatively impacting banks' finances. The Government decided to compensate banks for the impact of these additional average reserve requirements by remunerating them partially through a Central Bank resolution in December, 1987. The Government thus implemented a policy of allowing banks to fulfill one-half of their reserve requirements with negotiable certificates issued by the BCB, bearing market rates. This measure had the advantage of establishing a market in government securities and establishing open market operations--an important instrument of monetary policy not then available to BCB. Since the 1987 measures were taken, reserve requirements in Bolivia have been stable at 20% for demand deposits and 10% for time and savings deposits. In 1992, with the closure of BANEST and the transfer of the deposits of public enterprises and agencies from BANEST to private banks, the Government established a 100% reserve requirement on such deposits. Further, in 1993, under regulations to the newly passed Banking Law, time deposits over one year became exempt from any reserve requirements. 52. Evaluation. Measures taken to refine the reserve requirements helped remove a distortion which had an impact in the allocation of savings, credit and foreign exchange. Since such measures were taken, the Central Bank did further develop its facility with open market operations through Central Bank Certificates of Deposit. This instrument was used in subsequent years, with no interference in reserve requirement policy. IV. Evaluation of the Technical Assistance Program 53. Technical Assistance funds of US$ 2.4 million under the Credit consisted of four components: (i) support of consultants to assist the SBEF in the development of its institutional capability, support to the GSF in reviewing the financial condition of banks and in preparing rehabilitation plans as required, assistance in the drafting of a new Banking Law, and work on BAB's restructuring; (ii) funding for the external audits of banks done based on the financial statements of July 31, 1988; (iii) training; and (iv) purchase of computer equipment. Funds were to have been provided to three institutions: the SBEF, the GSF and BAB. In the latter case however, funds were later reallocated to assist in the restructuring of BANEST. 54. Technical assistance to the SBEF (US$ 1.6 million) in general resulted in concrete and demonstrable results. Development of stronger prudential regulations was assisted by expert 114 consultants. Training of SBEF staff helped to develop the capacity to enforce such regulations. Finally, computer equipment assisted analysts and inspectors in the work as well as enabled the installation of a credit risk analysis system for improved monitoring both by the SBEF and by banks. When combined with the policy measures supported by the Credit, the SBEF's institutional capacity developed from very little into a strong institution during the course of three years. It is also important to note the catalytic effect of a strong and dedicated lead consultant at the SBEF for over three years which helped both to motivate the agenda for regulatory reform and institution-building as well as served as a means of organizing the training and technical support provided under the Credit. 55. Funds allocated to assist the GSF (advisors, equipment and training) were initially used with positive results. However, as indicated above, much of this human resource investment proved to be wasted, since a large proportion of staff trained with such funds were either fired or resigned after a new Government took office in August 1989. The limited technical assistance funds disbursed after that date had little impact on the institutional capacity of the GSF. With a lack of clarity of purpose provided by the Central Bank and a weakened staff complement, remaining training and consultants' support was less effective in achieving the initially established goals. 56. Funds allocated to assist in the restructuring of the BAB were never disbursed, pending concrete restructuring measures and were reallocated to be used in the restructuring of BANEST. Funds were not disbursed for BANEST until the July 1991 Supreme Decree indicated more concretely the institution's future role and functions. Once the future role was clarified and concrete measures taken, the funds were put to good use. Specifically, multiple options were explored for sale and/or liquidation of BANEST, including an evaluation of the legal treatment of BANEST's contingencies, portfolio restructuring measures, valuation of BANEST's branch network and valuation of BANEST's fixed assets and assets received in loan foreclosures. V. Role of IDA 57. Cofinancing-Trust Funds. Under an Administration Agreement between the Government of Sweden and IDA and an exchange of letters between the Government of Sweden and the Government of Bolivia, a trust fund of US$ 855,505 (Swedish Kroner 5.0 million equivalent) was established in February, 1992, administered by IDA in connection with the FSAC. Funds were provided to the Government of Bolivia earmarked to repay IBRD debt. The Trust Fund Administration Agreement ended on June 30, 1993. 58. The Japanese Overseas Economic Cooperation Fund (OECF) signed a loan agreement for US$70 million equivalent with the Government of Bolivia in October, 1989. The conditions of the loan were essentially those of the FSAC and funds were provided for balance of payments support. Such funds were disbursed by November, 1990 (Yen 9.108 billion total). 59. Disbursements. The Credit was disbursed in two tranches, excluding the technical assistance component. Considering that the Government moved swiftly in carrying out most of the recommended reforms, the first tranche was quickly disbursed for US$45 million as was the second tranche for US$22.6 million. The remainder (US$ 2.4 million) was allocated to technical assistance. Three subsequent reflow amending agreements were signed for a total of US$ 34.9 million equivalent. Per an agreement at negotiations, IDA agreed to establish a special account for US$ 14 million equivalent in order to permit the prompt disbursement of the first tranche, 115 with the import receipts subsequently collected. As indicated below, some funds (US$ 683,000) were not disbursed under the third reflow amending agreement because requests for disbursement according to the full documentation requirements (because of the lack of submission of audits of Statements of Expenditures) were not received prior to loan closing. 60. The slower disbursement for the technical assistance component was established to permit IDA supervision of the Credit to extend for what was estimated to be 36 months. Credit administration actually lasted 54 months when including reflow amendments and 60 months including the period when receipts were accepted for expenditures before loan closing and the period of administration of the Swedish trust fund. Disbursement of technical assistance funds proceeded smoothly during most of the disbursement period, with the assistance of a management service agreement with UNDP as a procurement agent for the funds. In 1991, the management service agreement was cancelled and remaining technical assistance funds managed directly by IDA and the Central Bank of Bolivia. In the latter case, difficulties were experienced owing to disbursement delays from the Central Bank to the respective users of TA funds. 61. Records and Audits. Credit management suffered from severe problems in the prompt delivery of audit reports, and, in particular, delivery of a separate auditors' opinion of the Statement of Expenditures (SOEs). On October 4, 1990, the SOE procedure was suspended by IDA because of the failure to submit an overdue 1988 audit report of the SOEs. Difficulties in submitting timely audit reports reflected the extremely weak financial management capability of the GSF and the GD in the Central Bank. Delays in the submission of audits of the SOEs reflected the same, as well as repeated misunderstanding by the counterparts of the SOE audit requirements and procedures. Also, a difficulty arose whether or not to accept UNDP's own audit of technical assistance funds under its administration for purposes of IDA's audit requirements. Such UNDP audit was ruled by IDA as acceptable. VI. Lessons Learned 62. The Lag Between Adjustment and Growth. While Bolivia was able to meet many of the macroeconomic targets established under the Credit (inflation, fiscal deficit, remonetization), private investment and per capita GDP growth did not increase significantly until 1992 and 1993, some seven years after the initiation of liberalization measures. The Bolivian experience parallels the experience in other countries where a significant lag has existed between adjustment and growth. This indicates that a supply response of investment funding can often take many years after a macroeconomic track record has been established. Recognition of such a lag would have made for more realistic economic planning and preparation for medium-term measures for adjustment, including institution-building. However, recognition of such a lag would not have likely led to modifications in the design of the Credit. 63. Adjustment and the Reduction of High Real Interest Rates. Related to the point above, the time taken for real interest rates to decline can also significantly lag the initial period of adjustment. Interest rates in Bolivia did not decline with the rapidity hoped for. The country risk premium required to attract public deposits and investment financing was affected by monetary policy objectives and perceptions of risk that lingered throughout the entire five-year period since the Credit was signed. The Bolivian experience suggests that deposit interest rates came down only gradually and were more impacted by reductions of international rates than reductions in country risk premia. The process of reducing the risk perceived of systemic threats or that of individual institutions typically lags liberalization of economic policies. 116 64. Reductions in Spreads. The degree to which financial spreads would n=t decrease due to increases in volume and efficiency of financial intermediation was not fully appreciated when the Credit was designed. The expectation was that reductions in costs would be translated into reductions in spreads rather than the increase in profitability observed in Bolivia. The latter suggests that it may take some time for existing or new entrants to respond in a competitive way to efficiency gains. Alternatively, barriers to entry in banking may continue to exist, even if legal licensing for entry and other procedures appear not to restrict such entry. 65. The Limited Utility of Sub-Loan Refinancing in order to Increase Economic Activity and Reduce Interest Rates. While a loan repurchasing mechanism has proven successful in some countries as a prudential measure to mitigate against the effects of a systematic portfolio solvency problem, the effects of the loan repurchasing mechanism in Bolivia (at subsidized rates) are unclear both with respect to increasing economic activity as well as in reducing interest rates'. While loan portfolios did improve during the period when support was provided, it is also virtually impossible to evaluate the effect, if any, of the repurchase scheme on banks' balance sheets on a sustainable basis. 66. Rehabilitation and Liquidation of Insolvent Financial Institutions. The experience of the GSF under this project suggests that technical capacity and professional management is a necessary yet not sufficient condition to take expeditious measures for the restructuring and/or liquidation of financial institutions in crisis. The institution charged with such tasks must also have the political will and technical autonomy to carry out its mandate. Both were not the case in Bolivia where during the five-year period supported by the Credit, no institutions were rehabilitated, intervened or liquidated (except for State-owned institutions). 67. Restructuring of State-owned Banks. The experience of this project suggests that: (i) The objectives of the State-owned financial institutions should be clearly established and such objectives should serve as a basis for proceeding with any restructuring plan. The burden of proof should be on the Government to demonstrate what market failure exists in the financial markets, why it needs a State-owned entity to address such a market failure, what and how measures are being taken to remedy such failures and how the specific institution will address such a failure. In the case of State-owned banks in Bolivia, these key questions were not addressed; and (ii) If modification of the State's role as an owner of financial institutions is determined and justified (through financial institution restructuring, privatization and/or liquidation) and if such restructuring is central to the objectives of the operation, restructuring measures should be required to be taken prior to Board Presentation so as to demonstrate the clarity of the objectives at the outset and to ensure the commitment to the measures involved. Restructuring and liquidation are not easily achieved either politically, legally or managerially, so that a clear definition of the objectives and up-front measures reflecting the required commitment can make the process easier and lead to a greater chance of success. 'I/ At end-1993, the total amount of the portfolio repurchased by the Central bank was approximately USS 90 million verses a deposit base in the commercial banking system of US$ 2.1 billion. 117 68. Institution Building and Technical Assistance. Technical assistance had both successes and failures under the Credit depending upon the clarity of the objectives of the measures supported and the commitment of the Government to building strong and capable institutions. Institution-building proved integral to achieving the policy objectives supported by the Credit. In the case of the SBEF, a commitment to institution-building had a symbiotic relationship with a commitment to strong banking institutions and together they represent a major success in the program. On the other hand, in the case of the GSF, where the objective was unclear and the commitment not sustained, institution-building measures became mired in uncertainty and ultimately failed. The experiences of BAB and BANEST also suggest that a commitment and clarity of purpose is critical to institution-building measures. Finally, the experience of the Credit's technical assistance component suggests that strong consultants, working directly with the counterparts on multi-year assignments can have substantial positive results if such consultants bring the skills and commitment needed and are matched by equally motivated counterparts. 69. Financial Covenants and Audit Compliance. The lesson of this Credit with respect to requirements of timely submission of audits is that ensuring such requirements are met requires that: (i) the financial management of the counterpart entities being audited is sufficiently developed so that a timely and accurate audit can be carried out; (ii) the borrower is familiar with the requirements and procedures for audit compliance, including audit requirements for Statements of Expenditure. In this project, what was reported during supervision as non- compliance with the financial (audit) covenant reflected problems in financial management and record-keeping not just for this credit but for all Central Bank operations. If financial reporting appears weak, specific assistance may have to be provided under the Credit simply to ensure that the financial covenants of the Credit itself can be met. Ongoing public administration reforms such as the Enhanced Management System Operation are seeking to correct these deficiencies. VII. Sustainability 70. In general, most measures taken under the Credit are expected to be irreversible and have a sustainable impact: (i) the commitment to macroeconomic framework established by the 1985 reactivation decree (including market determination of interest rates) has since been consistently sustained. The broad parameters of the economic model being pursued are generally not debated. Moreover, fiscal discipline and monetary management have been and continue to be supported by IMF ESAF arrangements; (ii) in banking regulation and supervision, with the passage of the 1993 Banking Law, most prudential regulations could only be changed by presenting amendments to Congress. While this is possible, amendments under consideration, in general, are only to strengthen prudential regulations rather than to weaken them. Further, although the Superintendent of Banks has the authority to modify circulars, the legal autonomy of the Superintendent shields him or her from pressures to relax prudential standards. In the same way, while the institutional capacity of the SBEF could be weakened, such is unlikely given the political and budgetary autonomy of the institution; (iii) all State-owned Banks have been closed and are in the process of liquidation. While new institutions could be created, it would be legally costly and difficult to reverse the process already well-advanced; (iv) as indicated, in the case of the Central Bank, measures taken to establish a unit to manage bank crises had very limited success and the functions of the Financial Systems Department have since been curtailed and refocused. Whether this Department's functions prove sustainable is not material since its functions are so limited to begin with.  119 PART II: BORROWER'S ASSESSMENT' Backgound The grave economic crisis Bolivia experienced during the early 1980s, which was characterized by the effects of dedollarization, hyperinflation and financial speculation, led to a contraction in economic activity and had a marked impact on the financial system in general and banks in particular. Banks saw their assets shrink considerably in real terms, their foreign exchange risks mount and their portfolio arrears increase. Although the situation was mitigated somewhat by the promulgation of Supreme Decree 21060 on August 29, 1985, the banking system by that time found itself in a precarious position as regards its available resources, the quality of its portfolio, and its asset base. Physically and administratively, the banking system was also being operated on a much larger scale than needed to service an economy in recession. In addition, during this period of crisis the financial system as a whole was affected by a relaxation of government controls and supervision. In these circumstances, it was necessary to restore public confidence in the Government's medium- and long-range economic policy and to formulate a strategy for financial sector adjustment. Credit Agreement 1925-BO As part of the reconstruction process it undertook in the second half of the 1980s, the Government entered into Credit Agreement 1925-BO with the International Development Association on June 24, 1988, for an original amount of SDR 50.6 million, to be used to support a financial sector reform program. Progra Objectives Bolivia's objectives as specified in the Credit Agreement were to: (a) strengthen the financial position of the banks; (b) bring about a rapid reactivation of the productive sector; (c) build up public confidence in the domestic banking system; and (d) reduce the high cost of credit. I. Review of the Bolivian Economy, 1988-1993 In August 1985, the Government introduced its Economic Stabilization Plan, launching a series of structural reforms basic to a free-market economy. Economic policy, with slight differences from Government to Government, was designed to restore stability and reinstate a process of sustainable economic development. The key elements of the new economic policy may be summarized as follows: Reduction of the FIscal Deficit: Law 843 of May 20, 1986, which established a new taxation system, together with subsequent increases in certain tax rates, improvements in tax collection and cuts in current expenditure, helped bring the fiscal deficit under control. However, although the public sector deficit, which had been equivalent to 6.7% of GDP in 1988 was reduced to 9/ English Language Translation Prepared by IDA. The original spanish text prepared by the Borrower is included in the Report as Annex 2. 120 4.7% by 1992, it rose again to 6.4% in 1993, as expenditures increased prior to the national elections. Restrictive Monetary Policy: In real terms, monetary emission showed an annual average growth rate of only 0.39%. Open-market operations through Central Bank fixed-term certificates of deposit were begun in 1988 and made it possible to regulate financial system liquidity, build up international reserves and, beginning in May 1991, induce a decrease in interest rates. Flexible Exchange Rate Policy: Through the BOLSIN system, the local currency was devalued at a pre-established rate, which contributed simultaneously to the accumulation of reserves and to increasing stability in general price levels. The average exchange rate against the U.S. dollar increased from Bs 2.32 in 1988 to Bs 4.26 in 1993. Between 1988 and 1993, growing trade and current account deficits were offset by a growing surplus in the capital account produced by higher levels of foreign direct investment and external borrowing. External debt policy had two objectives: (i) elimination of debt with private banks; and (2) the renegotiation of bilateral debt. Over the same period, there were buy-backs of almost all external commercial debt. Debt of US$800 million to Argentina was eliminated, debt to Brazil was reduced by US$155 million, and US$370 million of debt to the U.S. was cancelled. Renegotiations of bilateral debt through the Paris Club (I, II, III and IV) led not only to payment deferrals but also to cancellations of 30% (Paris III) and 50% (Paris IV) of principal due for payment during the consolidation period. Structural Adjustment Reform Policy: In mid-1988, under an IMF Enhanced Structural Adjustment Facility, Bolivia took the following steps toward structural reform: (i) restructuring of State-owned banks; (2) adoption of the Financial Administration and Control System Law; and (3) adoption of the Mining Law, Hydrocarbons Law, Investment Law, and Banks and Financial Entities Law. The impact of these various policies was manifested in a low inflation rate, 3.07% average annual growth in GDP, and an increase in total investment as a percentage of GDP from 12% in 1988 to 17% in 1993. H1. Maintenance of Market-Determined Interest Rates Financial repression had been one of the most characteristic features of the Bolivian economy. The crisis that emerged in the early 1980s demonstrated not only that the growth model chosen was unworkable but also that control of the central resource-allocation mechanism was inadequate. One of the objectives of Bolivia's Stabilization Program and basic structural reforms was to restore to the capital markets the function of determining interest rates. Government actions were focused on removing the causes of distortions, promoting development of the market, and strengthening financial system institutions by: (a) refinancing the default loan portfolio of private banks and strengthening them institutionally; 121 (b) strengthening regulation and supervision of the financial system - by restructuring the Superintendency of Banks, training its staff, and providing equipment and necessary technical assistance; (c) implementing a new legal and juridical framework - on the basis of the Banks and Financial Entities Law of April 14, 1993, and of the regulations now being issued pursuant to it both by the Superintendency of Banks and the Central Bank; (d) reducing government participation in first-tier financial intermediation operations by closing down the State-owned banks (Banco Minero, Banco Agricola, Banco del Estado); and (e) establishing a second-tier bank to administer development resources (a project, now at the appraisal stage, which would mean eliminating the Development Credit Department of the Central Bank). III. Institutional Strengthening of an Independent Superintendency of Banks Supreme Decree No. 21660 of July 10, 1987 restored to the Superintendency of Banks those powers vested in it by the General Banking Law which had to do with supervision of the national financial system in a modern and efficient manner. With the assistance of World Bank experts, the conclusion was reached that it was advisable to strengthen the ability of the Superintendency of Banks to: - determine its own objectives and responsibilities; - draw up medium-term institutional projections; - design and develop modem work systems; - regain credibility in the eyes of the public; and - carry out such organizational tasks as formulation of risk-limits, recruitment of qualified personnel, and precautionary audits. Prudential regulations and norms were introduced governing capital requirements, valuation of loan portfolios, a new accounts manual and external audit standards. Superintendency decision-making is based on a simplified "organic" structure, work systems that are designed to provide early warnings, and a broad range of computerized support systems. In addition, there is a flow of information in the form of periodic data from financial institutions, reports showing the economic and financial performance of each institution, evaluations by financial analysts, and the findings obtained from periodic inspections of the institutions. IV. Measures to Improve Banking Regulations and Accounting Practices The Superintendency of Banks has issued various Circulars, Resolutions and Regulations which constitute norms, procedures, controls and valuation systems of financial institutions. The accounts manual establishes key accounting practices to be followed so that accounting procedures used by financial institutions and the reports they are required to file with the Superintendency are consistent and uniform. The manual lays down a set of accounting criteria and codes for financial institutions to follow, thereby simplifying the generation of aggregated sector data and comprehensive monitoring of the financial system. 122 The key achievement where regulation of the banking system is concerned was the Banks and Financial Institutions Law, approved on the basis of the Bill presented by the Superintendency of Banks. Since its promulgation, important sets of implementing regulations have been issued governing the activities of financial institutions. V. Reduction of the High Cost of Credit Under the Stabilization Program, restrictions on the capital market were lifted and interest rates became market-determined. However, given the distortions and speculative attitude prevailing at the time the restrictions were removed, interest rates initially rose to very high levels. Subsequently, as the Program reduced the imbalances, rates showed a steady downward trend, although without reaching the low levels anticipated. These results can be attributed to: - economic policies conducive to stability; - financial strengthening of banks; - measures for the remuneration of reserve requirements; - opening of lines of credit by the Central Bank; and - open market operations, based on CD discount rates designed to usher in lower rates, especially after May 1991. As for the shrinkage of real spreads in foreign-currency operations, this can be attributed to a drop in bank operating costs which are more the result of greater monetization of the economy and intermediation than of any restructuring of the banks themselves. Without a doubt, remuneration of reserve requirements contributed greatly to this turn of events. VI. Bank Audits by Qualified External Auditors In order to obtain an accurate picture of the status of the country's financial system, the Superintendency of Banks issued an invitation to domestic and foreign audit firms to bid on contracts to audit the June 30, 1988 financial statements of the 21 banks (including those in liquidation) that made up the system. After examination of bids by UNDP's Project Services Office, contracts were awarded to five specialized firms, and at the same time, an audit coordinator was hired to verify and supervise their work. These audits resulted in the issue of reports that revealed the true financial condition of Bolivia's banks. VH. Establishment of a Mechanism for the Management of Problem Banks Under the terms of the Credit, the Financial System Department of the Central Bank was to establish an adequate mechanism for managing banks with problems. Although an unresolved argument as to which agency - the Superintendency of Banks or the Central Bank - had which powers prevented this mandate from ever being carried out to the full extent, the Department did develop and introduce strengthening, rehabilitation, and liquidity-support arrangements for troubled banks. VM. Restructuring of Banco Minem, Banco Agricola and Banco del Estado These three banks, which were being restructured with part of the proceeds of this Credit, are now in the process of being liquidated. 123 Banco Minero de Bolivia: Resolution No. 02/91 of December 21, 1991 ordered commencement of a process of closure and liquidation of this institution in accordance with the terms of the General Banking Law, the Commercial Code and other relevant statutory provisions, since its financial statements showed that over 70% of its loan portfolio was in default and that its losses exceeded Bs 10 million. Resolution No. 220/91 issued by the Superintendency of Banks on December 29, 1991 gave instructions for commencement of the process of closing down the institution's operations. Currently, the liquidation process is going ahead, in accordance with the terms of Supreme Decree 23459 of March 31, 1993. Banco Agfcola de Bolivia: Liquidation of this institution was begun under the terms of Supreme Decree 22861 of July 15, 1991 and Resolution No. 136/91 issued by the Superintendency of Banks on July 19, 1991. The main reasons for closure of this bank were the default levels in its loan portfolio, which had risen to 65% of the value of the total portfolio, and its accumulated losses of over Bs 63 million. Under these circumstances, the bank was no longer regarded as credit-worthy by international lending institutions, a fact that prevented it from continuing to mobilize external resources for investment in Bolivia's agriculture sector. Banco del Estado: Supreme Decree 23334 of November 30, 1992 ordered suspension of this bank's activities, while Supreme Decree 23567 of July 26, 1993 ordered that its real estate holdings be transferred to the Treasury and that upon completion of the transfer arrangements, its liquidation should proceed. At the present time, the Supreme Decree announcing voluntary liquidation of this bank is being drafted, as is the instrument to be issued by the Superintendency of Banks giving instructions for implementation of the liquidation process. IX. Institutional Strengthening of the Central Bank's Financial System Department Under the terms of the Credit, a plan of action for strengthening of the Financial System Department of the Central Bank was to be drawn up and implemented. For that purpose, the Department was equipped with data-processing equipment, while local and foreign consultants were contracted to carry out special tasks and provide personnel training in the following areas: - analysis and evaluation of financial institutions; - preparation of strengthening and rehabilitation programs; - analysis and financial projections; and - development of a monitoring system. A sum of US$626,000 allocated from Credit proceeds to cover the costs involved was administered by UNDP's Project Services Office. X. Resolution of Dedollarization Problems During the period prior to November 1982, Bolivian banks had accumulated dollar assets in excess of their dollar liabilities. With introduction of the floating-rate system and the rapid increase in the price of dollars, customers found it impossible to cover their US$-denominated obligations to the banks, a situation that affected crucial sectors. The ensuing bank debt amounted to US$65.5 million. In order to resolve the problem, the Government issued Series B bonds to a value of US$60.8 million. Redeemable after 25 years and paying interest at half- yearly intervals, these were allotted to nine domestic and three foreign banks. The issue was 124 collateralized by US$10 million in AAA-rated bonds purchased abroad with Credit proceeds earmarked for that purpose. At the present time, as the economy is highly dollarized, one of the Government's objectives is to achieve its remonetization, and thereby to restore public confidence in the national currency. XI. Evaluation of the Technical Assistance Provided for the Superintendency of Banks A total of US$1,620,000 was allocated to the technical assistance program for strengthening of the Superintendency of Banks. The breakdown of that amount was as follows: AMOUNT (US$) 1. External audits of banks 800,000 2. Services of bank inspectors 480,000 3. Computer hardware 116,000 4. Training abroad 100,000 5. Project to develop an institutional information system 100,000 6. Experts to help draft new Banking Law 24,000 TOTAL 1,620,000 1. External audit of banks: Payments made under this heading went to contract external audit firms by the Superintendency of Banks in 1988. 2. Services of bank inspectors: By the time their contracts came to an end, these consultants had provided adequate training for Bolivian inspectors. 3. Disbursement for computer hardware: Through public bidding procedures, a DEC System 3100 equipment was purchased, with capacity for 32 work stations. It supports the following applications: A Central Risk Monitoring System, Legal Reserve Require- ments, Interbank Operations, the BOLSIN, and Administrative Systems. 4. Training abroad: With prior approval from the World Bank, funding was made available for visits to supervisory agencies and attendances at courses and events abroad. 5. Project to develop an institutional information system: Implementation of this project, which was fully consistent with the long-term (5-7 years) Information Technology Plan, involved the bringing on line of hardware purchased and associated application software. 6. Experts to help draft a new Banking Law: The new Banking Law was promulgated on April 14, 1993. The original Bill, remitted by the Superintendency of Banks to the Ministry of Finance in March 1990, was sent to Congress the following September, with observations and recommendations from such institutions as the World Bank, the International Monetary Fund, the Bankers' Association (ASOBAN), and others. 125 (Letter to IDA) CENTRAL BANK OF BOLIVIA Our ref: GSF-E-141/94 La Paz April 20, 1994 Mr. Krishna Challa Division Chief Trade, Finance, Industry & Energy Operations Division Country Department III, Latin America and the Caribbean Regional Office The World Bank Dear Sir: Subject: Financial Sector Adjustment Credit (1925-BO) Project Completion Report We acknowledge receipt of your communication of April 7, 1994, to which were attached draft versions of Parts I and III of the Project Completion Report in this matter. In accordance with your suggestion, we met with Mr. Mark Dorfman on April 14 for follow-up purposes and to clarify any uncertainties we might have after examining these materials. As we indicated to Mr. Dorfman, we have no objections to raise to Part I, since the views expressed there coincide with our own as set out in our letter to the Bank dated January 28, 1994. As to Part III, the data it provides have been carefully reviewed, and we have no objections to raise here either. We should simply like to repeat what we have said on earlier occasions, namely that the most noteworthy effects of Credit 1925 on Bolivia's financial system have been: (a) the degree of financial relief the beneficiary institutions have obtained; (b) the considerable reduction in their default portfolios, which has not only brought a corresponding improvement in their overall quality but has also strengthened the quality of their equity bases; and (c) in conjunction with other factors, the reduction in the cost of money. . Yours truly, Is/ Fernando Candia Castillo President  127 PART III: STATISTICAL INFORMATION LOAN/CREDIT DATA Amounts (US$ 000) As of 11-30-93 Original Disbursed Cancelled Repaid Outstading 10 Credit 1925-BO 70,000 66,697 53 0 70,024 Credit 1925-BO-1 11,300 11,923 0 0 12,741 Credit 1925-BO-2 9,100 9,852 66 0 10,036 Credit 1925-BO-3 14,500 13,478 683 0 13,725 TOTAL 104,900 106,526 Timetable of Key Events: CUMULATIVE LOAN/CREDIT DISBURSEMENT (US$ Million) Credit EY89 FY90 FY91 EY22 1925-0 (i) Planned 68.5 1.5 (ii) Actual 56.2 10.5 3.3 (iii) (ii) as % of (i) 82% 700% n.a. 1925-1 (i) Planned 11.9 (ii) Actual 11.9 (iii) (ii) as % of (i) 100% 1925-2 (i) Planned 9.8 (ii) Actual 9.85 (iii) (ii) as % of (i) 101% 1925-3 (i) Planned 14.5 (ii) Actual 13.5 (iii) (ii) as % of (i) 93% 1e/ Disbursed and outstanding amounts do not reconcile with original amounts due to currency fluctuations (SDR-US$). 128 MISSION DATA Measure Planned Date Actual Date Time taken by the Country to Prepare Credit 12 months Initial Financial Sector Study Mission April 17, 1986 Initial Preparation Mission - FSAC September 26-October 9, 1986 First Presentation to the Bank April 198711 Initiating Memorandum Presented to Loan Committee March 19, 1987 Appraisal Mission April 27-May 16, 1987 Delivery and Discussion of Financial Sector Study June 1987 Post-Appraisal Mission November 2-14, 1987 Completion of Negotiations May 20, 1988 Approval by Board of Directors June 16, 1988 Loan Signing June 24, 1988 Date of Effectiveness June 1988 September 27, 1988 Approval of Second Tranche Release Jan., 1989 June 21, 1989 Signing of First Reflow Agreement March 22, 1989 Signing of Second Reflow Agreement December 21, 1989 Signing of Third Reflow Agreement April 16, 1991 Supervision Missions September 26-28, 1988 November 27-December 3, 1988 February 26-March 3, 1989 March 20-24, 1989 November 30-December 9, 1989 May 1990-February 199112 March 25, 1991 May 20-26, 1991 August 17-29, 19923 Closing Date June 30, 199214 December 31, 1992 Closing Date of Swedish Trust Fund Grant Agreement June 30, 1993 "/ Per the President's Report. '2/ During this period, while there were no formal supervision missions, preparation mission and the appraisal mission for the SAC were used as an opportunity to monitor progress under the FSAC and to revise form 590's accordingly during this period. '3/ Supervision of the Structural Adjustment Credit. "/ Per the third amending agreement. 129 STAFF RESOURCES USED IN LOAN PREPARATION/SUPERVISION (Staff Weeks) Fiscal Year 1986 1987 1988 1989 1990 1991 1992 1993 1994 Total Preparation 42.3* 54.3* 96.6 Appraisal 17.1 32.5 49.6 Negotiations 3.2 3.2 Supervision 0.1 10.3 16.2 7.3 7.2 1.5 42.6 PCR 3.2 3.2 Total 42.3 71.4 35.8 10.3 16.2 7.3 7.2 1.5 3.2 195.2 *Includes select assessment of other areas of the financial sector. FOLLOW-ON ADJUSTMENT OPERATIONS BOLIVIA: Structural Adjustment Credit No. 2298-BO approved on August 12, 1991 in the amount of US$ 35 Million equivalent. A subsequent Adjustment Credit (Capitalization Program Adjustment Credit - US$ 50 Million equivalent) is under preparation.  Annex I Page 1 of 3 BOLIVIA - Financial Sector Adjustment Credit (Credit 1925-BO) Proiect Completion Report Policy Matrix (Including Evaluation) Reform Issues Actions Already Taken Effectiveness Com- Second I*anche Compliance/ Areas pliance/ Evaluation Evaluation Maintenance of Macroeconomic Program Macroeconomic Framevork Full Macroeconomic Frameork Full compliance consistent with the objectives of compliance consistent with the the program objectives of the program. Market Low level of Liberalization of interest rates in August Maintenanceof market Auction of deter- resource 1985 with exclusion of a special type of determination of interest rates Development Credits mination mobilization development linked loans which will cany and eventual phasing out of the instituted October, of rates of libor plus 5%. special exclusion of development 1990. interest linked loans (in Medium-Term). rates. lasti- Ineadequate Banking The Government established an o Issue a Supreme Decree, o Operating tutional Superintendeq independent Banking Superintendent and enacting the Operating Regulationsof the strength named the Superintendent in December Regulations of the Superintendency -cng 1987. Superintendenq; and fully implemented. o Prepare and present to o Draft Banking law Congress draft heavily modified amendments of the before Congress existing bank supervisory and not passed legislation allowing the until April, 1993. Superintendency to intervene and to apply sanctions and fines. Need to improve Require external audit of banks by Regulations improved banking regulations qualified auditors (July 1987). Bank from 1987-1994 and accounting statements will be audited twice a year. through issuance of practices so that Enactment of more stringent regulations revised circulars and bank statements on: regulations in 1993 reflect their real (1) loan portfolio classification according Banking LAw. financial condition, to risk of default thus forcing them (2) provisions for potential loan losses to restructure or (3) interest accruals on problem loans exit the market. (including past due loas) undertaken in Dec. 1917. Annex 1 Page 2 of 3 BOLIVIA - Financial Sector Adjustnent Credit (Credit 1925-BO) Proied Completion Report Policy Matrix (Includina Evaluation) Inefficient and rigid In December 1987, the Government set up a Supreme Resolution issued Full Appoint a permanent Vice- Appointment and mechanism to an administrative unit in the Central Bank enacting the revised statutes compliance President of this unit training did not lead handle ailing banks (Gerencia del Sisemna Fnanciero) to which incorporate the new possessing the experience to the results which slows down handle the rehabilitation of problem banks. role and functions of the and qualifications envisioned. the solution to the The Government and the Bank have Central Bank OSF . satisfactory to IDA. over-dimensionand agreed on a set of guidelines for the o Acting Vice-President of unit solvency problems functioning of this administrative unit). appointed of the banking o Staff satisfactory to the system. Association appointed. o GSF guidelines issued. Possibility for a Under the Reactivation Decree the o Government issue a Supreme Full The Government will issue a Full compliance and bank to provide Government limited this kind of credit to Decree and the compliance new Supreme Decree results. credits to finance no more than 50% of the equity of the Superintendenq issue a eliminating the possibility of investors, including banks as of July 31, 1987. corresponding Resolution, recapitalizationthrough own shareholders, prohibiting banks from lending to shareholders. The to recapitalizethe extendingereditto finance Superintendency will issue bank. any investorig equity regulations to urge banks to investments of such banks. collect promptly and o Superintendencl has issued prohibiting them from re- regulations accelerating financing, rescheduling or collection of credits given to renewing previously given finance equity investments in loans for this purpose. banks, and prohibition their reneal, refliancing or rescheduling. Current regulations Loan concentration rules will be tightened Lan concentration on alending to to limit credit granted to a single borrower and related pasty related parties are to no more than 20% of a bank' capital lending rules specified confitsing and even ad reserves, regardless of the maturity of in 1993 Banking Law. contradictory the loan. The Superintendesq will also issue a resolution making more restrictive the rules on leanding to related parties. Weak financial Partial priatization of BAMIN as agreed Establish a high level Policy o Action plans for condition of the by Government and is being implemented. Group to cause the restructuring BAB three major public preparation of action plans and BANEST banks (Bace and implementation never imple- Minero, Bace schedules for the meated. Agricola od Bance restructuring of BAB and o BAB closed and del Estado). BANEST. liquidation begun, July, 1991. o BANEST restructured, July, 1991 and closed, 1993. Annex 1 Page 3 of 3 BOLIVIA - Financial Sector Adiustment Credit (Credit 1925-BO) Pro8ect Completion ReDort Pole Matrix (Includina Evaluation) o Furnish IDA satisfactory plans of action and implementation schedules to restructure BAB and BANEST. o Technical assistance component will provide funding to assist the implementation of BAB's restructuring. Reduc- Large spreads due a) Partial remuneration of RRs by Central Government issue a Supreme Repurchase ing the to need to Bank, in the form of a negotiable Decree authorizing the Central mechanism cost of compensate for cartificate will provide breathing space Bank to purchase assets from led to credit non-carning assets, to banks to reduce intermediation commercial banks subject to a uncertain such as non- spreads and leading rates (December repurchase obligation. results. remunerated RRs. 1987). Potential substantial b) Government announced that it will issue Issue regulations, through De-dollarization losses to banks as a dollar denominated bonds that the banks the Superintendenq, giving mechanism fully result of the can exchange for the Bolivian currency banks, until September 30, implemented. *dedollarizationof deposits they made in Central Bank. In 1988, to accept dollar- 1982. March 198, after reaching agreement denominated bonds in with foreign creditors on commercial * exchange for Boliviano debt repurchase, the Government issued deposits in the BCB, in the regulations necessary to make this accordance with Articles 49 solution effective. and 50 of the Reactiaion Decree, or take other necessary or appropriate action with respect to such deposits.  135 Annex II Page 1 of 13 EVALUACTION DL CREDrTO TDA 1925-BO ANTECEDENTES La aguda crisis econmica pacdecida por la Replica dutr.nc la primera parce de la àécada de los 30. carerizada por los eeeccCs de la desdolarizaciòLn. la hiperin?lació3n y la especuación financiera, reduj la acividad econmica y tvo una auerKe incidencia en el siseta financiero y muy par&icularmence en el bancaro. e 0 LOS acti vos de lo's ban.cos dismninuyeron considerablemence en rèrminos reales. surgieron fuerte.s riesgos de cambio j crecio la morosidad de sus areras. Esta si tuac ión. dé aIguna maner.a se viò arenuada con la promulgacin del D. 5. 21050 de 29 de agosto de 1985. Sin embargo a esa fecha. el siscreima bancario se enconcraba en rrancc eroro en ruanro a recursos. calidad de su carrera y base pacrimonial. Se presentò también un sobredinensionamientoI de SLu estructura fisica y adminisrracjva para acender una econoMIa en estado de recesióon. A.dciconalrmence. durane esre periodo de crisis. el Sistemva Financiero se viò aRfeccado por un relajamiento de los mecanismos de con rol y supervisiön por parre del Esado. Anre esras situaciones era necesario devolver la conZianza al púiblicr sobre la politica econc:4mica a mediano y largo pla0. y diseñar uina estrategia encaminada a lograr el ajliuse del sector r,!inan ciero. CONVENIO DEL CREDITO Dentro de este proceso de recomposición.. a partir de la segundå mJitad de la década, el Gobierno Nacional suscribiö un convenio de crédito con la AIF IDA. el .24 de junio de 1988, el mismo que representaba un monto original de 50.6 millones de DEGs. con el objetivo de llevar a cabo un programa de refforma del sector financiero. Se lo denomin Crédito IDA 1925-BO. OBJETIVOS DEL PROGRA A Los objetivos contenidos en el crédito consistian en: a) fortalecer la si tuación financiera de los bancos. b) acelerar la reactivación del sector productivo. c) consolidar la confianza del público en la banca nacional y d.) reducir el elevado Costo del crédi to. 136 Annex II Page 2 of 13 I. EVALUACION DE LA ECONOHIA BOLIVIANA - PERIODO 1988 - 1993 En Agosto de 1985. el Gobierno puso en marcha el denominado Plan de Estabilizaciòn Econòmica e iniciò un conjunco de reformas estructurales dentro de un sistema de economia de libre mercado. La politica economica. con diferentes matices de forma en los distintos gobiernos. estuvo dirigida a consolidar la estabilidad y reiniciar L112 roeso s0eniSdo de crecimiento económca del pais. Las principales medidas de la nueva politica econòimica se las puede resumir er7: Reducción del Déficit Fiscal-- La promulgación de la Ley 843 de fecha 20.5/86 sobre un ~ Nuevo Sistema Tributario" y el posterior 2 incremento de la tasa de algunos impuestos . a crompaiado de Lun mejoramiento de los inlstrumentos de recaudación y control del gasto corriente, permi tieron con trolar el déficit fiscal. El défici t del Sector Påblico. como porcentaje del PI. que en 1983 alcan=J a 5. 7 V bajó al 4. 7 t en 1992. sin embargo. debido a la coyuntura electoral. en 1993 volvió a subir hasta si tuarse en 6. 4,. Una politica monetaria restrictiva.- La emisfön monetaria en térmwinos reales ha experimentado una tasa de crecimiento Pronmedio anual de solamente el 0.39%. Las operaciones de mercado abierto a través de los Cercificados de Depósito a Plazo Fijo del Banco Central de Bolivia. inicia das en 1988. peritieron regular la liquidez del si s tema financiero. incremen tar las reservas internacionales y a partir de mayo de 1991, a inducir una baja en las tasas de interés. Una política cambiaria flexible- A través del sistema del Bolsin. la moneda local se devaluò a una frecuencia preestablecida. de manera que privilegià simultåneamente la acumulación de reseryvas la estabilidad en el nivel general de precios. El tipo de cambio promedio. que en 1988 alcanzaba a Bs2. 32 pcor aoL'ar ameri cano. se increment en 1993 a 3s4. 26. 137 Annex II P-age 3 of 13 Durante el periodo de análisis se presenta un déicit creciente en la Balanza Comercial y adicionalmenje en la Cuenta Corriente de la Balanza de Pagos. Este déficit se ve compensado con el creciente superávit de la Cuenta de Capital resultante de mayores entradas de inversión directa extranjera y de endeudamiento externo. La política sobre la deuda externa tuvo dos objetivos: 1) la eliminación de la deuda con la banca privada y 2) la renegcciación de la deuda bilateral. Entre 1,98 y 1993 se recompró la casi totalidad de la deuda con la banca privada internacional. En el tratamiento de la deuda bilateral, se eliminó la deuda de $us. 800 millones con la Argentina. se redujo Sus. 155 millones con el Brasil y se lograron condonaciones de la deuda con los Estados Unidos de Norteamrica por un monto de $us. 370 millones. Las renegocíaciones de la deuda Bilateral vía Club de París, (1. II, 1I Y IV). no sólo lograron diferimientos en el pago sino también condonaciones del 30% (Paris III) y 50% (París IV) de los capitales comprometidos para su pago durante el periodo de consolidación. Politica de Reformas Estructurales de la economa. - A mediados de 1988 se negoció con el F2I una línea de Ajuste Estructural de Facilidades Ampliadas (ESAF). Se ejecutaron las siguientes reformas estructurales: 1) Reestructuración de la Banca Estatal. 2) Aprobación de la Ley SAFCO, 3) Aprobación de las leyes de Mineria, Hidrocarburos, de Inversiones y de Bancos y Entidades Financieras. Los resultados de estas políticas se exteriorizaron en una baja tasa de inflación. un crecimiento del PIB a una tasa promedio anual del 3.07%; en tanto que la Inversión total como porcentaje del PIB que en 1988 alcanzaba al 12%. se incrementó al 17% en 1993. II. MANTEMINIENTO DE LAS TASAS DE INTERES DETDVJINADAS POR EL MERCADO La represión financiera era uno de los elementos más carateristicos de la economía boliviana. La crisis de los primeros años de la década pasada, demostró no sólo la inviabilidad del modelo de crecimiento adoptado. sino también lo inadiecuad7o qui¿e resul taba el control del mecanio cencral que determinaba la asignación de recursos. 13g Annex II Wage 4 of 13 Un objetivo del programa de estabilización y de las reformas estructurales básicas. fué devolver al mercado de capitales la función de determinar las tasas de interés. Las acciones del Gobierno se dirigieron a acacar las causas que originaban distorsiones, a promover el desarrollo del mercado y el fortalecimiento institucional del sistema. Estas acciones fueron: a) El refinanciamiento de la cartera en mora de la banca privada y su fortalecimiento insti tucional. b) El fortalecimiento del sistema de regulación y supervisión financiera el mismo que fue ejecutado con la reposJción de la Superintendencia de Bancos. capaci tación y formación de su personal y finalmente con el equipamiento y la asistencia técnica necesaria. c.) La implementación de un nuevo marco Juridico Legal con la promulgación de la Ley de Bancos y Entidades Financieras promulgada el 14 de abril de 1993. normando la actividad de las instituciones financieras. Promulgada la Ley. tanto 'la Superintendencia de Bancos como el Banco Central de Bolivia. se encuentran en proceso de emitir las reglamentaciones respectivas. d) La disminución de la participación del Estado en las operaciones de intermediación financiera al usuario final con el cierre de la banca estatal: Banco Minero. Banco Agricola y Banco del Estado. e) El establecimiento de un Banco de Segundo Piso para que administre los recursos de desarrollo. actualmente en proceso de evaluación para su posterior implementación. Esto implicará la eliminación de la Gerencia de Desarrollo del Banco Central de Bolivia. III. YORTALECINIKNTO INSTITUCIONAL DE UNA SUPRINTEMJDNCIA DE ~NCOS INDEPEDIENTE El Decreto Supremo N* 21660 de 10 de Julio de 1987. reestableció las atribuciones de la Superintendencia de Bancos que le otorga la Ley General de Bancos: a saber. la Supervisión del Sistema Financiero Nacional de manera moderna y eficiente. 139 Annex II 3age 5 of 13 Con la contratación de expertos del Banco Mundial se estimó conveniente fortalecer la Superintendencia de Bancos. comando en cuenta los siguientes aspectos: - Determinación de sus objetivos y responsabilidades. - Proyección institucional a mediano plazo. - Diseño y desarrollo de sistemas de trabajo modernos. - Recuperación de la credibilidad ante la opinion pública. - Tareas organizativas como: estructuración de normas de limitación de riesgos, selección de personal calificado y control preventivo. Las normas prudenciales se orientaron a los requerimientos patrimoniales, evaluación de carcera de créditos, nuevo manual de cuentas y normas sobre auditorias externas. Para la toma de decisiones se tiene una estructura orgánica simplificada, con sistemas de trabajo orientados a mantener un esquema de alerta y amplio apoyo de sistemas computarizados. Además. se cuenta con información periódica que remiten las entidades financieras. informes sobre el comportamiento económico financiero de cada entidad, evaluación por analistas e inspecciones periódicas a las'entidades. IV. MEDIDAS PARA MEJORAR REGULACIONES BANCARIAS Y PRACTICAS CONTABLES A partir del funcionamiento de la Superintendencia de Bancos. se han emi tido varias Circulares. Resoluciones y Reglamentos que constituyen normas. procedimientos. controles y sistemas de valuación de las Entidades Financieras. Asimismo. el Manual de Cuentas establece las principales prácticas contables adoptadas. con el fin de armonizar y uniformar el sistema contable y los reportes informativos que envían las entidades sujetas al control de la Superintendencia de Bancos. El Manual somete a un mismo criterio y codificación la contabilidad de las entidades financieras, facilitando la obtención de información agregada del sector y permi tiendo el control global del sistema. El logro principal en cuanto a medidas de regulación bancaria fue la promulgación de la Ley de Bancos y Entidades inancieras en base al anteproyecto presentado por la Superintendencia de Bancos, sobre el cual se han establecido varias normas reglamentarias importantes para la actividad de la7entidades del sistema financiero. 140 Annex II Dage 6 of 13 V. REDUCCION DEL ALTO COSTO DEL CREDITO Con el programa de estabilización se liberò el control sobre el mercado de capitales y las tasas de interés pasaron a ser determinadas por el mercado, empero, dado el escenario de distorsiones y operaciones especulativas en el que se produjo la liberalización, inicialmente se colocaron en niveles muy altos. Posteriormente, en la medida en que el Programa de Estabilización redujo los desequilibrios, las tasas de interés mostraron una tendencia sostenida decreciente, aunque no alcanzaron aún los niveles esperados por el programa de reformas. Estos resultados pueden ser atribuidos a: - Las políticas económicas, que privilegiaron la estabilidad. - El fortalecimiento financiero de los bancos. - Las medidas para remunerar el encaje legal requerido. - Las lineas de crdito abiertas por el BCB. - Las operaciones de mercado abierto que vía tasas de descuento de los Certificados de Depósito, orientadas a inducir bajas, especialmente a partir de mayo de 1991. Por su parte.. la baja en los spreads reales en moneda extranjera, es atribuible a una baja en los costos de operación de los bancos, originada más por una mayor monetización e intermediación, que por un ajuste en la estructura de los mismos. Sin duda., la remuneración a las reservas del encaje legal requerido con tribuyeron de manera importante en esta dirección. VI. AUDITORIAS =ERNAS DE BANOS POR AUDITORW CALIFICADOS Con el propòsito de conocer la situación real del Sistema Financiero Nacional. la Superintendencia de Bancos y Entidades Financieras, en uso de sus atribuciones, procedió a contratar audí toias externas a través de la Oficina de Servicios para Proyectos del PNUD, pre via convocatoria a empresas de 141 Annex TI Dage 7 of 13 auditoría externa nacionales y extranjeras. para realizar un examen de los estados financieros a los 21 bancos del Sistema Financiero Macional (incluyendo los bancos en liquidación). al 30 de junio de 1988. Los trabajos de auditoria fueron adjudicados a cinco firmas especializadas previa evaluación por parte de la Oficina de Proyectos del PMUD. Asimismo, se contrataron los servicios de un coordinador de auditoría para la verificación y supervisión de estos trabajos. El resultado de estos trabajos, permitió conocer los dictámene's donde se explicaba la situación financiera de los bancos del sistema. VII. ESTABLECIMIENTO DE UN MfCANISf0 PARA EL TRATAMIENTV DE BANCOS CON PROBLEMAS Según el Programa, la Gerencia del Sistema Fínanciero del BCB debió establecer un mecanismo adecuado para manejar Bancos con problemas. Sin embargo, la permanente discusión de cual era el organismo responsable, la Superintendencia'de Bancos o el Banco Central. resultó en que no se llevó a cabb enteramente este cometido. Para casos especiales. la Gerencia del Sistema Financiero ha preparado y puesto en práctica programas de fortalecimiento, rehabilitación y soporte de liquidez. VIII-REESTRUCTCRACON DE LOS BANCVS HINER, AGRCOLA Y DEL ESTADO Los Bancos: Banco Minero. Banco Agrícola y Banco del Estado que estaban siendo reestructurados con recursos de la Linea IDA 1925. en la actualidad se encuentran en proceso de liquidación. BANCO MINERO DE BOLIVIA Intervención y Liquidación Mediante Resolución NPOZ/91 de 21 de diciembre de 1991 se inicia el proceso de cierre y liquidación del Banco Minero de Bolivia de acuerdo a la Ley General de Bancos, el Código de Comercio y disposiciones aplicadas en la materia, en vista de que su si tuación financiera demostraba que más del 7c=i de la cartera de préstamos se encontraba en mora: además de registrarse pérdidas por encima de Bs10 millones. 142 Annex 1I Dage 8 of 1.3 Mediante Resolución de la Superintendencia de Bancos N2 220/91 de 29 de diciembre de 1991 se inició el proceso de cierre de operaciones del Banco Minero de Bolivia. Al presente, el proceso de liquidación continúa. según determina el D.S. 23459 de 31 de marzo de 1993. BANCO AGRICOLA DE BOLIVIA rntervención y Liquidación El proceso de liquidación del Banco Agricola de Bolivia se inició en cumplimiento del D.S. 22861 de 15 de julio de 1991 y Resolución de la Superintendencia de Bancos N2 136/91 de 19 de julio de 1991. Las principales causales para el cierre del Banco Agricola de Bolivia. fueron los niveles de mora en su cartera de prèstamos, que alcan=aron al 65.1 de la cartera total y sus p~rdidas acumuladas que excedieron Bs 63 millones, provocando que el mismo deje de ser sujeto de crédito de los organismos internacionales, impidiendo por consiguiente, la captación de recursos externos para la inversión en el sector agrícola. BANCO DEL ESTADO Mediante D.S. 23334 de 30 de noviembre de 1992 se dispone la suspensión de actividades del banco y mediante D.S. 23567 de 26 de julio de 1993, se dispone la transferencia de los inmuebles de propiedad del Banco del Estado al Tesoro General de la Nación. determinandose que una vez terminada dicha transferencia, se proceda a la liquidación de dicha entidad financiera. A la fecha, está en etapa de elaboración el Decreto Supremo para la liquidación voluntaria del Banco del Estado, así como el dictamen que debe emitir la Superintendencia de Bancos, para efectivizar la misma. IX. FORTALECINIMMNTO INSTITUCIONAL DE LA GERNCIA DEL SISTnA FINANCIER DEL BANCO CA2rAL DE BOLIVIA El Programa contemplaba la preparación y ejecución de un plan de accióL encam:nado a fortalecer la Gerencia del Sistema Financiero del Banco Central de Bolivia. Para ello, se equipó con procesadores de datos y se contrataron consul tores nacionales y extranjeros, los mismos que desarrollaron trabajos específicos y de capacitación al personal en: 143 Annex II Tage 9 of 13 - Análisis y evaluación de entidades financieras. - Preparación de programas de fortalecimiento y rehabilitación. - Elaboración de análisis y proyecciones financieras. - Un sistema de monitoreo de las entidades. El monto asignado para este fin ascendió a $us. 626.000. el mismo que fue administrado por la Oficina de Servicios para Proyectos del PNUD. X. RESOLUCION DE LOS PROBL~íAS DE LA DESDOLARIZACION Durante el Periodo anterior a Noviembre de 1982, los bancos acumularon activos en dólares en cantidades superiores a sus pasivos de la misma moneda. Con la aplicación del sistema de flotación y el alza acelerada del precio de la divisa, surgió la imposibilidad de pago de obligaciones en dólares a los bancos por parte de los prestatarios, afectando a sectores estratégicos. La deuda bancaria por este concepto alcanzó a $us. 65.5 millones. Para su resolución el Gobierno emitió los Bonos Serie "E" cuyo monto fue de $us. 60.8 millones con un periodo de redención de 25 años con maduraciones semestrales. Estos fueron entregados a nueve bancos nacionales y tres extranjeros. Esta emisión contó con el respaldo de Bonos Triple "A", adquiridos en el exterior con $us 10 millones que destinó el Programia para este fin. A la fecha, la economía boliviana se encuentra altamente dolarizada y uno de los objetivos del actual Gobierno es lograr su remonetización. devolviendo la confianza del público en la moneda nacional. XI. EVALUACIÓN DETL PRORMA DE ASISTANCIA TCNICA PARA LA SUPERINTEY DENCIA DE BANCOS. La Asistencia Técnica para el fortalecimiento de la Superin tendencia de Bancos y Entidades Financieras fue de Sus. 1. 620. 000. 00. asignados de acuerdo al siguiente detalle: 144 Annex II lage 10 of 13 MONTO SUS. 1. Auditoria Externa de Bancos 800.000.00 2. Inspectores bancarios 480.000.00 3. Equipo Hardware 116.000.00 4. Estudios en el Extranjero 100.000.00 5. Proyecto de Desarrollo del Sistema de Información Institucional 100.000.00 6. Expertos para la Ley de Bancos 24.000.00 TOTAL 1.620.000.00 1.- AUDITORIA AX7ERMA DE BANCOS. - Se efectuaron los pagos correspondientes a las firmas de audi toria externa, contratadas por la Superintendencia de Bancos en la gestión 1988. 2.- INSPECTORES BANCARIOS. - Los contratos de los conjul tores para el Proyecto concluyeron, dejando un entrenamiento adecuado para los inspectores nacionales. 3. - DESEIBOLSO POR BAUIPAHIiNTO "HARDWARE". - A travás de lici tación pública. se adquirió el equipo DEC Sistem 3100 con capacidad de 32 estaciones de trabajo. actualmente soportando la aplicación de Central de Riesgos. Encaje Legal,. Operaciones Interbancarias, Bolsín y Sistemas Administrativos. 4.- ASTDIOS AY AL lrTRANJE. - Previa autorización del Banco Mundial, se efectuaron visitas a entidades de supervisión, cursos y eventos en el exterior. 5.- PROYECTv DE DESARAOLLO DE SISTPMA DE IN7t0HACIÓN INSTITUCIONAL. - Se implementó el proyecto de sistematización global acorde con el Plan Informático de largo plazo de cinco a siete años. con la perspectiva de implementar el sistema de hardware y software de aplicación. 145 Annex II Dage 11 of 13 6.- EXPER=OS PARA LEY DE BANCOS. - La Ley de Bancos fue promulgada el 14 de abril de 1993. El anteproyecto fue elevado por la Superintendencia de Bancos al Ministerio de Finanzas en el mes de marzo de 1990, volviéndose a presentar el anteproyecto en el mes de septiembre del mismo año. con observaciones y recomendaciones de instituciones como ser el Banco Mundial, el Fondo Monetario Internacional, ASOBAN y otros.  147 Annex II ,age 12 of 13 RANCO CENTRAL DE BOLIVL\ G-SF - E-1 4 1 /94 Seio r Krishna Challa DIVISION CHIEF TRADE, FINANCE, INDUSTRY AND ENERGY DIVISION COUNTRY DEPARTMENT 111-LATIN AMERICA AND CARIBBEAN REGION THE WORLD BANK Presente. - Es t imado Dec'or: Ref: FINANCIAL SECTOR AJUSTMENT CREDIT <CREDIT 1925-B0): PROJECT COMPLETION REPORT. En relación a su nota de fecha 7 de Abril de 1994, en la que adjunta un borrador de lá evaluación del Crédito, (parte 1 y 111), de acuerdo' con su sugerencia, hemos mantenido una reunión el día 14 de Abril del corriente mes con el Sr. Mark Dorfman, a efectos de efectuar un seguimiento y aclarar cualquier aspecto derivado del análisis de los mencionados documentos. Luego del examen de sus informes y de acuerdo con el mismo Dr. Dorfman, deseamos manifestarle que los mismos no merecen objeciones de nuestra parte, debido a que coincideTi corin nue-trUos criterios ya expuestos en nuestra carta de fecha 28 de Enero de 1994, enviada a su autoridad. Con relación a la información contenida en la Parte 111 del PCR, adjunta a su car ta, la misma ha sido adecuadamente revisada y tampoco merece observación alguna. CASILLA 3128 TELEX 3540 NAVIANA TELEFONO 374151 LA P.%Z BOLIVIA 148 Annex II llage 13 of 13 BANCO CENTRAL DE BOLIVI.A Finalmente, lu ya expresado en oportunidades anteriores, en sentido de que los efectos más notables derivados de la aplicación del Crédito en el sistema financiero buliviano, se han v.isto reflejados básicamente en: a) un desahogo financiero de las entidades beneficiadas, b) una considerable reduccian de sus carteras morosas con el consiguiente maiojramiento de su calidad a su vez traducida en un fortalecimiento cualitativo del patrimonio de los bancos y c) ha coadyuvado, juntamente con ntros factores, a la reducción del costo del dinero. Con este motivo, saludo a usted atentamente. Fernando Candia Castillo. PRES IDENTE CASILLA 3118 TELEX 3840 MAVI.%-<A TELETONO 374151 LA PAZ BOLIVIA MAP SECTION  149 IBRD 20s16 8 R A Z IL BOLIVIA RCAOS: - en- T .o a,,<o" -- ?r ack$ rr Q.. . ...- err ns Nahomat C-201 -an Mr \.. . . .. . . . ... . . . .. . . . . ..i soe - -Internaiwel S0ondan 4. ~~.\J-.ioioe P E R U -oak sana. e e, - .a 0 5o :00 50 :00 :s ? I ser, &M-jon L ARNIA Too PoAZ.- .X<y BAI O R U RO PA R A G UA Y C L YLT N - UiQu iSA A", i C H l L E ( P O1 TA R!.' -0 PARAGA To~"eqooo A ... URUGU-41 G E i N A-TI NA sL E.Deroo ;r.'i(   DO Ln