Colombia - Second Municipal Development Project (formerly known as Second Water Sector Project)

Report No. PIC631 Project Name Colombia-Second Municipal r() N Development Project Region Latin America and the Caribbean Sector Urban Development Project ID COPA6861 Borrower Financiera de Desarrollo Territorial (FINDETER) Implementing FINDETER Agency address: Calle 72, No. 10-07, Piso 4 Santafe de Bogota, DC contact: Antonio Gomez Merlano, President phone: (57-1) 210-1377 fax: (57-1) 210-1106 Date PID Prepared January 1996 Projected Appraisal Date June 16, 1997 Projected Board Date December 16, 1997 COUNTRY AND SECTOR BACKGROUND 1. Colombia's approximately 1,050 municipalities show great diversity in their size, population, geographical characteristics, resource endowment and future decentralization potential. Over the past decade, significant political, socio-economic and other changes have occurred within which decentralization has figured prominently. While implementation of constitutionally-mandated decentralization policies is proceeding relatively well in such larger municipalities as Bogota, Valle de Cauca and Pereira, the heterogeneous nature of the municipalities, their weak financial, technical and administrative base, the poor state of their infrastructure and other assets and the diverse functions, responsibilities and roles which they have to assume under decentralization, have highlighted several problem areas. In general, while the smaller ones face a wide range of difficulties trying to meet their obligations in an autonomous and self-sustaining manner, most municipalities suffer from high dependency upon central government transfers; overstaffing, with low-skilled, poorly-paid people; frequent turnover of key technical staff and deteriorating, deficient or non- existent infrastructure facilities, and they are not yet equipped to fully assume the new role envisaged for them. 2. Because of their weak institutional, administrative and legal framework, municipalities have traditionally had great difficulty obtaining financial resources for their capital and recurrent expenditures. In an era when most appeared either unable or unwilling to raise such funds locally, and access to commercial bank loans was not feasible both because of their precarious condition and the low level of interest of commercial banks to lend to municipalities, the national government had to assume this role. Early GOC efforts to establish access of municipalities to the banking system began as long ago as 1975  with the creation of a special municipal credit window (FFDU) in the national mortgage bank (BCH). As the focus upon decentralization increased the GOC eliminated FFDU in 1990 and created FINDETER as an autonomous financial institution (86% GOC and 14% regional government ownership), to assist state and local agencies in assuming their new role. Additionally, in an attempt to rationalize its own funding, set priorities and help promote 'social investments' in basic infrastructure works, the GOC took steps to use FINDETER to administer also some of its own already established programs, including two cofinancing funds. 3. FINDETER has now evolved into a credible financial institution and has been a key player in several recent decentralization initiatives, especially benefiting medium and small municipalities. FINDETER does not function as a first tier institution, but works in partnership with commercial banks, municipalities and local entities under clearly- defined operating procedures covering such areas as municipal creditworthiness; criteria for sub-project selection, evaluation and finance; implementation and follow-up actions. Commercial banks providing loans to borrowers under FINDETER's program can obtain refinancing of up to 85% of the loans they make. FINDETER's interest rate and fee structure provides it with a positive return; however, while they are above the inflation rate, FINDETER uses the cost of funds as the reference point rather than charging market rates. 4. In comparison with other countries, the Colombian system is unique insofar as it does not provide loans directly but refinances these through commercial banks which are fully responsible for their administration. Since its creation, FINDETER has made about 1,100 loans for a total of approximately $1.0 billion to about 500 subnational entities through twenty-five intermediary banks. Among the municipal works financed are those for expansion and rehabilitation of water and sewerage systems, telephone services, streets, schools, markets, parks in addition to municipal administration strengthening programs. It has reached about 60% of the country's municipalities, many of them with populations under 10,000. In line with recent laws aimed at making water and sewerage systems more autonomous and self supporting, FINDETER has also recently began financing privatization initiatives, the most prominent one being the operation and maintenance of the Cartagena water system by AGBAR of Spain (under the $150 million loan'2961-CO'for a water and sewerage sector project). 5. FINDETER also is currently implementing a municipal development project with Bank ($60 M) and IDB ($44 M) financing. The latter project also has technical assistance and cadastre improvement components to enable borrowers to increase their operational efficiency and become more financially independent. It is progressing well and all of the funds have now been committed with disbursements expected to be fully completed before the originally-scheduled closing date of December, 1997. On several occasions during 1995, and most recently at the annual meetings in October, the Government has expressed keen interest in a second Bank/IDB financed municipal development operation. 6. FINDETER has generally achieved much of what the GOC initially envisioned for it over the past five years and most borrowers have been satisfied with the impact its funding has had upon their municipal -2 -  operations. Others see it as being too bureaucratic and at times non- responsive to their needs. Its dual role (as a refinancing entity with its own resources as well as a cofinancing agent of the GOC) (see 1/) has also caused some confusion among clients which tends to undermine the objectives of accountability and financial discipline among borrowing municipalities. Finally, while FINDETER has had sound technical staff and well-established and transparent operational systems, it is not immune to political interference in its operations. Partly in response to some of these concerns, FINDETER has decentralized many of its functions and granted greater autonomy to its regional offices and it has revised its operational manual to make it more flexible while still maintaining its basic objectives. 7. There remain some fundamental questions involving the future role of FINDETER which still need to be addressed. FINDETER remains highly dependent upon external and GOC concessionary funding. While the long- term goal is to have municipalities borrow on commercial terms when they seek loans, this is not currently feasible, given present macro-economic conditions in Colombia and the precarious creditworthiness of most municipalities. The Bank's 1995 sector report on local government capacity (see 2/) highlights several areas where FINDETER's assistance, along with technical assistance and greater community participation, are required to develop within municipalities the capacity to better respond to the needs of local communities. While FINDETER's prominence in sub- national investment has declined relatively as a result of a stronger participation of private banks in the last few years, its continued presence as a source of funding for municipal investments is still needed. Nevertheless, because of the changes in the environment in which FINDETER operates, its evolving role has to be more clearly defined and a 'transition' plan which also should be developed. Over the next 4-5 years, FINDETER should: (a) continue to refinance loans (as a bank of last resort) which assist municipalities to address their key infrastructure needs; (b) work with municipalities and the Central Bank to identify obstacles to market sources of finance and develop a program under which municipal entities are 'graduated' to the normal banking system; (c) develop its own internal capacity to promote private sector involvement in municipal infrastructure investment; and (d) conduct a study to determine FINDETER's future role (e.g. privatized lender, absorption by Departments or Regions, guarantor for privatization initiatives, etc.). THE PROJECT 8. Project Origin. The GOC requested (paragraph 5) that the Bank and IDB each consider a follow-up loan to FINDETER to provide continued support for the GOC decentralization program and its drive for greater efficiency, and to assist in defining the future role of FINDETER within a decentralized system. 9. Project Objective and Description. The project would: (i) consolidate and expand the municipal credit market by continuing to assist FINDETER in its financing of municipal infrastructure in support of the Government's decentralization policy and its national development plan (Salto Social); (ii) strengthen the financial capacity of the municipalities, especially the relatively larger ones, so that they - 3-  could complement their own resources by commercial borrowing; and (iii) finance technical assistance to help FINDETER develop an overall strategy for its transformation to meet evolving demands generated by GOC's intention to accelerate its decentralization and privatization efforts. The project would have three components comprising: Part A, investment and preinvestment subprojects involving the construction and rehabilitation of various municipal infrastructure works; Part B, technical assistance to help municipalities and local government institutions become more autonomous and to strengthen their administrative and financial management capacity to provide public services in partnership with the private sector, and; and Part C, technical assistance to FINDETER to: (i) conduct studies on its future role, (ii) develop plans for transforming it in line with the findings and recommendations of such studies, and (iii) promote the efficient delivery of municipal services through such mechanisms as civil society involvement and private sector participation. 10. Project Cost and Financing. The estimated total project cost is about $0 million with the Bank and IDB each providing about $75 million, and FINDETER, commercial banks and beneficiaries financing the remaining $100 million. Project preparation is being supported by a Japanese PHRD Grant of about $0.8 million equivalent. 11. Project Implementation. FINDETER as borrower, would be responsible for project implementation. As the beneficiary of Component C of the Project, FINDETER would also be responsible for its execution (The C(i) study will be overseen by a special committee with representatives both from government and the private sector to avoid conflict of interest issues). Municipal governments and affiliated entities, including private or mixed-capital companies operating services on behalf of municipal governments, would be eligible beneficiaries under Parts A and B of the Project, retaining full responsibility for subproject execution. FINDETER's guidelines would be used to appraise, approve and supervise subloans made in connection with eligible investment, preinvestment, and technical assistance subprojects. Subloans would be made through eligible financial intermediaries by refinancing up to 85 percent of a credit extended to an eligible beneficiary for financing up to 100 percent of an eligible subproject. Eligibility criteria for both beneficiary entities and investments would be established in Credit Regulations statement (Reglamento de Credito) which would apply to all FINDETER lending regardless of the origin of funds. As with the ongoing loan, FINDETER would refinance credits at a variable interest rate pegged to the market deposit rate (DTF) and financial intermediaries would assume the credit risk of subloan operations and charge a spread determined competitively. 12. Project Sustainability. To the extent that project sustainability will depend largely on continued and improved municipal creditworthiness, the project will promote the objective of sound municipal financial management and assist municipalities in strengthening their capacity to manage their own sources of revenue as well as external financing, in addition to greater private sector involvement. 13. Lessons Learned from Past Operations in the Country/Sector. With - 4 -  most of the works financed under the ongoing project either are just being completed or are underway, it is not easy to draw definitive conclusions on the lessons learned. Nevertheless, based upon indicative data, the overall impact of the project has been positive for the municipalities which received subloans and technical assistance. FINDETER's procedure for subproject evaluation and its insistence on minimum borrower performance criteria have now become standard procedures in many municipalities, irrespective of financing source. Additionally, the TA component has provided training to staff of about 700 municipalities in several areas. However, initial indications are that because this was more of a supply-driven process, the impact being less than it would have been if municipalities had been given greater flexibility to determine their TA needs and to seek loans for addressing them. This approach will be used in the new operation. 14. Environmental Aspects. Infrastructure deficiencies have imposed a heavy burden on the urban environment with serious public health and productivity implications. The project would ameliorate such problems by financing the construction and rehabilitation of various infrastructure in eligible municipalities. At the national level, the Government of Colombia has established regional entities (CARS), which have responsibility for ensuring compliace with environmental laws. Selection criteria for investment financing would ensure that subprojects meet such environmental standards and reflect the government's sector policies. 15. Program Objective Categories. The project's principal contribution is toward environmentally sustainable development, by financing the construction and rehabilitation of public infrastructure in participating municipalities. The project would also contribute to poverty reduction, since the poor stand to benefit more from such municipal infrastructure investments. It would also promote private sector participation in the provision of urban infrastructure services. 16. Poverty Category. This project will not be included in the Program of Targeted Interventions. 1/ Reference paper on Colombia National Cofinancing System transmitted to GOC on December 1, 1995. 2/ Colombia, Local Government Capacity: Beyond Technical Assistance (Report No. 14085-CO of July 7, 1995). Contact Point: Public Information Center The World Bank 1818 H Street N.W. Washington D.C. 20433 Telephone No.: (202)458-5454 Fax No.: (202)522-1500 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. - 5 -