Philippines - First and Second Municipal Development Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 16800 PERFORMANCE AUDIT REPORT PHILIPPINES MUNICIPAL DEVELOPMENT PROJECT (LOAN 2435-PH) AND SECOND MUNICIPAL DEVELOPMENT PROJECT (LOAN 3146-PH) June 12, 1997 Operations Evaluation Department 'his document has a restricted distribution and may be used by recipients only in the ierformance of their official duties. Its contents may not otherwise be disclosed without Vorld Bank authorization._ Currency Equivalents (annual averages) Currency Unit = Philippines Pesos (P) 1984 US$1.00 P16.7 1990 US$1.00 P24.3 1985 US$1.00 P18.6 1991 US$1.00 P27.5 1986 US$1.00 P20.4 1992 US$1.00 P25.5 1987 US$1.00 P20.6 1993 US$1.00 P27.0 1988 US$1.00 P21.0 1994 US$1.00 P27.7 1989 US$1.00 P21.7 1995 US$1.00 P25.7 1996 US$1.00 P26.2 Abbreviations and Acronyms BLGF Bureau of Local Government Finance CPO Central Project Office DBM Department of Budget and Management DILG Department of Interior and Local Government DOF Department of Finance DPWH Department of Public Works and Highways GFI Government Finance Institutions ICR Implementation Completion Report IRA Internal Revenue Allotment LGA Local Government Academy LGC Local Government Code LGU Local Government Unit LOGOFIND Local Government Finance and Development Project MDF Municipal Development Fund MDP Municipal Development Project MLG Ministry of Local Government (now DILG) MTP Municipal Training Program NEDA National Economic Development Authority OED Operations Evaluation Department ODA Overseas Development Assistance PCR Project Completion Report PMO Project Management Office RCDP Regional Cities Development Project RPTA Real Property Tax Administration RPTU Real Property Tax Unit SAR Staff Appraisal Report Fiscal Year Government: January 1 - December 31 Director General, Operations Evaluation . Robert Picciotto Director, Operations Evaluation Dept. : Roger Slade for Elizabeth McAllister Division Chief : Yves Albouy Task Manager : Kyu Sik Lee FOR OFFICIAL USE ONLY The World Bank Washington, D C 20433 U S.A Office of the Director-General Operations Evaluation MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Report on the Philippines Municipal Development Project (Loan 2435-PH) and Second Municipal Development Project (Loan 3146-PH) Attached is the Performance Audit Report (PAR) on the Philippines: Municipal Development Project (Loan 2435-PH, approved in FY84) and the Second Municipal Development Project (Loan 3146- PH, approved in FY90) prepared by the Operations Evaluation Department. The Municipal Development Project was the first Bank supported project of its kind in the Philippines, based on a "bottom-up", demand-driven approach intended to enhance strong local participation and project ownership. The second project was an extension of the first to different regions. The objectives were to establish institutional mechanisms to provide local governments with: access to long-term finance, technical assistance and training for project preparation and implementation, and improved property tax collection. The project comprised: (i) financing infrastructure sub-projects in participating municipalities; (ii) upgrading maintenance activities; (iii) improving real property record and tax collection systems; (iii) supporting a training program for local government staff; and (v) providing technical assistance to local governments. The Audit confirms the completion reports' findings that both physical and institutional objectives have been achieved: financing of infrastructure sub-projects for a large number of municipalities exceeded the appraisal estimates; indirect impacts of sub-projects on the local economy were significant; and the capacity building at both the central and the local levels was substantial. The Audit also finds that the achievements in real property tax collection under the first project were more significant than stated in the PCR. The PAR spells out an agenda for the future that is key to further enhancing the project results and their sustainability, some of which have been addressed in the ongoing third project: (i) keep the demand driven approach for sub-project selection and avoid targeting particular types of LGUs for particular types of sub-projects; (ii) mitigate the budgetary and technical constraints for maintenance activities; (iii) increase financial and administrative autonomy of economic enterprises such as public markets financed by the project; and (iv) minimize the negative impacts of increased central government transfers on local revenue generation. The Audit has identified elements for improving the design of the fourth project now under preparation: (i) avoid targeting particular types of municipalities for particular types of sub-projects to 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. keep the demand-driven approach; (ii) expand the municipal training program to cover managing city- wide investment programs to cope with a rapid urban growth; (iii) identify and eliminate disincentive elements imbedded in the local revenue mobilization; and (iv) encourage private sector participation wherever appropriate such as in managing economic enterprises or maintenance activities. The Audit rates the outcomes of both projects as satisfactory, their institutional development impact as substantial, their sustainability as likely, and performance of both the Bank and the Borrower as satisfactory. The ratings concur with those of the PCR/ICR. Attachment Contents Preface....... .................................................. 5 Basic Data Sheets................................................... 7 Evaluation Summary ....................................... ........ 13 1. Background .................................................. 17 Legacy of Urban Lending to the Philippines .............................. 17 Shifts in the Urban Lending Paradigm ............................. ..... 17 Decentralization as a Development Policy Objective ......................... 17 2. Project Objectives and Design ...................................... 19 Objectives and Description ......................................... 19 Shifts in Approach and Design in MDP II................................ 19 Key Agencies Involved ................................................ 20 PCRICR Findings and Lessons .............................. ........ 20 3. Implementation and Results .......................................... 23 Slow Start and Implementation Delay .................................. 23 Physical Achievements .................................... ....... 23 Overwhelming Demand for Revenue Generating Projects ............... ...... 23 Side-Effects on Local Social and Economic Development ................... 24 Institutional Achievements .................................... ..... 24 Impact on LGUs'Access to Long-Term Project Financing ............ ......... 24 Impact on Training Local Government Officials and LGU Capacity Building............ 25 Impact on the National Government Technical Assistance Capacity ..... ......... 25 Impact on Local Revenue Generation ...................................... 26 4. Agenda for the Future............................................ 27 Changing Market for Project Finance .................................. 27 Demand side: LGUs at Different Stages of Development. ................. ..... 27 Supply side: MDF and Local Finance Reform ....................... 28 Operations and Maintenance ............................................ 28 Financial Autonomy of Economic Enterprises ............................. 29 Disincentive to Local Revenue Generation .................................... 29 This report was prepared by Mr. Kyu Sik Lee (Task Manager), who audited the projects in October 1996. Mrs. Grace Mostert and Mr. Arthur Anger provided administrative support. 2 5. Ongoing MDP III and Follow-on Project ....................... ........ 31 Ongoing MDP III....... .......................... ............31 Local Government Finance and Development Project (LOGOFIND) ...... ........31 6. Lessons and Recommendations.............................. ........ 33 Ratin gs.......................................................33 Borrower Performance............................................33 Bank Performance...............................................33 Lessons .......................................................33 Demand-Driven Approach, Participation, and Ownership.....................33 Sequencing Project Components...................... .................34 Piloting to Mainstreaming Analogy.....................................34 Recommendations............................................... 34 Local Government Finance Reform and Changing Role of MDF ................34 Expanded Role of LGA.............................................. 34 Reducing Disincentivesfor Local Revenue Generation........... ..................... 35 Private Sector Participation in Maintenance and Contract Management... ........... 35 7. References .....A....................................................................................................... 37 Annex A. Comments from the Borrower. ......................... ........ 39 3 Principal Ratings MDPI (Loan 2435-PH) MDPII (Loan 3146-PH) Outcome Satisfactory Satisfactory Sustainability Likely Likely Institutional Development Substantial Substantial Borrower Performance Satisfactory Satisfactory Bank Performance Satisfactory Satisfactory Key Staff Responsible Appraisal Implementation Completion MDP I ICR Prepared By Thomas Zearley (Loan 2435-PH) Task Manager Stuart Whitehead Stuart Whitehead Thomas Zearley Division Chief Inder Sud Inder Sud J. Shivakumar Country Director Kirmani Kirmani Callisto Madavo MDP H ICR Prepared By Toru Hashimoto (Loan 3146-PH) Task Manager Yoshine Uchimura Thomas Zearley Toru Hashimoto Division Chief Praful Patel Jeffrey Gutman J. Shivakumar Country Director Gautam Kaji Callisto Madavo J. Khalilzadeh- Shirazi  5 Preface This is the Project Performance Audit Report (PAR) on the Philippines: Municipal Development Project (Loan 2435-PH) and Second Municipal Development Project (Loan 3146- PH). The first loan was approved on June 5, 1984, for an amount of US$40 million equivalent and closed on June 30, 1993. The second loan was approved on December 14, 1989, for an amount of US$40 million equivalent and closed on December 31, 1996. The PAR is based on the Project Completion Report (PCR, Report No. 15100) issued on November 3, 1995, the Implementation Completion Report to be issued in June 1997, the Staff Appraisal and President's Reports, the Loan documents, a review of the project files, and discussions with Bank staff. An audit mission visited the Philippines during October 10-23, 1996. Excellent cooperation and support given by the central and local government officials during the Audit mission is gratefully acknowledged. Following the initiative taken by the Bank's Resident Mission in Manila with a draft proposal for "Monitoring Results-on-the-Ground of World Bank Assisted Projects" (World Bank, 1996b), the National Economic Development Authority (NEDA) in collaboration with the Bank's Resident Mission has launched a "Results Monitoring" project. A staff member of the Resident Mission participated in the Audit mission to learn about the impacts of MDP I and II and provide inputs to the "Results Monitoring" project. The PCR/ICR provide a satisfactory account of the project experience with regard to preparation, implementation, and both physical and institutional achievements. The Audit confirms the PCR/ICR findings, identifies and discusses key remaining issues, and spells out an agenda for the future, especially with regard to local revenue generation, operations and maintenance, and alternative sources of project financing. Following standard OED procedures, copies of the draft PAR were sent to the Borrower for comment. Comments received from Mr. Danilo C. Trajano, Project Director, Central Project Office, Department of Public Works and Highways, have been reproduced and attached to the of the report as Annex A.  7 Basic Data Sheet MUNICIPAL DEVELOPMENT PROJECT (LOAN 2435-PH) Key Project Data (amounts in US$ million) Appraisal Actual or Actual as % of estimate current estimate appraisal estimate Total project costs 74.6 68.8 92 Loan amount 40 35.9 90 Cancellation 4.1 Date physical components completed 06/1991 06/1993 Cumulative Estimated and Actual Disbursements FY84 FY85 FY86 FY87 FY88 FY89 FY90 FY91 FY92 FY92 FY93 Total Appraisal estimate (US$M) 3.00 3.60 6.40 6.80 9.20 7.00 4.00 N/A N/A N/A N/A 40.00 Actual (US$M) 0.00 3.08 1.38 1.78 0.50 2.21 2.38 12.66 7.00 4.92 -0.1 35.81 Actual as % of appraisal 0.00 86 22 26 5 32 60 N/A N/A N/A N/A 90 Date of final disbursement: November 12, 1993 Project Dates Original Actual Preparation N/A 02/83 Appraisal Mission N/A 08/18/83 Negotiations 04/84 04/84 Board approval 06/84 06/05/84 Signing 07/84 08/10/84 Effectiveness 12/84 02/21/85 Closing date 06/30/91 06/30/93 Staff Inputs (Staff Weeks) Preappraisal Appraisal Negotiations Supervision PCR TOTAL 30.5 45 9.1 84.3 9.1 178 8 Mission Data Date No. of Specializations Types ofproblems (month/year) persons represented* Identification/ 02-03/83 4 preparation Appraisal 8/83 4 A Supervision I 10/1984 2 A,C Supervision II 03-04/1985 2 A,C Supervision III 01/1986 2 A,C Rising political instability, changes in city administrations; local elections imminent. Supervision IV 11/1986 3 A Erosion of project cities and investment programs, slow start for RPTA. Supervision V 03/1987 3 A,D Infrastructure component delayed; weak local government finance. Supervision VI 01/1988 1 B Delay in receipt of project accounts; financial statements inadequate . Supervision VII 06/1988 5 A DPWH reorganization, low staff morale. Supervision VIII 11/1988 1 F Supervision IX 08-09/198 1 A MTP delayed; increase in project cities starting to tax CPO. Supervision X 02-03/1990 2 A,C Shortfall of loan funds; poor quality of work by contractors; arrears in interest payments; delayed project audits. Supervision XI 10/1990 2 A,C Contract awards delayed; inefficiency in managing Special Account in Central Bank. Supervision XII 07-08/1992 3 A,C Slow release of Bank loan funds due to cash release ceilings of DBM. Supervision XIII 11-12/1992 3 A,B,C Second extension of loan closing date to June 30, 1993. Supervision XIV 07-08/1993 3 A,B,C Supervision XV 04/1994 A,B,E (Completion) *Key to specializations. A-Economist, B-Financial Analyst, C-Engineer, D-Auditor, E-Urban Specialist, F-Consultant/Other Other Project Data Borrower: The Republic of the Philippines Executing Agency: Department of Public Works and Highways Department of Finance FOLLOW-ON OPERATIONS Operation Loan No. Amount Board Date (US$ million) Second Municipal Development Project 3146-PH 40 December 14, 1989 9 Basic Data Sheet SECOND MuNICIPAL DEVELOPMENT PROJECT (LOAN 3146-PH) Key Project Data (amounts in US$ million) Appraisal Actual or Actual as % of estimate current estimate appraisal estimate Total project costs 57.2 52.8 92 Loan amount 40.0 37.7 94 Cancellation 2.3 Date physical components completed 06/1996 11/1996 Cumulative Estimated and Actual Disbursements FY90 FY91 FY92 FY93 FY94 FY95 FY96 FY97 Appraisal estimate (US$M) 3.2 3.4 5.8 7.2 7.4 7.1 5.9 40.0 Actual (US$M) 2.5 1.2 6.5 8.9 9.3 2.6 5.1 1.6 39.2' Actual as % of appraisal 78.1 35.3 112.1 123.6 125.7 36.6 86.4 94.3 Date of final disbursement June 1997 ' Actual amount will be determined upon approval of pending Withdrawal Application No. 31. Project Dates Original Actual Identification N/A May, 1988 Preparation N/A November 16, 1988 Appraisal Mission February, 1989 March 11, 1989 Loan Negotiations June, 1989 November 3, 1989 Board Approval July, 1989 December 14, 1989 Loan Signing August, 1989 January 19, 1990 Loan Effectiveness October, 1989 March 2, 1990 Project Completion June, 1996 November 30, 1996 Loan Closing December 31, 1996 December 31, 1996 10 Staff Inputs (staff weeks) Preappraisla Appraisal Negotiations Supervision PCR Total Staff Weeks 31.7 18.3 6.3 72.2 9 137.5 Mission Data Date No. of Specializations Types ofproblems (month/year) persons represented Identification May-88 I A N/A Preparation Nov-88 3 A,A,E Project preparation work slowed down because budget releases are delayed due to lack of final Investment Coordinating Committee (ICC) project clearance. Appraisal Mar-89 3 A,A,E Delay in obtaining final Investment Co-ordinating Committee (ICC) approval for the project. Supervision I Jan-90 N/A N/A N/A Supervision II Apr-90 I A No major problems. Supervision III Dec-90 2 A, B No major problems. Some confusion over the procedures to be followed for procurement of civil works contract. Supervision IV Aug-91 N/A N/A Contract bidding rescheduled because of delay in approving the 1991 budget. Supervision V Aug-92 2 A, B Delays in cash releases for subproject expenditures due to potential unvaiability of funds and untimely release of approved budgets. This resulted in some contractors suspending construction. Supervision VI Jan-93 3 A,B,C Delalys in cash releases and budget ceilings for sub- loan releases to local governments. Progress is already being affected in a number of cases, with contractors reducing the pace of work or suspending work. Supervision VII Aug-93 3 A,B,C Contract award in the project centers for local components is being delayed by the limited annual budgetary allocations for on-lending through the MDF. Supervision VIII May-94 (File missing) (File missing) Supervision IX Aug-94 2 C,D Despite repeated requests from DOF and the Bank, the Department of Management and Budget has been reluctant to apply the full IRA intercept against delinquent sub-borrowers. Supervision X Mar-95 2 G,E Potential institutional bottlenecks due to budgetary mismatch between national components (DPWH) 11 Date No. of Specializations Types ofproblems (month/year) persons represented and sub-loans (DOF). Supervision XI Jul-95 3 D,D,E Potential institutional bottlenecks due to budgetary mismatch between national components (DPWH) and sub-loans (DOF). Supervision XII Jan-96 2 G,E No major problems. Supervision XIII Jun-96 3 E,F,G No major problems. Supervision XIV Jan-97 2 G,E No major problems. Completion May-97 2 G,E Key to specializations: A-Economist E-Consultant B-Engineer F-Operations Officer C-Financial Analyst G-Urban Planner D-Urban Financial Specialist Other Project Data Borrower: The Republic of the Philippines Executing Agency: Department of Public Works and Highways Department of Finance FOLLOW-ON OPERATIONS Operation Loan No. Amount Board Date (US$ million) Third Municipal Development Project 3455-PH 68 March 31, 1992  13 Evaluation Summary Background 1. The legacy of the World Bank's urban lending to the Philippines during the past two decades closely reflects the evolution of the Bank's urban lending operations from: (i) sites and services and slum upgrading projects for low income areas (in the 1970s); to (ii) city-wide infrastructure investment projects for pre-selected cities (in the early 1980s); and to (iii) the current municipal development projects to reach a large number of municipalities by encouraging competition among them. It also reflects changing Government policy. After the revised Local Government Code was signed into law in 1991, the Government has been actively pursuing devolution of responsibilities to cities and municipalities to enhance greater local autonomy. The Municipal Development Program has been a key element in pursuing these policy objectives. The first and the second Municipal Development projects have been completed; a third project is being implemented; and a fourth project is in preparation (paras. 1.1-1.4). The current Country Assistance Strategy indicates that strengthening financial autonomy of local governments and improving their capacity for managing urban growth are an important part of the overall development policy. Project Objectives and Design 2. This PAR covers the first and the second projects (MDP I and MDP II). The second project was an extension of the first for different regions with identical objectives and design. The project objectives were: (i) to establish a mechanism to provide local governments with direct access to long-term development finance; (ii) to establish a central technical intermediary to assist local governments in project preparation and implementation; (iii) to strengthen local technical and financial capacity for project implementation and service management by establishing a municipal training program; and (iv) to improve local government fiscal performance by improving the property tax collection system. The projects comprised: (i) improvements of basic infrastructures including water supply, sanitation, roads, drainage, public markets, bus terminals, and slaughterhouses; (ii) upgrading and procurement of various maintenance activities; (iii) upgrading real property records for improving tax collections; (iv) training programs for local government staff for municipal finance and project management; (v) technical assistance for project implementation and local government budgeting and fiscal administration. Implementation and Results 3. The implementation of MDP I was delayed due to the political transition after the "People's Revolution" in 1986, only one year after the project became effective. The delay was also caused by the change of senior officials after the presidential election of 1986. The recession in the Philippines brought about serious budget constraints at both the national and local government levels in that period. Implementation of the project picked up momentum after the local elections in early 1988. 14 4. The projects' achievements exceeded the targets at appraisal: MDP I attracted 42 Local Government Units (LGU), almost three times more than planned. MDP II was also over- subscribed: after admitting 35 LGUs to the program, other eligible applicants had to be shifted to the next follow-on project. The project effectively provided badly needed financial access and technical assistance to resource-poor LGUs. Contrary to the original project design, however, the majority of the sub-projects were simple, revenue generating economic enterprises such as public markets, bus terminals and slaughterhouses, which facilitated implementation with minimum risks for financial and technical constraints. Indirect impacts of sub-projects such as a public market on the local economy were significant: they attracted a large number of commercial and manufacturing enterprises to the vicinity of the market creating employment; and the land price for non-residential use rose by 100 to 200 folds, substantially increasing local tax revenues. The MDP projects triggered the process of social and economic development in participating cities and municipalities (paras. 3.3-3.7). 5. Under MDP I and MDP II, the Municipal Development Fund (MDF) has established itself as a long-term credit window for LGUs. Under MDP III, the MDF has begun operating as a revolving fund as a sufficient amount of the "second generation" fund was accumulating under MDP I and II. The Municipal Training Program (MTP) significantly contributed to the capacity building of the Local Government Academy (LGA), the main training institution for local government officials. The Central Project Office (CPO) has established itself as a capable project implementation agency at the national level and has provided valuable technical assistance to LGUs for the preparation and implementation of sub-projects. The real property tax component also resulted in a substantial expansion of the real property tax base and an increase in actual tax collections (paras. 3.8-3.17). Ratings 6. The Audit rates the outcomes of both projects as satisfactory, their institutional development as substantial, and their sustainability as likely, and performance of both the Bank and the Borrower as satisfactory. The ratings concur with those of the PCR/ICR. Agenda for the Future and Follow-on Projects 7. Several key issues must be addressed to further enhance the projects' results and their sustainability: (i) the need to meet financing needs of LGUs at different stages of development, from simple revenue generating projects for small resource-poor municipalities to more complex infrastructure projects for rapidly growing cities (paras. 4.1-4.4); (ii) the need to mitigate the budgetary and technical constraints for maintenance activities (paras. 4.5-4.6); (iii) protection of economic enterprises, such as public markets and bus terminals,with an independent budget system (paras. 4.7); and (iv) disincentive structure introduced in local revenue generation after the 1991 Local Government Code, with a substantial increase in the intergovernmental transfers (paras. 4.8-4.9). 8. As early as 1991, over 300 cities and municipalities expressed interest in obtaining loans from the MDF. To meet this demand, a third project was prepared and approved by the Board in 1992. MDP III is a continuation of MDP I and II for further expansion of the program nationwide. MDP III was very timely since the project would assist the national government to develop and carry out its decentralization programs after the Local Government Code was 15 revised in 1991. MDP III paid particular attention to improving the maintenance activities with a pilot scheme for selected LGUs and moving the MDF toward operating as a revolving fund. A fourth project, "Local Government Finance and Development Project" (LOGOFIND) is now in preparation. The main objective is to implement a broad policy reform for assisting the transition of financially stronger LGUs from the MDF to alternative sources in the capital market, while continuing the MDF's role of providing long-term credit access to resource-poor LGUs. Lessons 9. Demand-Driven Approach, Participation, and Ownership. A "bottom-up", demand- driven, program approach to project financing is more efficient and effective for project implementation than the "top-down" pre-selected project specific approach. Beneficiary local governments perform better and show greater commitment to the project when they are primarily responsible for project preparation, management, and implementation. 10. Sequencing Project Components. The institutional framework for project financing (MDF) was put in place prior to undertaking actual physical investments. Because of the demand-driven approach, MDP first attracted revenue generating sub-projects which presented minimum risks for cost recovery. This outcome showed that sequencing of project components in response to the preference of the beneficiaries can avoid implementation delays and cost recovery problems that often occur in a complex urban development project prepared in a "top- down" manner. 11. Piloting to Mainstreaming Analogy. After the participating municipalities have completed a rather simple, low risk, revenue generating sub-projects such as a public market, they tend to enhance their creditworthiness with a stronger financial base, and expand their investments to infrastructure type projects (e.g., roads, drainage, water supply and sanitation). Thus, the experience gained in the Philippines MDP program shows the validity of the proposed "New Project Cycle" (Picciotto and Weaving, 1994). Recommendations 12. Local Government Finance Reform and Changing Role of MDF. The MDF attracted mainly revenue generating projects with minimum risk. The LGUs were initially reluctant to finance social/infrastructure projects with cost recovery features. These experiences suggest that targeting particular types of LGUs for particular types of sub-projects should be avoided. Even under the follow-on project (LOGOFIND), the credit window for the first-timers (poor and less experienced) should continue to be open for simple revenue generating projects. 13. Expanded Role ofLGA. The role of LGA for training municipal officials should be expanded from training at the project level (preparation, financing, and implementation) to LGUs' capacity building for carrying out planning and implementing a city-wide infrastructure investment program and managing rapidly expanding urban areas. For example, Santa Rosa faces a tremendous challenge to meet a sharp increase in demand for both residential and non- residential land and all types of infrastructure services as the city is attracting large multinational firms. 16 14. The LGA should also expand its dissemination program whereby the experiences accumulated by the LGUs graduating from MDP can be shared with the newcomers. Mayors and senior officials of Bauan and Pulilan are already serving as lecturers in the LGA seminars, but a more proactive program such as "twinning" could be effective. 15. Reducing Disincentives for Local Revenue Generation. The increase in the Internal Revenue Allotment (IRA) ratio to 40 percent as part of the revised Local Government Code dampened the incentives to generate local revenues (para. 4.8). To remedy this disincentive structure, the Audit recommends: (i) to introduce matching grants above the standard allocation of IRA tied to the extent of local revenue collection or of successful cost recovery; (ii) to continue supporting the Real Property Tax Administration (RPTA) program to capture tax revenues from the rapidly rising property values, in particular, from the expanding non- residential tax base in rapidly growing LGUs; and (iii) to introduce a "Presidential" award system according to the level of financial autonomy measured by the ratio of IRA receipts to the total municipal revenue. For the four cities the Audit mission visited, this ratio was: Bauan, 16 percent; Santa Rosa, 23; Pulilan, 49; and Butuan City 79. 16. Private Sector Participation in Maintenance and Contract Management. To make what the projects achieved sustainable in the absence of recurrent budget funds for maintenance and technical personnel, LGUs may consider farming out the maintenance activities to private firms or resort to contract management based on user fees as a short-term solution. 17. To protect the financial viability of the MDP-financed economic enterprises (public markets, bus terminals, and slaughterhouses), contract management or other forms of private sector participation could be adopted. Mandaluyong City in Metro Manila has been using a management contract arrangement for its public market, and Santa Rosa is considering such an arrangement for its market. 17 1. Background Legacy of Urban Lending to the Philippines 1.1 World Bank urban lending to the Philippines during the past two decades reflects the evolution of urban lending operations: (i) the "sites and services" for housing and slum upgrading projects targeting low income areas in the 1970s; (ii) the "regional cities development" projects aiming at city-wide infrastructure improvements for a small number of pre-selected cities in the early 1980s; and (iii) the current "municipal development program" based on a demand-driven approach intended to create competition among a large number of participating municipalities. Shifts in the Urban Lending Paradigm 1.2 After three sites and services and slum upgrading projects (Loans 1282, 1647, and 1821), the Philippines Regional Cities Development Project (RCDP) (Loan 2257) was approved by the Board in 1983. The RCDP had included only four large regional cities and the selection and design of sub-projects were determined by central government agencies in a "top-down" manner. As early as 1981, the Government and Bank missions discussed the need to cover a large number of municipalities, and to shift to a "bottom-up" demand-driven approach that would induce strong local participation and project ownership (MDP I SAR, p. 4; MDP II SAR, p. 7). The overall strategy was to establish institutional arrangements by which the Local Government Units (LGUs), including municipalities, could undertake project selection, preparation, financing, and implementation on their own. The Municipal Development Project (Loan 2435) with a loan amount of US$40 million, approved by the Board in June 1984, was the first Bank intervention intended to assist the Government to develop such institutional mechanisms. The MDP project indeed represented a shift in the lending paradigm in the Philippines urban sector from the "projectized approach" to a "program approach". 1.3 As the first project, MDP I had attracted almost three times more LGUs (42) than originally planned in the SAR (15); a second project, MDP II (Loan 3146, approved in December 1989), was prepared to meet the excess demand and to cover a wider geographic area. However, MDP II, with a loan amount of US$40 million, was also quickly over-subscribed. Subsequently, a third project, MDP III (Loan 3455, approved in March 1992), was prepared with a larger project size of US$68 million which is now being implemented. A fourth project, "Local Government Finance and Development Project" (LOGOFIND), with a broad framework for local government finance reforms is now in preparation. Therefore, this Audit took a program evaluation approach focusing on the process of institutional learning over a longer time horizon. Although this Audit was limited to MDP I and II, completed in 1993 and 1996 respectively, the analysis extends to the experience of MDP III to date, and the lessons drawn provide implications for the fourth project under preparation. Decentralization as a Development Policy Objective 1.4 After the revised Local Government Code was signed into law in 1991, the Government has been pursuing devolution of responsibilities to LGUs to enhance greater local autonomy (MDP III SAR, p. 1). A recent Country Assistance Strategy (World Bank, 1996a) indicates that 18 the issues related to local government devolution are an important part of the overall development policy, in particular: (i) strengthening the ability of resource-poor LGUs to improve service delivery; (ii) improving the incentives for LGUs to raise revenues within their own jurisdictions; and (iii) coping with the rapid urban growth by managing both positive and negative externalities that are taking place outside individual local jurisdictions (World Bank, 1996, p. 6). Indeed, at the Aid Consortium held in Tokyo in 1996, it was agreed that urbanization and municipal finance will be the main development agenda in 1997. The Municipal Development Program has been the key element for reaching these policy objectives. 19 2. Project Objectives and Design Objectives and Description 2.1 Objectives of MDP I a. To establish an institutional mechanism, the Municipal Development Fund (MDF), to provide local governments with direct access to long-term development finance; b. To establish a permanent national-level technical intermediary, the Central Project Office (CPO) (i) to assist local governments in identifying infrastructure investment priorities; (ii) to evaluate project proposals for financing; (iii) to monitor and control the program; and (iv) to act as a principal liaison with the Bank and other external funding agencies in promoting urban service improvements throughout the urban hierarchy; c.. To strengthen local technical financial capacity for project implementation and service management through the implementation of a broad-based Municipal Training Program (MTP) and through organizational and fiscal reforms; and d. To improve local government fiscal performance, through the Real Property Tax Administration (RPTA) program. 2.2 Description of components of MDP I a. Improvements of basic infrastructure including water supply, sanitation, solid waste disposal, slum upgrading, roads, drainage, shoreline protection, bus terminals, public markets, and slaughterhouses; b. Upgrading and procurement of equipment for various maintenance activities; c. Tax mapping activities which include updating cadastres, appraising properties, improving records management, and increasing collections; d. Training programs, including municipal finance and revenue administration, enterprise management, project development, contract management, and operations and maintenance; e. Technical assistance for project implementation and improvements in local governments' budgeting and fiscal administration. Shifts in Approach and Design in MDP H 2.3 While MDP I covered LGUs located outside Metro Manila, MDP II covered LGUs in Metro Manila and its surrounding provinces. The project objectives and components of MDP II were identical to those of MDP I. However, based on the excess demand experienced under 20 MDP I (para. 1.3), there was a shift in approach in MDP II from financing larger sub-projects in a limited number of LGUs to financing smaller sub-projects in a larger number of LGUs to reduce risks associated with the implementation and financing capacity of LGUs and to reach a large number of LGUs. 2.4 This shift would have required more training and technical assistance for LGUs to prepare sub-projects since the CPO's capacity was becoming constrained. MDP II, however, had not included a training component to support the MTP initiated in MDP I. Nevertheless, the LGUs under MDP II were allowed to participate in the MTP under the auspices of the Local Government Academy (LGA). Under MDP III, the financial support for the MTP continued. 2.5 The experience of MDP I also showed that resource-poor LGUs were unable to finance "public-good" type infrastructure sub-projects such as roads and drainage systems. To mitigate these difficulties, MDP II specifically allocated a third of the Bank loan amount to be used as grants for supporting such infrastructure sub-projects (called "national components" in the MDP). Key Agencies Involved 2.6 The Department of Public Works and Highways (DPWH) was the lead agency for the project, and Chair of a Project Steering Committee. The Central Project Office (CPO) under DPWH was the technical intermediary providing technical assistance, evaluating project proposals for financing, monitoring project implementation, and acting as liaison with the Bank. The Department of Finance (DOF) managed the Municipal Development Fund (MDF), the mechanism for channeling long-term credit to LGUs, and DOF's Bureau of Local government Finance (BLGF) supervised and administered the Real Property Tax Administration (RPTA's) tax mapping project. The Department of the Interior and Local Government (DILG) houses the Local government Academy (LGA) which implemented the Municipal Training Program (MTP). PCR/ICR Findings and Lessons 2.7 According to the PCR of MDP I and the ICR of MDP II, both projects achieved their infrastructure financing and institutional objectives. Even though the political changes in 1986 delayed implementation of the first project (MDP I), its innovative demand-driven project design had resulted in the participation of 42 LGUs compared to 15 included at appraisal. In MDP II, 35 LGUs participated and additional 7 eligible LGUs that had applied had to be accommodated later in MDP III. All sub-projects under MDP II were completed ahead of schedule. The majority of the sub-projects under both MDP I and II were revenue-generating public markets, bus terminals, and slaughterhouses. Infrastructure-type projects were rare. 2.8 The PCR and the ICR documented that the Municipal Development Fund (MDF) was successfully established as a mechanism to provide LGUs with direct access to long-term financing; the Central Project Office (CPO) established itself as a technical intermediary to assist LGUs in project preparation and implementation; and the Local Government Academy (LGA) effectively carried out the Municipal Training Program (MTP). The PCR of MDP I, however, understated the achievement of the tax mapping (RPTA) program. The Audit mission found that, according to the BLGF data (BLGF, 1996), the total tax revenue rose by 50 percent after the completion of the RPTA program under MDP I. 21 2.9 The main lesson of the project was that a bottom-up demand-driven, competitive selection process is more efficient and effective than the top-down, pre-selected beneficiary approach used under previous Bank-financed urban projects. The MDP program could reach a larger number of LGUs for financing small and simple projects (a sub-loan size ranging from 4 to 95 million pesos), that tend to reduce risks associated with both financing and implementation capacity constraints. The project also showed that projects are more successful when local governments assume responsibility for project identification, preparation and implementation with strong ownership. 2.10 Both the PCR of MDP I and the ICR of MDP II rate the project outcomes as satisfactory, their institutional development as substantial, and their sustainability as likely. Based on the findings of the Audit mission which visited Bauan and Butuan City (under (MDP I), and Pulilan and Santa Rosa (under MDP II), the PAR verifies and confirms the PCR/ICR findings, and identifies and analyzes several key issues remaining for sustainability. The PAR draws a set of broader lessons and makes recommendations for the follow-on project, Local Government Finance and Development Project (LOGOFIND), and other future operations, especially with respect to local revenue generation, operations and maintenance, and alternative sources of project financing.  23 3. Implementation and Results Slow Start and Implementation Delay 3.1 The slow start of MDP I was due to the political transition after the "People's Revolution" in 1986, only one year after the project became effective. Implementation was also delayed because the change of government after the presidential election of 1986 resulted in the replacement of senior officials of national agencies with new officials who were not familiar with the project. At the local level, the change in government also resulted in the replacement of mayors with Officers-in-Charge, some of whom critically reviewed investment programs initiated by previous mayors, a process that took considerable time. The recession in the Philippines brought about serious budget constraints at both the national and local government levels. Implementation of MDP picked up momentum only after the local elections in early 1988 (MDP I PCR, p. 5; MDP III SAR, p. 7). Physical Achievements 3.2 The Audit mission visited four project cities: Bauan and Butuan City which participated in MDP I, and Pulilan and Santa Rosa in MDP II. Overwhelming Demand for Revenue Generating Projects 3.3 As noted above, a total of 42 LGUs participated in MDP I, almost three times more than the original appraisal target of 15. Moreover, the Audit mission confirmed that 20 of the 42 LGUs participating in MDP I were from the two lowest (5th and 6th) income classes of LGUs. This means that the MDF effectively provided badly needed financial access and technical assistance to this class of resource-poor LGUs. Contrary to the expectation from the original project design (para. 2.2a), however, the majority of the sub-projects turned out to be "revenue generating" projects, i.e., economic enterprises such as public markets, bus terminals, and slaughterhouses. Under MDP I, 36 out of 42 participating LGUs financed a public market. Infrastructure-type projects with uncertain prospects of cost recovery were less popular. Of the 95 sub-projects financed by the 42 LGUs, 16 were for roads and drainage systems, 6 for solid waste collection, and only one for a water supply system. 3.4 A total of 35 LGUs participated in MDP II. An excess of 7 eligible applicants had to be turned over to MDP III. As in the case of MDP I, most of the MDP II sub-projects were also public markets: 30 of the 35 participating LGUs financed a public market; only six LGUs had infrastructure sub-projects such as roads, drainage and sanitation. Of the 61 sub-projects financed by the 35 participating LGUs under MDP II, 6 were for roads, 4 for drainage, and 2 for sanitation. 3.5 The strategy of financing smaller projects for a larger number of LGUs was very successful. Smaller sub-projects facilitate implementation and reduce the financial burden (counterpart funds) on the local governments and can be completed in a timely manner. With the revenues generated from the sub-projects, especially public markets, these LGUs were able to increase their creditworthiness and became eligible for additional financing through the next phases of MDPs. A number of LGUs have implemented a series of sub-projects under 24 subsequent phases of the MDP programs. Bauan City which the Audit mission visited, for example, had successfully implemented a public market and a water supply project under MDP I, and now it is implementing several social and infrastructure sub-projects under MDP III, including school buildings, drainage systems, and flood protection. Pulilan, which successfully completed a public market under MDP II, is now at the appraisal stage for infrastructure-type sub-projects under MDP III. These experiences under MDP support the logical framework of the "New Project Cycle" of listening, piloting, and mainstreaming sequence (Picciotto and Weaving, 1994). Side-Effects on Local Social and Economic Development 3.6 Indirect impacts of sub-projects such as a public market on the local economy of participating LGUs were significant, especially for the small poor municipalities such as Pulilan which was in the lowest (6th) income class of LGUs before the project. During its visit to Pulilan, the Audit mission confirmed that the successful completion of the public market had significant positive impacts on "triggering" the process of economic and social development process in Pulilan: more than 50 commercial enterprises have been established in the vicinity of the public market, including three large multi-national manufacturing establishments; local business tax revenue rose by seven folds from 640,000 pesos in 1991 to 4 million pesos in 1995; the value of non-residential land near the market rose more than 200 times, from 55 pesos per square meter in 1992 to 12,000 pesos in 1996, which contributed to a substantial increase in the local real property tax revenue, from 602,000 pesos in 1991 to 1.4 million pesos in 1995. 3.7 After the project, Pulilan moved up from the 6th to the 2nd income class of LGUs in only four years, indicating a significant rise in the living standard of its 60,000 population. The city's income rose four fold from 6 million pesos in 1991 to 23 million pesos in 1995. It should be noted here that this successful outcome is owed partly to the leadership of Pulilan's dynamic mayor. The Audit mission observed similar positive outcomes in other three cities visited. In the case of Butuan City, in 1995, the revenue from three MDP I sub-projects (public market, bus terminal, and slaughterhouse) accounted for 49 percent of the city's income of 29.5 million pesos from business operations. Institutional Achievements Impact on LGUs'Access to Long-Term Project Financing 3.8 Under MDP I and II, the Municipal Development Fund (MDF) has established itself as a long-term credit window for LGUs. The projects substantially achieved the policy objective of shifting gradually from grant financing to loan financing for investment projects at the local level. Nevertheless, even under MDP II, the MDF had continued to function merely as a "disbursement mechanism" for all types of Official Development Assistance (ODA) funds, and did not evolve as a financial intermediary with a revolving fund as envisaged in the SAR. The original project design stipulated that: "to enable the fund to grow, become self-sustaining, and minimize pressure on the budget, it should revolve, so that repayments from local governments would be re-invested to expand the overall program" (MDP I SAR, p. 14). Under MDP III, however, the Audit mission confirmed that the MDF has begun operating as a revolving fund: in 1996, 30 percent of loanable funds from the MDF came from the second generation fund which was accumulating under MDP I and II, reaching an amount of 990 million pesos in 1996. 25 3.9 The on-lending rate was 14 percent under MDP I and 11 percent under MDP II, respectively, corresponding to the Bank's interest rate plus a 3 to 4 percent margin. These rates were substantially lower than the market rate. Under MDP III, however, the MDF is charging a market-based rate. The LGUs' repayment performance has been good without any payment arrears, although about 7 percent were collected through the Internal Revenue Allotment (IRA) "intercept" (i.e., deducting the repayment amount from the national government transfer account). The future role of the MDF is the main focus of the proposed local government finance reform to be implemented by LOGOFIND, under preparation. Some of the remaining issues are discussed in the next section. Impact on Training Local Government Officials and LYU Capacity Building 3.10 The Municipal Training Program (MTP) significantly contributed as a catalyst to the capacity building of the Local Government Academy (LGA) in its curriculum, faculty, and overall quality of the program. The LGA has established itself as a solid institutional base for municipal training. The Audit mission confirmed the scale and scope of the MTP implementation and its impacts on the skill level of individual officials and on the municipal capacity building. The Mayor of Pulilan indicated to the Audit mission that the MTP's impacts on training of his staff and technical assistance for project preparation and implementation made the MDF more attractive than other sources of financing. Pulilan is now participating in MDP III. 3.11 In many cases, those officials from the participating municipalities who went through the MTP and implemented MDP sub-projects became lecturers invited by the LGA (for example, Mr. San Pedro of Pulilan and Mayor Castillo of Bauan) to share their experiences with officials of other municipalities, a good example of spillover effect generated by the MTP. 3.12 The LGA, however, needs to develop its financial and administrative autonomy to become sustainable. For example, the MTP staff in the LGA get paid 20 percent more than other staff and the LGA is likely to lose the MTP staff as the MDP financing ends. The LGA could become like the Development Academy of the Philippines, a training institute for national government officials, which is privately funded and self-financing. Although the LGA has adopted an independent financial auditing system, any remaining bureaucratic red tape for managing LGA needs to be lessened further. Impact on the National Government Technical Assistance Capacity 3.13 The Central Project Office (CPO) has established itself as a capable project implementation agency at the national level. With high quality staff, CPO operated efficiently and implementation was accomplished as planned. Partly benefited from the experience of MDP I, the implementation of MDP II was completed ahead of schedule. 3.14 As the number of participating municipalities increases, now a total of 138 LGUs including 61 participating in MDP III, the CPO's technical assistance capacity cannot meet the increasing demand for its services. Therefore, the LGA's training program is becoming more important. The future role of the CPO is now being reviewed in the context of the reforms to be proposed in LOGOFIND. The extensive institutional learning accumulated should be maintained and the process continued in any new organizational form that may emerge as part of the reform. 26 3.15 A key issue is the CPO's inability to retain its staff after the completion of each phase of the MDP program. The project staff are organized for each project. As MDP II is coming to its completion, the staff on that project will be laid off and it may not be possible to recall them when LOGOFIND begins. The staff resource should be managed in a way to maintain the continuity of the institutional learning process. Otherwise, the opportunity cost foregone by losing staff with valuable experience will be high. Impact on Local Revenue Generation 3.16 Through the Real Property Tax Administration (RPTA) program, the registration and assessment coverage expanded markedly by 35 and 37 percent, respectively, under MDP I. A total of 71 municipalities participated under MDP I and 91 under MDP 1I. The model case is that of Santa Rosa where 100 percent of the real property tax units (RPUs) have been registered in the computer file with updated assessed property values. In Santa Rosa, the real property tax revenue tripled after the project: from 4.7 million pesos in 1992 to 15.8 million pesos in 1995, which accounted for 17 percent of its total income of 93.4 million in that year. 3.17 Under MDP I, the real property tax revenue for the RPTA program as a whole increased by 50 percent (BLGF, 1996). Although this information was available at the time when the PCR for MDP I was prepared, the PCR had understated the achievements of this project component. The results under MDP II are not available yet. It is significant to find that the RPTA program made it possible for the participating LGUs to collect taxes from non-residential properties whose values skyrocketed after the MDP-financed sub-projects were completed, especially the public markets (para. 3.6). There is a need for continuing support for this program which could become the important base of local revenue generation. 27 4. Agenda for the Future Changing Market for Project Finance Demand side: LGUs at Different Stages of Development 4.1 Owing to the fast growing economy of the Philippines and the decentralization policy, urban centers outside Manila and other large cities have been expanding rapidly. Visiting the four project cities, the Audit mission was able to observe the changing patterns of the demand for investment funds in response to the rapid urban growth and development. Indeed, each one of the four cities visited represents a particular stage of socio-economic development with a different kind of financial need. Santa Rosa has graduated from MDF: Santa Rosa, which financed a public market under MDP II, is now able to get loans from Government Financial Institutions (GFI) or commercial banks without difficulties. The recent influx of direct foreign investments, including the new plants established by Coca Cola, Toyota and others, turned the city into a most attractive customer to lend money. Santa Rosa, according to its planning officer, would rather avoid a World Bank-type loan which takes too long to prepare and implement, even though it has the advantage of being longer-term and technical assistance comes with it. Bauan is shifting its financing need from revenue generating projects to social/infrastructure projects: After the successful completion of revenue-generating projects such as a public market under MDP I, Bauan is now financing school buildings, roads, drainage systems, flood control and shore protection under MDP III. The city has developed the financial and technical capability to expand its investment program from simple revenue-generating projects to more complex infrastructure projects. Pulilan was a small poor municipality that badly needed financial and technical assistance to trigger the development process: The public market financed under MDP II has made very positive indirect impacts on income, employment, property values, and local revenues, shifting the city from "Income Class 6" to "Income Class 2" in a four year period. Pulilan is a good example of a resource-poor city that has a potential to develop and grow with a small dose of initial intervention. Butuan City is in transition: With a dynamic leadership, the city is in the process of reorganizing the municipal government and streamlining its management. The majority of LGUs in the Philippines would fall in this category which badly need both access to long-term credit and technical assistance under the MDP program. Butuan City, having successfully completed the economic enterprise sub-projects, is now participating in MDP III to finance infrastructure-type projects including roads, drainage, and traffic management. 28 Supply Side: MDF and Local Finance Reform 4.2 The Audit confirmed that a "bottom up" demand-driven approach for MDP I and II was successful because the selection and design of sub-projects were made by the LGUs themselves with a strong sense of participation and ownership. This important lesson implies that targeting a particular income class of LGUs for financing particular types of sub-projects from particular sources of funds (i.e., segmenting the demand side of the financial market) should be avoided. Allocating loanable funds from different sources to LGUs should be best left to the market. 4.3 The MDF must graduate from being a disbursement mechanism under MDP I and II to a revolving fund. Encouragingly, this is increasingly the case; under MDP III, MDF is operating as a revolving fund with 30 percent of the fund in 1996 coming from the second generation fund. 4.4 As LGUs "graduate" from the initial phase of the MDP program (MDP I or II) with a stronger financial base, their investment and financial needs change from financing simple projects like a public market to larger, more complex infrastructure projects. There is a need for providing alternative sources of funding on the supply side (GFIs and commercial banks) to meet the changing structure of demand. The Department of Finance, in collaboration with the World Bank, developed a new policy framework for local government financing whose implementation is supported by LOGOFIND. The policy framework is intended to capture the changing demand structure of LGUs' long-term project financing as characterized above. While strong creditworthy LGUs would be encouraged to have access to other sources of financing, including GFIs and commercial banks, the MDF will continue to play a catalytic role in supporting resource-poor, less creditworthy LGUs and assisting them to make the transition to the financial market when they "graduate" from the MDF. Operations and Maintenance 4.5 Since there is no recurrent budget item for maintenance in the municipal budget system, the maintenance work is done on a case by case basis supported by the general municipal budget. The participating LGUs were required to set up a "Maintenance Trust Fund", but most LGUs failed to do so. The CPO has had no mandate to monitor operations and maintenance of the sub- projects after they are completed. The lack of regular maintenance is the most serious hindrance to sustainability. 4.6 Under MDP III, a pilot incentive scheme is being experimented: a matching grant is given to nine municipalities for 70, 50, 30 percent of the maintenance expenditures for the first three years, respectively, after which the municipalities are expected to continue the maintenance work using their own resources. The Audit mission found that the nine participating municipalities selected for the program are, however, some of the well-managed and financially better-off LGUs. Even if the pilot program turns out to be successful, it may not be widely transferable to other LGUs that may find it difficult to come up with adequate matching funds. A close evaluation of this experiment will be in order upon the completion of MDP III. A short- term solution could be to farm out the maintenance activities to private firms. 29 Financial Autonomy of Economic Enterprises 4.7 The Bank's urban development projects often face the maintenance problem because of the difficulties of collecting user charges from households for infrastructure type services such as water supply and sanitation. In the case of MDP, however, most of the sub-projects have been revenue generating such as public markets, bus terminals, and slaughterhouses, for which cost recovery from service charges or rents was not the problem. According to the MDP I SAR (para. 4.02), rents and fees collected from these economic enterprises were supposed to cover at least recurrent costs of operations and maintenance and debt services. The 1991 Local Government Code stipulated that such economic enterprises maintain a budget that is independent from the overall municipal budget, but this seldom occurs. The Audit mission learned that often economic enterprises are forced to keep a redundant payroll since they are not subjected to the payroll ceiling of 45 percent of its budget, as is the case with the municipal government, and unable to allocate funds for key activities such as maintenance. In the absence of the budgetary discipline on the part of the municipalities, an adoption of contract management or some other forms of private sector participation may be a viable solution in the short run. Disincentive to Local Revenue Generation 4.8 After the 1991 Local Government Code (LGC), the Internal Revenue Allotment (IRA) ratio was gradually raised from 20 percent (in 1992) of the total municipal revenue to 40 percent (in 1995), as a number of national government functions, mostly health, education, and social services, were devolved to provincial and municipal governments. On the average, the IRA transfers account for about 80 percent of LGUs' total income. The sudden increase in the revenue in the majority of LGUs had a dampening effect on the local revenue generation effort. Some LGUs had excess cash surplus to the extent that it was used for wage increases. The increase in IRA reduced the relative importance of the RPTA program, an unintended substitution effect on the implementation of the program. The LGC introduced a further disincentive for local revenue generation: since 1992, all residential properties valued less than 175,000 pesos have been exempted from the real property tax. 4.9 The increase in the IRA ratio, however, created a certain degree of inequity among LGUs: some poor LGUs with additional devolved functions had to suffer from a sort of "unfunded mandates" to carry out the devolved functions without sufficient funds. This year's national budget included a provision to remedy such a situation: of the total IRA amount of 71 billion pesos, 6.7 billion pesos will be set aside as a special allocation for covering additional "costs of devolution" (Republic of Philippines, 1996).  31 5. Ongoing MDP III and Follow-on Project Ongoing MDP III 5.1 Demand for the MDF financing from LGUs was very strong. At present, over 300 cities and municipalities expressed interest in obtaining loans from MDF. To meet this demand, the CPO initiated preparation of the follow-on project, MDP III, which was approved by the Board in March 1992. MDP III was a continuation of MDP I and II to strengthen the institutional development process being achieved under the program and for further expanding the development assistance to more LGUs. MDP III was also very timely since the project would assist the national government to develop and carry out its decentralization program after the Local Government Code was revised in 1991 (MDP III SAR, pp. 16-17). 5.2 The design and components of MDP III were similar to those of MDP I and II, but it did not target any particular regions. As of September 1996, 29 LGUs completed loan agreements, and 32 more LGUs are at various stages of preparation. There were three key elements in MDP III intended to address issues encountered in the previous projects: (i) improving the "maintenance culture" (i.e., preference for financing new investments rather than maintaining old ones) with a pilot program (MDP III SAR, p. 19; and para. 4.6 above); and (ii) operating the MDF as a revolving fund as envisaged in the original project design in MDP I (MDP III SAR, p. 21; para. 3.8); and (iii) gradually adjusting the on-lending rate upward to the market rate. In addition, BLGF has established a training program for treasurers and assessors of municipalities. 5.3 The Audit, however, concluded that the attempts made under MDP III to address the remaining issues identified could have been much stronger. The pilot program for maintenance activities mentioned above may not be widely transferable to other LGUs since most LGUs would not be able to come up with adequate matching funds. The next follow-on project, under preparation, is expected to mitigate these shortcomings of the MDP program. Local Government Finance and Development Project (LOGOFIND) 5.4 After the identification mission of LOGOFIND in October 1996, the Region's MDP team prepared the Project Concept Document for it. In January 1997, the Region made a decision to proceed with project preparation. 5.5 Within a broad policy reform framework (Llanto, et al., 1996), LOGOFIND will address the issues associated with the down side of the bottom-up demand-driven project design. The self-selection process tends to generate competition among LGUs and only those that are creditworthy and capable of making necessary policy changes are able to participate in the MDP and have access to credit. Many LGUs which are poor and non-creditworthy have been left out, widening interregional income disparities. LOGOFIND intends to implement a policy framework which aims at "graduating" more successful LGUs to the private financial markets while providing assistance to weaker LGUs. Implications of the lessons drawn form MDP I and II on LOGOFIND were discussed above (para. 4.4). Also, the remaining issues identified in Section 4 above are expected to be addressed in LOGOFIND.  33 6. Lessons and Recommendations Ratings 6.1 The Audit rates the outcomes of both MDP I and MDP II as satisfactory, their institutional development impact as substantial, and their sustainability as likely. The ratings concur with those of the PCR/ICR. The institutional mechanism for long-term credit (MDF) and the Municipal Training Program under the LGA have been firmly established at the national level, and the extent of capacity building for project preparation and implementation at the local level was substantial. These achievements under MDP I and II are expected to be further strengthened under the ongoing MDP III and LOGOFIND under preparation. Borrower Performance 6.2 The Audit mission confirmed satisfactory performance of the Government and implementing agencies. The directors of the CPO and MDF were instrumental in steering MDP through the politically difficult start-up period. Moreover, the project implementation was successful because the high quality staff of both CPO and MDF were able to make quick adjustments to accommodate a much larger than expected number of LGUs participating with particular types of sub-projects. The Audit mission also confirmed the excellent work carried out by the director and staff of the LGA in implementing the MTP. The staff of the BLGF should also be commended for their persistent effort in implementing the RPTA program, establishing the important local revenue base. On the whole, the compact among the officials of different agencies at all levels and their strong project ownership contributed to the success of the project. Bank Performance 6.3 The Audit mission confirmed the favorable self-evaluation reported in the PCR/ICR. The Bank project team was innovative in using a "bottom-up" demand-driven approach as early as 1984. The importance of local participation and project ownership was recognized as key elements of success a decade before these concepts were widely accepted in the Bank. The Bank was flexible during implementation, quickly adjusting the project design to the responses coming from the LGUs. MDP I was able to accommodate 42 LGUs instead of 15. The project implementation also showed how the sequence of listening, piloting, and mainstreaming could be applied in operations (see Picciotto and Weaving, 1994, for the "New Project Cycle"). The CPO noted that the Bank did its best in supervising the project implementation providing the necessary advice and inputs with field visits. On the whole the Audit confirms the Bank's satisfactory performance. Lessons Demand-Driven Approach, Participation, and Ownership 6.4 A "bottom-up", demand-driven program approach to project financing is more efficient and effective for project implementation than the "top-down", pre-selected, project specific approach. Beneficiary local governments perform better and show greater commitment to the 34 project when they are primarily responsible for project preparation, management, and implementation. Sequencing Project Components 6.5 The institutional framework for project financing (MDF) was put in place prior to undertaking actual physical investments. Because of the demand-driven approach, MDP first attracted revenue generating sub-projects which presented minimum risks for cost recovery. This outcome showed that sequencing of project components in response to the preference of the beneficiaries can avoid implementation delays and cost recovery problems that often occur in a complex urban development project prepared in a "top-down" manner. Piloting to Mainstreaming Analogy 6.6 After the participating municipalities complete a rather simple, low risk, revenue generating project such as a public market, they tend to enhance their creditworthiness with a stronger financial base, and expand their investments to infrastructure-type projects (e.g., roads, drainage, water supply and sanitation). The logic of the "New Project Cycle" (Picciotto and Weaving, 1994) is supported by the experience gained in the MDP program. Recommendations Local Government Finance Reform and Changing Role of MDF 6.7 The MDF attracted mainly revenue generating projects with a minimum risk. The LGUs were initially reluctant to finance social/infrastructure projects with cost recovery features. These experiences suggest that targeting particular types of LGUs for particular types of sub- projects should be avoided. Even under LOGOFIND, the credit window for the first-timers (poor and less experienced) should continue to be open for simple revenue generating projects. Expanded Role of LGA 6.8 The role of LGA for training municipal officials should be expanded from training at the project level (preparation, financing, and implementation) to LGUs' capacity building for carrying out planning and implementing a city-wide infrastructure investment program and managing rapidly expanding urban areas. For example, Santa Rosa faces a tremendous challenge to meet a sharp increase in demand for both residential and non-residential land and all types of infrastructure services as the city is attracting large multinational firms. 6.9 The LGA should also expand its dissemination program whereby the experiences accumulated by the LGUs graduating from MDP can be shared with the newcomers. Mayors and senior officials of Bauan and Pulilan are already serving as lecturers in the LGA seminars, but a more proactive program such as "twinning" could be effective. 35 Reducing Disincentives for Local Revenue Generation 6.10 The increase in the IRA ratio to 40 percent as part of the revised Local Government Code dampened the incentives to generate local revenues (para. 4.8). To reduce this disincentive, the Audit recommends: (i) to introduce matching grants above the standard allocation of IRA tied to the extent of local revenue collection or of successful cost recovery; (ii) to continue supporting the RPTA program to capture tax revenues from the rapidly rising property values, in particular, from the expanding non-residential tax base in rapidly growing LGUs; and (iii) to introduce a "Presidential" award system according to the level of financial autonomy measured by the ratio of IRA receipts to the total municipal revenue. For the four cities the Audit mission visited, this ratio was: Bauan, 16 percent; Santa Rosa, 23; Pulilan, 49; and Butuan City, 79. Private Sector Participation in Maintenance and Contract Management 6.11 To make what the projects achieved sustainable in the absence of recurrent budget funds for maintenance and technical personnel, LGUs may consider farming out the maintenance activities to private firms or resort to contract management based on user fees as a short-term solution. 6.12 To protect the financial viability of the MDP-financed economic enterprises (public markets, bus terminals, and slaughterhouses), contract management or other forms of private sector participation could be adopted. Mandaluyong City in Metro Manila has been using a management contract arrangement for its public market, and Santa Rosa is considering such an arrangement for its market.  37 References Brillantes, Jr., A. B., 1996. "Future Vision for Enhancing LGU Capabilities." Local Government Academy, Department of the Interior and Local government. Bureau of Local Government Finance, Department of Finance, 1996. "Project Completion Report of the Real Property Tax Administration (RPTA) Program under MDP I." Central Project Office, Department of Public Works and Highways, 1996. "Project Review for MDP L" Llanto, G.M. and et al., 1996. "Local Government Units' Access to the Private Capital Markets." Philippine Institute for Development Studies. Local Government Academy, Ministry of the Interior and Local Government, 1993. "Accomplishment Report MDP I." (November 1988 to June 1993). Picciotto, Robert and Rachel Weaving, 1994. "New Project Cycle for the World Bank?" Einance and Development. The World Bank. Project Management Office, Department of Public Works and Highways, 1996. "Monthly Monitor: MDP II, September." Republic of the Philippines, 1996. "Budget of Expenditures and Sources of Financing, Fiscal Year 1997." World Bank, 1996a. Philippines: Country Assistance Strategy. World Bank, 1996b. "Monitoring Results-on-the-Ground of World Bank Assisted Projects." Resident Mission, Manila.  ANNEX A 39 Comments from the Borrower PRENUMED LM)P 3) CENTRAL PROJECT OFFICE MMINUTE BLDG., E. Jacinto St., U.P. Dilirnan Quezon City, PhiLppines Tel. No. 926-5384 * Fax No. (632) 926-5319 Date Apni 22, 1997 No of Pagcs: 2 T o . YVES ALBONY Chief Infrastructure and Energy Division Operations Evaluation Department FaxNo (202) 476391 RooM NO. G 6125 From : DAJWO C. TRAJANO Project Director P5MLUMEDivMINLTE Projects Fax No. (632) 926-5319 Rec : Comrents on MD? I (Loan No. 2435-PH) MDP1 2 (Loan No. 3146-PH) PerFormance Audit Report We extend our appreciation for inishing DPWH a copy of the Performance Audit Report for MDP 1 and MDP 2 (First and Second Municipal Development Projects). The said report was r-fered to us by DPWH Undersecretary Teodoro T. Encarnacion for comments inasmuch as ihe MDP projects werc directly implemented by this Office. We basically agree and confirm the concents of the Report, however. plcase considar the hercin assached comments of DPWH in the final report. We also take this opportunity to extend our gratitude to Mr KYU SIX LEE for coming up with an objective evaluation of die two NMP projects. Our warmest regards. Very truly yours. A4Lo O KA.IANO Pr9ect ector) ANNEX A 40 CPO's COM.1ETS ON MDF AUDIT REPORT 1. PREFACE (1st PARA, last sentence p. 3) MDP Il loan signing was January 19. 1990 and its loan effectivity was March2, 1990, 2. Prmet Obiecve. and Dcsi-*- (2nd sentence, p. 9) MDP 11 area coveragc !icluded Metro Manila and the Einge provinczs of Cavite, Laguna, Rizal and Bulacn. 3. P RTCZ FT,INGS AJD L=SSONS (PARA 2.9, 2nd sentcnce, p. 17) The lowest subloan size was about P4.0 milicn (Norzagaray, Bulacan, MDP 1) and the highest was about P95 million (Butuan City, MD? ill). 4 Physical Achievemems (PARA 3.5, ist senence, p. 20) The Municipality of Bauan also implemented a success.u wate supply project both inNMDP I and MDP I[ 5. Cbanging Market for Projcct Finance (PARA 4.1, BAUAS. n. 23) The Mumicipality of Bauan also implemeAnted a successu water suppiv project both in MDP T and MDP I. The project is opcrated/managed by the Municipality and considered as a reve=ue genc:ang projcct.  IMAGING Report No.: 16800 Type: PPAR