Honduras - Prospects for public sector reform (Vol. 2 of 2) : Main report

Report No. 10318-HO Honduras Prospects for Public Sector Reform (In Two Volumes) Volume II: The Main Report September 30, 1991 Pubic. ..ector Management Division Technical Department Latin America and the Caribbean Region FOR OFFICIAL USE ONLY Document of the World Bank 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.  GLOSSARY OF ACRONYMS BANASUPRO Suplidora Nacional de Productos Basicos BANMA Banco Municipal Aut6nomo BANTRAL Banco Central de Honduras BCIE Banco Centroamericano de Integracidn Econdmica CG Contadurfa General COR Contralorfa General de la Repdblica CM Consejo de Ministros CNA Consejo Nacional Agrario COHDEFOR Corporacidn Hondurefha de Desarrollo Forestal CONAPLAN Consejo Nacional de Planificaci6n CONSUPLANE Consejo Superior de Planificaci6n Econ6mica COPEN Comite Permanente de Emergencia Nacional CSC Consejo de Servicio Civil DGA Direcci6n General de Aduanas DGCP Direcci6n General de Credito Pdblico DGP Direccion General de Presupuesto DGT Direcci6n General de Tributaci6n ENEE Empresa Nacional de Energfa Electrica ENP Empresa Nacional Portuaria FNH Ferrocarril Nacional de Honduras GDS Gabinete de Desarrollo Social HONDUTEL Empresa Hondurefla de Telecomunicaciones lAs Instituciones Autdnomas IHCAFE Instituto Hondureffo del Cafe IHMA Instituto Hondureflo de Mercadeo Agrfcola IHSS Instituto Hondurefho de Seguridad Social INPREMA Instituto Nacional de Previsi6n del Magisterio INA Instituto Nacional Agrario INFOP Instituto Nacional de Formaci6n Profesional INJUPEMP Instituto Nacional de Jubilaciones y Pensiones de Empleados del Poder Ejecutivo JNBS Junta Nacional de Bienestar Social PANI Patronato Nacional de la Infancia SANAA Servicio Aut6nomo Nacional de Acueductos y Alcantarillados SCT Secretarfa de Cultura y Turismo SDNSP Secretarfa de Defensa Nacional y Seguridad Piblica SEC Secretarfa de Economfa y Comercio SECOPT Secretarfa de Comunicaciones, Obras Piblicas, y Transportes SECPLAN Secretarfa de Planificaci6n, Coordinaci6n y Presupuesto SEP Secretarfa de Educaci6n Ptblica SGJ Secretarfa de Gobernaci6n y Justicia SHCP Secretarfa de Hacienda y Credito Pdblico SP Secretarfa de la Presidencia SRE Secretarfa de Relaciones Exteriores SRN Secretarla de Recursos Naturales SSP Secretarfa de Salud Piblica STPS Secretarfa de Trabajo y Previsi6n Social TGR Tesorerfa General de la Repdblica UNAH Universidad Nacional Aut6noma de Honduras  FOR OmCIAL U* ONLY HONDURAS: PROSPECTS FOR PUBIC SECTOR REFORM I&= OF Puge No. 1NTRODU`ClON . ......... . ....... 1 I. THBEECONOMYANDTHEPUBJCSECTOR ..................... 2 A. Evolution of the Economy in the Last Decade . ................. 2 B. The Economics of the Publc Sector ..... ....................... 6 C. The Eonomic Policy of theNewGovenment ................. 10 D. The Riks and ChaUenges Ahead .. ................ . 12 IL. AN ASSESSMENT OFTHE PUDIUC SECTOR ... .1............ 14 A. Thenstitutionaland Legal Fnmework ...................... 14 The Basic Structure of the Hondurn Publictor ...............c. 15 Institutional Setting of th Cental Admistri ..............16.. 16 Territorad and FunctionalD t zaion ... . ....... . 17 Principal PublicSector LegalInstments . .............. . 22 B. Budgetary Trendsoft ePublicSecow .. ....23 TheCentml Govemnent ............................... 24 Non-Financial Publc Entrs ............e. . .26......... 26 PublicInstitutes .................................... 28 Iviunicipalities ... .... . 29 C. PublicSectorWagesandEmployment . ........ 29 This report is based on the findings of a Public Sector Assessment mission that visited Hondurs in Octobe 1991. Main contnrbutors to th report include Antonio Martfn del Campo (mission leder), LATPS; Angel Gonzglez-Malaxechevarzia, LATPS; Jaime Vdzquez-Caro, LATPS; PubGlo Gerchunoff (Cwsultant); Ann Mitchell (Consutant); Rchard Moor (Consutant); and ndr Ruptah (ConsuILtnt). Edgad Martfnez (Consutant) also partiipated ine miusion. Bain Tuncer, Lead Economis, LA2C2, advisd the mission. The responsible managers wer: Shahd A. Chaudhy, Chief, LATPS; Mario Voij, Chief, LA2C2; and Rain B. Stckhan, Director, LA2. i Thi document has a retricted distribudon 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.  D. Structur Optimization ofthe Pubic Sector ............ ...... 32 Feasibility of an Administrative Reform Program ................ 32 Dedgn of an Administrative Refom Program forthePS ........... 33 Program Implementation ........ .............................. 36 m. MANAGEMENT OF PUBLIC SECTOR FUNCT`IONS IN THE CENTRAL GOVERNMENT ...................................... 37 A. Macroecononic Management ................ . . . . . . . ... 37 B. Management of Tax Revenues ............ ..... ......... . 38 DGT MImned Taxes ................................. 39 DGA Managed Taxes ........ ...... . .. 41 C. Ihe Management of Expenditures ....... .............. . 43 Strengthening the Public lnvestnent Progranming Process .... ...... 44 Strengthening Financial..ement. ...................47 D. The Management of Intemn Administration ................... 52 E. The Manaementof Intemal and Extnal Control ............... 52 Interm Control and GAO .... ...... .. .......... . 53 External Control and CGR ........................... . . . 54 TV. DECENTRUU2ED ADMUGSTRATION ........ 56 A. Public nterprises .. ...... ........................... 57 Agrictural and Food Distrbuton Entapriss ........ .... 57 Public Utilides and Transport Services Entexprises ............... 59 B. The Experience with CONADI ......... 62 C. PublicInstitutes ...... ...... ...... 62 D. Mulcipies ... .......... 9 ...66 ii  AM=XTBE Table I Selected Macroeconomic Indicators .............. 70 Table 2 Selected Indicators of Macroeconomic Policy .................. 71 Table 3 Participation of the Pulic Sector . ..................... . 72 Table 4 Recent Economic and Fiscal Performnuce .................... 73 Table 5 CO's Budget 74 ..... ........ ...... 0...... . . . Table 6 PE's Importance in the Economy ... ......... .. ........ 76 Table 7 PE's Budget 77... . ............... . . . . ... Table 8A Relative Importance of Individual PE's (1989) ................... 79 Table 8B Relative Importance of Individud PE's (1989) ............. 80 Table 9 FNEE's Budget .................... . .... . ........ . 81 Table 10 SANM's Budget .............................. ..... 82 Table 11 HONDUTEL's Budget .... Table 12 PI's Budget 85 .................................... -Table 13 IHSS's Budget . ....... . . . . . . . Table 14 INJUPEMP's Budget .. ... . . ....... .. . . . . . 88 Table 15 INPREMA's Budgt................... Table 16 Municipalities' Budget 1.. ... ...... .... 91 Table 17 Public Enterprises: Employment, Wages and Real Wage Rate. ... 93 Table 18 Public Institutes: Employment, Wages and Real Wage Rate .94 Table 19 Central Government: Wages and Employment . 9... 95 Table 20 Wage/Employment by Secretiat and Level.. .. 96 Attachmnt Summary of Recommendations ...  INTRODUCTION 1. This study contains an assessment of the public sector issues in Honduras, and a set of recommendations to increase the internal efficiency of the public sector and its contributions to the Honduran modem economic development. The study lays down the foundation for a policy dialogue and subsequently for a possible public sector reform loan. The study is also expected !o guide through the more specific, analytical work, that may be developed in the process of preparation of a Bank operation. 2. The report is structured as follows: Chapter I reviews the macroeconomic context and identifies the need for public sector reform in order to ensure the sustainability of progress made by the current economic progrm. 3. The first three sections of Chapter II develop an assessment of the Honduran public sector by analyzing: (a) its institutional and legal framework; (b) the trends of the functional and categorical composition of public expenditure; and (c) the statistics of public employment and wages. The last section of Chapter II discusses the feasibility of an administrative reform program and ajproposal for its design and implementation. 4. Chapter m reviews key public sector management systems in the Central Govemment and makes recommendations to reform and strengthen those systems. The following Central Government functions are covered: (a) macroeconomic management; (b) management of tax revenues; (c) management of expenditures, including investment programming and integrated financial management; (d) internal administration; and (e) internal and external control. 5. Taidng as a point of departure the analytical basis provided in Chapter It, a global assessment of the Decentralized Administration is presented in Chapter IV. On the basis of such assessment, Chapter IV outlines different strategies for the reform of the main components of the Honduran Decentralized Administration, i.e., Public Enterprises, Public Institutes and Municipalities. 6. While the three areas for public sector reform proposed by this study - Administative Reform, Reform of Public Sector Management, and Reform of the Decentralized Administration - have to be seen as complementary parts of a broad stategy, and ideally progress should be made in all fronts simultaneously. Experience in other countries, as well as the analyds of the Honduran public sector, indicate that public or re*orm would normally involve a sequence of reforms that combines a sense of priority with feasibility. It is the trust of this assessment that cunrently in Honduras the keystone for starting an ambitious process of state moderization is the administrative reform of the public sector. Administrative reform of te Honduran public sector can be implemented in the short term; at the same fime, progress can be made in the design and implementation of specific programs to refrm and improve public sector management. Finally, adminstrave reform should also provide the vehicle to prepare, at the inOtudonal level, restucturing/privatization programs for the Autonomous Insdtutions, and to support actual implementation of the new wole forseen for the Municipaliies.  I. THE ECONOMY AND THE PUBLIC SECTOR 1.1 The Honduran economy during the last decade was characterized by: (i) moderate economic growth that barely kept pace with population growth; and (ii) worsening medium term Imbalances. A major cause for these Imbalances and a growing macroeconomic instability was a large, persistent fiscal deficit and a 'arge, increasing public sector participation in the economy. However the manifestations of the disequilibria and negative impacts of the persistent deflckt were temporarily contained by a series of ad hg= measures including: (i) increasing arrears on its foreign debt; and (ii) additional command-control mechanisms. By the end of the 1980s, the country's economic performance deteriorated sharply and Honduras entered a stagflationary process reflecting the fundamental structural weaknesses in the economy and the lack of economic policy consistency. 1.2 In 1990, the new Government initiated a major stabilization program within the context of broad-based economic reform. The former consisted of a commitment to reduce the fiscal deficit and a shift to non-inflationary finance as well as an effort to obtain a competitive real exchange rate. Reforms were designed and partly implemented regarding foreign trade liberalization, financial sector reform, a more efficient tax administration, and a strategy to reduce the inhibiting Incentive structure in agriculture derived from the previous policy regime. 1.3 However, to consolidate and implement the structural reform strategy, will require a significant public sector reform including: (i) a major redefinition of the roles of public and private sectors in the economy; and (ii) management improvements to obtain internal efficiency of the redefined public sector. This report focusses on the nature of the public sector reform strategy that must be implemented in tandem with any adjustment program. A. Evolution of the Economy in the Last Decade 1.4 The 1980s can be divided into three episodes.' The first episode, between 1980 and 1983, was characterized by a relatively high but declining rate of inflation (average of 11%), with low economic growth (average of 0.2%); the external account, on the other hand, was deteriorating (average current account deficit excluding transfers was about 10.7% of GDP). The latter was partly due to the increasing fiscal deficit compounded by an overvalued real exchange rate and falling terms * See Graph 1, Table 1 -Annex Tables- for the main macroeconomic indicators and Graph 2, Table 2 for the evoludon of key macroeconomic policy variables for the period 1980 to 1990.  3 Graph 1 laInflation - Gvowtht teseurce 9uame and Current accon (% of GOP) .as.4 0 a, $la; ,4& a's 06 87 as as go 41 t 2 63 44 J6 40 r7 n4 *o 0 -:L 30 ~ l ln sten 1dJA *n ud- n~~~~~~~~~~~~~~~~~~~ 6~~~~~~~~~~ *0 6 2 -13 -*. * 4 so 01 aesmntldM adsuoiMoe W4.0 of OOPI ~ ~ ~ ~ ~ ~ ~ ( o GP  4 Graph 2 2SaFIual Defiuit (i of GOP) and 2b.Ral Interest Pate and Foreign Finanoing (I of fleal deo.) Margin Over parity so 1 .3 70 eo 25~~~~~~~s _|0 f @ 9- h -10 - *0 I . . . . . . . . . .. . . . .n. . 20 - -800~~~~~~~~~~~~~~~~~~~~~~~~~~~~C so Al 92 43" 66 84 61 14 89 906s 61 62 63 64 as as 67 .00 06 go -limBo det. - rfmlgn ha. - real mn. -mmagin UAWea exchange rate 2d.Money Supply (Index 1e80ol00) (% growth) 140 ~ ~ ~ ~ ~ ~ ~ ~~~~~2 120 NmgI . ftws-isnS o, el oe  S of trade (see Graph 3). There was increased monetization of the economy (MI rose as a I Granh 3. Tlems of Trade proportion of GDP) given the failing inflation (Inex 190ea*i@ and It owth) rate. It . _0 1.5 The second episode, from 1984 to 1988, included a stable and low inflation Ito (about 3.6% average). The inflation pattern mo reflected both non-monetary finance of the flscal deficit as well as price controls (see Graph 4). There was moderate economic growth (average of 3.6%), the current account os of the balance of payments improved slightly (an average of 9% of GDP) reflecting the . \ / ., improved terms of trade and the completion of the hydroelectric- project, El Cajon (which also contributed to a falling fiscal deficit), as well as __._,_._,_._,_._,_*_ a depreciation of the effective real exchange oo as a' a @ rate due to the overvalued dollar. During this period flnancial intermediation increased as - '. -so real interest rates became positive (average of _ 3.3%). 1.6 The final episode occurred from Graph 43Ez Watet and Electricity prices 1988 to 1990, when inflation accelerated (Rea index 1980-100) (average of 20.5%) due partly to a rising fiscal m0 deficit and increased monetary financing. Economic growth become negative in 1990, and lie the external deficit was about 8% of GDP. Both the real interest rate and the margin over international parity became highly negative, thus endangering the financial intermediation *\ accumulated in the previous period. A thinner financial sector will further reduce the deficit so compatible with the reduction of inflation. 1.7 By the end of the 1980s there were clear indications of the fundamental weakness of the economy and a need to develop a consistent macroeconomic policy. so * as as *J as ad a? as as go . eteeojpu Kwh) tmIH bto guS ml  6 B. Th Economics of the Public Se1 or 1.8 A principal cause of the deepening medium-term imbalances and growing macroeconomic instability was the uncontrolled expansion of the public sector and a large and sustained fiscal deficit.1 1.9 The public sector has expanded rapidly since the second half of the 1970s. Initial public sector expansion was stimulated by the euphoria generated by the coffee boom. By the 1980s, public sector growth was used as a means to cushion the domestic economy from the effects of a sharp deterioration in the terms of trade. 1.10 By the beginning of the decade, non-financial public sector (NFPS) ex,:nditures (on an accrual basis) were about 34% of GDP (see Table 1.1). A substantial part of increased expenditure was associated with the EL Caj6n hydroelectric power project (about 5.9 and 7 % in 1983 and 1984, respectively). Expenditures have remained high since but with current expenditures rising and capital expenditures falling. Ihe implicadons of this growing dominance of current expenditures for long-term growth are alarming. 1.11 The fiscal deficit of the NFPS has risen and fallen throughout the decade, reaching a peak of 12% of GDP in 1983. From 1983-87, the fiscal deficit fell, reaching a low of 7% in 1987, and thereafter increased to an average of 7.6% in 1989-90. The fall took place mainly at the expense of public investment including the completion of the El Cajdn project. The rise since 1987 Is mainly due to increased current expenditures as capital expenditures have continued falling. 1.12 The overall deficit movements mainly reflect the deterioration in the Central Government's budget. Public Enterprises, on the other hand, have shifted from a surplus to a deficit (except for HONDUTEL and recently ENP) since 1985, their deficits to some extent reflecting the non adjustment of tariffs and user charges to inflation (see Graph 4). Considering the fiscal deficit net of transfers and net lending, the enterprises have been a burden on Government fmances throughout the 1980s (see Table 1. 1). 1.13 From 1980 to 1985 the overall deficit was financed principally through budgetary assistance from the USA as well as disbursements for the El Cajdn project. From 1985 onwards however, arrears grew dramatically, and in the last few years financing, was done increasingly by money expansion. 2 Ih this document fiscal deflcit means the financial deficit of the non-fnancial public sector (NFPS). With high and variable inflation and major realignments of the exchange rate, a more appropriate idicator would be the real flscal deficit, where the public sector includes public financial institutions, thus incorporating the quasi-deficit.  7 Table 1.1: ouernment's Budget (% of GDP, Subperiod Averages) 1980-83 1984-88 1989-90 Non-Financial Pulc -SecGtor Current Revenues 23.6 26.7 27.3 Current Expenditures 21.9 26.2 25.6 Capital Revenues 0.1 0.3 0.2 Capital Expenditures 11.9 8.9 8.5 Overall Deficit -10.0 -8.1 -6.7 Financing of which: Net Domestic Financing 4.0 3.9 3.5 Net External Fiancing 6.3 4.6 1.8 Grants and Other -0.2 -0.3 1.4 Central Government Current Revenues 13.8 15.7 16.5 Expenditures 15.0 17.9 18.3 Capital Revenues 0.5 0.1 0.0 Capital Expenditures 7.5 6.5 5.8 Overall Deficit -8.3 -8.5 -7.6 Finacing of which: Net Domestic Financing 2.9 2.9 3.7 Net Externai Financing 5.4 5.7 3.9 Non-Financial Public Enternrises J1come 7.2 8.4 9.4 Current Expenditure 4.7 5.7 5.6 Capital Expenditure 6.1 3.7 3.2 Deficit -3.6 -0.9 0.7 Deficit (excludes Net Transfers) -4.7 -1.9 -4.9