Peru - Social Development and Compensation Fund (FONCODES) Project

Documut of The World Bank FOR OFFICIAL USE ONLY Report No. 12245-PE STAFF APPRAISAL U.EPORT PERU SOCIAL DEVELOPMENT AND COMPENSATION FUND (FONCODES) PROJECT NOVEMBER 16, 1993 MICROGRAPHICS Report No; 12245 PE Type: SAR Latin America and the Caribbean Regional Office Human Resources Operations Division Country Department I 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 AND EQUIVALENT UNITS (As of November 15, 1993) Currency Unit = Sole (S./) US$1 = 2.16 Soles (S./) GLOSSARY OF ACRONYMS ANC National Association of Centers BCR Central Reserve Banlk CIAS Inter-ministerial Committee for Social Affairs COMDES Social Development Committees COOPOP National Office of Popular Cooperation CORDE CALLAO Departmental Cooper. for the Development of Callao CORDE LIMA Departmental Cooperation for the Development of Lima DC Direct Contracting FONAVI National Housing Fund FONCODES National Fund for Social Compensation and Development GOP Government of Peru GTZ German Development Agency ICB International Competitive Bidding IDB Inter-American Development Bank IIN Nutrition Research Institute IMF International Monetary Fund INABIF National Institute of Family Well-being INADE National Institute for Development INEI National Institute for Statistics and Informatics INFES National Institute of Educational Infrastructure KfW Kreditanstalt fur Wiederaufbau LCB Local Competitive Bidding LS Local Shopping MEF Ministry of Economy and Finance MIGA Multilateral Investment Guarantee Agency MD Medical Doctor NGO Non-governmental Organization OPIC Overseas Private Investment Corporation PAHO Pan-American Health Organization PRONAA National Program for Food Support PRONABECE National Program for Goiter and Cretinism Control SIF Social Investment Fund SOE Statement of Expenditures TPS Social Policy Workshop UNICEF United Nations Children's Fund WHO World Health Organization PERU FISCAL YEAR January 1 - December 31  FOR OMCIAL USE ONLY PERU SOCIAL DEVELOPMENT AND COMPENSATION FUND PROJECT STAFF APPRAISAL REPORT TABLE OF CONTENTS LOAN AND PROJECT SUMMARY I. INTRODUCTION 1 II. POVERTY IN PERU Social Indicators 1 Social Expenditures 3 Social Services 4 m. ECONOMIC REFORM AND POVERTY ALLEVIATION The Economic Reform Program 5 Poverty Alleviation Strategy 7 Financing Poverty Alleviation 8 Implementation of the Poverty Alleviation Strategy 9 IV. BANK STRATEGY FOR THE SOCIAL SECTORS IN PERU Rationale for Bank Involvement 11 Lessons Leamned from Bank Experience with Social Investment Funds 12 This report is based on the findings of pre-appraisal and appraisal missions which visited Peru in April and July 1993. Mission members were Messrs/Mmes. Alexandre Abrantes (LA1HR), Mateen Thobani (LA1EA), Jean-Paul Faguet (LA3BO), Nuno Crato, Jos6 Durdn, Eugen Finkel and Christian Hurtado (Consultants), and Andrea Delbruck (KfW). Messrs. Rainer B. Steckhan and Alain Colliou are the Department Director and Division Chief, respectively, for this operation. Peer reviewers were Xavier Coll (LA4HR), Jean-Jacques de St. Antoine a-A2HR), Margareth Grosh (PHRPA), and Cecilia Valdivieso (MN2PH). Messrs./Mmes. Theresa P. Jones, Karen Cavanaugh, Juliana Weissman, Sarah Menezes (LAMHR) and Izumi Ohno (LAlCO), contributed to the report at headquarters. This report draws extensively upon the Bank's Peru Poverty Assessment and Social Policies and Programs for the Poor Report (Report No 11191-PE) and the Social Assistance Program in Peru report, prepared by the GOP for the Consultative Group Meeting held in Paris in June 1993. 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.  V. NATIONAL FUND FOR SOCIAL COMPENSATION AND DEVELOPMENT -- FONCODES Background and Objectives 13 Performance 14 Estimated Impact 16 Organization 18 Project Portfolio 20 Financing 21 Community-based Project Cycle 22 Inter-institutional Coordination 27 VI. THE PROJECT Objective and Scope 28 Dcription 28 Lending and Implementation 30 Costs and Financing Plan 30 Procurement 32 Supervision and Reporting 35 Disbursements and Documentation of Expenditures 36 Accounts and Audits 38 Cost Sharing and Sustainability 38 Environmental Aspects 39 Mid-term Review 39 VH. BENEFITS AND RISKS Benefits 40 Risks 40 VHII. AGREEMENTS REACHED AND RECOMMENDATION Agreements 41 Recommendation 43 Annexes 1. Socio-economic Indicators for Peru 2. Letter of Social Sector Policy 3. FONCODES Portfolio, January 92 - March 93 4. FONCODES Administrative Structure 5. Project Costs and Financing Plan 6. Estimated Schedule of Disbursements 7. Key Performance Indicators 8. Supervision Implementation Plan 9. Documents Included in the Project File Maps IBRD No. 24209 -- PERU: Departments IBRD No. 25190 - PERU: Poverty Map  i PERU SOCIAL DEVELOPMENT AND COMPENSATION FUND PROJECT STAFF APPRAISAL REPORT LOAN AND PROJECT SUMMARY Borrower: Republic of Peru. Executing Agency: Fondo Nacional de Compensaci6n y Desarrollo Social -- FONCODES. Beneficiaries: Low-income households, through community organizations, NGOs and other entities. Amount: US$100 million equivalent. Terms: Standard IBRD terms, with 20 years maturity and a five year grace period. Project Objectives: The project would (a) sustain the GOP poverty alleviation efforts, (b) mitigate the social costs of macro-economic adjustment, and (c) strengthen the institutional capabilities of FONCODES. The project would: (i) genciate employment and improve social services; (ii) promote strong and self-reliant community organizations; (iii) complement other nation-wide projects in education and health; and (iv) maximize support from other potential donors. Project Description: The project would support the overall operation of FONCODES for the period 1994 to 1996. More specifically, it would: (a) support a range of community- based, labor-intensive projects, with a strong focus on education, health and nutrition, and other areas that would assist poor rural and peri-urban populations; and (b) support the institutional development of FONCODES. Benefits: The project would: (a) improve the availability and accessibility of social services for the poor; (b) provide high-return social and economic infrastructure in poor areas; (c) raise employment and income of workers employed in community projects; (d) strengthen community participation and transparent decision maldng; and (e) attract other donors' investments.  ii Risks: The main risks of the project are: (a) discontinuity and weakened management of the implementing agency in the event of excessive political instability and interference; (b) ineffective community project implementation due to poor targeting, appraisal, supervision or lack of sustainability; and (c) weakening of existing institutions, due to the potential diversion of funds from line ministries and municipalities. Environmental Category: B Estimated Costs: PERU: Social Development and Compensation Fund Project. Estimated Costs (USS million) Componentu Local Foreign Total FONCODES Community-based projects 398.5 70 468.5 bIstitutional Development 17.5 9 26.5 Total Cogst 416 79 495 o taxes an uties Probable Financing Plan: PERU: Social Development and Compensation Fund Project, Co-financing (US$ million) F nadng PlanT Local Foreign T Total l Government of Peru 200 0 200 Beneficiaries 42 0 42 World Bank 80 20 100 Inter-American 80 20 100 Development Bank . Other Donors (including KfW) 14 39 53 Total 416 79 495 Retroactive Financing: Up to US$10 million equivalent would be permitted for eligible e.-penditures incurred since August 1, 1993.  iff Estimated IBRD Disbuzrsements: Per: Social Development and Compensation Fund Project Estimated IBRD Disbursements (US$ million) __ _ lBRD Fisca Year 1994 1995 1996 1997 Auual 1 25 40 25 101 t.Cumulative 25 65 90 100 Economic Rate of Return: Not applicable Poverty Category: PA - Poverty Alleviation; Program of Targeted Interventions  PERU SOCIAL DEVELOPMENT AND COMPENSATION FUND STAFF APPRAISAL REPORT I. INTRODUCTION 1.1 This report presents a Social Development and Compensation Fund Project for which a World Bank (Bank) loan of US$100 million equivalent to the Republic of Peru is proposed. Total project cost is estimated at US$495 million equivalent. The Project would consist of a loan to enlarge and enrich the programs of the National Fund for Social Compensation and Development - - FONCODES, and to improve its effectiveness and efficiency. The Government of Peru (GOP) created FONCODES in 1991, to mitigate the effects of the previous economic crisis and the social cost of economic adjustment, through the financing of small-scale, short-term investment projects of immediate impact on the poor and most vuhlerable. FONCODES has been designed as a transitional institution, to operate efficiently and transparently, until the institutional capacity of State social sector entities is strengthened and structural transformations are consolidated. Until now, the GOP has been the only source of FONCODES financing, excep; for a small technical assistance grant provided by the Inter-American Development Bank (IDB) for the institutional development of FONCODES. The GOP, the IDB and other bilateral donors such as KfNW have expressed interest in supporting an expansion of FONCODES programs. 1.2 This report: (a) describes the extent and causes of poverty in Peru; 0) reviews the GOP's program to restructure the economy and the strategy to alleviate poverty, including the role of FONCODES; (c) describes why the Bank should support FONCODES; (d) describes and appraises the objectives, performance and organization of FONCODES; and (e) proposes a Bank loan to expand and deepen the FONCODES program and improve its effectiveness, and provides the framework for project implementation. II. POVERTY IN PERU Social Indicators 2.1. Poverty is a long-standing problem in Peru. During the last twenty years, a higher incidence of poverty has persisted in Peru, relative to most of its neighbors in the region. A comparison of social indicators among countries in the region shows that Peru ranks near the lowest in most poverty-related areas such as health, and falls below countries which have similar per capita  -2 - GDPs. In 1991, Peru had a GNP per capita of US$1,070 equivalent and an infant mortality of 53 per 1,000 births, higher than other middle income countries in Latin America such as Colombia, Ecuador, Jamaica and Paraguay. Moreover, improvements achieved in the last decade were one of the lowest in the region. 2.2 Poverty is widespread and has worsened over the last eight years. According to (wo recent nutrition surveys which covered 75 percent of the country, about 12 million people (53 percent of the population), fall below the poverty line, with annual incomes below the cost of the basic household basket which includes food and non-food commodities (US$ 411 and US$245, on the coast and in the mountainous areas, respectively). Three and a half million people (21 percent of the population) are extremely poor, with an annual income below the cost of the basic food basket (US$277 and US$193, on the coast and in the mountainous areas, respectively). Between 1983 and 1990, real wages decreased at a 6.1 percent rate. Unemployment stands officially at 5.9 percent of the economically active population, but it is estimated that 78.5 percent of the economically astive population is presently under-employed. Finally, 45 percent of the population does not have access to a reliable source of clean water, and 62 percent does not have access to a public sewerage system. 2.3. The prevalence of poverty is highest in the rural mountainous areas, where two thirds of the households are poor and 47 percent fall into the extreme poverty category. In the mountains less than half the population has access to a public water system, and only 8 percent have access to public sewerage removal service. The indigenous populations are much poorer than the rest of the population: they account for 40 percent of the extremely poor and 25 percent of the poor; among the indigenous populations, the poorest are the Aymara speakers, of whom 86 percent are poor and 70 percent are extremely poor. Poverty is also closely related to education: about two thirds of the extremely poor households are headed by someone with no more than primary education. 2.4. In health, the situation is characterized by high infant and maternal mortality rates, malnutrition, high prevalence of endem-ic diseases and new epidemics, such as cholera. In 1991, the infant mortality rate was 53 per 1,000 births, higher than one would expect in a middle income country. The situation was far worse in some rural areas, due to long-standing regional and ethnic inequalities. In Huancavelica, Cuzco, Apurimac, Ayacucho and Puno, infant mortality rates were higher than 100 deaths per 1,000 births. In 1991, matemal mortality was at an alarming 30 per ten thousand births and was due to causes which could be prevented with family planning and deliveries being assisted by trained birth attendants. Malaria, leishmaniasis, hepatitis, dengue fever and yellow fever are endemic. Moreover, some diseases are on the rise: tuberculosis cases increased 20 percent over the last 10 years and malaria cases have doubled over the same period. Between 1980 and 1989, acute respiratory illnesses increased six-fold and acute diarrheal infections doubled. 2.5. The 1991 cholera epidemic demonstrated in a dramatic way the precariousness of health and sanitary conditions nationwide. Between February  - 3 - and June 1991, 223,000 cases were reported, one of the most serious epidemics of this century. Although neighboring countries also suffered cholera epidemics, none had such a large number of cases and deaths. 2.6. In nutrition, chronic child malnutrition is a serious and widespread problem. In 1991, malnutrition affected 13 percent of children under the age of 5, but the percentage was as high as 73 percent in some rural areas, and is estimated to cause about 9,000 deaths per year. Child growth seems to be jeopardized more by inappropriate weaning practices and infection than by lack of food availability. In 1986/87, a national survey estimated that goiter was endemic in 88 percent of the mountainous and jungle communities, averaging 34 percent among school children. The government has mandated the production and distribution of iodized salt, but only 60 percent of the population has access to it, due to its high cost, poor distribution and the widespread availability of non- iodized salt. The incidence of iron deficiency anemia has not been estimated, but small-scale studies suggest it is also a problem among pregnant and lactating women, and children. 2.7. In education, the situation is characterized by high illiteracy and repetition rates. In 1991, about 15 percent of the population was illiterate. The problem was particularly sexious among the rural population (29 percent illiterate) and women (21 percent illiterate). Forty-four percent of rural women could not read or write. Although figures suggest high primary and secondary enrollment ratios, repetition rates are very high. By 1988 it was estimated that, for each 100 children entering primary school, only 31 finished on time, 45 percent fiiled to pass at least once, and 24 dropped out altogether. The average Peruvian student was 2.5 years behind the grade the student should have been attending at his or her age, and those from Quechua- or Aymara-speaking parents were about 3.6 years behind. The picture was similar at the seconda y level, where a large percentage of students taldng a standardized test at the end of the cycle scored below the norm in mathematics, language, social sciences and natural sciences, and about 7 percent drop out before graduation. Pre- school attendance of children 3-5 year old was about 50 peicent. Social Expenditures 2.8. Peru has generally spent less than its neighbors in the social sectors and investments have dwindled in recent years. For example, in 1987, in South America, only Argentina and Paraguay spent less in education, as a proportion of GNP. The health share of central government expenditures has remained fairly stable at 4-5 percent through the 1970s and 1980s, falling to about 3.2 percent in 1990, when it was only 0.5 of GDP and the equivalent of US$8.3 per capita. As for the education sector, the government emphasis has lessened, from about 18 percent of central government spending in the 1970s, to 9.7 percent in 1990, when it had fallen to 1.4 percent of GDP and the equivalent of US$25 per capita.  -4 - 2.9 Public resources available for social services in Peru have become scarcer with the severe recession and the near vanishing of the country's tax system but, on average, social expenditures were somewhat protected from the most severe expenditure reductions. In 1990, central government expenditures amounted to 15 percent of GDP which, in real terms, means that they were 65 percent lower than in 1980 and 30 percent below the 1970 level, but health expenditures only decreased about half as much as total expenditures and in education the figures suggest a similar picture. In spite of scarce resources, formal cost-sharing was not considered an option until very recently, although there is some evidence that the poor have to incur significant out of pocket health care expenditures. Social Services 2.10. In general, the situation regarding tie provision of social services is the following: (a) generally adequate number of facilities which, however, are often deteriorated and lack appropriate technology; (b) a reasonable supply of personnel, who are poorly distributed and trained; (c) severe shortages of supplies; and (d) inefficiency and low priority given to cost-effective technologies. 2..11 In health, there has been a significant expansion of the prmary health care infrastructure over the last ten years. The number of health centers has increased by 60 percent and the number of health posts has doubled, supplying a relatively good level of 1.9 facilities per 10,000 inhabitants. However, there is marked physical deterioration of buildings and widespread scarcity of equipment, personnel is poorly distributed and little is spent on critical cost- effective interventions. Personnel is concentrated in Lima and other cities, being scarce in the mountainous areas (1 doctor/34,000 people), and the number of nurses is clearly insufficient (doctors/nurses = 1.29). Salaries and morale are very low, resulting in abysmal productivity (e.g. 2 consultations per hour in ambulatory care). Finally, public services are poorly coordinated with other sources of traditional community-basel health care, such as municipalities, NGOs, the church and grass-roots oiganizations, leading to ineffective and inefficient management of resources. 2.12. While the coverage of high risk groups with health services may appear adequate, he intensity and quality of services is poor. In 1991, child-health services covered an impressive 86 percent of all infants under age of one, but only reached 24 percent of children aged 1-4. Matemal-care services covered 57 percent of pregnant women, but only 13 percent of those lactating, and only 36 percent of women at child-bearing age used family planning services. The high coverage of infants under one may reflect the fact that parents have to take their children to a health center in order to get a birth certificate. The number of consultations was also very low, 0.4 ver year for a pre-school and school age child. The availability of critical pharmaceuticals is inadequate, due to disorganized distribution, budget constraints and failure to give it priority.  2.13. in nutrition, the Ministry of Health's Child Growth and Development Programn is the only large scale promotional program. The program is well designed and essentially ai ns at targeting nutrition supplements to mothers and children at high risk of mnalnutrition, and at rehabilitating malnourished children. Low funding for the program contributes to a high concentration of activities in Lima and limited supervision outside the capital. In addition, the Ministry operates the National Program to Control Goiter and Endemic Cretinism (PRONABECE), but there are no data on which to judge its effectiveness and efficiency. 2.14. In education, there has been an impressive expansion of primary enrollments. Parents are committed to sending their children to school, as 97 percent of each age cohort enrolls in the first grade, on time. By 1990, while enrollment was up, the real level of expenditures in education declined to a low of US$80 per student, causing: (a) an exodus of trained teachers from the system; (b) poor maintenance of the infrastructure; and (c) lack of textbooks and teaching materials in the classroom. 2.15. Due to salary erosion, many trained peisonnel left the teaching profession and the proportion of uncertified teachers rose to 50 percent in 1990. As a result the quality of service deteriorated, repetition rates increased, particularly in the early grades, and the wide geographical disparities in educational attainment and efflciency increased. Secondary education offers very little intermediate technical or professional training. 2.16. In spite of the low levels of academic performance, 25 percent of the relevant age group is enrolled in institutions of higher education and government spending on higher education represented, in 1984, about a third of total expenditures in education, surpassed on the continent only by Venezuela. HI. ECONOMIC REFORM AND POVERTY ALLEVIATION The Economic Reform Program 3.1. The major reason for the persistence of a relatively high incidence of poverty in Peru is the past dismal performance of the economy. The Govemment intervened excessively in the economy and the legal and administrative structure discouraged growth. The economy became closed and did not create enough jobs. The public sector became overextended and wasted resources. An attempt to implement an unorthodox economic program in the mid-1980's compounded these problems and caused plummeting output and hypeifation. The Government was forced to reduce spending to extremely low levels, although social services were somewhat protected. Nevertheless, the overall scarcity of resources has meant that Peru has been able to spend very little on the social sectors.  - 6- 3.2. In July 1990, the situation was characterized by hyperinflation (400 percent in August 1990), deep recession, high unemployment, and severe reduction of family income, with real wages reduced by one-half in three years. Tax revenues collapsed, the deficit reached 13 percent of GDP and the Central Bank was depleted of its reserves. The Government defaulted on paying its debts to international creditors and lost its credibility in the international financial markets. Finally, the economic collapse resulted in severe deterioration of all public services. Basic infrastructure, health services and swurity were left to deteriorate as the crisis deepened, leading to increasing poverty and loss of social cohesion. 3.3. To reverse a long period of poor economic perfornance, r.sing poverty levels and declining living standards, the Government in 1990 launched an economic stabilization and structural reform program aimed at controlling inflation, establishing the basis for sustainable economic growth, and reestablishing international credibility. The stabilization program included: (a) fiscal discipline and reform of the exchange rate mechanism, (b) deregulation of economic activity, and (d) promotion of competitiveness. 3.4. The Government reduced public expenditures to the level of its fiscal resources, severed all subsidies, and fought tax evasion and smuggling, bringing inflation down to 56 percent by February 1993. It adjusted monetary policy to match the reduced inflation targets and set the exchange rate to discourage cheap imports and stimulate exports. Finally, it linked the primary emission of currency to the purchase of foreign exchange by the Central Bank and deregulated the financial system and interest rates. 3.5. The Government deregulated the commercial and financial markets, reduced import duties drastically and removed other restrictions to imports. It liberalized international financial operations, allowing for transfers from Peruvians abroad. Finally, the Government limited its intervention in the economy, and reduced the number of civil servants, by offering strong incentives for early retirement. 3.6. To promote competitiveness, the Government is implementing a large program to privatize about 70 public enterprises, attracting capital into the country and generating productive investments and sustainable employment. The GOP is also promoting private investment by: (a) opening the infrastructure, education and other social sectors to private initiative, (b) facilitating land transactions, (c) negotiating international banking guarantees with MIGA and OPIC, and promulgating a code for international investments, and (d) opening the market for private pensions. Finally, the Government passed a series of laws to promote an efficient labor market, including the elimination of indexed wages, temporary contracts, and linking job stability to productivity and the financial situation of the firm. 3.7. To reestablish international credibility, the GOP renegotiated the servicing of its bilateral and multilateral debt and has recently cleared its arrears with the Bank and the International Monetary Fund (IMF). In 1991, the  - 7 - international community, led by the USA and Japan, reacted positively to the economic program described above and created the First Support Group. From this Group, Peru received a combination of grants and loans. In 1993, a Second Support Group committed about US$2.8 billion for 1993-94 and Peru has again become eligible to borrow from the IMF. The debt to the Paris Club and other international creditors has also been renegotiated, while negotiations with China and other East European creditors are still underway. Poverty Alleviation Strategy 3.8. Economic recovery, stimulated by economic stabilization and deregulation, is the basis of the poverty alleviation strategy. Economic growth will benefit the poor by providing them with more opportunity to use their assets, such as labor and land. It will offer job opportunities, raise income and provide for the basic needs of the poor. However, in the short run, the poor are likely to be adversely affected by the program, as the benefits of growth will not flow immediately to all the poor, particularly in Peru, where macroeconomic instability and economic deterioration have been severe and where extreme regional disparities exist in the welfare of the population. 3.9. In the meantime, the poor must have access to health and education services; otherwise, they will not be able to benefit from the opportunities available in an expanding economy. In spite of improved social services, in the short run, some groups will remain vulnerable, because they are already living on the edge. For these people, social compensation programs, such as employment generation and food assistance, can complement the two main elements of a poverty alleviation strategy - promotion of broad-based growth and improved and more equitably distributed social services. 3.10. To tackle the problem in the long-term the Government is trying to stimulate economic recovery, is increasing its social investments, and requiring that social programs be targeted to the poorest and be more efficient. Specifically, the objectives of the GOP poverty alleviation strategy are: (a) to improve the availability and quality of primary and preventive health care, with an emphasis on rural and peri-urban areas; (b) to improve the efficiency and quality of education, with an emphasis on primary education in rural and peri-urban areas; (c) to support schools with feeding programs and the distribution of books and other teaching materials; and promote basic literacy and job training for adults; (d) to distribute food supplements to the most vulnerable strata of the population in rural and peri-urban areas; (e) to raise income and generate employment in poor rural and peri- urban areas, through labor-intensive social infrastructure projects and support to production; and (f) to support credit for small, informal sector micro-entrepreneurs and farmers, in order to improve efficiency.  - 8 - 3.11. To respond to the immediate needs of the poor, the GOP created the Social Emergency Program in August 1990, with activities in the areas of education, health and nutrition, and employment for the poorest. Over two months, the Government channelled about US$65 million of food and health care supplies through community organizations such as mother's clubs, community kitchens and the Catholic Church. In August 1991, the GOP created the National Fund for Social Compensation and Development - FONCODES, a social development fund to finance temporarily labor intensive projects with a strong focus on employment generation, health and nutrition services and education programs, as well as other investments for productive activities, such as support to micro-enterprises and farmers, that could assist urban and rural populations. 3.12. Given the current resource constraints and the need for continued fiscal discipline, the GOP is targeting its poverty alleviation programs to the very poor and the most vulnerable. Geographically, targeting is based on poverty maps, which have been drawn on the basis of low income, high unemployment or under-employment, associated with high infant mortality, malnutrition, illiteracy and repetition rates, as well as with poor accessibility to social services. On the basis of these criteria, Apurfmac, Huancavelica, Ayacucho, Cuzco, Cajamarca and Puno correspond to the poorest areas of Peru (Maps). It is proposed that poverty surveillance be carried on a regular basis by the Inter-ministerial Commission on Social Affairs and the Technical Committee for Social Development, which include the Central Reserve Bank (BCR), the National Institute for Statistics and Informatics (INEI), the Social Policy Workshop (TIS), the Nutrition Research Institute (IN) and UNICEF. Financing Poverty Alleviation 3.13. The GOP is increasing the level of its investment in the social sectors and requiring that social services be more efficient. From August to November 1990, the Government allocated US$89 million to an emergency social program, raising it to US$124 million in 1991, and again to US$225 million in 1992. For 1993, the GOP has allocated US$424 million (1 percent of GDP) for the alleviation of extreme poverty and plans to raise its support to a level of 1.5 percent of GDP by 1995. One-half of these investments are to be channelled through FONCODES, and the rest through other agencies. In 1993, the Ministries of Education and Health have been allocated US$338 million and US$194 million, respectively. 3.14. Private investment in the social sectors and in poverty alleviation is significant, amounting to more than US$35 million per year. It is estimated that Non-Governmental Organizations (NGOs) spend some US$10 milion, that the Catholic Church invests another US$20 million, and that private enterprises contribute directly with some US$5 million. 3.15. Multilateral and bilateral agencies have contributed significantly to poverty alleviation programs and their assistance will continue to be essential for some time.  -9- llmplementation of the Poverty Alleviation Strategy 3.16. The poverty alleviation strategy will be implemented by a combination of central and decentralized responsibilities, with strong and direct community participation, and with the involvement of both public and NGOs. 3.17. The later-ministerial Committee for Social Affairs (CIAS) coordinates the Country's poverty alleviation strategy and policy. The CIAS is chaired by the Prime Minister and includes the Ministries of the Presidency, Economy and Finance, Health, Education and Labor. 3.18. The CIAS is to be supported by several technical Social Development Commtees (COMDES), which would be created on an ad hoc basis to deal with specific issues and include specialists from the relevant sectors. One specific COMDES would monitor and oversee progress in achieving the targets. The Ministry of Economy and Finance (MEF) provides the secretariat for these COMDES. 3.19. The Ministry of Economy and Finance (MEF) will carry out the necessary poverty studies, to identify the most vulnerable strata of the population, study alternative strategies for financing the social sectors, propose target groups and specific program objectives, coordinate with ministries and other executing agencies, appraise programs and projects and evaluate, axpost, how these affect the life of the target population. 3.20. The Ministries of Education and Health will implement the relevant long-term development programs and are being allocated specific budgets for this purpose. Social sector lne ministries and other existing social agencies and programs are at this time weak, and will take some time to reform. 3.21. There are also a wide range of other active social sector agencies, but considerable gaps and duplications in functions exist: (a) the National Program for Food Support (PRONAA) provides food assistance and security, mainly in areas seriously affected by terrorism; (b) the National Institute of Educational Infrastructure (INFES) is responsible for rehabilitating, building and equipping schools; (c) the National Office of Popular Cooperation (COOPOP) promotes community work; (d) the National Institute of Family Well-being (INABIFF) provides social services for problem families, children and adolescents; (e) the National histitute for Development (INADE) manages large national investment projects; and (f) the National Housing Fund (FONAVI) finances projects in urban infrastructure. 3.22. The Fondo Nacional de Compensacl6n y Desarroilo Social - FONCODES, created in August 1991, will cushion the poor and the most vulnerable against the negative effects of economic adjustment, and until line ministries and other more permanent social agencies undergo strengthening and reforn. It operates as a social bank and financial intermediary for national social investments, and for multilateral and bilateral grants and loans. It  - 10- finances small, community-based, labor-intensive, privately contracted, projects with a strong focus on employment generation, health, nutrition and education programs, on the rehabilitation of both the economic and social infrastructure, as well as other investments, such as support to micro-enterprises, targeted on urban and rural populations living in extreme poverty. It is an instrument to improve the quality, equity and efficiency of social investment. This project would specifically contribute to an enlargement and enrichment of its programs and improve its effectiveness and efficiency. 3.23. Municipalities are seen as a necessary part of the poverty alleviation strategy, but have been unable to respond effectively, given the constraints imposed by central-local fiscal relationship,, imperfect or absent investment financing and cost-recovery mechanisms as well as weak administrative capacities. At this time, municipalities are under-funded and access to quality of municipal-level services is still deteriorating, with the attendant negative consequences for productivity, poverty alleviation and environmental amelioration. 3.24 Municipalities are being progressively involved in the implementation of the poverty alleviation program, and are receiving increasing responsibilities and resources from the Central Government. In time, municipalities are expected to be the major actors in poverty alleviation, as they take responsibility for primary education, primary health care, public health, children centers, recreation, and special employment programs. At present the "Glass of Milk Program", in which committees of mothers distribute milk to target children, is already managed by municipalities. 3.25. Communities have organized themselves to respond to their immediate social needs. Mothers' clubs, "Glass of Milk" clubs, community kitchens, and neighborhood associations have proliferattd. To apply for FONCODES grants, communities have organized themselves into thousands of "executing committees" which have been able to generate about 12,000 proposals and execute half as many. The education decentralization reform, which is being proposed by the Ministry of Education, in which parents' committees will be awarded by the Ministry a grant per enrolled student for directly managing primary schools, offers a test for how further social responsibilities could be assumed by communities. 3.26. Non-governmental organizations (NGOs) are deeply involved in the implementation of poverty alleviation programs. At present, in Peru, it is estimated that there are over 700 NGOs, organized in the National Association of Centers (ANC) and other consortia. For years, they have been active in rural development and support to micro-enterprises (36 percent), basic education (57 percent), basic health care (23 percent), human rights (10 percent), and environment and social studies (45 percent). Many of them are deeply involved in FONCODES community-based projects, as promoters, intermediaries and implementers.  - 11 - IV. BANK STRATEGY FOR THE SOCIAL SECTORS IN PERU Rationale for Bank Involvement 4.1. The Bank is supporting the Government of Peru in a three-part poverty alleviation strategy, which consists of: (a) encouragement of broad-based economic growth, through private sector development and public sector reform, (b) development of human capital, and (c) mitigation of the short-term impact of adjustment. 4.2. To encourage economic stability and adjustment, the Bank has approved four adjustment and one technical assistance loan: (a) Trade Policy Reform Loan (L-3437-PE), including a reform of the -xchange regime, tariffs, import barriers, export regime and trade institutions; (b) Structural Adjustment Loan (L-3452-PE), including reforms of the macroeconomic and fiscal policies, social sector strategy, privatization and deregulation, agriculture, labor issues and social security; (c) Financial Sector Adjustment (L-3489-PE), including reforms of the development banks, "Banco de La Naci6n", privatization, banking supervision and regulation and capital markets; (d) Privatization Technical Assistance (L-3540-PE); and (e) Privatization Adjustment Loan (L-3595-PE). 4.3. In the area of human capital and poverty alleviation, Bank strategy emanates from the Poverty Assessment and Social Policies and Programs for the Poor (Report No. 11191-PE), and is to: (a) Alleviate poverty and cushion vulnerable groups against potential negative effects of the economic adjustment program; (b) Improve the provision of basic social services to the poor and to the most vulnerable groups; (c) Strengthen the effectiveness and self-reliance of community and other non-governmental organizations; and (d) Support the rehabilitation of the social infrastructure in the poorest rural and peri-urban areas. 4.4. To implement this strategy, the Bank is preparing a Basic lHealth and Nutrition Project, and identifying a Basic Education Project, which are expected to strengthen and contribute to the reform of the relevant line ministries. 4.5. The proposed project would complement these long-term efforts with a rapid and targeted initiative to assist low income communities to: (a) reestablish basic infrastructure and public services, (b) generate employment and (c) put in place the key elements of a social safety net. With its range of experience with  - 12 - social funds, the Bank is well placed to help strengthen FONCODES' management, improve its effectiveness and stimulate the involvement of other potental donors. Lessons Learned from Bank Experience with Social Investment Funds 4.6. Pioneered in Bolivia, Social Investment Funds (SIFs) have since spread to other countries in Latin America, including Guyana, Haiti, Honduras, Nicaragua, and are under preparation in Chile, Ecuador, and Guatemala. Typically, they target low-income groups and areas by financing small-scale development projects, generated and administered by community-based organizations. Projects are generally carried out by private contractors, incorporating a high proportion of local labor and materials. 4.7. Experience shows that success of SIFs depends on: (a) Semi-autonomous manageme and weUl paid high quality staff to reduce the potential for political influence; (b) Demand-riven mechanisms for project generation, with strong local participation, to ensure ownership, sustainability, project relevance and stimulation of community organization and social cohesion; (c) Targeting mechanim based on poverty maps, to ensure that the poorest groups and areas are reached; (d) Promotion and support for community-based project generation, in poor municipalities where communities have difficulty in generating projects; (e) Simple conmmunity-based project desig and transparent procedures to allow for efficient sub-project appraisal and implementation; (f) Execution of community-based projects by private contractors, to stimulate efficiency and strengthen the local economy; and (g) Regular and frequent financial and operational audits to ensure transparency and accountability, which are essential to mobilizing external funds. 4.8. Poorly implemented Social Investment Funds can result in: (a) Instability of the implementing agency; (b) Poor targeting, projects not reaching the poorest or the most vulnerable; and (c) Nonsustainable or otherwise ineffective community-based projects, due to poor appraisal, execution or supervision; and (d) Weakening of other social sector agencies, such as the ministries of education, health or public works.  - 13 - 4.9. Most conditions for a successful operation in Peru have been present since August 1992, and have contributed to the remarkable record of FONCODES since then: (a) high-level management is of high quality and enjoys significant autonomy from political influence; (b) projects are based on grass- roots community organizations; (c) targeting, appraisal and selection are adequate; and (d) project execution draws extensively on the local private sector. On the other hand: (a) promotion and project development must be supported in some very poor areas where demand is lower than what could be expected from the level of poverty, and (b) project sustainability and supervision have to be improved. These concerns have been included in the revised Operational Manual which was transmitted to the Bank prior to negotiations (8.1). V. NATIONAL FUND FOR SOCIAL COMPENSATION AND DEVELOPMENT -- FONCODES 5.1. The proposed Project would support the overall operation of FONCODES for the period 1994 to 1996. It would consist of a loan to enlarge and erdich FONCODES' programs, and to improve its effectiveness and efficiency. The next sections describe and appraise FONCODES' objectives, activities and impact, resources and organization. Background and Objectives 5.2. The Government of Peru created FONCODES on August 15, 1991, in an effort to mitigate the social costs of economic adjustment through the financing of small scale, short-term social investment projects of immediate impact on the poor and most vulnetable. After the first 17 months of operations, the GOP reviewed the Fund's legal statutes on December 30, 1992, in order to reinforce its autonomy and improve its efficiency. On that date, FONCODES became a decentralized public agency, which depends directly on the President of the Republic, with technical, administrative, economic and financial autonomy. It also became the principal social sector Government magnet for international, bilateral and multilateral aid, credit and development agencies. 5.3. FONCODES finances small-scale projects in social and economic infrastructure, as well as programs in social assistance and income-generation, geared towards improving the living standards of the poor. Emphasis is given to the areas of education, health and nutrition, sanitation and employment- income generation. Projects and programs must be managed by community organizations with technical assistance from regional and municipal governments, ministries, NGOs and independent professionals.  - 14 - 5.4. FONCODES targets its social assistance projects towards the population affected by structural poverty, and its infrastructure and employment generating programs to those who have slipped into poverty and extreme poverty as a result of recession and economic adjustment. These groups include: (a) Severely depressed rural and indigenous communities and those most affected by instability; (b) Community organizations in peri-urban areas; (c) Small-scale farmers, fishermen and artisans, and other micro- entrepreneurs; and (d) Womeni and children. Performance 5.5. During its short life, FONCODES has had a remarkable performance. From January 1992 until March 1993, PONCODES, reviewed 12,035 community-based project proposals, for an estimated US$542 million, of which FONCODES approved 6,036 (50 percent approval rate), estimated to be worth US$176 million. Approval rates varied by type of project. By February 1993, 4,073 contracts had been signed with community organizations, which completed 818 projects (20 percent), and disbursed the full US$116 million FONCODES budget allocation for 1993 (Annex 3). FONCODES - Proposals and Contracts, by Sub-project Type. August 1992 - March 1993 Type of Project Proposals Approved | Approval ; (US$542 M) (US$176 M) Rate Social Assistauce 6.4% 6.0% 31% Social Infrastructure 42.6% 56.5% 43% Economic Ilfrastructure 32.0% 31.0% 31% Income and Employment 19.0% 6.5% 11% Generation 5.6. FONCODES has been effective in targeting its resources to the poorest areas. Ninety-two percent of all community-based projects it has financed originated in the 50 poorest provinces, and it has allocated 50 percent of its investments for this purpose. Community projects in these extremely poor areas account for: (a) 49 percent of all contracts, (b) 48 percent of newly-generated jobs, and (c) 35 percent of all beneficiaries. 5.7. Community-based projects were appraised and executed without major problems even in areas under the state of emergency, such as Ayacucho, Huancavelica and San Martfn. In these areas, FONCODES approved over 1,000 projects, for more than US$55 million, which generated more than 2.1 million workdays and benefited more than 2 million people. Projects were carried out even in Iberia (Madre De Dios), close to the border with Brazil, in an area which can only be reached by plane or after several days of rough road travel.  - 15 - 5.8. During identification, preparation and appraisal, Bank staff and consultants visited more than 50 community-based projects and reviewed the files of many more. In general, Infrastructure projects, which constitute more than 80 percent of the portfolio, were of good quality, using high quality materials and equipment. For some, such as water and power supply, and irrigation, the sustainability and maintenance of the project had not been well considered. The Project would introduce these concerns as key elements of appraisal and supervision (para 6.38.) 5.9. Social assistance projects, which constituted only 6 percent of FONCODES portfolio, varied in quality. Some health projects, such as cholera and endemic disease control, were typical Ministry health promotion and preventive campaigns, managed through WHO/PAHO, with relatively little community participation. On the other hand, education sector projects, such as the school breakfast project, offer excellent examples of how to transform vertical, top-down social programs into highly participative community-based projects. In the school breakfast project, parent associations organized themselves into executing committees, representing at least 1,000 students, to present project proposals, in which they would take the responsibility for delivering school breakfasts to a certain number of students for a year. FONCODES hired the Institute of Nutritional Research, a specialized NGO, to define the technical specifications for a balanced school breakfast and to organize a local competitive bidding procedure for companies wishing to providing the nutritional supplements. FONCODES signed an umbrella contract with the winning company, to provide a certain number of school breakfasts over one year. When a community-based project is approved, the company starts delivering monthly supplies to the Departmental capital, where the parents' associations come to collect them. After checking that all is in order, the executing committee authorizes the payment to the supplier. The parents also organize the daily preparation and delivery of the school breakfasts to the students, during the morning break. 5.10. Credits to small-scale farmers and entrepreneurs, for income and employment generation, constitute only about 6 percent of the project portfolio. FONCODES provided for the establishment of revolving funds, to be administered by NGOs (79 percent), such as CARE, IDESI and HABITAT, and by 'savings and loans" financial institutions, such as the Federation of Municipal Savings and Loans. Because banks generally do not give loans to small-scale entrepreneurs, often in the informal sector, NGOs and savings and loans are, at present, the Peruvian financial institutions which are best placed for reaching the target beneficiaries. Credit awarded at market conditions has benefited mostly rural communities (66 percent of the awarded loans), and the financial intermediaries ensured adequate training and technical assistance to the beneficiaries, and have had low loan default rates, ranging from 4 to 8 percent. The Lima Savings and Loans was an exception, as it did not provide adequate technical assistance, showed poor loan judgement, and accumulated a much higher level of bad debts. As a result, FONCODES will not renew its contract with this agency.  - 16- 5.11. The contracts with the financial intermediaries were not clear on the provisions for returning the revolving funds to FONCODES, and were not standardized regarding the financing of the operational costs of the intermediary institution and the credit conditions for beneficia!ies. Supervision of this type of projects needed more resources and an improved management information system. The project would make sure that these would be taken into consideration in the institutional development of FONCODES (paras 5.52, 8.1,c.) 5.12. Community-based projects to support small-scale farmers, with the exception of those which distributed agricultural inputs to areas suffering from last year's drought, appeared to be adequately targeted and of high priority, to be well designed and sustainable, and to rely on the private sector for execution. 5.13. The operation of FONCODES has been efficient, with administrative costs representing only 4 percent of the total budget in 1992. FONCODES increased its sub-project processing rate from 308 projects a month in late 1992, to 858 projects per month in the first quarter of 1993. The time taken to approve or reject a project proposal has diminished from an average of 119 days in late 1992, to 42 days in the first quarter of 1993. Yet, this achievement occurred in spite of clear resource shortages: vehicles were too few, as were computer terminals, telephones, faxes and radios. The proposed project would support the institutional development of FONCODES, according to a plan FONCODES has developed with the technical assistance of IDB and is acceptable to the Bank. According to the plan, all Regional Offices would have at least two vehicles, an adequate number of computer terminals and peripherals, and a telephone, fax and radio system (para 6.3.b.ii.) Estimated Impact 5.14. Community-based projects funded by FONCODES are estimated to have benefited over 10 million people and generated over 8 niillion paid workdays, i.e., about 30,000 man-years. FONCODES - Impact and Cost Effectiveness, by Sub-project Type 7ype of Projec t Benefiiaries Wor*-days T US$ per I US$ per I Milion JMillion benefic. work day Social Assistance 8.1 N.A. 1.3 N.A. Social Infrastructure 3.5 2.2 15.2 25 Economic lnfrastructure 1.8 3.2 23.7 13 Income and Employment 1.8 2.6 13.5 10 Generation  - 17 - 5.15. The relatively few social assistance projects benefited more than twice as many people as any other type of project. On the other hand, economic infrastructure sub-projects benefited relatively fewer people, but generated the largest number of workdays. Income and employment generating sub-projects were the most efficient in creating jobs. The credits to small-scale farmers and entrepreneurs incorporated the beneficiaries into the formal economic structure and assisted them in organizing production and taling advantage of economies of scale, while infrastructure projects have trained many unskilled workers, providing local populations with valuable assets. 5.16. During appraisal a sample of 10 typical projects was selected for a beneficiary assessment. All projects were clearly oriented to satisfy real needs of the beneficiaries, although in two cases, one could argue that the satisfaction of other needs might have been more urgent. The commitment and direct contributions of the population were remarkable, including voluntary work- hours, collective volunteer work-ays, and acceptance of salaries well below market wages, which allowed the project to reach the most needed. Equally remarkable was the working relationship between the communities, promoters, inspectors and FONCODES staff. This beneficiary assessment served both to assess a certain number of projects, but also to develop the terms of reference for an ongoing expost evaluation of a sample of projects, which the project will include, based on a mix of traditional economic evaluation and a more qualitative beneficiary assessment (paras 5.61., 6.25.g.) 5.17. All the evaluated projects were successful in the immediate alleviation of poverty and in generating temporary employment, mostly for unskilled workers, but the effective generation of permanent employment was modest, as is usually the case for social investment funds which are designed to provide short-term poverty alleviation measures during a period of economic adjustment. To generate more permanent employment, FONCODES would have to promote certain project types, such as agriculture land rehabilitation, terracing, community kitchens, storage and commercialization centers, cattle breeding, dairy and livestock, fishing, and investments in small enterprises. 5.18. Some of the evaluated community-based projects would not be sustainable, unless additional investments were carried out. Typicaly, it was a question of an originally comprehensive and sustainable project, being cut into several smaller unsustainable sub-projects to accommodate FONCODES eligibility and appraisal criteria, with the underlying hope of being able to have the series of sub-projects approved in succession and, thereby, achieve the original project objectives. In such cases, it would make sense for FONCODES to request a revision of the relevant proposal, or to promote the needed complementary community projects (para 6.38.) 5.19. Communities also benefited from organizing themselves to prepare and manage project execution. This process contributed to community organization dynamism, self-reliance and effectiveness. Communities were energized by their positive experiences and many have proceeded from completing their first project to preparing a second one.  - 18- 5.20. The risk of FONCODES being used as an instrument of political manipulation was considered during project preparation and appraisal. The Bank's and the IDB's staff and consultants involved reviewed FONCODES' past experience and confirmed that there had been no serious or negative political manipulation in FONCODES project selection. Almost all of the projects visited were genuinely grass-roots, community-based and responded to real needs of the population. In some remote areas, the name FONCODES was not even associated with the Government, but was thought to correspond to the acronym of an NGO. The project would monitor the risk closely, through Bank supervision and independent ex post evaluation of a sample of projects. Organization 5.21. FONCODES is a small organization, relative to the overall resources and number of projects it manages. It has a staff of 200, 70 percent of which are professionals. These are complemented by another 250 external evaluators and supervisors. In 1992, overhead costs were about 4 percent of the institution's yearly budget. 5.22. The organizational structure is simple and sound. The President of the Republic directly appoints the five-member Board of Directors which is chaired by the Minister of the Presidency. The Board defines general policies and regulates and supervises the overall operation of FONCODES. It also ratifies decisions on community-based projects which would cost over US$100,000 equivalent. One of the Board members is appointed Executive Director, and is responsible for executing Board decisions and for the institutional representation of the Fund. The rest of the organizational structure (Annex 4) is still evolving and is presently composed of: (a) A General Manager, who plans, organizes, coordinates, supervises and evaluates, according to the statutes and policies established by the board; (b) Three line managers, for: (i) Programs and Projects, responsible for targeting, promotion, and appraisal; (ii) Supervision and Control, responsible for supervision, and contract management; and (iii) Operations, for budgeting, accounting and managing disbursements and personnel; (c) 21 Regional Managers, responsible for Regional Offices, which promote, select, appraise and supervise projects in their jurisdiction; these are coordinated by a Regional Coordination Manager.  - 19 - (d) Three support managers, for: (i) Legal Affairs, for legal counsel of Management; (ii) Internal Control, which ensures compliance with appropriate procedures and accountability through regular audits and ad hoc enquiries; and (iii) Planning and Management Information Systems, in charge of information network and institutional development; and (e) One Special Advisor on External Technical Assistance and Financing, in charge of liaison with multilateral and bilateral agencies. 5.23. FONCODES is presently building the capacity of its Regional Offices and intends to grant them significant autonomy in promoting technical assisiance, appraisal, selection and supervision of community-based projects. At present 70 percent of all project proposals are appraised at regional offices, which can direcdy approve projects costing up to US$10,000 equivalent. The project would support this decentralization effort, through quality assurance mechanismns, such as standards setting, training and regular monitoring and control. At present, neither Tacna nor Apurimac have a regional office, due to a low demand for community-based projects. This is a cause of concern in the case of Apurimac, which is an area with a high prevalence of poverty and extreme poverty. The project would help develop the Apurimac Regional Office to promote projects and provide technical assistance to communities wishing to propose projects. 5.24. The staff is dedicated and of good quality, but overworked. Vehicles and equipment are, at present, insufficient for the number of projects which will need to be appraised and supervised. Research and development was not adequately supported and the coordination between appraisal and supervision could be improved. The project would assist FONCODES in implementing an institutional development plan, developed with the technical assistance of IDB, which would address the identified deficiencies (para 6.3.b). The institutional development plan is available in the Project files. 5.25. As a result of project preparation, FONCODES has created a research and evaluation function to study needs, develop innovative community-based project concepts, evaluate expenence and incorporate lessons learned into new community-based project design and administrative procedures. The project would support the institutional development of FONCODES, including the rehabilitation of facilities, purchase of vehicles and equipment, technical assistance, studies and training. It would improve the integration between project appraisal and supervision. It would also promote a post community project evaluation, to evaluate the impact on beneficiaries.  - 20 - Project Portfolio 5.26. FONCODES finances community-based projects in the following areas: (a) Social Assistance, including projects in: (i) health and nutrition, such as primary health care, disease prevention, family planning, medical supplies, and (ii) education, such as pre-schooling, school supplies, school libraries, literacy campaigns and training of unemployed workers; (b) Social Infrastructure, including water treatment and supply, sewerage, health post rehabilitation and medical equipments, community kitchens, school rehabilitation and equipment, and rehabilitation of sports and community centers; (c) Economic Infrastructure, including economically viable projects with a significant social impact such as rehabilitation of small roads and sidewalks, irrigation systems, terracing, land rehabilitation and erosion control, reforestation, electricity supply, and markets; projects in categories (a) to (c) above are financed through grants provried by FONCODES to community- based entities; and (d) Income and employment generation projects for small-scale farmers, fishermen and micro-enterprises; these projects are implemented through loans, at market rates, provided by intermediaries which administer revolving funds for this purpose received from FONCODES. 5.27. At the start, FONCODES supported a wide and open portfolio of projects, without imposing any priorities, to generate community demand and creativity. At the present stage, when demand vastly out-paces the availability of funds, FONCODES intends to prioritize those types of projects which would contribute more to poverty alleviation, and would focus its activities into the poorest areas. The project would add this priority ranldng to the appraisal criteria (para 8.1.b.i.) 5.28. As described above (para 5.18), some community-based projects would not be sustainable alone. They would need to be complemented by additional components or by other associated community-based projects: rehabilitation of schools would need to be complemented with fiuniture, school books, and assurance that a teacher is available; health nosts would require that a source of clean water, basic medical equipment and supplies, exist and that health personnel would be available at least twice or three times a week; community kitchens would need to have a source of clean water; school breakfasts and medical suipply projects would require some assurance of continuity. The project would promote these complementary inputs and projects (para 6.38). 5.29. Again, some projects, such as water and power supply, and irrigation, would not be sustainable without proper organization and training of the user community. Such training and organizational development would be covered by adding specific components to medium sized projects, or by organizing  - 21 - specific projects to cover training and organizational needs of a number of similar small projects. For water and sewerage projects, as well as for irrigation projects, FONCODES would promote the creation, training and support of cc.mmunlity-based resource management committee, which would be responsible for maintenance and minor repairs and would ensure the collection of tariffs. FONCODES would also contract out the preparation and distribution of the relevant infrastructure maintenance manuals. Financing 5.30. Until now, FONCODES has been almost solely financed by the Public Treasury. In 1992 and 1993, it was granted US$87 million and US$214.9 million equivalent, respectively, of which 97 percent came from the Treasury. 5.31. FONCODES provides financial support to organized communities for project preparation, labor and materials and for the services of an adviser/inspector who can ensure the technical quality of the community project. Financing is provided through: (a) Grants to community organizations carrying out social assistance, rehabilitating social and economic infrastructure; and (b) Transfer of Funds to Fiduciaries, such as the Savings and Loans (Cajas Municipales) and NGOs, which in turn lend such funds at standard market rates to small-scale farmers, fishermen and micro-enterprises. 5.32. At present, revolving funds constitute a mere 6 percent of FONCODES' investments. FONCODES would only support this type of project temporarily, in cases of market failure, until the government sets an overall policy on credit to small and medium enterprises. At negotiations, assurances were obtained that this type of project would not constitute. at any time. more than 10 percent of total grants or loans aproved by FONCODES (para 8.2.c.) 5.33. FONCODES' initial portfolio included loan guarantees for financial institutions making loans to small-scale farmers, fishermen and micro- enterprises, but no proposal was ever approved. At negotiations, assurances were obtained that this type of project would not be eligible for FONCODES funding (paM 8.2.c.) 5.34. Until now, the overall portfolio of FONCODES shows that projects have been small and community-based, costing an average of US$30,000 equivalent. To achieve this result FONCODES has required that: (a) project execution time should not exceed one year; (b) basic salaries should not exceed the minimum wage for an unsldlled civil worker; (c) labor costs must account for at least 30 percent of the budget; and that (d) average costs per unit should not exceed the average unit costs of such projects in the region or municipality.  - 22 - 5.35. Cost Sharing. During the emergency phase of poverty alleviation, communities have not been asked to share the costs of projects. In some cases, they have not been asked to pay for the costs of providing the services associated with the project (e.g. water and power supply). However, a preliminary review of approved community-based projects shows that the majority of them already include substantial community contributions, in the form of management costs, land, materials, complementary inputs, and even volunteer work. These contributions were estimated to vary from an average of 6 percent of total costs in social assistance projects, to 19 percent in some social infrastructure projects, such as the rehabilitation of schools. Also, power and water supply infrastructures is typically transferred to municipalities at the time of project completion, and the municipalities collect and administer user fees. 5.36. The Project would require community contributions for all projects approved by FONCODES, which would be on average 10 percent of project capital-costs, adjusted to the type of project, and poverty levels. Such cost- sharing scheme and maintenance arrangements would improve community ownership and project sustainability (para 6.36). In addition, for certain types of projects, such as irrigation, water and power supply, communities would be required to organize to collect charges, to cover the recurrent costs, and the municipality or the relevant ministry would ensure maintenance. Community-based Project Cycle 5.37. FONCODES' project cycle includes targeting, identification and promotion, appraisal and selection, contracting and disbursements, supervision and ex-post evaluation. 5.38. Thrgeting. Although community-based projects are demand-driven, and originate in communities, FONCODES establishes budgetary and activity targets on the basis of poverty maps. Far from an attempt to plan projects, the targets are a reference for establishing priorities among the vast needs of the Peruvian poor. The objective is to ensure that between regions, and within each region, the more developed groups do not use most of the resources, and to avoid that the poorest, who may be less able to generate good projects, remain uncovered. 5.39. Targeting is based on poverty maps, constructed with a poverty index based on income per capita and infant mortality rates. For each fiscal year, tentative budgetary targets are established for each area, and the allocation is then fine-tuned by the Board for conditions of special hardship, such as living under emergency security conditions. The final allocation is confirmed by a task-force which includes the Central Reserve Bank (BCR), the National Institute for Statistics and Informatics (INEI), the Social Policy Workshop (TPS), the Nutrition Research Institute (IN), FONCODES and UNICEF. Management monitors the demand for community-based projects per area, on a monthly basis, and the Regional Offices, which are closer to community needs, take the leading role in promoting and supporting project preparation in  - 23 - those areas where need is well recognized but demand is below what could be expected. The present system has so far produced a fair distribution of funds. 5.40. Community project identification and promotion are carried out by FONCODES regional office staff or by individual external promoters, who can be any person or body, private or public, willing to (a) inform and organize the population to present a community-based project to FONCODES, and (b) assist a community in project preparation. 5.41. FONCODES and other promoters meet with formal and informal community leaders, municipal authorities and NGOs, to describe: (a) opportunities offered by FONCODES; (b) major eligibility requirements; and (c) steps to prepare a project proposal. FONCODES also uses other dissemination techniques, such as the distribution of written materials, and the production of radio programs. Special promotion efforts are made in certain areas, where the poverty mapping identifies populations living in extreme poverty and lacking the capacity to generate and prepare projects. In these cases, FONCODES or an intermediary, such as an NGO, undertake spezial promotion efforts and assist the community in preparing a project proposal. 5.42. Project promoters work on their own initiative, after learning about the opportunities created by FONCODES. For approved projects, FONCODES can finance project preparation costs retroactively, including the promoters' fees, up to a maximum of 5 percent of total project costs. 5.43. Community organization. To submit a project, communities organize themselves and nominate executing committees, the nucleos ejecutores, which receive and manage the respective FONCODES grant, and are responsible for project implementation. Where communities are extremely poor and lack the capacity to independently present a project proposal, NGOs, the Catholic Church or municipal governments participate as promoters and provide technical assistance. Depending on the nature of the program, they may also enter into a management contract with the community. 5.44. Appraisal and selection. FONCODES specialists, in the Programs and Projects Division or in the Regional Offices, are responsible for appraising the community project proposals. Alternatively, appraisals are done by external evaluators contracted by FONCODES for this purpose, typically through the recommendation of the College of Engineers. There is still a lack of FONCODES evaluators for some project categores such as loans for small-scale farmers and micro-entrepreneurs. 5.45. Appraisal is based on standard eligibility and appraisal criteria, which are described in the Operational Manual, and typically include: (a) Eligibility: (i) Rural or pen-urban area, in extreme poverty or under emergency rule;  - 24 - (ii) Labor-intensive, with a focus on local unskilled workers; (iii) Simple design, rapid execution time; (iv) Contribution to basic social service provision; (v) Comwunity participation in project development and maintenance; (vi) Use of local inputs; and (vii) Costs compatible with estimated local market costs; (b) Appraisal: (i) Poverty alleviation potential; (ii) Project quality; (iii) Costs and efficiency; (iv) Estimated rate of return, when relevant; (v) Poverty; estimated income of beneficiaries; (vi) Sustainability; and (vii) Managing capacity of the executing committee. 5.46. In the sample of projects reviewed during project preparation and appraisal, Bank staff and consultants found that appraisals had been conducted professionally and with good judgment. In addition, the IDB is conducting an independent in-depth review of a random sample of 70 projects financed by FONCODES, and the report of the evaluation will be available to the Bank before negotiations. 5.47. As described above, cost-sharing has not been a requirement and sustainability arrangements have sometimes been overlooked (paras. 5.18, 5.28- 29, 5.35-36). The Project would require that these be included among the eligibility and appraisal criteria (para 6.38). 5.48. Until now, FONCODES has not made systematic environmental impact evaluations of community-based projects. The Project would require such evaluations for certain types of projects (para 6.39). For this, FONCODES is developing summary environmental impact guidelines, with the technical assistance of the IDB. 5.49. The FONCODES Selection Committee includes the General Manager, the three line managers and the legal counsei. It approves the community-based projects to be financed, on the basis of a summary staff appraisal report. Regional Office Managers can directly approve small projects (up to US$10,000 equivalent), after consulting with the General Manager. The Board ratifies decisions on large projects, such as those estimated to cost more than US$100,000 equivalent. 5.50. Project appraisal is supported by a management information system which standardizes cost estimates and unit-cost reviews. The system is based on a data base of project input costs (wages, construction materials, equipment and professional services), calculated for six geographical areas. The data base is updated monthly, on the basis of prices quoted in the Construction Price  - 25 - Review, which is published monthly in Peru. The system also has a Unit-Price Analysis Component, based on criteria and standards published by the Peruvian Chamber of Construction and Public Works), which includes standards for the commonly requested FONCODES projects such as irrigation, electricity supply, and roads. The unit-cost system was reviewed at appraisal and considered to be satisfactory, transparent, well maintained, and to reflect real prices in the Peruvian market. However, the system has been introduced only recently and has been used for only 50 percent of the projects. The projects processed by external evaluators are not presently subject to this control. The system is in rapid expansion, and the project would ensure that all community-based projects are subject to the same type of standard cost analysis. 5.51. Contracting and Disbursements. Once a community-based project is approved, FONCODES signs a sub-project agreement with the executing committee which, in turn, executes the project by force account or by hiring a private contractor, an NGO or a municipality. In addition the executing committee signs an agreement with an inspector acceptable to FONCODES. The inspector is responsible for directly controlling the works or project execution and for reporting to the FONCODES supervisor on all technical, administrative and accounting issues. He is paid by the executing committee, out of the proceeds of the FONCODES grant. Funds are deposited in a bank account and controlled jointly by the inspector and the executing committee treasurer. 5.52. Some contracts need to be improved, namely those that pertain to financial intermediaries which administer funds as fiduciaries for credit to small- scale farmers and entrepreneurs (para. 5.10). The latter would need to clarify the responsibility of the intermediary institution regarding assumption of credit risk, refunding FONCODES for the administered funds, coverage of operation costs and inclusion of standardized credit conditions. At negoQian FONCODES presented reviewed model contracts in which these issues were satisfactorily addressed (8.l.c). 5.53. Following the contract, FONCODES disburses about 60 percent of the expected costs of the project to a special account opened by the executing committee for the community project. Further disbursements are authorized by the regional FONCODES project supervisor, based on project progress or completion. 5.54. The executing committee normally contracts the works directly with local skilled and non-skilled workers. For works or services of some complexity, the executing committees will typically contract with local private enterprises or NGOs. 5.55. Given the nature and small size of community-based projects, FONCODES has not systematically imposed any procurement rules upon the executing committees. The Project would require that Bank guidelines for procurement of goods and services be used in all community-based projects  - 26 - funded by FONCODES, and in the institutional development of FONCODES (paras 6.13-24) 5.56. Project supervision and control are carried out by the concerned division in FONCODES. Supervision is done directly by FONCODES regional staff, or is contracted to intermediaries, such as the College of Engineers, with clear terms of reference. Supervisors: (a) monitor project execution; (b) authorize disbursements; (c) ensure compliance with contract covenants concerning executing committees, the contracts and suppliers; (d) verify community participation and arrangements for maintenance and project sustainability; and (e) sign the project completion report, check accounts and set the final financial balance. 5.57. FONCODES has had difficulty in ensuring adequate project supervision of the large number of community-based projects it has approved. At the beginning, only about 20 percent of the community-based projects were subject to adequate supervision. This resulted from shortages in personnel, vehicles and lack of access to an automated momtoring and control system which are now being resolved. The proportion is presently 85 percent and can be expected to reach 100 percent in the next several months. The Project would contribute to improving the intensity and specialization of supervision, through the implementation of the FONCODES' institutional development plan, which has been developed with the assistance of the IDB (para 5.24, 6.3.b), 5.58. Project supervision is supported by a management information system which keeps track of physical, social and financial performance. The system has the key elements needed for good management and was able to produce, at short notice, all management reports required by project preparation and appraisal. The existing system is functioning well and is particularly suited for supervising infrastructure and engineering projects. However, it is not as well suited for monitoring social assistance and income and employment generation projects. The system is presently being upgraded with the technical assistance of the 1DB. 5.59. Accounts and Audits. FONCODES' accounting systems follow the usual and customary model of public accounting but have, until recently, been mostly implemented by hand. The system is presently being automated, as part of the development of the management information system, under the technical assistance of the IDB. 5.60. FONCODES is subject to regular audits by the Accountant General. In addition, it has ordered a private firm to conduct an audit of its activities and accounts, as well as of a sample of 100 community-based projects. 5.61. hx-post evaluation of community-based project impact has not, until now, been made on a regular basis. As part of Project preparation, FONCODES has created a new research and evaluation unit which will coordinate community-based project evaluations. The project would include an ongoing evaluation of a sample of completed projects, which would be  - 27 - contracted to an independent organization, such as an university or a specialized research-oriented NGO, consisting of a mix of traditional economic evaluation and beneficiary assessment (para 6.25.g). 5.62. Operational Manual. The organization and functions of FONCODES are described in an Operational Manual and a Users' Guide, which include a main section describing the general operation of the Fund, and specific sections which cover each project category, and the most frequently sought project types. Both the Manual and Guide are still evolving, as is the whole organization. They were reviewed by Bank's staff and consultants, during preparation and appraisal, and found to be adequate for the present development stage of FONCODES. They still have some inconsistencies, leaving evaluators and supervisors with excessive discretion. These deficiencies are being addressed under technical assistance of both the Bank and the IDB. Copies of both are available in the Project files. 5.63. In addition to the above weaknesses, some Bank concerns, including prioritizing (para 5.27), cost-sharing (para S.35, 5.47), sustainability (para 5.18, 5.28-29), and environmental appraisal (para 5.48), are inadequately covered in the manual. At negotiations, FONCODES Mresented a revised version of the Operational Manual, which the Bank found to be satisfactory (ra 8.4.b). Inter-institutional Coordination 5.64. FONCODES' mandate and activities potentially overlap with those of other government agencies, as described above (para. 3.21). To avoid duplication, inefficient use of resources and inter-institutional conflict, FONCODES coordinates its policies and activities with those of other social sector ministries and government agencies, through a Commission which has been formed by the National Institute of Education Infrastructure (INFES), the National Institute of Development (INADE), the National Office of Popular Cooperation (COOPOP), and the Departmental Cooperation for the Development of Lima and Callao (CORDE LIMA and CORDE CALLAO). The coordination has until now been generally satisfactory. The roles, interfaces and articulation between these institutions is described at length by the Ministry of Economy and Finance in the "Institutions which Develop Poverty Alleviation Programs" report, which is part of the Project files. 5.65. Certain community-based projects, such as the rehabilitation of schools and health posts lead to significant additional recurrent costs in personnel, supplies and maintenance. In addition, community-based projects such as new roads, water, sanitation and power supply can have significant impact on the existing networks. In both cases, community project proposals must include an approval letter from the relevant line ministry or agency, to ensure that they fit into the plans of the relevant Ministry, regional or municipal governments. 5.66. For a time, there was a certain degree of overlap between FONCODES and another Government fund - National Housing Fund (FONAVI) under which the Ministry of the Presidency finances investments in urban  - 28 - infrastructure. FONAVI, through its Program of Supervised Credits, makes loans to community-based organizations for urban infrastructure improvements in a manner similar to that of FONCODES, but requires significant cost- sharing. PONAVI coordinates with FONCODES and to avoid duplication and overlap they have agreed that FONAVI would operate in major cities, supporting large infrastructure projects, such as roads, water, sanitation and power supply, while FONCODES would target its resources to rural areas and in smaller, isolated communities, and give priority to small social assistance and rehabilitation of social infrastructure. 5.67. In some cases, central and local government agencies have done more than just coordinate with FONCODES, and have become directly involved in the preparaton or execution of community-based projects. Although community organizations typically identify, propose and manage projects, several public corporations have been involved in promoting projects, and in assisting communities in project preparation and supervision. In fact, different Ministries have been involved, in some capacity, in about 13 percent of the projects (e.g. cholera control in an emergency area, drug and other supplies for health posts), and local governments have participated, in some capacity, in 38 percent of the projects. VI. THE PROJECT Objectives and Scope 6.1. The Project's objectives are to: (a) sustain the GOP poverty alleviation efforts, (b) mitigate the social costs of maco-economic adjustment, and (c) strengthen the institutional capacity of FONCODES. Specifically, the Project would support the overall operation of FONCODES for the penod 1994 to 1996. 6.2 The Project would contribute to poverty alleviation by supporting, through FONCODES, a range of projects with a strong focus on education, health and nutrition, and other areas that would assist the poor rural and urban populations, and by promoting the efficiency and effectiveness of FONCODES. The community-based projects would (a) generate employment and improve access to social services, (b) support social development, (c) complement other long-term projects in health and education, with effective mechanisms to reach the poor in the short run, and (d) maximize support from other potential donors. Description 6.3. The Project, with a total cost of US$495 million, would have two components: (a) Support to FONCODES community-based projects, with a total cost of US$468.5 million (95 percent). This component  - 29 - would finance, through the Fund, a range of community-based, labor-intensive projects, with a strong focus on health and nutrition, education and on other areas that could assist poor rural and urban populati-ns. From FONCODES' past experience, it is estimated that the Loan would support community-based projects in all four FONCODES project types: (i) Social Assistance (14 percent), including: health promotion and disease prevention campaigns, primary health care and family planning services, medical supplies, nutritional supplements, pre-schooling, literacy campaigns, institutional development of community-based organizations, school libraries and materials, and retraining of unemployed workers; (ii) Social Infrastructure (37 percent), including: water treatment and supply, sewage collection and treatment, environmental sanitation, health post rehabilitation and equipment, school rehabilitation and equipment, community kitchen construction or rehabilitation and equipment, and sports and community center construction and equipment; (iii) Economic Infrastructure (33 percent), including: rehabilitation, extension and construction of wells and irrigation systems, land rehabilitation and reforestation, road and sidewalk rehabilitation, marketing infrastructure, and electricity supply; and (iv) Credits to small-scale farmers and entrepreneurs for income and employment generation (9 percent), including support and capacity building to micro-enterprises, small- scale fisheries, agriculture inputs and small-scale processing firms . (b) Institutional Development of FONCODES, with a total cost of US$26.5 million (5 percent). This component would finance: (i) works, such as the rehabilitation and refurbishing of FONCODES' offices; (ii) goods, including vehicles, communications and computing equipment; and (iii) services, including training of FONCODES staff in project management, technical assistance for project appraisal and supervision, poverty studies, ex post evaluations of community-based projects funded by FONCODES, audits of FONCODES and community- based projects, and support to enity-bed project preparation and implementation.  - 30 - Lending and Implementation 6.4. The proceeds of the Loan (US$100 million equivalent) would be lent to the Republic of Peru, which would pass them on as a grant to FONCODES, which would, in tum, use the Loan in conjunction with other funds from the National treasury and other international donors and credit agencies to finance community-based projects and to support its institutional development. Community projects would be supported in the form of: (a) Grants awarded to community organizations, NGOs or public agencies, which would contract works and supervise project execution -ith the assistance of an approved inspector; and (b) Transfer of Funds to intermediary financial institutions, acting as fiduciaries, which in turn would lenid funds at standard market rates to support investments in small-scale enterprises. 6.5. As a condition of loan effectiveness. a SubsidiAgreement for making funds available by the Borrower to FONCODES. on terms acceptable to the Bank. would be signed (para 8.4.a) 6.6. The Project would be implemented over a period of about four years. FONCODES would be the implementing agency. The structure and operational procedures of FONCODES, including criteria and procedures for project identification, preparation, appraisal, and implementation of community-based projects, were reviewed by the Bank and are generally satisfactory, with the exception of the issues mentioned in paragraph 5.63. FONCODES current management is satisfactory to the Bank. At negotiations. assurances were obtained that: (a) FONOCODES would maintain an Executive Direto. General Mana=e. and Line Managers with eprncand qualifications aQccptble to the Bank (paM 8.2.a): and (b! any substantial change in the Operational Manual or User's Guide would be require prior Bank approval (para 8.2.b). Costs and Financing Plan 6.7. The total project cost, net of taxes and duties, expressed in July 1993 prices, is estimated at US$495 million equivalent. The estimated foreign exchange costs (US$79 million) represent 16 percent of the total project costs. The Bank would finance 25 percent of foreign exchange costs and also 25 percent of local costs. The financing of local costs under the project is a consequence of: (a) the foreign exchange component of total costs is only 16 percent, and (b) the project is targeted to areas of the country where extreme poverty is high. A breakdown of project costs is shown in Annex 5 and is summarized below. The disbursement schedule is shown in Annex 6.  - 31 - 6.8. Since the project is essentially a financial intermediary type of operation, physical targets depend on community-based projects to be presented and no contingencies have been provided. Any increase in the average community- based project amounts would be reflected in a reduced number of projects executed. 6.9. The cost estimates and average size of community-based projects (US$30,000 equivalent) reflect a consensus of sector specialists and the experience accumulated by FONCODES, based on its experience in financing of projects in 1992-1993 and the projected average costs and number of projects for 1994-1995. The project is expected to finance about 16,500 community- based projects over three years, i.e. about 5,500 community projects a year, which seems realistic when compared with an average of 6,000 projects per year for 1992 and 1993. The costs of the institutional development component, which would finance rehabilitation works in FONCODES offices, studies, audits and evaluations, technical assistance, training and administrative systems, are based on the average cost of technical assistance provided by UN agencies and on the market costs of consultants and training services in Peru. 6.10. The proposed Bank loan of US$100 million equivalent would represent about 20 percent of total project cost. Local beneficiaries, including ultimate beneficiaries, municipalities, NGOs and other entities, would contribute US$42 million equivalent (about 9 percent of total project costs). The Borrower's contribution would be US$200 million equivalent and would partly finance FONCODES' operating costs. This amount seems realistic when compared with the Government's past contribution to FONCODES, of over US$300 million equivalent in 1992 and 1993. PERU: Social Development and Compensation Fund Project. Estimated Costs (USS million) Conwnents ~Local Foreign Total Percent Community-based Projects Social assistance 60 11 71 14.3 Social infrastructure 158 28 186 37.6 Economic infrastructure 140.5 24 164.5 33.2 Income/Employment Generation 40 7 47 9.5 Sub-total 398.5 70 468.5 94.6 l Institutional Development of FONCODES Rehabilitation Works 1.5 0 1.5 0.4 Equipment and vehicles 2 4 6 1.2 Technical assistanee 7 3 10 2.0 Operating costs 7 2 9 1.8 Sub-total 17.5 9 26.5 5.4 Total Costs 416 79 495 100.0 Net of taxes and duties  - 32 - 6.11. The project will receive parallel financing from the IDB and the Government of Germany (KfW). The IDB has indicated that it would contribute US$100 million for the project, to finance social and economic infrastructure community-based projects. Other donors, including KfW, would support the Project with another US$53 million equivalent, to finance the whole range of FONCODES projects in a pre-determined area, which is likely to be the Inca Region. FONCODES would propose to the lenders which projects would be financed by each institution. Joint supervision (para 6.26) would ensure inter- lender coordination. PERU: Social Development and Compensation Fund Project. Financing Plan. US$ million Finaning Plan Loc | Foreign T Total Government of Peru 200 0 200 Beneficiaries 42 0 42 World Bank 80 20 100 Inter-American sO 20 100 Development Bank Other Donors (ncluding KfW) 14 39 53 Total 416 79 495 6.12. The Loan would retroactively finance community-based project expenditures incurred after August 1, 1993, provided they were eligible under the terms and conditions set in the loan agreement, up to a maximum of 10 percent of the Loan. Procurement 6.13. Procurement of works, goods, and services, as well as the contracting of consultants with Bank funds would be carried out in accordance with Bank guidelines. A recent review by the Bank of the procurement procedures followed by both the public and prvate sector in Peru show that these are generally acceptable. The procurement procedures followed by the public sector are largely based upon competition, with only minor exceptions of direct contracting which are compatible with Bank guidelines. 6.14. Very little procurement would be carried out by FONCODES directly. This would be limited to some rehabilitation of FONCODES offices and their respective equipment. Most procurement would be done by community executing committees, or intermediaries such as NGOs, municipalities or ministries, using standard bidding documents acceptable to the Bank.  - 33 - 6.15. To facilitate FONCODES' administrative procedures, the IDB, KfW and the Bank would enter into an agreement to adopt common procurement procedures in this project. PERU: Social Development and Compensation Fund Procurement Methods by Category. US$ million Category Procurement Method ANFB | Total ICR LCB Other Communty-Based Projects Works 0.00 17.87 81.41' 244.21 343.50 (0.00) (12.51) (56.99) (69.5) Goods and Services 0.00 4.89 22.26a 72.86 100.00 (0.00) (3.42) (15.58) (19.00) Consultants 0.00 1.26 5.74 18.00 25.00 (0.00) (1.26) (5.74) (7.00) Total 0.00 24.02 109.41 335.07 468.50 (0.00) (17.19) (78.31) (95.50) Instfuonal Development of FONCODES Rehabilitation Works 0.00 0.27 1.23' 1.50 (0.00) (0.14) (0.62) (.75) Goods and Services 0.00 0.23 1.03a 4.75 6.00 (0.00) (0.14) (0.62) (.75) Consultants 0.00 0.54 2.46 7.00 10.00 (0.00) (0.54) (2.46) (3.00) Operating Costs 0.00 0.00 0.00 9.00 9.00 (0.00) (0.00) (0.00) (0) Total 0.00 1.04 4.72 20.75 26.50 (0.00) (0.81) (3.69) (4.50) TOTAL 0.00 25.05 114.13 355.82 495.00 (0.00) (18.00) (82.00) (100.00) 4ote: Figures in parenheses are the respective amounts Inaced by the Bank loan ' Local Shopping or Direct Contracting. b Not Bank Financed. 6.16. Procurement of Works would be as follows: (a) International Competitive Bidding (ICB), if any, for contracts esfimated to cost US$3,000,000 equivalent or more;  - 34 - (b) Local Competitive Bidding (LCB), for contracts estimated to cost from US$250,000 to US$3,000,000 equivalent each, up to an aggregate amount of US$18,300,000 equivalent; (c) Local Shopping (LS), requiring at least three quotations, for contracts estimated to cost Ifrom US$35,000 to US$250,000 equivalent each, up to an estimated aggregate of US$47,000,000 equivalent; and (d) Direct Contracting (DC) for small works not exceeding US$35,000 each, in remote locations (when shopping is not possible) either with the only available or interested contractor, or with the community as a contractor (provided that the community has the legal capacity to enter into contracts or agreements), on a one contract per community basis. These measures would not be jointly applicable with direct purchasing of equipment and/or materials as under 6. 19.d below, and up to an aggregate amount of US$35,000,000 equivalent. 6.17. Locial shopping and direct contracting are justified because of the small scale of most community-based projects which demand little, if any, heavy equipment. Most works would be carried out in scattered places, where it is unlikely that large domestic contractors would be interested in bidding for civil works. A system of standard regional unit prices would guide the selection of contracts under direct contracting. 6.18. No International Competitive Bidding (ICB) is expected, because of the small size and decentralized nature of FONCODES community-based projects. However, ICB would be required for any contract exceeding US$3,000,000 equivalent. 6.19. Procurement of Goods and Services. The types of goods to be procured under the project mainly consist of basic construction materials, equipment and supplies for health posts and schools, medical supplies, school books, small administrative systems, vehicles, computing systems and other equipment for FONCODES. The types of services to be procured under the project are disease prevention campaigns, family planning, primary health care, literacy courses, studies, audits, evaluations, management services and training. Goods and services would be procured as follows: (a) ICB, if any, for contracts estimated to cost US$250,000 equivalent or more; (b) LCB for contracts estimated to cost from US$50,000 to US$250,000 equivalent, up to an aggregate amount of US$5,000,000 equivalent; (c) LS with at least three quotations, for contracts estimated to cost from US$5,000 to US$50,000 equivalent each, up to an aggregate amount of US$16,000,000 equivalent; and (d) Direct contracting for community-based projects in remote locations, when shopping is not possible, for (i) small items of equipment each costing up to US$5,000 equivalent; and (ii)  - 35 - construction materials costing up to US$15,000 equivalent, restricted to one contract of each kind per project and not jointly applicable with direct contracting for works as under 6.16.d. above, up to an aggregate amount of US$7,000,000 equivalent. 6.20. Consultants would be selected and contracted in accordance with Bank guidelines for the use of consultants. All contracts with individual consultants, and those with consulting firms costing more than US$100,000 equivalent, would require the Bank's prior review. Any taxes paid by consultants would be excluded from Bank financing. 6.21. The Bank will undertake a prior review of: (a) Contracts for works exceeding US$150,000 equivalent; (b) Contracts for goods exceeding US$100,000 equivalent; and (c) The first contract for each kind, per year, regardless of the amount involved. 6.22. Based on FONCODES' experience in financing of projects in 1992-1993 and the projected average costs and number of projects for 1994-1996, it is estimated that the Bank will review about 65 contracts per year (4 percent of Bank-financed projects). Other contracts would be reviewed a postenoni, on a sample basis, which is acceptable given the nature of the project. 6.23. Starting July 1, 1994, FONCODES would review the standard regional unit-prices for works and goods, twice a year, no later than January 1 and June 1, and promptly change such prices, in form and substance satisfactory to the Bank, if the review so recommends. 6.24 FONCODES would retain the services of a procurement auditor satisfactory to the Bank, to prepare procurement audits, at least every six months, on the basis of appropriate samples of procurement documentation. The audit reports would be sent to the Bank not later that two months after their completion date (para 8.2.e). Supervision and Reporting 6.25. Starting on September 1, 1994, FONCODES would submit to the Bank semi-annual reports, on March 1 and September 1, comparing achievements with the set of agreed performance indicators (Annex 7). These reports would include information on: (a) community-based projects presented, appraised, in execution, completed and evaluated, including beneficiaries, employment generated, amounts committed and executed, costs per beneficiary and generated workdays; (b) list and summary reports of studies, technical assistance summaries; outlines of courses and numbers of staff trained, and management systems installed;  - 36 - (c) full documentation on any project costing over US$250,000 equivalent, regardless of the source of financing. (d) FONCODES costs and financing; (e) changes in FONCODES staffing and structure; (f) supervision visits; and (g) ongoing ex-post evaluation of a sample of completed projects, which would be contracted to an independent organization, such as an university or a specialized research-oriented NGO, and consist of a mix of traditional economic evaluation and beneficiary assessment. At negotiations, assurances were Qbtained that FONCODES would retain the services of an independent organization. under terms of reference acceptable to the Bank and not later than June 30, 1994, for purposes of carrying out evaluations of community-based projects which have been executed (para 8.2.-f 6.26. The Project would require about 24 staff-weeks of supervision per year, including about 13 weeks in the field. The supervision team would include the Task Manager and consultants with experience in the operation of similar social investment funds in Latin America. Their main areas of expertise would be operations, health and nutrition, education, rural development, infrastructure engineering, and finance. The Bank has collaborated with other multilateral and bilateral agencies, such as IDB, GTZ and KfW while preparing and appraising the project and would continue to do so during supervision. Disbursements and Documentation of Expenditures 6.27. The proposed Loan would be disbursed over a period of four years, to be completed by March 31, 1997. The final date for presentation of requests for approval or authorization to disburse in respect of community-based projects would be September 30, 1996. The project Closing Date would be June 30, 1997, three months after the completion date. PERU: Social Development and Compensation Fund Project Etimated Schedule of Disbursements, USS million Bank Semester Disburs. Cwnmd. Dlsburs. Lon Fiscal Ending during Amount as % of Balance Year Semester Total FY94 30-Jun-94 25 25 25 75 FY95 31-Dec-94 20 45 45 55 FY95 30-Jun-95 20 65 65 35 FY96 31-Dec-95 15 80 80 20 FY96 30-Jun-96 10 90 90 10 FY97 31-Dec-96 5 95 95 S FY97 30-Jun-97 5 100 100 0  - 37 - 6.28. Disbursements are expected to occur faster than is usual for LAC projects, but are consistent with the previous experience of FONCODES and with other social investment funds in Latin America. Disbursements are expected to occur as follows: 6.29. Disbursements would be made against the following categories of expenditures (Annex 6): (a) Community-based projects, 70 percent of expenditures made in works and goods, and 100 percent of expenditures made for technical assistance, for eligible projects, up to an aggregate amount of US$95 million equivalent; (b) Institutional Development of FONCODES: (i) works: 50 percent of local expenditures, up to an aggregate of US$750,000 equivalent; (ii) equipment: 50 percent of local and 100 percent of foreign eligible expenditures, up to an aggregate of US$750,000 equivalent; (iii) technical assistance, including consultants, studies, audits, and training: 100 percent of eligible expenditures, up to an aggregate of US$3,000,000 equivalent; and 6.30. At negotiations, it was agreed that retroactive financing of up to US$10 million would be permitted for eligible expenditures incurred since August 1, 1993. Funds would be used for financing a backlog of eligible community- based projects approved by FONCODES, in line with the eligibility and appraisal criteria acceptable to the Bank. 6.31. Withdrawal applications with a contract value of US$250,000 equivalent or more for works, US$150,000 equivalent or more for goods, US$100,000 equivalent or more for services with consultant firms, and aU individual consultant contracts would be supported by full documentation and the rest would be made on the basis of Statement of Expenditure (SOEs), for which supporting documents would be maintained by FONCODES and would be made available for review by the Bank. 6.32. A Special Account would be opened in a commercial bank satisfactory to the Bank, with an initial deposit of US$10 million equivalent. This would correspond to about three months of expenditures required under the Project. FONCODES would forward the Bank the documentation necessary for disbursement (SOEs or full documenta in), covering a number of projects or contracts for services whose aggregate sum would be at least US$3 million.  - 38 - Accounts and Audits 6.33. An independent audit firm audited FONCODES accounts and those of a random sample of 100 community projects, for the period between January 1, 1992, and July 1, 1993. At negotiations, the Bank reviewed the audit report and was satsfied that the accounts are in good order and follow generally accepted accounting practices (pam S.1 .d.). Assurances were obtained that FONCODES would adopt the reommendations of the audit reort management letter. 6.34. Under the Project, private independent external auditors acceptable to the Bank would annually audit FONCODES. No later than six months after the end of its fiscal year, FONCODES would submit to the Bank certified copies of the audit reports contqining the auditor's opinion on: (a) project accounts, including SOEs; (b) whether procurement was carried out in accordance with agreed guidelines; and (c) adequacy of internal controls to minimize the possibility of misuse of funds or other improprieties. 6.35. Auditors would undertake special semi-annual audits of community-based projects supported by FONCODES, on the basis of acceptable accounting norms and procedures. Auditors would examine a sample of community projects, review individual contracts, ascertain whether the terms of these contracts are complied with, inspect progress of works, reconcile the physical progress with financial expenses incurred, and state whether procurement guidelines are being respected. The auditors would prepare quarterly reports for the Board of FONCODES and for the Bank (to be submitted no later than two months after each quarter), as well as an annual summary. For this, auditors would audit a significant sample of projects, acceptable to the Bank. Cost-sharing and Sustainability 6.36. Beneficiary communities would contribute with at least 9 percent of total project costs, in cash, labor or materials, overheads and other inputs. Furthermore, communities have to ensure that the project can be sustained after completion, including maintenance and operation. Certain types of community- based projects would have higher cost-sharing requirements than others, depending on their relevance for extreme poverty alleviation. Based on FONCODES' experience with projects it supported in 1992 and 1993, it is estimated that communities would contribute to total project costs as follows: (a) Social assistance 5 percent (b) Social infrastructure 19 percent (c) Economic infrastructure 13 percent 6.37. Projects which provide credit to small-scale farmers, fishermen and entrepreneurs charge market interest rates and therefore can be said to provide full cost-recovery.  - 39 - 6.38. Community-based projects would need to be sustainable, alone or in conjunction with other complementary projects: (a) school classes would need to be complemented with furniture, school books, and ensure that a teacher is available; (b) health posts would require that a source of clean water, basic medical equipment and supplies be available, and that health personnel be on duty at least twice or three times a week; (c) community kitchens would need to have a source of clean water; school breakfasts and medical supply projects would require some continuity; and (d) water and electricity supply, and irrigation would require the establishment and training of a community-based resource management committee, which would be responsible for maintenance and minor repairs and would ensure the collection of charges. At negofaffins the Bank confirmed that these requirements have been incorporated into the Operaifonal Manual. as eligibility or appraisal criteria (para. 8.1 .b.ii-iW). Enviromnental Aspects 6.39. Since community projects are mostly small (average $30,000) and limited essentially to rehabilitation, they would not generate significant environmental impacts. Some projects, such as those concerned with reforestation, erosion control and small sanitary works, are expected to have a positive environmental impact. In any case, a summary environmental appraisal would be mandatory for certain projects, such as irrigation, which could have a potential negative environmental impact (para 5.48). At negotiations the Bank confirmed that summary environmental apraisal guidelines, acceptable to the Bank. have been included in the Operational Manual, where relevant (para 8.1.b.v.) Mid-Term Review 6.40. The GOP would conduct a mid-term review of progress in implementation of the project, in which the Bank would participate. The review would cover: (a) impact of community-based projects, both stated and unforeseen; (b) success in targeting of community-based projects to poorest areas/populations in Peru, and recommendations for improvement of targeting methodology; (c) efficiency of FONCODES in selecting, financing and supervising community-based projects, considered globally as well as by project category; (d) quality of the FONCODES portfolio, both between and among project categories; (e) adequacy, transparency and fairness of procurement practices, both within FONCODES and among community-based projects. (f) implementation of the Letter of Social Policy, including the role of FONCODES in the implementation of the overall poverty alleviation strategy.  - 40 - 6.41. At negotiations. assurancs were obtained that the Borrower would undertake a Mid-Term Review of FONCODES by June 30. 1995. Based on the review and on disussions with the Bank. the Borrower and FONCODES will take any necessay remedial action agreed with the Bank (pam 8.2.h.) 6.42. The Mid-Term Review would require about 18 staff weeks, of which 12 weeks in the field, and include the Task Manager and consultants with experience in the operation of similar social investment funds in Latin America. Their main areas of expertise would be operations, health and nutrition, education, rural development, infrastructure engineering, beneficiary assessment and finance. VII. BENEFITS AND RISKS Benefits 7.1. The project would benefit the poor and the most vulnerable by: (a) creating jobs and raising the income of workers employed by FONCODES, (b) investing in high return social and economic infrastructure in low income areas, (c) improving availability and accessibility of social services, (d) attracting other donors' investments, and (e) strengthening community participation, transparent decision making and social development. 7.2. It is estimated that good project implementation would result in: (a) improved access to social services, such as education and health, for about 3 million people per year; (b) improved social infrastructure, such as better schools, health posts, community kitchens, water and sanitation for 2 million people; (c) improved economic infrastructure, such as better roads, irrigation systems, electricity, and agriculture terracing, for about 1.3 million people; and (d) 4.5 million workdays in FONCODES' funded projects. Risks 7.3 The risks of the projects would be: (a) discontinuity and weakened management of the implementing agency, that could arise in the event of excessive political instability; (b) ineffective implementation, in the event of poor targeting, appraisal, supervision, or lack of sustainability; (c) weakening of existing institutions, and (d) poor governance, by FONCODES and by community executing committees. 7.4. To minimize risks, assurances would be sought that the replacement of the Executive Director, General Manager, Line Managers would be subject to prior Bank agreement on the experience and qualifications of the candidates, and ta FONCODES would promptly inform the Bank of any replacement of Regional Offlce Managers.  - 41 - 7.5. To foster good project implementation and sustainability, the Bank has requested FONCODES to make some changes in its policies and procedures, as described in sections V and VI. These changes have been adequately incorporated into FONCODES' Operational Manual. The Project would also include an ongoing impact and process evaluation of a sample of community- based projects. The bi-annual reports would be used by FONCODES to improve its operation and be a key element in Bank supervision. 7.6. The Government has prepared a Letter of Social Policy, which outlines the objectives and timing of structural reforms planned to restore satisfactory and sustainable delivery of social services. In addition, the Bank is supporting the Government in the preparation and implementation of projects in education and health, which are expected to strengthen the respective line ministries. An urban development operation, also in preparation would strengthen municipalities. 7.7. An improved management system, intensive supervision and an ongoing audit, as described before, would foster good gov 2rnance. At the Mid-Term Review, both objectives and procedures of FONC(ODES would be reviewed and corrective action taken. VIII. AGREEMENTS REACHED AND RECOMMENDATION Agreements 8.1 Prior to negotiations, the Borrower submitted the following documents, whose content was satisfactory to the Bank: (a) draft Letter of Social Sector Policy; (b) a modified Operational Manual including the modifications requested by the Bank: (i) prioritization of community projects (pam 5.27), (ii) comprehensiveness or complementarity of projects (pam 6.38), (iii) training requirements for the relevant project types (para 6.38), (iv) beneficiary contributions and cost recovery, where relevant (para 6.38), (v) draft summary environmental appraisal guidelines (para 6.39); (c) Terms of reference and proposed draft contracts for: financial intermediaries which administer revolving funds for credit to small-scale farmers and entrepreneurs (pam 5.52); and  - 42 - (d) Audit report, concerning FONCODES and 100 community-based projects, for January 1992-June 1993 (para 6.33) 8.2. At negotiations, assurances were obtained that: (a) FONCODES would maintain an Executive Director, General Manager, Line Managers with experience and qualifications acceptable to the Bank (para 6.6); (b) any significant change in the Operational Manual and User's Guide would require prior Bank approval (para 6.6); (c) credits to small-scale farmers and entrepreneurs would not represent more than 10 percent of FONCODES' portfolio (5.32), and loan guarantees would not be eligible for FONCODES funding (para 5.32); (d) FONCODES will follow the Bank's procurement and the consultant guidelines and the procurement procedures outlined in paragraph 6.13 through 6.23; (e) FONCODES would retain the services of a procurement auditor satisfactory to the Bank, to prepare procurement audits every six months on the basis of appropriate samples of procurement documentation (para 6.24); (f) FONCODES would retain the services of an independent organization, under terms of reference acceptable to the Bank and not later than June 30, 1994, for purposes of carrying out evaluations of community-based projects which have been carried out (para 6.25.g); (g) PONCODES provide the Bank with semi-annual reports whose contents, format and timetable would be as outlined in paragraph 6.25; (h) the Borrower would undertake a Mid-Term Review of FONCODES no later than June 30, 1995. Based on the review and on discussions with the Bank, the Borrower and FONCODES will take any necessary remedial action agreed with the Bank (para 6.41); (i) FONCODES would enter into agreements with executing entities and financial intermediaries under terms and conditions acceptable to the Bank; (j) counterpart funds would be available in the Peruvian Government 1994 budget. 8.3. The following would be a condition of Board presentation: (a) the Borrower would send to the Bank a Letter of Social Sector Policy, satisfactory to the Bank;  - 43 - 8.4. The following would be conditions of loan effectiveness: (a) A Subsidiary Agreement for making the funds available to FONCODES, on terms acceptable to the Bank, would be signed (para 6.5); and (b) FONCODES would formally adopt the Operational Manual and Users' Guide, satisfactory to the Bank (para 5.62). Recommendation 8.5. Subject to the above conditions, the proposed project would constitute a suitable basis for a Bank loan of US$100 million equivalent to the Republic of Peru, to be repaid over a period of 20 years, including a five-year grace period.  - 44 - ANNEX 1 PERU SOCIAL DEVELOPMENT AND COMPENSATION FUND PROJECT SOCIO ECONOMIC INDICATOS DATA YEAR SOURCE A. GENERAL COUNTRy DATA:_ _ 1. Estimated Total Population 21.9 1991 WDR (million) ________ 2. Population Projection 26 2000 WDR Mion) _ 3. Assumed Year of Reaching Net 2010 WRR Reproduction Rate of One 4. Size of Stationary 48 1991 WDR Population (Million) 5. GNP Per Capita (US$) 1070 1991 WDR 6. Average Annual GDP - 0.4 1980-91 WDR Growth Rate (%) 7. Urban Population as 71 1991 WDR % of Total 8. Illiteracy Rate (%) 15 1990 WDR 9. Area (1,000 Ki2) 1285 1990 WDR 10. Population . Density 16 1990 WDR (1.000 per KM2) B. POPULATION DATA: 1. Crude Birth Rate 27 1991 WDR (Per 1,000) 2. Crude Death Rate 8 1991 WDR (Per 1,000) _ 3. Annual Rate of Population Growth(%) 2.2 1980-91 WDR 4. Total Fertility Rate 3.4 1991 WDR 5. Population Age Structure (%) 0-14 Years 37.1 1991 WDR 15-64 Years 60.8 1991 WDR 6. Women of Child-bearing Age (15-49 as % of Female Population) 51 1991 WDR  - 45 - 7. Contraceptive Prevalence Rate Crotal %) 46 1990 SID C. HEALTH DATA: 1. Populaion Per Physician 1040 1984 WlDR 2. Populaton per Nurse NA - WDR 3. Population per Hospital Bed 590 MRE SI 4. MPSSP Budget as % of GNP 2.4 1990 HDR S. MPSSP Budget as % of Total Govt. Budget 6.2 1986 GFS 6. Maternal Mortality (per 10,000) 165 1988 WDR 7. Infant Mortality Rate (per 1,000) 53 1991 WDR 8. Life Expectancy at Birth (Years): Women 66 1991 WDR Men 62 1991 WDR 9. Proportion of Births Attended by Health Staff 55 1985 WDR GFS - Government Finance Statistics Yeabook HDR - Human Development Report  - 46 - ANNEX 2 PERU SOCIAL DEVELOPMENT AND COMPENSATION FUND PROJECT DRAFr LETIER OF SOCIAL SECTOR POLICY (To be addressed fom the Minister of Economy and Financo to the the Ditector of LAI) Lineas prioritarias de la polltica social de2. gobie:no El Gobierna peruano es conciente qua la solucift de los problemas estructurales del pals se encuentra en el crecimiento econ6m