Ecuador - Public Sector Management Project

Document of The World Bank FOR OFFICIAL USE ONLY 0w H,'g-/cc RIport Ne. P-4006-EC REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$8.0 MILLION TO THE REPUBLIC OF ECUADOR FOR A PUBLIC SECTOR MANAGEMENT PROJECT March 28, 1985 This document has s resticted distibution and may be used by reeipients only in the perfnce of ther olikcd dudes. Its contents may not otherwise be disclosed without World Bank authorization. I  CUIRENCY EqUIVALENTS Ecuador has a multiple exchange rate. In addition to the current official exchange rate of S|.67-US$l (which applies only to petroleum exports and some selected imports), there is an intervention rate of S/96.5-US$1 applicable to all other imports and non-oil exports. There is also a free market rate applicable to tourism and capital movements which was fluctuating around S/.119=US$l as of January 1985. Currency Unit: Sucre (S/.) Intervention Rate Calendar 1984 January, 1985 US$1 = S/.79 = S/.96.5 S/. 1 = US$.01 = US$.O1 S/. 1,000 = US$12.66 = US$10.36 FISCAL YEAR January 1 to December 31 ABBREVIATIONS BEDE - Banco de Desarrollo del Ecuador (Ecuadorian Development Bank) CEPE - Corporacion Estatal Petrolera Ecuatoriana (state petroleum company) CONADE - Consejo Nacional de Desarrollo (National Development Council) GTZ - Gesellschaft fur Technische Zusammenarbeit (German Agency for Technical Cooperation) IDB - Inter-American Development Bank IEOS - Instituto Ecuatoriano de Obras Sanitarias (Ecuadorian Sanitary Works Institute) IESS - Instituto Ecuatoriano de Seguridad Social (Ecuadorian Social Security Institute) IETEL - Instituto Ecuatoriano de Telecomunicaciones (Ecuadorian Telecommunications Institute) INECEL - Instituto Ecuatoriano de Electrificacion (Ecuadorian Electrification Institute) MOF - Ministry of Finance and Public Credit MINE - Ministry of Natural Resources and Energy USAID - United States Agency for International Development  FOR OMCIAL USZ ONLV ECaOADO PUBLIC SECTOR Et PMOJECT LOAN AND POJCT SUmWR Borrower: Republic of Ecuador RegcStizg Agencies: Up to US$2.5 million would be on-lent to CEPE, INECEL and IETEL with remainder used by Finance Ministry, CONADE and Ministry of Natural Resources. Amuut: US$8.0 million equivalent. Terms: Repayable over 17 years including 4 years of grace, at the Bank's standard variable interest rate. Ptroect Duscription: The project would help Improve Ecuador's public sector management to make better use of scarce financial and human resources. The main areas of assistance are: Ci) to introduce improvements in the national planning and budgeting systems by (a) strengthening the macrn- economic framework for planning and budgeting, including better management of external debt; (b) improving prepar- ation of the national budget; (c) putting in place a pilot financial information system and training account- ing professionals to use it; Cd) strengthening public investment monitoring; and (e) studying means for a phased reduction of revenue earmarking; and (ii) to support general management improvements where the state performs important economic activities by (a) helping to design a new system for monitoring performance of public enterprises; (b) providing direct assistance to key public enterprises (oil, power, and telephone companies) as well as to mining development initiatives; and (c) streamlining procurement and other administrative practices. Risks: Successful implementation of the proposed project depends on continued Government commitment, improved coordination among Central Government institutions and arrangements to facilitate contracting of the needed consultant services. Righer-level officials are committed to the management assistance proposed; consultations during project preparation have helped assure commitment from middle level technicians as well. The provisions for Project Coordiiator and advisory committee should aid in achieving better coordination among key agencies. The proposed use of a management service for contracting consultants should minimize delays in that regard. This doumcnt has a restd ditribution and may be ued by rfepients only in the perfonance of tlvir ofrflw dute Its contents may not otherwi be discosed without World Bank authortion.  - ii - ZaUmated Costs: Loa!aa --CUS$ million)-- Improed PlaninAg ad Budgetlng 3.5 3.3 6.8 Gconeral llgt. Iprv. in State Icon. Act. 1.3 3.5 4.8 Project Coordination 0.1 - 0.1 Baseline Costs 4. 6.8 11.7 Unallocated 0.4 0.6 1.0 Price Contingencies 0.4 0.6 1.0 Total Project Costs 1 5.7 8.0 13.7 lBank - 8.0 8.0 Central Goverment & Dec. Entities 5.7 - 5.7 Total 5.7 8.0 13.7 Istinated 1986 1987 1988 L989 US$ llbions by lank Fiscal Year Annual 1.8 3.7 2.0 0.5 Cumulative 1.8 5.5 7.5 8.0 late of Return: n.-. 1/ The tax content of the project would be negligible.  TERNATIONAL BME FOR IKCOEXlSTICTION AND DEVKLOFKNT REPOsT AND uA OF THE RESW OF TE I TO TIM BUCUTIVE DIR$CTORS ON A PROPOSED LOAN TO TRR REPUBLIC OF ECUADOR YOR A PUBLIC SECTOR PANhCEXNT PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Ecuador for the equivalent of US$8 million to help finance a public sector mnnagement project. The loan would be repayable over 17 years including 4 years of grace, at the standard variable interest rate. The Borrower would onlend about US$2.5 million of the loan in dollars to decentralized agencies such as the state oil, power and telephone companies (CEPE,INECEL and IETEL) at the same interest rate and terms as the Bank loan. PART I - THECONOK! 2. The most recent economic report on Ecuador, Report No. 5094-EC entitled 'Ecuador: An Agenda for Recovery and Sustained Growth- was distributed to the Executive Directors on Oftober 5, 1984. The subsequent raragraphs reflect the findings of that report as well as those of a Bank mission which visited Ecuador in November 1984, to analyze the public investment program. Annex I provides the main social and economic indicators. 3. Ecuador entered the seventies as one of the least developed Latin American countries. In 1967, petroleum was discovered in Ecuador's Amazon region and in 1972 the country became a net oil exporter. In 1973 world oil prices quadrupled and Ecuador's export earnings dou'led. During the seventies, Ecuadorian income and output expanded rapidly, perhaps at a rate unprecedented in its history. At constant 1983 prices, per capita GNP increased from US$1,190 in 1972 to US$1,430 in 1983, placing Ecuador firmly among the Bank's middle-income borrowers. 4. Between 1960 and 1980, much social progress was made. Life expectancy increased by ten years; death and infant mortality rates dropped by more than 40 percent; and school enrollment expanded rapidly. By 1980 virtually all children were attending primary school and a third of the relevant cohort attended schools of higher education. Today's citizens are better educated, in better health, and better fed than at any other time in Ecuador's history. Nevertheless, owing to the low level from which Ecuador started, Ecuador's social indicators lag behind those of other countries with similar levels of per capita income. Moreover, the benefics of growth were not evenly distributed. While a sizeable middle class emerged, about 40 percent of the urban and 65 percent of thie rural population live in absolute poverty.  5. Highly concentrated ownership of productive resources and unequal access to public services explain much of the skewness of Ecuador's income distribution. For example, 60 percent of the country's farmers derive their livelihood from only 11 percent of the arable land. Their farms are small-less than 5 hectares-and tend to be of the poorest quality. Low levels of education, primitive cultivation techniques, scarce use of technical inputs, and limited access to credit and to commercial marketing channels contribute to low farm productivity and incomes. But uneven distribution of the oil income also accounts for the disparities in social conditions. Thus, during the 1970S only about a quarter of total public investment was channeled to the rural areas, where 56 percent of the population and most of the poor live. 6. As many other Latin American countries, Ecuador is now beginning to emerge from a severe recession. Ecuador not only suffered from declining international oil prices and suspension of commercial bank lending, but also from the ravages of the Nino current which in 1983, practically wiped out cocoa exports (a major source of foreign exchange), severely damaged the countryside, and forced the country to import foodstuffs, domestic production of which normally suffices for the countryts needs. Per capita income dropped in 1982; in 1983 it dropped again, this time by more than 5 percent. While statistics are scarce, unemployment has surely risen, there have been some bankruptcies, and Ecuador's financial and industrial sectors are undergoing severe liquidity problems. The Impact of Petroleum 7. While the immediate causes for E-uador's economic downturn may be traced to falling oil prices and suspension of commercial bank lending, these factors only exacerbated impending problems, as the country had embarked on a unsustainable economic course. After the initial burst of oil exports in 1973, the country's volume of exports remained practically constant; export earnings increased mainly because the international price of oil went up, and the country's income increased because the terms of trade turned sharply in its favor. By 1980, the increased income made available since 1975 by relatively higher export prices was adding 8 percent to Ecuador's yearly income. The increased expenditures of the public sector-through which much of this income passed-were partially responsible for the improvement in the nation's living standards and physical infrastructure, as well as for accelerated industrial production. 8. This income had perverse effects as well. First, it slackened efforts to collect taxes from the non-oil portion of the economy. Thus, while petroleum revenues doubled relative to GDP between 1973 and 1983, non-oil taxes, including social security contributions, fell from 17 percent of GDP in 1973 to 10 percent in 1982 and total revenues, relative to GDP, stagnated. Second, because oil taxes were painless for the Ecuadorian consumer, there was an incentive to earmark them for various subsidies--imports, housing, roads, and education-and to keep domestic petroleum product prices frozen at the level of 1972. By 1980, the Ecuadorian consumer was paying only US$0.10 for a gallon of gasoline. The subsidy implicit in the difference between world prices and domestic prices was equivalent to about 8 percent of 1980 GDP,,  9. Third, the abundance of revenues and their ease of collection diminished incercives to contain the growth ot public sector expenditures. Revenues relative to GDP increased from 26 percent in 1973 to 29 percent in 1980, current expenditures went up from 16 percent of GDP in 1973 to 22 percent in 1980. Public sector savings decreased to such an extent that tb- surplus of 1973 (equivalent to 3 percent of GDP) became a deficit equivalent. to 5 percent of GD? by 1980 and 8 percent by 1982. Because of its status as an oil exporter, Ecuador was able to finance this deficit abroad with ease, but at a price. The public external debt more than doubled between end-1979 and end-1983; economic adjustment was deferred until Ecuador found its access to foreign funds severely limited. The abundance of oil income also affected Ecuador's exchange rate, allowing it to appreciate in real terms without causing financial problems. This made imports cheaper for Ecuadorian industrialists and consumers, but it also meant that non-oil exports suffered. With the important exception of shrimp, non-oil exports grew slowly in volume after 1974. Like the public sector, the external sector would also have encountered problems after 1980 had it not been for recourse to large external borrowings. 10. Monetary policies complemented both exchange rate and fiscal policies. Low interest rates--indeed, negative in real terms-led to a decline of financial savings relative to GDP. But Ecuador's financial system expanded credit rapidly in nominal and real terms, despite poor domestic resource mobilization, because foreign banks and the Central Bank provided it with resources. By 1983, three-fifths of the resources of the finance companies and over one-third of the banks' came from the Central Bank. Financial institutions, then, like the public and external sectors, became dependent on petroleum, through the Central Bank, and ultimately on external borrowing, through guarantees. They too encountered severe problems when, in 1982, petroleum receipts stagnated and Ecuador's access to external funds became severely limited. Recent Events 11. During 1981-82, the terms of trade turned against Ecuador as oil prices declined. Export earnings fell by about eight percent in 1982. Despite a reduced volume of imports, the current account deficit of the balance of payments exceeded US$1 billion, about nine percent of GDP. To finance it, the Authorities borrowed short-term and used dp about US$460 million of the country's international reserves, almost depleting them in the process. When the economic downturn worsened in 1983, Ecuador had to manage with severely limited financial resources as foreign banks restricted their net, new lending to US$430 million. To make matters worse, the Nino current's climatic shifts, which had inflicted some damage in 1982, continued to ravage the countryside with floods. 12. The Authorities' attempts to deal with the crisis have been, for the most part, prompt and in the right direction. First, they dealt with the exchange rate. In 1982, the sucre was devalued for the first time since 1970 and thereafter was adjusted frequently. It now stands at a rate which is as  -4- attractive for exporters as it was in 1970, before the oil boom allowed it to appreciate. Second, they dealt with the liquidity crisis by temporarily prohibiting or limiting many imports and renegotiating principal on the external private and public debt. Negotiations with the commercial banks for a multi-year rescheduling covering maturities falling due in 1985-1989 were concluded in the first quarter of 1985. Temporary import restrictions were eliminated as the liquidity of the Central Bank improved. 13. A fiscal austerity program was put in place by 1983 in cooperation with the IMF. The public sector deficit was reduced from about 8 percent of GDP in 1982 to about 1.4 percent in 1983 and virtually eliminated in 1984. Ecuador also complied with the rest of the IMF program. Partly as a result, inflation was more than halved in 1984, to about 20 percent, the balance of payments was practically brought into equilibrium, and growth resumed. A new IMF program for 1985-1986 was approved by the IMP board on March 11, 1985. Among other things, this program anticipates a public sector surplus equivalent to 3.4 percent of GDP for 1985 to be achieved by raising revenues, especially from petroleum exports, and holding down expenditures. 14. Finally, decisions taken prior to the crisis began to bear fruit in 1983. For example, owing to positive results of exploration efforts undertaken as far back as 1980 and the implementation of a secondary recovery program, oil production and oil exports rose 11 and 39 percent, respectively, in 1983. Outlook 15. The present Administration which entered office in August 1984, is the second one to be democratically elected after nearly a decade of military rule. The Government's economic philosophy essentially supports the market as an efficient resource allocation mechanism, with minimal Government intervention in economic affairs. Since coming to office, the Administration has taken a number of important and politically difficult corrective measures: it has again devalued the sucre, it has raised domestic petroleum products prices; it has raised interest rates close to positive real levels; it successfully concluded negotiations for multi-year rescheduling of its external debt; it has eliminated many import prohibitions; and it has moved to free prices in the agricultural sector. These are important measures in the right direction; they should encourage efficient utilization of resources and stimulate exports, agricultural production and domestic savings. 16. Owing to the devaluations of the sucre in the past two years, oil exports now amount to 18 percent of GDP. Virtually all of this income accrues to the public sector. Present prospects indicate that in future years, the oil sector will at least maintain its importance in the economy. Realization of the country's growth potential requires extremely careful management of this income. In particular, it will require continuation of frugal fiscal policies and tight monetary policies, very much along the lines of the 1985 program agreed to with the IMF. A public sector surplus channelled to the private sector via the monetary system may be required to avoid inflationary pressures and to maintazn an adequate flow of resources to the private sector. This delicate balance between public and private sector needs underscores the importance of good public sector management.  - 5 - 17. This balance is all the more important because Ecuador is likely to continue facing a shortage of foreign exchange in the next few years, especially if oil prices continue to stagnate or decline. In addition, Ecuador, like many other developing countries, will face greater difficulty than in the past in obtaining financing for its development effort from commercial sources. Yet, the country has abundant resources. With a good public investment program. continued improvement of sector policies, and tight monetary policies, the exchange rate should remain attractive for exporters. Under these conditions Ecuador could grow some 3 to 4 percent per year on average in 1985-1990 and attain equilibrium in both its overall fiscal and external accounts, remaining, therefore, creditworthy for Bank lending. PART 1I - BANK GROUP OPERATIONS IN ECUADOR 18. Bank Group operations in Ecuador date back to 1954 when a loan was made for a first highway project. Altogether, the Bank and IDA have extended 31 loans and six credits to Ecuador totalling US$628.2 million net of cancellations. As of September 30, 1984, US$420.3 million of this amount had been disbursed. The IFC has invested in five firms in Ecuador, including a large textile company, a sugar mill, a cement company, a mining enterprise and a development finance company. As of September 30, 1984, commitments for these operations amounted to US$28 million, of which IFC held US$10.4 million. Annex II contains a summary statement of Bank loans, IDA credits and IFC operat'ons as of September 30, 1984. 19. ExeLation of Bank Group financed projects has often been hampered by weaknesses in Ecuador's implementation capacity, reflecting the insufficiency of the country's public sector managerial and technical resources--a const-aint that is still a serious obstacle to Ecuador's economic and soc4al development. In recent years, the Government and Bank staff have worked together to step up disbursement of Bank loans. Among other initiatives, a Special Action Program for the country provided for revolving funds in five projects. As a result of these general efforts, disbursementr rose from US$26 million in FY83 to US$82 million in FY84. The country has recently set up a monitoring committee for all externally financed projects which should reinforce efforts to accelerate disbursements. The Bank plans annual portfolio implementation reviews to detect and resolve specific obstacles to execution of Bank-financed projects. Ecuador's average disbursement rate for 1981-1984 has been higher than the average for Latin American countries. 20. Bark and IDA lending in Ecuador was originally concentrated in transport and po-wer, where there were substantial bottlenecks to be overcome. To date, approximately 30 percent of Bank Group lending has been for infrastructure. Seven of the nine loans and credits extended for transport were to improve the country's road network and two were to help finance the expansion of the port of Guayaquil. Three power operations aimed at improving generation and distribution facilities in Quito. The first livestock development loan, approved in FY67, marked the beginning of a diversification in the Bank Group's lending program away from infrastructure.  -6- Since then, the Bank Group has made nine other loans and credits for agriculture and fisheries, seven loans to support industrial development, and two for pre-investment studies. These productive sector loans comprise 52 percent of total Bank lending to Ecuador. Bank Group support for social sectors-education, water supply and urban development-now accounts for about 18 percent of total Bank lending. 21. Turning to the future, the Bank strategy is to support Government initiatives in macroeconomic end sector reforms over the medium term. Bank lending would build on a core program for industry, agriculture and infra- structure to meet the following objectives: Ci) the completion of a physical and social infrastructure base capable of fostering development; (ii) the ex- pansion of productive capacity in crucial sectors; and (iii) the strengthen- ing of agencies to implement projects effectively. Additional projects would support policy improvements in energy, agriculture and the general develop- ment framework. The proposed public sector management project would help im- prove the Government's analytical ability to determine policy and its capa- city to monitor economic performance. In addition to the design and adoption of adequate sector policies, Bank lending will emphasize the generation of exports and employment. Besides the public sector management project recom- mended in this report, the Bank is preparing small-scale enterprise, DFC, and agriculture sector operations. The small-scale enterprise and DFC credit operations would increase production and improve employment prospects for the population. Both the agriculture sector project and the industry projects would support policy improvements in their respective sectors. In addition to Bank lending, the IFC is analyzing several possible operations, principally in agribusiness and fisheries. 22. Substantial development financing has also been provided to Ecuador by the Inter-American Development Bank (IDB), the U.S. Agency for International Development (USAID) and, to a lesser extent, by other bilateral sources. IDB has been the single largest lender to Ecuador. Loans outstand- ing from IDB to the country as of December 31, 1983 totalled about US$850 million equivalent. Past IDB lending has been concentrated in the power, agriculture, industry and transport fields. Most of IDB's loans to the coun- try have come from the Fund for Special Operations and normally carry conces- sional terms. It is likely that IDB will remain Ecuador's major development lender in the immediate future with power, agriculture and socially-oriented projects continuing to account for a large share of its lending program. By December 1983, USAID had about US$92 million in outstanding loans to Ecuador (including undisbursed). Its program concentrates on urban development, agriculture, health and the private sector. In addition to maintaining close contact with USAID, IDB and other aid agencies to assure compatibility of programs, Bank staff have organized a full public sector investment review which could serve as the basis for a Consultative Group meeting of Ecuador's creditors. Such a meeting is being considered for this calendar year. 23. As of December 31, 1983, the public and publicly-guaranteed medium- and long-term external debt of Ecuador (including undisbursed) totaled about US$7.3 billion, of which US$1.1 billion was undisbursed. Of the former sum, the Bank group provided about six percent; the IDB about twelve percent and USAID two percent. Through 1988, the Bank's share of Ecuador's outstanding and disbursed public foreign debt is expected to remain below seven percent, and the Bank's share of total public foreign debt service is projected to remain bctween three and four percent.  PART III - THE PUBLIC SECTOR 24. As indicated in Part I, the role of the public sector in the economy grew dramatically after 1972, as petroleum revenues increased marked- ly. Between 1973 and 1982, the public sector grew twice as fast as GDP, its value-added tripling over the period. Total public expenditures rose from 23 percent of GDP in 1973 to 34 percent in 1982. Although oil revenues financed this expansion at first, when the public sector required more funds than could be acquired from petroleum, Ecuador turned to foreign borrowing. By 1982, this borrowing capacity had been exhausted and the public sector had to adjust to more realistic limits. 25. The Bank undertook a comprehensive study of Ecuador's public sector as part of the 1979 country study: "Ecuador: Development Problems and Prospects". Subsequently, it analyzed aspects of the public sector in the context of the 1984 country economic memorandum and public investment review exercises. The present Government, which took office in 1984, has informed the Bank of its determination to intensify the adjustment of the economy and to improve the efficiency of the public sector. There are many areas in need of rationalization, but as a first step, the Government has expressed its desire to gain better control over the budget process, the execution of capital investment projects and the performance of public enterprises. It has sought the Bark's assistance in defining and financing these and ancillary efforts intended to improve the management of the public sector in general. The Government Structure 26. The Republic of Ecuador, according to its Constitution, has a demo- cratic government with three separate branches. The National Congress con- sists of 71 representatives directly elected for a four-year term. Supreme Court judges are named by the Congress for four-year terms. The President and the Vice President, also directly elected, preside over a cabinet of 12 ministers. The ministers are responsible for their respective portfolios and the 52 semi-autonomous entities attached to their ministries. To this group belong CEPE, the state petroleum enterprise, INECEL, the national power company and IETEL, the national telecommunications company, which together account for about 30 percent of public investment. The country's 19 provincial councils and 134 municipalities have functional autonomy. They own 14 municipal enterprises as well as small shares, together with the central government, of 17 provincial power companies. Some 39 autonomous institutions include universities, port authorities and national monetary and finance institutions, such as the Central Bank, the national public sector development bank (BEDE) and the social security instituteh (IESS). Finally, there are 128 advisory and coordinating bodies. 27. The core agencies dealing with development policy and economic management are the Ministry of Finance and Public Credit (MOF), the Central Bank, the Monetary Board, the National Development Council (CONADE), whose secretariat serves as the planning agency, and BEDE. MOF and CONADE are jointly responsible for planning and monitoring public development projects. Foreign exchange, financial and monetary policies are managed by the  Central Bank and the Monetary Board. Public debt is monitored by the Central Bank and managed by the MOF, but the latter's capacity for analysis of debt management options is very limited. The Office of the Presidency has a small unit in charge of administrative development which mainly serves as a source of information for the President. The current Vice President has taken on the task of spearheading administrative reform efforts, especially the streamlining of complicated administrative procedures which have, in the past, discouraged economic activities. The Brazilian Government, which has undertaken similar initiatives, has sent experts to Ecuador to provide assistance in the simplifying of paperwork. The Budget Process 28. The budget process is the principal instrument to program and im- plement public sector activities. However, the formulation of the public sector budgets is a complex and fragmented process. The National Budget represents only about 64 percent of tax revenues and, excluding transfers to other public sector entities, around 45 percent of public expenditures. The remaining tax revenues are directly allocated among the budgets of autonomous entities and to local governments through the widespread practice of earmarking, i.e., pre-assigning a fixed portion or amount of a revenue source to a specific recipient. This system curtails the control policy makers can exercise over the planning and expenditure of public resources and in particular over investment projects and their execution. 29. Of an estimated Sl.270 billion in 1985 tax revenues, all but 46 percent are committed through various forms of earmarking. The resulting disadvantages are substantial: amounts are alloted to recipients independent of their justifiable needs and only dependent on the development of the revenue source; there is almost no incentive for rigorous control of expenditures by recipients; earmarking renders budgetary programming exceedingly difficult; finally, the Administration has to calculate constantly the earmarked portions of revenues and the respective shares of recipients. 30. A significant portion of earmarked revenues (five to ten percent) is destined to a special extrabudgetary account to provide revenues to municipalities and provinces. It was set up in an attempt to introduce revenue sharing and to replace a large number of minor municipal taxes so as to centralize distribution of funds to local Government. Recently amended provisions of the Constitution and the National Budget Administration Law require that the National Budget be unified and MOF therefore recently has begun to integrate earmarked funds into the National Budget in order at least to centralize administration of separate funds. The IMF has provided assistance to the Government in technical aspects of budget consolidation. Still, a good number of funds and accounts exist outside the budget. The process of eliminating these funds will be slow and must take into account measures of administrative and legislative ref..rm which will ensure that the interests and vested rights of recipients are observed. 31. Budget preparation follows different courses for current and for capital expenditures. Budgeting of current expenditures by MOF follows the traditional incremental approach (increases over last year's levels). Capital expenditures are programmed by CONADE which receives project requests  -9- from the public agencies and sends a budget proposal to MOF. A draft National Budget is then prepared and transmitted to Congress. Because of weaknesses in macroeconomic forecasting capabilities, however, revenues are generally overestimated. For the period between 1979 and 1983, the annual average shortfall for each tax group was over 14 percent. Similar weaknesses in the recording and analysis of overall public debt, especially with the complications introduced by reschedulings, limit the Finance Ministry's ability to analyze options for financing the capital budget through borrowing over the medium term. Although the National Budget is prepared in program budgeting format (that is, expenditures are stated explicitly in support of program objectives), in practice it is not used as a programming tool. Programs are too aggregated and goals too generally stated. The absence of quantitative indicators does not permit an evaluation of goals accomplished. 32. Execution of the National Budget is a continuous process of nego- tiation in which program managers experience a high degree of uncertainty. Expenditures are authorized according to allotments by the Budget Directorate of MOF. These authorizations are made on the basis of availability of funds and, if funds are inadequate, disbursements against authorizations are often made at the discretion of the Treasurer. This cash-management approach to budget execution often results in different emphases than those indicated in the budget document. Fiscal management is made difficult because information on budget execution is scattered among the different public sector decentralized agencies, and is in different formats. While it is relatively easy for MOF to keep track of spending authorizations--monitoring of which has been computerized since 1983-information on actual expenditures arrives very late, sometimes more than six months after the close of the fiscal year. 33. The Government's accounting system is based on an adequate legal framework adopted in 1981. Public sector agencies have been gradually introduced to this system through training courses conducted by the Comptroller General. Several factors result in less than ideal accounting practices, however. First, not all public agencies have yet had access to the training; second, the Comptroller General emphasizes ex-post control rather than financial information needed for forward-oriented decision-making, and third, the public sector has not in the past accorded much importance to financial reporting and the accounting professionals are thus not particularly well-paid and trained. National Project System 34. A national project system was established by law in 1975. According to the system, CONADE is to provide the general and sectoral framework and to rank projects. MOF is to finance the investments within resource availabilities, and programming units of the executing agencies are to identify, formulate and evaluate projects. BEDE may lend to public agencies that need funds (beyond those available from the budget or operating surpluses) to undertake investments. However, actual performance varies from this theoretical framework. Macroeconomic projections for planning purposes are made separately and not always consistently by MOF, the Central Bank and CONADE. CONADE's role as coordinator has been limited in recent years. Its project inventory has deteriorated and links with agencies have loosened. Nevertheless, there are now indications that CONADE is regaining its importance as a development planning agency.  - 10 - 35. CONADE has recently develrped a project monitoring system, with IDB assistance, which has been tested on one or two projects. This system is not fully installed nor is it truly a management information system with a hier- archy of data aggregation. At the same time, BEDE has been charged with par- allel responsibility for monitoring progress of many major investments. A special ministerial committee, chaired by MOF, on which CONADE, BEDE, and Central Bank are represented, has been set up to facilitate execution of ex- ternally financed projects. Structure of Entities Performing Key Economic Activities for the State 36. After decades of creating semiautonomous or independent agencies in an ad hoc fashion to fulfill public functions (principally service delivery and natural resource exploitation) Ecuador's Administration is now faced with a multitude of these institutions, including some very powerful ones, and no consistent framework for their overall supervision or performance monitoring. The classification of these decentralized entities does not follow any economic rationale. Commercial enterprises are categorized with noncommer- cial; large state enterprises are treated more like a branch of government than some smaller ones. Typically, the entities "attached" to a ministry are governed by a company statute and a sector law. Some are subject to procurement lawc and civil service rules, while others are not. The relative autonomy of the decentralized entities depends on their age, ability to build an independent power base, access to income other than the National Budget, and the strength of the central ministry in their sector. 37. In addition to the lack of a regulatory framework for the overall supervision of these enterprises, there are no clearly defined guidelines ,which could help coordinate their activities and establish generally accepted targets of performance nor is there any institution which could uphold such guidelines and promote efficiency of these enterprises. In the new atmosphere of austerity, the Government strongly desires to assure efficient management by users of public funds through introduction of norms and systematic review of performance. Creation of a system to set financial and social targets and operational objectives for decentralized state entities could lay the foundation for better supervision of these bodies. This could include a unit to promuce coordination and centralized information on these entities (see para. 57). 38. Among the enterprises of the public sector performing economic activities, a few stand out because of their importance for the public sector and the national economy in general. These enterprises--described below--are exclusively owned by the State and, as monopolies, have been particularly prone to management problems. However, they perform essential services for the economy, realize a very substantial part of public investment and are large employers. They are principally in natural resource exploitation, strategic industries and basic economic infrastructure, activities reserved to the State by the Constitution. Petroleum Operations 39. The most important enterprise in this class is CEPE, the state petroleum enterprise. Set up in 1972, attached to the Natural Resources and  - 11 - Energy Ministry (MRNE), it acts as the state body to explore, exploit, pro- cess and market petroleum and petroleum products. Petroleum accounts for 72 percent of Ecuador's exports. Investment planned for exploration alone for the 1984-1990 period amounts to US$610 million, although this may be attenu- ated by recent contracts with multinational petroleum companies for explora- tion. 40. CEPE's efficiency dropped during its period of expansion. Its cur- rent expenditures rose twice as fast as its income. Since it was not held to any performance standards or required to pay dividends, few incentives ex- isted to improve efficiency or even to monitor the costs of production. On the other hand, since petroleum products are marketed domestically at regu- lated prices and since most petroleum export revenues are earmarked for other sectors, CEPE has little control over petroleum-generated income. The cur- rent Administration, with its private sector orientation, has given CEPE man- agement the task of converting the enterprise into a lean and efficient or- ganization. CEPE, in response, has begun to introduce improvements in ac- counting and financial management, and to analyze the legal framework, admin- istrative structure and procedures to identify other areas for efficiency im- provements. With USAID assistance, CEPE will examine ways to improve its marketing techniques. Power Ceneration and Distribution 41. INECEL, the national electrification institute, was founded in 1961 as a public enterprise attached to the Ministry of Natural Resources and Energy. Its main activities as the public enterprise to generate, transmit and regulate electric power were taken up in 1973. INECEL gradually has been acquiring major equity in most provincial power enterprises. However, like CEPE, it is not free to set the rates charged to electricity consumers. INECEL's annual investment budget over the 1982-1985 period amounted to US$400 million in current terms, or i6 percent of public sector investment. Together with its subsidiaries, it is one of the biggest consumers of s-ubsidized fuel for power generation. 42. INECEL's management problems are partly related to its position as a public sector agency (which can fall back on transfers from the Central Government if operating costs are not met) and partly to the size and organization of the electricity sector. Because of a lack of overall coordination, INECEL's departments operate with a great deal of internal autonomy; contacts among them are informal and personal, rather than systematic. No management information system exists to permit adequate supervision of this large organization. Financial reporting of the subsidiary provincial power companies is not consolidated into a single sector or enterprise statement, so sectoral performance is difficult to monitor. Public transfers in the form of fuel subsidies have been passed on to the consumer via lower rates. Poor financial performance is evidenced by low or negative rate of return in most recent years for INECEL and most subsidiaries as well as dependence on financial assistance from the Government to fund the sector's investment needs. Concerned about the organizational problems, INECEL has initiated an arrangement with ENDESA, a Spanish power company, for technical assistance in institutional improvements, including analysis of alternative organizational structures and  - 12 - procedural reforms. It is also revising its financial plan to take into account the recent debt rescheduling and petroleum price changes, as well as the needs of the sector to achieve a greater degree of self-financing. Mmidn 43. Mining, another economic activity reserved by the State, has so far played a minor role in the economy. The present Government stands poised to undertake a major effort, through the MRNE, to revive this sector, for its employment and export potential. The Government intends to attract private interests to this sector rather than set up a state mining enterprise. The major stumbling block for a broader involvemeint of private companies in min- ing has been ill-defined conditions regulating private mining activity. The 1974 law on Mining Development and its regulations have not provided a climate conducive to private investors and contractors. In particular, taxa- tion provisions are ambiguous. The Government recently has taken the first steps to establish a consistent and attractive framework for private inter- ests in the mining sector, by promulgating a new regulation removing the worst inconsistencies from existing legislation. As a next step, it intends to improve the provisions governing the fiscal aspects (e.g., tax incentives) to make it more attractive for investors and contractors and at the same time make it easier to administer. The Government furthermore has decided to es- tablish a set of guidelines spelling out its policies towards contractual relations with the private sector. Against the background of a highly competitive international mining industry, both measures will require careful preparation in order to successfully revive mining activities. Teleco nications 44. IETEL, the state telecommunications enterprise, attached to the Ministry of Public Works and Communications, was set up in 1972. It is responsible for the planning, development, operation and regulation of all systems of national and international telecommunications services. As such, it plays an essential role in the economic and social development of a country characterized by its topographic divisions. At this time, the company's services provide neither the coverage nor the reliability needed for rapid economic development. IETEL, similar to INECEL, has taken over nearly all formerly independent systems. It has to cope with a number of problems related to this former structure. For example, the somewhat unclear definition of the powers of regional managers results in overlapping and duplication of functions requiring additional efforts for coordination among regional managers and with IETEL's general management. Furthermore, low tariffs result in inadequate cost recovery, which is exacerbated by weak financial management. IETEL management is aware of the need for administrative reforms and plans to begin an institutional diagnosis soon. Other Agencies Performing Economic Activities 45. There are a number of other "attached entities and public enterprises in Ecuador's public sector. Many are of considerably less economic importance than those described above. Some are part of the Defense Ministry complex and therefore less susceptible to improvements through outside technical assistance. Others are already being provided assistance  - 13 - through direct project lending from the Bank or other international agencies. For instance, strengthening of the semi-autonomous institutions attached to the Agriculture Ministry will be supported by a proposed Bank agricultural sector loan and by a USAID-financed review of these institutions. Several public sector financial institutions are receiving management assistance through industrial, agricultural and housing project loans. Port authorities and water companies have received assistance in the past. 46. There remain, nevertheless, several important decentralized enti- ties which, while not ready at this time for assistance under the proposed project, could be candidates in the near future. The Social Security Agency, IESS, plays a large role in public sector investment--mostly housing projects and personal or mortgage loans to members--but it is a highly inefficient agency, as measured by excessive administrative expenditures and number of employees. Furthermore, its investments are at negative real interest rates, which is quickly reducing the value of reserves. IESS is governed by a Board of Directors on which Government representatives are in the minority and pensioners representatives are a strong influence. This fact makes the Government's desire to correct the most serious management problems very dif- ficult to implement. If a decision to introduce reforms can be reached, however, technical assistance for management improvements would have a high return. Similarly, the national water and sanitation institute, IEOS, has been plagued by ill-defined functions and weak management. Its organizational status (attached to the Health Ministry) is currently under review. Should this institutional issue be decided soon, IEOS could also benefit from management assistance. Therefore, the possibility of assisting additional decentralized entities, such as IESS and IEOS, in a modest way through this project would be kept open. A Government request in this regard vould be reviewed by the Bank and, if appropriate, could be funded from the unallocated portion of the proposed loan. Administrative Problems 47. The public sector has been plagued by cumbersome and inadequate administrative procedures resulting in long and costly delays in such key activities as procurement, business registration, and trade transactions. Procurement procedures, for instance, are governed by a 1976 law which seems to be rather broadly worded, but a host of regulations and subsequent restrictive practices adopted by some of the institutions involved, have led to rather unwieldy procedures. These developments led to the increased use of exemptions, partly written into the 1976 law, and partly included in special legislation. Institutions dealing with emergency works, such as flood-related reconstruction, seek to apply special rules to their procurement decisions, to avoid normal regulations. Similarly, Government regulations for business and commerce have proved a disincentive to entrepreneurs rather than encouraging economic growth. To counter these problems and, in order to facilitate public sector administration by more rational procedures, the President has recently given a mandate to the VicePresident to prepare new legislation governing the entire area of public contracting, and to streamline (or "de-bureaucratize") Government procedures in general.  - 14 - Past Bank Technical Assistance Projects in Support of the Public Sector 48. Two technical assistance projects have been funded by Bank loans in the past. Both were for pre-investment studies and were coordinated by FONAPRE, an agency of CONADE. The first (Loan 1230-EC for US$4 million of May 24, 1976) was to finance the preparation of rural development projects, in particular to establish a rural planning unit of JUNAPLA, the predecessor of CONADE, and to help prepare rural development projects. The project took eight years to implement because contracting procedures proved very complex, terms of reference for consultants had not been defined in advance and co- ordination between executing agencies was insufficient. All of these obstacles have been addressed in the proposed loan, so as to reduce possible delays in implementation (paras 63 - 65). Despite its execution problems, the project helped establish a rural planning unit, whose functions eventually became part of the new Rural Development Secretariat, and produced a number of studies, one of which led to a Bank loan for the Tungurahua Rural Development Project. A Project Completion Report currently is under preparation. The second (Loan S-006-EC for US$11 million of November 3, 1977) was to finance general pre-investment studies. Loan funds are nearly all disbursed. Eleven studies have been satisfactorily completed; the remaining three studies are expected to be finished by their respective deadlines. In addition the project has helped to Improve organizational effectiveness of FONAPRE. A 1982 Bank loan to INECEL, which included funding for institutional strengthening in the areas of finance, organization, and data processing, was cancelled by mutual agreement when the Government was unable to take adequate measures to improve INECEL's financial situation. PART IV - THE PROJECT 49. As indicated above, the Government seeks to strengthen its ability to control public sector expenditures and make timely decisions to facilitate execution of public investments. It also wants to promote efficiency in decentralized agencies and public enterprises and promote private sector participation in development. During the August 1984 Bank mission to discuss the draft country economic memorandum with the newly-installed Administration, the possibility of Bank assistance for these public sector management improvements was identified. UNDP and GTZ helped to finance preparation of the proposed project, but their resources are not sufficient to finance the full execution of the activities proposed. Likewise, USAID financed a study of technical assistance needs for economic management for the use of the new Administration, and will be financing some studies complementary to the project proposed here (tax administration, fiscal policies, petroleum marketing). Preliminary discussions regarding the project's content tcok place during the 1984 Annual Meetings and in a follow-up preparation mission in November. Appraisal took place in January 1985. There is no separate Staff Appraisal Report. Annexes III to VI contain supplementary project information. Negotiations were held in Washington from March 21 to March 22, 1985 and the Ecuadorian delegation was headed by Mr. A. Dahik, Economic Advisor to the President.  - 15 - Project ObMectives and DescriptioL 50. The main goaln of the proposed project are to help the Government improve its systems for macroeconomic management and the efficiency of public investment. These are goals calling for a sustained effort, especially where rigidities have a legal foundation which requires reform. Emphasis for this initial project would be placed on carrying out activities which could yield operational improvements relatively quickly, and laying the base for medium- term institutional strengthening through training and analysis of possible legislative reforms. Follow-on assistance to address broader public manage- ment goals could be provided as a second stage. 51. This project would support programs to: (a) Introduce improvements in the national budget process, includ- ing public investment planning, to transform this system into an effective instrument of fiscal policy, management and control and to better coordinate the planning/budgeting process with macroeconomic realities. Subactivities would be: (i) strengthening the macroeconomic framework of annual op- erational plans and budgets and the capacity to analyze external debt management options; (ii) improving guidelines for budget preparation to facilitate consolidation and to transform the process into more of a program budgeting exercise; (iii) improving control over budget execution by bettering the financial information system of the public sector, including training of accounting professionals; (iv) redesigning existing monitoring systems for public investment to make them more useful for managers and more timely for any corrective actions needed; and (v) analyzing means of reducing revenues earmarking. (b) Make more efficient the State's involvement in economic activities by: (i) laying the basis for better integrating decision-making in decentralized agencies with Government priorities through proposals for establishing a system to oversee and centralize information on public enterprises; (ii) Reducing the decentralized public sector's managerial and financial burden on the Central Government and increasing its contribution to economic growth through management improvements in key public enterprises, specifically, CEPE the petroleum company, INECEL the power company, and IETEL the telephone company;  - 16 - (iii) developing an incentives system to attract private investment to the currently underdeveloped mining sector; and (iv) streamlining administrative (including procurement and contracting) procedures which now cause serious delays at considerable cost to public agencies involved in economic activities. Strengtbened Macroeconomic and Debt Analysis 52. This component, which would account for nine percent of project costs (excluding contingencies), would help develop a better macroeconomic framework for ase during budget preparation. CONADE, which makes projections and assumptions short- and medium-term planning, would improve its current macroeconomic models to incorporate financial policies and a flow-of-funds approach, and develop a computerized data base. MOF's Public Credit Secretariat would strengthen its debt reporting system and develop a program for analyzing the impact of different debt management alternatives (e.g., interest rate changes, reschedulings). Both activities would be coordinated with the Central Bank. Sixty months of consultant services are programmed. Improved Budget Process 53. The budget preparation component would account for about 14 percent of total project costs (excluding contingencies). The main focus for this technical assistance would be the General Budget Directorate of the MOF, with some involvement of the programming and budgeting units of the line ministries. Officials involved in the preparation of the budget would, supported by the proposed technical assistance, design an institutional framework for and start implementation of an adequate program budgeting system. About 60 months of consultant services have been programmed for this activity. 54. In order to obtain better data on actual use of funds authorized, special emphasis would be placed on establishing a financial information system that would provide timely budget execution data to MOF officials (28 percent of project costs). This would allow for corrections to be made in an optimal fashion, taking into account unspent balances, rather than in the form of inefficient across-the-board cuts or postponements of priority investments. To do this, expansion of MOF's computer-based information system (now only used by the Treasurer and Budget Secretariat) would be supported to facilitate the budget formulation and monitoring process. On a pilot-basis, key sector ministries would be brought into this information system. Upgrading of the accounting staff in public agencies through training in the use of financial information systems to permit them to play a more modern, managerial-oriented role would also be financed under the project. Both consultant services (108 months) and supporting computer equipment would be provided for the system design and training.  - 17 - HonitorKig Investmenta 55. This activity would account for six percent of project base costs. CONADE and BEDE already have efforts underway for computer-based systems to generate data on project progress. These would serve as the basis for a more coordinated program to serve all central institutions (CONADE, MOF, the Central Bank, and BEDE) so that the most essential information needed for monitoring public investment progress is provided to top level decision- makers. This activity should improve the Government's ability to prepare and modify annual operational plans as well as to determine the need for special facilitative action for lagging investments. Since budget expenditure is one of the principal measures of project progress and is more affected by unfore- seen budget constraints than current expenditures, this activity would be closely coordinated with the above-described assistance for improved budget processing. Twelve months of consultant services and supporting computer equipment are programmed. Reducing E rking 56. Finally, an analysis of the actions needed for reducing the pervasive earmarking of revenues would be undertaken by the MOF with technical assistance from this component (about eight months of consultant support and one percent of project costs). Resulting recommendations could form the basis for proposed legislative changes to help overcome the earmarking-related rigidities of the budget process. Superlision of Decentralized Entitles 57. During the initial phase of this component, a new system for Central Government monitoring of decentralized entities would be designed (under the general supervision of the Vicepresidency) including recommendations for an appropriate institutional framework, the preparation of a more coherent regulatory framework for these decentralized agencies, recommendations for dealing with state shares in mixed companies and proposals for reducing the number of coordinating bodies to conserve scarce time of top-level decision makers. During the follow-up phase, the entity (new unit or other institutional arrangement) responsible for coordinating and centralizing information on public information on public enterprises and other decentralized agencies would be supported by consultants and, as needed, equipment and training. It would develop and initiate systems for setting performance objectives, for obtaining and consolidating information and for evaluating performance results against targets. Observation visits to other countries and participation in international seminars could also be financed. About 36 consultant months are estimated to support this component, which would account for nine percent of total project costs, ekcluding contingencies. Public Enterprise Mauaginnt 58. About 29 percent of total project costs would be allocated to this activity initially. CEPE would receive a subloan of US$1.2 million to finance advisory services (about 60 months), training and equipment necessary  - 18 - to continue reforms in financial management and introduce changes, as needed, in the legal framework affecting CEPE, in administrative procedures now used by the company, and in the organizational structure to permit better coordination of internal units. INECEL would receive a subloan of US$1.0 million to support the continued assistance from ENDESA in administrative structure, as well as help strengthen INECEL's capacity for financial analysis of the company's operations. Sixty months of assistance is estimated for this activity. However, because of the importance of a financial rehabilitation plan for INECEL (para. 42) as an indication of the company's commitment to management improvements, a copy of such a plan approved by the Government would be furnished to the Bank as a condition of disbursement for the INECEL subloan (para. 5, Schedule I of the draft Loan Agreement). IETEL would receive a subloan of about US$300,000 to undertake a diagnostic study of its organization and management to define areas for reform. Twelve months of short-term visits have been programmed for this. Finally if other public enterprises become candidates (para. 46) for technical assistance subloans, a limited amount of funding could be made available from the unallocated reserve. !ining Development 59. Technical assistance to the MRNE's Directorate of Geology and Mines to define fiscal and other incentives and model agreements for private sector involvement in mining development would be financed, for which about one percent of project costs (eight months of consultant services) has been allocated. An interministerial advisory cnmmittee has been constituted for the Government's efforts in this regard. *prov e Administrative Practices 60. This component, which accounts for two percent of project costs, can eventually result in considerable savings for the public sector. Consultant assistance (about six months) under the supervision of the Vicepresidency to help rewrite regulations to streamline complicated procurement practices would be provided. Training and observation visits of personnel who are attempting to reduce paperwork and simplify administrative procedures would also be financed. The Government, through revised and simplified regulations, aims to reduce the current significant delays which executing agencies experience in obtaining equipment or initiating contracts, and which private entrepreneurs experience in cases where economic activity is excessively regulated. Project Emecution 61. MOF has agreed to employ a full-time Project Coordinator, satisfactory to the Office of the Presidency and CONADE, as a condition of effectiveness (Sections 3.01(b) and 5.01(a) of the draft Loan Agreement). An interim coordinator (who will also be responsible for USAID-funded assistance in the fiscal area) has already been contracted to assure that project momentum is maintained until the regular Coordinator is on board. The full-time Coordinator would be responsible for overall coordination of project execution. He would be contracted by MOF and would work regularly with the executing agencies. Furthermore, MOF, CONADE and the Office of the  - 19 - Presidency would each name representatires to an advisory group to assist the Project Coordinator. Since this group viould assure the Coordinator's day-to-day access to the key participating institutions, its formation would be a condition of loan effectiveness (Sections 3.01(d) and 5.01(b) of the draft Loan Agreement). 62. Because of the importance of keepizag a top-quality professional as Project Coordinator and of assuring that he can devote full attention to the coordination of project activities, his services would be financed from resources of the proposed loan (under one percent of project costs). The Coordinator and the general advisory group would operate under terms of reference acceptable to the Bank and would be maintained for the entire project execution period (Sections 3.01 (b) and td) of the draft Loan Agreement). The Coordinator would be the principal contact for all project-related matters and would be responsible for assuring that consultation is maintained with the anpropriate officials of the Government and the Bank on items such as terms of laference, contracting of consultants and procurement of goods. He would also prepare periodic progress reports. In order to provide flexibility of scope for this project, the Project Coordinator would also be responsible for reviewing with the advisory group any requests for new or expanded assistance and making recommendations to the Bank. The Bank in turn would review the availability of funding and appropriateness of the request in light of project objectives, before agreeing to reallocation of funds. This flexibility is not expected to result in revisions of more than ten percent of current allocations. 63. The HOF's General Budget Directorate would be responsible for the execution of the budget process and financial information component and the earmarking study. The MOF Public Credit Secretariat would be responsible for assistance to improve its debt management capacity. The MOF training office, in coordination with Comptroller General's Office, would be responsible for the financial information training component. CONADE would coordinate the assistance for improving macroeconomic analytic capacity and, in cooperation with BEDE, would supervise the project investment monitoring component. CEPE, INECEL and IETEL would each execute the activities financed by their subloans, in accordance with subsidiary agreements satisfactory to the Bank, the signing of which would be a condition of disbursement for each respective subloan (Sections 3.01 (e) and para. 4, Schedule 1 of the draft Loan Agreement). The Vicepresidency would oversee the technical assistance for the supervision system for decentralized agencies and the preparation of improved administrative procedures. The Natural Resources Ministry's Mining Directorate would oversee the technical assistance for Mining Development. 64. To assure timely contracting of consultants for projects, the Government has decided to contract with UNDP's Office of Project Execution (OPE) to recruit and administer contracts for individual consultants and firms which would carry out each Central Government activity; OPE would be used selectively for the subloan-financed technical assistance for the public enterprises. Signing of the agreement with OPE would be a condition of disbursement for the Central Government components (Section 3.02 (b) and para 6, Schedule 1 of the draft Loan Agreement). OPE estimated overhead of eight percent of value of contracts has been incorporated in the cost estimates per consultant months. Project executors are expected to use experienced  - 20 - consulting firms for major components in order to simplify the contracting process and to assure quality and timeliness of advisory services. These consultant firms are likely to make use of Ecuadorian expertise for the project where this would enhance the understanding of the environment in which reforms or new procedures are to be introduced. Substantive backstopping would be part of normal supervision by Bank staff, which would closely follow project execution and provide advice as needed. 65. The scope uf each component has purposely been designed to be practical and quick-results oriented. This should help assure that project execution could take take place in about three years. Draft terms of reference have been prepared for all components (see Annex IV). The tentative implementation plan is included as Annex VI. Progress of each of the activities under the proposed project would be regularly reviewed against the implementation plan by the Bank and the Government and any schedule adjustments mutually agreed upon. 66. No major legislative changes are required for the success of this first-phase project. However, to the extent that recommendations for such changes develop in the process of project execution, they could form the basis for any follow-on project, if mutually agreed. Project Cost and Financing 67. Total project costs net of taxes are estimated at US$13.7 million, of which US$8.0 million, or 58 percent, represent foreign exchange (see Annex V for detailed project costs table). This includes an unallocated amount equal to US$ 1.0 million (US$600,000 o' the proposed loan), or nine percent of base costs, to cover physical contingencies for equipment, unforeseen additional consultant months for the activities described and the possible inclusion of assistance to IESS or IEOS (para. 46). Price contingencies are based on international inflation of 7.5 percent in 1986 and 8 percent in 1987. Inflation for local costs in dollar equivalents represents eight percent for 1986-1987 since foreign exchange policy is currently to keep the value of the sucre approximately in line with the dollar. The proposed Bank loan of US$8 million would cover 58 percent of the project's estimated financial requirements, or all of the foreign exchange costs. The local costs would be covered by the Central Go-ernment (US$4.5 million), and for appropriate components, by CEPE, INECEL and IETEL (US$1.2 million). The Government would be the Borrower and would onlend in dollars the portion for the decentralized agencies at the same interest and terms as the Bank Loan (Section 3.01 (e) of the draft Loan Agreement). 68. A total of 424 staff-months of external consulting services is required to execute the project. This comprises the bulk (88 percent) of expected foreign expenditures. Costs per consultant-month have been based on 1985 prices for similar contracts for top-rated management consultants in neighboring countries. Procuremtent and Disbursement 69. The proposed loan would finance consultants' services, Project Coordinator's salary, some computer hardware and software and foreign costs  - 21 - of training. Contracting of consultants would be in accordance with the Bank's "Guidelines for the Use of Consultants" (Schedule 5, Section II of the draft Loan Agreement), with which UNDP/OPE has considerable recent experience. Computer equipment and software amounting to about US$0.7 million would generally be procured through international shopping including quotations from at least three suppliers. Where only a small amount of equipment (under US$20,000) is needed for pilot-testing, local procedures satisfactory to the Bank would be used (Schedule 5, Section I of the draft Loan Agreement). 70. Disbursement of the loan is estimated to require about three and one-half years. The Bank loan would disburse: (i) 100 percent of the costs of consultants services (including the Project Coordinator) ; (ii) 100 percent for directly imported equipment and 85 percent of the expenditures for locally purchased equipment; and (iii) 100 percent of foreign expenditures for training and observation visits. Disbursements for contracts with a value of up to $30,000 and for training would be carried out against statements of expenditures. Documentation for this group would be kept in country files for review during supervision and would be audited regularly. 71. To accelerate the initiation of the project, a Special Account would be set up for the payment of project costs. The Bank would advance up to US$900,000 to the Account (about four months of project expenses), which could be used to pay all foreign and local expenditures, if the Government so chooses (Section 2.02 (b) and Schedule 4 of the draft Loan Agreement). To permit the early initiation of key services, especially those of the Project Coordinator, retroactive. financing for eligible expenditures after March 1, 1985 up to a total of US$200,000 would be permitted (Para. 3, Schedule 1 of the draft Loan Agreement). Project Benefits and Risks 72. The proposed project is expected to help the Government begin to address certain of its most important public management problems, principally those affecting economic management and the country's natural resources, in a coordinated fashion. It should result in the design and installation of better performance monitoring systems for general budget execution, public sector investments and state-owned enterprises. Higher level Government officials, who have focused their attention on public sector management problems in a comprehensive way, are convinced of the need for the project; consultations during preparation have helped assure commitment from middle-level technicians as well (especially in the Budget Directorate). 73. Nevertheless, traditional bureaucratic independence will slow the establiz.iment of mechanisms for coordination of planning, budgeting and monitoring of public sector activities. The provision of a full-time Project Coordinator and an advisory committee representing key participating agencies is intended to permit early detection of problems in execution and the proposal of solutions. There is also the risk that the country's commitment to administrative reform will not be maintained. To the extent that this project includes only selected targets, e.g. budget, major state enterprises,  - 22 - where e ficiency improvements should be of spec al interest , it should succeed in laying the bases for prolonged commitment to better public sector management on the part of the Government. PART V - LGAL SToIJIEUTS AND ATORITY 74. The draft Loan Agreement between the Republic of Ecuador and the Bank, and the !;eport of the Committee provided for the Article III, Section 4 (iii) of the Articles of Agreement are being distributed to the Executive Directors separately. 75. The main features of the draft Loan Agreement are referred to in the text of this report and are listed in section III of Annex III. Special conditions of effectiveness for the loan would be the employing of the Project Coordinator and the establishment of an advisory group representing the Office of the Presidency, CONADE and MOF. A special condition of disbursement of loan funds to each participating decentralized agency would be the signature of a satisfactory subloan agreement between the Borrower and that agency. For the INECEL component, an additional condition of disbursement would be the furnishing to the Bank of a financial rehabilitation plan approved by the Government. Finally, the signing of a management service contract with UNDP/OPE would be a condition of disbursement for the Central Government components of the project. 76. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VL - RE W ON 77. I recommend that the Executive Directors approve the proposed loan. A. W. Clausen President Attachments March 26, 1985 Washington, D.C.  --23-~~ ~ ANNEX I * -23- TAILB 3 pas i of 1004(10000400 o. U) TlOAL 253. 263.0 283.0 ASZCIN.14L t7.0 U.S 0.0 m_ C61 .. 350.0 130. 2100.0 2349.3 (lI UINS Of OIL "WALUr) 151.0 223.0 S71.0 t99.3 L122.8 -wLf - wia susnmu ?WRAUON.H10-It" (11V_U1) 462.0 5044.0 7966.0 3RSA0101AU0 (2 Or "VAL) 54.4 33., 45.5 00.3 40.8 NPIUA?IU OJCTZ0U POPULATIOn 1 3 20 (NIJr) 2.5 TATIOUMV MUOIATIMO CM"L) V2.0 IoPULTOUm UKEXIlI 1.9 NMIUATIOS DRUM1 353 so. a0. 13.0 20.7 27.5 33.7 52.9 NI N. 1111. 1. L1A 94.1 120.6 12Z.7 92.4 156.3 POUUATUO A51300113T1R (2) 0-1 1U 04.0 5.3 44.t 39.9 31.6 15-G6 YU 3Z.0 30.S 32.? 0.0 61.1 *5 Am AIM 3.0 3.5 3.4 0.1 7.1 1TOTA 2.9 2.6 I 2.0 2.4 1.0 4.9 4.2 3.6 3.0 3.7 Mu 33n 3413 (CM ?IOJ) 40.0 43.2 37.0 31.3 23.4 a WUSR 4 (PU TWO)1 16.0 12.9 5.4 6.1 5.5 C35 ISVSU UCTI 1 3.A 3.2 2.6 2.0 1.0 VDJILT 71UIIIUC IOWYOSI. U 0 L 0) *- 9.0 AZ3 2 d am CZ Oi KUI W ) .. ,, 34.0 I. 4o.. MU OF MO O. PO CATA (1f90-71100) 104.0 101.0 101.0 110.3 110.5 M CAiT SO19LT or 041.033 (2 or JU1UDUK) 84.0 9:.O 97.0 110.0 126.0 11rO1 (C015 FM DAY) 49.0 33.0 52.0 67.3 69.7 or mum3 AND" Al ran 23.0 27.0 20.0 /i 34.t 34.5 C11. CAC 1-4) DU61 wnA 25.1 13.5 7.4 S.7 3.2 U-.s LugI W . AST KM (128) 30.7 35.9 02.3 64.7 07.4 13341 NM. 34 (n a ) 160.0 107.3 75.1 60.6 s4.2 *C1351O S1 VAYIS (V10W) TOTAL 12.3 /AA 34.0 42.0 /f 65.4 W34 32.5 70b 76.0 64.071 76.1 UISAL 1.9 ^. 7.0 13.0 7! 40.2 (3 OF POIAT1OU OTAL .. 22.4 32.3 It 12.9 .. .. 0.0 7! 07.0 311L3 .. .. 13.0 7r 24.5 PIfL.UOIU NI YsIwCIIm 2070.0 2820.0 760.0 1917.7 1003.5 POM. NO 3 3 PI306 2340.0 a 1360.0 570.0 813.5 704.4 ypb. Mm f0 L 3BD TOU31L 530.0 420.0 500.0 367.2 326.3 113A1 300.0 5 300.0 .. 411.5 201.5 UISAL .. 440.0 .. 2636.3 A43S1 0113S N lOSPPtTAL .. 17.1 27.3 20.0 TOUL 5.1t 3.2 5.3 /A 31AL .. .. . ..