Argentina - Cordoba Provincial Reform Loan Project

Document of THE WORLD BANK FOR OFFICIAL USE ONLY Report No. P 7401 AR REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED PROVINCIAL REFORM LOAN IN THE AMOUNT OF US$303 MILLION TO THE ARGENTINE REPUBLIC TO SUPPORT THE PROVINCE OF CORDOBA October 23, 2000 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency Equivalents Currency Unit: Peso US$1 = ARG$1 Fiscal Year January 1 to December 31 ABBREVIATIONS AND ACRONYMS BPC Banco de la Provincia de C6rdoba (C6rdoba Provincial Bank) CAS Country Assistance Strategy CPI Consumer Price Index EFF Extended Fund Facility EPEC Empresa Provincial de Energia de C6rdoba (Electricity Distribution Company) ENRE Ente Nacional Regulador de Electricidad (National Electricity Regulatory Agency) GDP Gross Domestic Product ICR Implementation Completion Report IDB Inter-American Development Bank IMF International Monetary Fund IPAM Instituto Provincial de Atenci6n Medica (Provincial Institute for Medical Attention) LPR Letter of Provincial Reform OECD Organization for Economic Cooperation and Development OSP Obra Social Provincial (Provincial Health Insurance Fund for Workers) PDP Proyecto de Desarrollo Pronvincial (Provincial Development Project) PRESSAL Provincial Health Sector Reform Project PROSAP Provincial Agricultural Development Project PRL Provincial Reform Loan PRODYMES Secondary Education Decentralization Project PROMIN National Program for Maternal and Child Nutrition and Health SSAL Special Structural Adjustment Loan Vice President: Mr. David de Ferranti Country Director: Ms. Myrna Alexander SMU Director: Mr. Ernesto May Task Manager: Mr. Ronald Myers  ARGENTINA CORDOBA PROVINCIAL REFORM LOAN LOAN SUMMARY FOR OMICIAL USE ONLY Borrower: The Argentine Republic Implementing Agencies: Subsecretaria de Programaci6n Regional, Ministerio de Economia, the Provincial Coordinating Unit and Provincial ministries and agencies Beneficiary: Provincial Government of C6rdoba Poverty: Although C6rdoba's per capita income, at about $7900, is close to the national average, serious poverty exists compounded by gaps in the delivery of health, education, and social protection services. Within the reform program to be supported, the health component has a specific goal to reach the poor and provide basic health coverage to non-insured indigent population. The education component seeks to redirect spending towards schools in poorer neighborhoods and would provide for special retention programs to reduce the drop out rate among children from poorer families. A major effort will be made to strengthen the delivery of social assistance to the poorest. Amount: US$303 million Terms: A single currency loan in US dollars, repaid in 15 years, including five years of grace at the Bank's standard variable interest rate Commitment Fee: 0.75 percent on undisbursed loan balances, beginning 60 days after signing, less any waiver Onlending Terms: Identical to those contracted by the Argentine Republic with the Bank Schedule of Disbursements: (in US$ Million) _______________________I Disbursement Cumulative First Tranche 2 quarter FY2001 103 103 Floating Tranche 3rd quarter FY2001 100 203 3 . Third Tranche T-quarter FY2002 100 303 Economic Rate of Return: Not applicable Loan Identification No.: P068344 This document bas a resticted distr on and may be used by recipients only in the performance of their official dues. Its contet may not otherwise be disclosed without World Bank authorizaon.   ARGENTINA FOR OFFICIAL USE ONLY CORLDOBA PROVINCIAL REFORM LOAN TABLE OF CONTENTS Page Number I. THE SETTING I Recent Economic Performance and External Shocks I The Provincial Context 4 Individual Provincial Reform Programs 9 II. THE PROVINCE OF CORDOBA 15 The Challenge 15 The Reform Program of C6rdoba 15 Strengthening Public Finance 17 Modernizing Public Administration 25 Social Sector Reform 27 III. THE PROPOSED LOAN 35 Loan Objective and Rationale 35 Lessons Learned from Previous Operations 36 Role of the National Government 37 Collaboration with Other Operations and Technical Assistance Needs 37 Coordination with Multilateral Institutions 38 Loan Description 39 Borrower and Loan Amount 39 Tranche Disbursement 39 Letter of Provincial Reform 39 Conditions of Tranche Release 39 Program Implementation 40 Disbursement, Procurement and Auditing 40 Environmental Concerns 40 Benefits and Risks 41 IV. RECOMMENDATION 42 This Report is based on the findings of a team composed of Ronald Myers (team leader), Roberto Panzardi, William Dillinger, Linn Hammergren, Stefan Alber-Glanstaetten, Hemant Shah, Luis Guasch, Jacob Bregman, Alejandro Yepes, Michele Gragnolati, Gillette Hall, Truman Packard, Romulo Leon, Daniel Taillant (Consultant), Milka Casanegra (Consultant), Peter Gregory (Consultant), Osvaldo Albano (Consultant), Federico Mejer (Consultant), Martin Rodriguez (Consultant), and Luis Perez (Consultant) that visited Argentina in April and July 2000. Other team members included Sandra Alborta, Jeffrey Rinne, and Jyoti Shukla.  ANNEXES A. Letter of Provincial Reform B. Matrix of Conditionality C. Fiscal Outlook D. Privatization of Electricity Company E. Documents in the Project File F. Statements of Loans and Credits G. Country at a Glance Map - IBRD 29500  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED PROVINCIAL REFORM LOAN IN THE AMOUNT OF US$303 MILLION TO THE ARGENTINE REPUBLIC TO SUPPORT THE PROVINCE OF CORDOBA 1. I submit for your approval the following memorandum and recommendation on the proposed loan to the Argentine Republic for US$303 million to support fiscal and structural reform of the Province of C6rdoba. The loan would be a variable rate LIBOR-based dollar loan, with a grace period of 5 years, a final maturity of 15 years and level repayment of principal. The Argentine Republic would onlend the local currency equivalent of the loan to the Province on the same terms (an arrangement made possible by the 1:1 peso to US dollar exchange rate fixed by Argentine law). L. THE SETTING Recent Economic Performance and External Shocks Economic Reform and Growth 2. Since the launch of the Convertibility Plan in 1991, the Argentine economy has been transformed through a currency board arrangement as part of a sweeping set of reforms that altered the monetary system, improved fiscal and tax policies, liberalized trade, and reformed the public sector including privatization and changes to the social security system. All of this was intended to reverse the long-term trend of slow growth, low labor productivity, state domination, low domestic savings, weak investment, high volatility, and chronic inflation, which the country had suffered for the previous 25 years. When hyperinflation broke out in 1989, the rate of poverty in the country climbed to over 40 percent of the population. 3. The economic results of the Government's reform program have been dramatic. Argentina has experienced strong average economic growth in the 1990's, with the size of the economy expanding from an estirnated $141 billion in 1990 to $282 billion by 1999, despite being hit by two severe external shocks and ensuing recessions Instead of experiencing hyperinflation, Argentina has now one of the world's lowest rates of inflation. The Federal Government's fiscal deficit receded from an average of about 6-8 percent of GDP for most of the 1980s to 1.4 percent in 1998. Foreign debt is moderate as a share of GDP, equivalent to 51 percent; however, the country's export base is small so that total external debt represents more than four times the annual base of exports of goods and services, and debt service has represented 60 to 85 percent of total exports in recent years. 4. Although the Government has moved aggressively to lower total debt and debt service with a debt restructuring plan in 1993, and increased the maturities of the public share of external debt to about 9.7 years on average, the large amount of external indebtedness and dependence on external capital flows to finance the fiscal deficit and increased investment levels have left the economy exposed and vulnerable to external shocks. Moreover, while many social indicators have improved in the past ten years (for example, infant mortality has dropped from 25 deaths per 1000 births in 1991 to about 19 deaths per 1000 births in 1998), 1  poverty levels have stubbornly stayed high despite rapid economic growth. The Bank's latest estimates put poverty at about 29 percent of the urban population. It is likely much higher in the rural areas. This situation is compounded by rising income inequality and high unemployment, especially for the unskilled, indicating that the benefits of growth have not been widely shared. Thus, Argentina still has a large social agenda to fulfil as the continuation of its economic program. External Shocks 5. During the 1990s, Argentina has suffered the consequences of two serious external shocks. The first came in late 1994-1995 after the devaluation of the Mexican peso. The economy shrank by 2.8 percent in 1995 but following this crisis, strong, investment-led growth returned. Real GDP growth was 5.5 percent in 1996 and an impressive 8.1 percent in 1997. Support from the Bank Group, IDB and IMF were critical in helping Argentina to recover and to implement continuing reforms as well as launch important targeted social programs. The second test occurred in 1998-99, as a result of the combined effects of the downturn in East Asia, the devaluation of the Russian ruble and the Brazilian real, and deterioration of commodity prices. For 1998 as a whole, GDP growth was 3.9 percent, although it turned negative in the fourth quarter. Even though the economy went into recession in late 1998, Argentina's commitment to prudent macroeconomic management and the discipline inherent in its currency board arrangement generated confidence and Argentina was among the first emerging economies to regain access to international capital markets. The Bank's special support late in 1998 played a significant role in this reentry. 6. The economic downturn in 1999 turned out to be deeper and longer than expected, especially in light of the progress made in Brazil to stabilize its economy. Overall, Argentina's GDP is estimated to have declined by 3.2 percent in 1999, a larger drop in output than experienced during the Tequila crisis of 1995. Unemployment, after falling to about 12 percent from the high of 18 percent reached in 1996, increased to 14 percent in late 1999. The volume of exports remained fairly stable (although prices had fallen) as Argentina was able to find substitute markets for its exports. Because of the sharp contraction in domestic activity, the current account balance improved slightly to 4.3 percent of GDP, due to declines in imports (particularly capital goods) that surpassed declines in exports. Inflation remains extremely low, with deflation during 1999. 7. Fiscal performance deteriorated during 1999 and the fiscal program went off track in the latter part, ending the year with a deficit of about $7.4 billion, considerably higher than the target of $5 billion agreed with the IMF. The higher deficit was the result of higher interest costs, the duration of the recession, and a general weakening of fiscal discipline during the election year. Provincial governments encountered similar conditions and they ended the year with a deficit of about $4.5 billion, almost twice the deficit in 1998. In total the consolidated public sector fiscal deficit amounted to about 4.2 percent of GDP, excluding privatization receipts. As a result, the new administration took swift action in December 1999 to restore order in the fiscal accounts, including those of the Provinces. 8. At the end of 1999, the economy began to gradually recover from the recession; however, the recovery has been slow. In the first half of 2000, GDP grew by 0.6 percent (year-on-year). Industrial production grew by 2.7 percent and 1.7 percent (year-on-year) in  the first and second quarters of the year; however, this is due to a bump up at the end of 1999, and further growth has stagnated since then. Unemployment rose somewhat from 13.7 percent in October 1999 to 15.4 percent in May, 2000. In general, access to financial markets has been relatively good, but with a high degree of volatility in spreads. Average spreads on foreign bond issues have fallen about 1 percentage point in the first half of 2000, relative to average spreads during 1999, and maturities have lengthened considerably. Exports have been performing extremely well, growing by almost 14 percent, year-on-year, in the first six months of 2000. 9. Confidence in the banking system remains strong. The system has maintained its deposit base in both pesos and dollars, exhibiting growth in the first half of the year (7 percent). (In contrast, during the tequila crisis, 18 percent of deposits were withdrawn from the system and a significant number of banks were forced to close, restructure and merger.) However, credit growth to the private sector has been slightly negative, as banks have taken a cautious stance. The cutting off of domestic firms from credit has imposed a very strong limitation on new investment and a burden on firms attempting to adjust to the change in markets as a result of the devaluation of the Brazilian real. In recent months, moreover, tightening interest policy in the United States, as well as some uncertainty generated by the sluggish recovery, caused another rise in spreads on Argentine foreign debt and a spike in domestic interest rates. As of end-September, international reserves had increased by about 4 percent compared to a year earlier, although there has been some re-composition from cash reserves of the Central Bank ($25.3 billion) towards liquidity reserves of private banks held overseas ($8.1 billion). 10. Prospects. The recovery has been more sluggish than expected and so far in 2000 modest overall growth has been led by strong export growth. The latest revised projections for the last quarters of 2000 and 2001 have GDP growth at 2 to 3 percent per annum with a continuation of low consumer demand and investment offset by improvements in terms of trade and high export demand. The current account balance should improve somewhat from last year's 4.3 percent of GDP, to below 4 percent. Inflation will remain extremely low, or even negative. Without more rapid growth, job creation is expected not to rebound, and the unemployment rate to remain at relatively high levels in the 15 percent range. Slower than hoped for economic reactivation, combined with large financing needs to refinance its stock of debt plus the anticipated fiscal deficit for 2001 (the financing program for 2000 has by and large been met), have affected country risk perceptions so that the markets are expected to continue to monitor economic developments carefully in Argentina. The recent resignation by the Vice-President amid signs that the cohesion of the governing Alliance party is faltering has also been perceived negatively by the markets, adding to country risk perceptions. Despite these continuing risks, the Government remains firm in its economic stance, presenting to Congress a budget adhering to the Fiscal Responsibility Law; the currency board arrangement is expected to continue to provide discipline to economic policy-making ; and precautionary measures taken by the Central Bank in recent years should continue to provide for stability in the financial system. 11. IMF Program. A new agreement with the IMF for a three-year, $7.4 billion Stand-By Arrangement was approved in March 2000. The target 2000 deficit for the Federal Government was recently revised to $5.3 billion (1.8 % of GDP) and an increase in consolidated public sector debt (for both the provinces and the Federal Government) of $7.0  billion. There is an indicative target for the provincial governments of a consolidated deficit of $2.9 billion in the year 2000. To support improvements in provincial finances, the Federal Government would exercise its authority to limit external debt and borrowing from the domestic banking system by the provinces. It is also implementing a program of debt relief for about one-third of the smaller provinces willing to put in place fiscal measures to control spending. The Bank has been asked to contribute to this effort by and taking the lead is assisting the larger provinces in meeting the year 2003 zero-deficit target and by supporting second generation reforms in these provinces and other provinces, focusing on health and education spending. The Provincial Context 12. Provincial governments have long played an important role in overall fiscal performance and macroeconomic stability. Argentina's public sector is highly decentralized, with provinces and municipalities accounting for about half of total public spending. In particular, they have increasingly become the key public sector level for providing public services in health, education and infrastructure, with responsibility for over 90 percent of public spending in health and basic education (Table 1). Thus, provincial reform becomes a central element in the efforts of Argentina to reduce its macroeconomic vulnerability through improved fiscal performance and to increase competitiveness and enhance equity through human resource development. (This effort will be complemented at the federal level by a renewed program of state modernization focused on improvements in human resource management, service delivery, organizational strengthening of key agencies, and an active information sharing with the provinces on public sector modernization experiences- an effort to be funded in part by the pending reprogramming of the Bank-financed Y2K loan to Argentina.) Table 1: Argentina: Allocation of Responsibilities by Government Levels Exclusively Central Central and Provincial Provincial and Municipal Municipal Government Governments Governments Governments Defense Social Security Primary Education Markets, cemeteries Foreign Affaires Social Assistance Secondary Education Solid Waste Inter-provincial Higher Education Health Care Local streets, drainage transport Preventive Health Water and Sewerage Trade regulation Economic development Regional and local roads Mail and telex Justice and Security Land Use Housing Fire Control Passenger and cargo terminals Electricity and gas energy 13. During the 1980s, high inflation rates, lack of budgetary discipline, easy access to borrowing and reliance on the Federal Government for transfers and bailouts all contributed to persistent fiscal deficits. The situation improved in 1992, due to the reforms that the Federal Government had initiated under the Convertibility Plan, and a major national tax effort. However, this deteriorated again soon after due to excessive spending by the provinces, given their inability to manage the rapid increase in the funds transferred from the center. The financial crisis of 1995 aggravated the fiscal situation of the provinces once 4  again when the pool of total public revenues fell dramatically. Provincial revenues dropped 5 percent in real terms, provincial expenditures failed to adjust, and the provincial deficit reached a record high of $3.5 billion or 1.4 percent of GDP, about half of the consolidated public sector deficit at that time. In 1995-96, out of 24 provinces, only four had balanced fiscal accounts. Most of the others faced important liquidity shortages, increased borrowing, and accumulated arrears. Some provinces resorted to printing their own money. 14. Recognizing the importance of provincial finances to macro-stability in a federal state, provincial reform has been a priority for the Federal Government since the early 1990s. During 1992 and 1993, it negotiated two agreements with the provinces to promote structural economic changes. The provinces agreed to improve own-source mobilization, restructure provincial taxes and eliminate distortionary taxes, privatize public enterprises, including the provincial banks and utilities, deregulate the provincial economy, and transfer the provincial pension funds to the national system. In exchange, the Federal Government guaranteed a shared-revenue floor to each province, sheltering them from any downfalls in revenue. It also provided a Transformation Fund, which helped finance those reforms and provide technical assistance and advisory services. While a number of provinces began implementing a program of reforms during 1993-94, it was not until the financial crisis of 1995 that a large number of provinces began to reform in earnest. 15. With a more favorable macroeconomic environment beginning in late 1996, arid the reforms undertaken by many provinces, the overall fiscal situation of the provinces improved remarkably. During the 1997-1998 period the deficit averaged only $0.5 billion (about 30% of the consolidated deficit). However, with the current economic downturn, the deficit level has increased again and is estimated to. reach $4.5 billion in 1999, similar to their level relative to GDP in 1995 during the Tequila period. Moreover, a number of provinces that had borrowed excessively now have untenable debt service burdens aggravated by the recent economic downturn: total debt service payments in 1999 were about $4.3 billion on the stock of provincial debt of $19 billion. Since much of these debts are guaranteed with the individual provinces' income from federal revenue sharing and are deducted automatically, the shortfall of revenues after debt service falls directly on the payment of salaries and suppliers the provinces owe. Table 2: Fiscal Performance at Federal and Provincial Levels Est.* 1995 1996 1997 1998 1999 2000 Millions ofpesos Federal Government -2545 -5889 -4341 -4170 -7,348 -5300 Provincial -3530 -1840 -1377 -2359 -4,509 -2900 Administrations Total -6075 -7729 -5718 -6529 -11,827 -8200 Shares of GDP (%) Federal Government - 1.0 -2.2 -1.5 -1.4 -2.6 -1.8 Provincial -1.4 -0.7 -0.5 -0.8 - 1.6 - 1.0 Administrations Total -2.4 -2.8 -2.0 -2.2 -4.2 -2.8 Excludes privatization. Revenues *Revised IMF Program 5  Main Challenges in Provincial Reform 16. The process of decentralization has increasingly forged a direct link between the institutional capacity of sub-national governments and the human and infrastructure development required to put the country on a sustained growth path. The Argentine public sector over the last decade has shed unproductive activities and become more focussed on core functions. With the federal level concentrating on social security, general regulatory functions and national defense, much of the most complicated and critical service delivery functions rest with the provinces. Social and economic progress in Argentina will depend on the ability of the provinces to deliver health, education and public safety functions effectively and within the context of sustained fiscal balance. 17. Over the past ten years, the Government's strategy has progressed from ensuring macro-economic stability, installing a competitive policy framework for the productive sectors, and providing basic security for the population to a strategy increasingly emphasizing second generation reforms, community development and social services. In light of the role of the provinces in these key areas, it is clear that the locus of activity had to shift from the central level of administration to that of sub-national governments. Important challenges remain, which the national and provincial administrations will need to deal with: Revenue-Sharing. A long-standing issue facing the Federal Government and the Provinces has been the system of revenue sharing between the two levels of government and among the provinces (the system of co-participation). The last time this arrangement was modified was in 1988, after protracted federal-provincial negotiations. At issue is finding a better balance between: (i) the collection of taxes and responsibility for spending; (ii) the incentives for spending and social equity for the poorer provinces; (iii) the predictability of revenues and the need for fiscal adjustment; (iv) the level of revenues collected and the incentives for economic efficiency; and (v) the transparency in the allocation process and the need to provide emergency support. A new agreement that is more equitable and efficient could help provide greater incentives for provinces to collect their own revenues, spend more wisely, and relieve reoccurring political pressure on the Federal Government for bailouts. However, finding such a balance, while ensuring the 100 percent acceptance by all the parties needed to put the new system into place by law, has been difficult (in contrast, the Convertibility Law, which radically changed the economic landscape in Argentina, only required a two-thirds majority vote). The political difficulties of reaching a new agreement cannot be overstated, particularly with current fiscal problems that gives the Federal Government little with which to bargain. Indeed, the Constitutional reform of 1994 had mandated that such an agreement be reached by 1996 (but that date was last extended in 1999 to late 2001). On the other hand, as an increasing number of provinces see the wisdom of bringing their own house in fiscal order, with the support of the Federal Government, the Bank and the IDB, the constituents for a system that rewards greater efficiency has grown markedly during the past decade. Heterogeneity among Provinces. There is no uniform solution. The situation in the 24 provinces remains highly disparate. There are well performing provinces, such as La Pampa and San Luis, which are able to provide good quality public services to their small and well off populations. The largest provinces, such as Santa Fe, Mendoza, 6  C6rdoba and the Province of Buenos Aires, have undergone varying degrees of adjustment in the 1990's but still have difficulties in cyclical downturns and need to upgrade the quality and coverage of their public services. Since the largest concentration of the urban poor are in these provinces, it is critical that they are able to meet the challenge of poverty reduction. Other resource rich provinces, such as Chubut, Neuquen and Santa Cruz, have small populations, low levels of poverty, and high revenues from natural resources but could benefit from reforms to enhance quality and efficiency of the public services. At the other end of the spectrum, there are a number of provinces, typically among the poorest, with high social demands, poor institutional capacities, weak fiscal performance and high debt. * Fiscal and Debt Problems. Chronic deficits and dangerous levels of indebtedness in a few of provinces generate social and political unrest and contribute to the overall fiscal problem in Argentina. Unfortunately, some of these provinces are among the country's poorest and it is difficult to conceive that growth combined with fiscal restraint will be sufficient to face their debt burdens. A part of the problem is the short term nature of their debts and another part of the problem is the lack of incentives by the banks and capital market to restrain new borrowings as provincial debts enjoy full guarantee from the respective province's share of federal-shared revenues. Achieving a sustainable fiscal position in some cases may require a combination of debt restructuring and fiscal measures; in other cases, fiscal measures alone may be sufficient. The approach should be case-by-case, and well grounded on changing future incentives to prevent a reoccurrence. At the same time, there is still much to be done to lower the overall fiscal deficit, particularly among the largest provinces - such as Buenos Aires, Cordoba, and Santa Fe -- which have the capacity to meet their debt obligations and account for the bulk of the aggregate provincial deficit in the past year. Regional Dimensions of Poverty. Poverty rates are substantially higher in provinces in the north, particularly in the Northwest (46 percent) and Northeast (49 percent). Conversely Buenos Aires (including the City and Province) and five Patagonian provinces in the southern part of the country have lower poverty rates than the national average. Argentina's economic performance has also has a varied impact depending upon the region. In the early 1990's, overall poverty rates fell by 48 percent, but poverty in the two poorest regions in the Northeast and the Northwest fell by about half of that. in other words, the poorest provinces benefited less from overall growth than the richer ones. However, when poverty rose during the 1994-98 period, the increases in poverty were greater in those provinces that traditionally had the lowest poverty rates; that is, the province of Buenos Aires, Cuyo (western provinces straddling the Andes) and the Pampa region (the central plains). More generally, the provinces in the Northeast and Northwest tend to have higher percentages of rural populations and indigenous peoples: a survey of rural poverty in two of these provinces showed that poverty rates among the rural populations are exceedingly high-some 70 percent. * Differences in Social Performance. Social indicators show large variance among regions, particularly in health. In Greater Buenos Areas and the larger provinces such as Santa Fe and C6rdoba, the health profile is broadly similar to that of the developed world. Other areas of the country, particularly the poorer North, face a very different health 7  profile. For example, their infant mortality rates of 29 per 1000 are almost 70 percent higher than in greater Buenos Aires. Regional difference in education are less stark, with most parts of the country performing poorly in retention rates, but the quality of education, based on national testing, is particularly deficient in the North. Municipal Governments. The process of reform in Argentina has been cascading: it occurred first that the federal level in the early 1990's and then shifted to the provincial level by the mid-1990's. It has yet to reach the municipalities that have the potential to take on more responsibilities and to become more accountable. Issues in fiscal management and revenue sharing also remain as a major challenge in provincial- municipal relations. Although municipal governments in the aggregate only account for less than 10 percent of public expenditures, the failure- of most to engage in meaningful reform undermines these efforts in a number of provinces, and provides a weak basis for confronting growing urban problems and meeting the needs of the poor for basic infrastructure, garbage and waste disposal, and other urban services. A very large deficit of basic water and sanitation services exists. Some municipalities are increasing providing primary health care, day care services, community kitchens and the distribution of food supplements for the poor. Thus, there is room for greater decentralization and consolidation of social services at the local level. Municipalities are also at the interface with the private sector, concerned with business licensing, among other things, which has an impact on private sector development. As of now, there is no comprehensive strategy as to how to bring the process to reform to this level of government. Bank Support for Provincial Reform 18. The Bank has been a major partner of the Government since the early 1990's in supporting provincial reforms and institutional strengthening, through a series of ongoing investment operations in health, education, agriculture, renewable energy, water supply, roads and flood control and successful completed operations, including First Provincial Development Project (Ln. 3280), First Provincial Reform Loan (PRL I) (Ln. 3836), Provincial Bank Privatization Loan (Ln. 3878), and Provincial Pension Reform Loan (Ln. 4116)1, supported with important analytical work.2 As a result: * 18 provincial banks and 22 other loss making major public enterprises were privatized during the period 1995-99 and eight provinces transferred their provincial pension systems to the reformed national system; * provinces have initiated programs, and some are well advanced, in improving their tax collection systems (cadasters, etc), fiscal management and budgeting systems; . provinces have entered into fiscal agreements (pactos fiscales) with the Federal Government to change distortionary provincial taxes and there is an active dialogue, facilitated by the Bank and in collaboration with the Fund, on further reform of the federal-provincial tax sharing regime and provincial tax systems (co-participation); All of these operations were rated either satisfactory or highly satisfactory by OED. 2 Including Argentina Provincial Finances Study, Report No. 15487; Argentina: Reforming Provincial Utilities, Report No. 15063; Cordoba-Public Sector Assessment, Report No. 15132-AR; Argentina: Revitalizing the Tucuman Economy, Joint Bank/IFC Note, dated November 2, 1995. 8  * most provinces are engaged in the national program to improve the quality of secondary education; and support is being provided to improve the management of provincial public hospitals; and * each year the Bank conducts a review of provincial finances and uses financial criteria to determine eligibility by the provinces to funds for capital investments; the only exceptions are for social sector and for flood protection (in the Northeast, subject to recurring floods that cost the Argentine economy as much as lpercent of GDP in losses). During the 1995-99 period, the twelve provinces that participated in the provincial reform program (PRL I and PRL H)3 have out performed other provinces in a variety of critical areas. Local tax collections have increased 26 percent in the PRL provinces, as compared to 19 percent for all provinces, and expenditure growth has been about 25 percent less than the overall average. Individual Provincial Reform Programs Background 19. In 1996, the Federal Government recognized the need for a second phase of provincial reforms. After undertaking some of the basic structural reforms-including privatizations- which provided a better balance in the role of the state and its fiscal means and a more stable, immediate fiscal situation, it was clear that the provinces needed to address issues of the quality and equity of core public services, especially in health and education which had been decentralized to that level. The intended reforms were to help the provinces improve the efficiency in public spending, reduce the size of their central administrations, secure and maintain fiscal balance, reduce debt stock and debt service to manageable proportions, and enhance responsiveness, quality and equity in the provision of social services. Four provinces were selected for piloting this approach -- Tucuman, Salta, San Juan and Rio Negro - and to participate in the Bank's Second Provincial Reform Loans (PRL II) approved in 1997. These provinces were selected based on their previous reform performance under the First Provincial Reform Loan (PRL I), the difficulties that they continued to face and their commitment to engage in further reforms. Reform Goals and Actions 20. The provincial reform prograrn for individual participating provinces seeks to ensure an efficient and responsive delivery of remaining public social services within fiscally sound policies. While the nature of the problems may vary across provinces and the reform programs are tailor-made to each, the pillars of the reform program are common and include three basic components: public finance, education, and health. 21. Reforms in public finance are focused on achieving a sustainable fiscal situation and 3 Including the provinces of Entre Rios, Misiones, San Juan, Catamarca, Santiago del Estero, Tucuman, Salta, Rio Negro, Chubut, Santa Cruz, Corrientes, and Chaco. This performance is all the more impressive given that this group includes several provinces that "dropped out" of the reform process, and that the provinces that this group is compared with includes several traditionally strong fiscal performers and provinces undertaking their own adjustment effort outside the PRL umbrella. 9  are based mainly on strengthening ongoing reforms in the participating provinces, particularly in increasing current savings to lower the debt burden. Local resource mobilization is emphasized not only to increase revenues, but to enhance accountability and to reduce, at least somewhat, the pro-cyclical impact of federal transfers derived mainly from consumption taxes. Civil service reform is promoted not only to enhance the productivity of public employees, but to increase resources available for investment bv reducing the wage bill. Experience under the ongoing PRL II suggests that increased local revenues, changes in the structure of expenditures, and lowering debt are all required to provide for greater flexibility when the provincial governments need to adjust in the face of economic downturns, such as the Tequila crisis and more recently the external shocks from Asia, Russia and Brazil. The basic elements of the program include: * improvement in tax collection and administration to promote higher reliance on own-source revenues and increased accountability; * civil service reform including reduction of the wage bill and redundant personnel; improved training and compensation; control to lower absenteeism and overpayments; and, * rationalization of public expenditures and prioritization of government spending, with emphasis on privatization and outsourcing to improve reliability and quality of public services and lower the fiscal burden. 22. On the social sector side, the emphasis is to increase the efficiency and quality of the education and health sectors, focusing on demand and poverty reduction aspects, while promoting increased involvement by the private sector. The large majority of provinces appear to devote sufficient resources to public health and education, most at levels higher than OECD countries relative to per capita incomes; however, the efficiency and quality of this spending are poor. The basic strategy is to protect current levels of spending, while at the same time changing the structure of expenditures to increase investment and providing incentives for improvements in efficiency, quality and equity. In some provinces, savings from improvements may not be sufficient and increased spending would be required. 23. In education, despite attractive returns to higher education, dropout rates from secondary school among the poor are high. In Argentina only 24 percent of students in the lowest quintile complete secondary school, compared to 76 percent for the upper quintile. Proposed education reforms seek to ensure the extension of obligatory education (from six to nine years) as mandated the National Education Law, while improving efficiency and quality. Given the low productivity in most provinces, with student/teacher ratios in some cases double those of comparators, and high levels of teacher absenteeism (sometimes four times as high as comparators), much of this can potentially be financed within the current budget, with some short-term increases to cover investment in classrooms, materials and teacher training. In addition, most provinces need to undergo important reforms to provide incentives to improve quality, including changing seniority-based teacher remuneration systems into merit-based systems, and decentralizing greater control to the school level. Priority actions include: * Increasing low student/teacher ratios and the participation of staff actively teaching as a share of total staff, * Reducing disproportionate use of temporary and substitute education personnel; 10  Improving the incentives for quality improvement; * Increasing the participation of the private sector; and, * Reducing administrative costs. 24. In health, despite the availability of health care generally through public hospitals, care is of poorer quality for poorer people. For example, 25 percent of women in the lowest income levels are delivered by non-doctors, while none at the upper level; over 30 percent of women in the lowest quintile have no post delivery follow-up, compared to only 2 percent of those in the upper quintile; 74 percent from the lowest quintile have to wait more than 24 hours for a consultation, as compared to only 45 percent of those in the upper quintile. Proposed health reforms seek to increase overall investment largely within the current budget envelope and to induce improvements in efficiency, quality and equity by separating the supply of services from the financing, promoting cost-recovery for care provided by public hospital to insured patients, promoting hospital accreditation and quality assurance systems, and providing the indigent population with health insurance. A fundamental element of this strategy, self-administered public hospitals, was pioneered in Argentina under the ongoing Provincial Health Development Project (PRESSAL, Ln. 3931-AR). On the financing side, the Bank supported reforms in the national health insurance system (Health Insurance Reform Loan Ln. 4002/3AR and Health Insurance Technical Assistance Project Ln 4004- AR) to enhance efficiency and promote competition. The PRL program combines these two reform elements in participating provinces and promotes the incorporation of the uninsured poor into the system to help ensure equity in access to services. The main actions being undertaken cover reforms in the area of personal health care delivery, public health finance and public health administration and include: * Extending the Provincial Health Insurance to the uninsured poor; Restructuring the Provincial Health Insurance carrier (Obra Social Provincial); R Reducing staff and reallocating resources to non-personnel expenditures; * Reallocating resources from personal health care to essential public health services, including health promotion, reproductive health and injury control; * Promoting public hospital autonomy; * Improving the integration between primary and secondary health care; and * Accreditation of hospitals and ambulatory services and introduction of quality assurance systems in public hospitals. Progress in Provincial Reform 25. Of the four pilot provinces for PRL II, the loans for Salta and Tucuman have been completed and evaluated using the new intensive learning approach, including participatory workshops and review by specialists from outside the region. Both have been evaluated by OED as satisfactory.4 The ICRs note that overall fiscal performance by the four provinces under this program has been exceptional when compared to other provinces. In particular, during the 1996-98 period they averaged an increase in current savings of 93 percent, compared to a nine percent decline in current savings by the other provinces; and their debt stock increased on average only two percent, as compared to almost 19 percent in other provinces. With the deterioration in the overall economy during 1998-99, and national and 4 Reports Nos 20699 and 20698, both dated June 30, 2000. 11  provincial elections in 1999, the performance has been more mixed, but for the 1996-99 period as a whole, PRLII provinces continued to outperform other provinces, with average increases in own resource mobilization of 17 percent, compared to 12 percent for all provinces, and in maintaining spending increases at under 10 percent, as compared to a 17 percent increase for all provinces during the period. However, both San Juan and Rio Negro encountered difficulties in meeting fiscal targets in 1999 and the final tranches were cancelled in both cases. ICRs for these two loans are now underway. 26. Emerging lessons from the ongoing experience suggests that the loan design for a direct relation between the Bank and the participating province is important in enabling the Bank to bring to bear its international experience and in providing a mediating influence between the federal and provincial stakeholders. Project design also puts local governors at the forefront of implementation and dialogue has helped to improve performance under other investment operations in which the provinces participate. In addition, the provincial approach to promoting needed sector reforms in health and education appears to be a fundamental complement to the Bank's efforts in these areas at the national level. Drawing on the ongoing ICR effort and supervision, important lessons from this experience include: - Fiscal adjustment and social sector reform: There can be tensions in meeting these two objectives, particularly where fiscal adjustments are not taken upfront and need to be undertaken in the middle of the reform process. Although the programs provided for protecting overall spending in health and education, sector reforms often become associated with fiscal adjustment resulting in unwarranted resistance. Moreover, urgent needs to downsize staffing may result in losing better qualified staff before adequate human resource management systems for the social sectors can be put into place to provide incentives for better performance. At the same time, since the bulk of public spending is in these sectors, their reform is crucial in sustaining fiscal equilibrium. The lesson is that sequencing is important and that the PRLII approach is more successful and sustainable for provinces that have already achieved a level of control in their fiscal and debt situations. - Timing: The loans were designed to fully disburse within 12-18 months of effectiveness; however, the reform effort took longer than anticipated and even longer to begin showing results. This makes it even more important to consider political cycles. All the provinces in the program held elections during the last year of implementation, and in two cases there was a change in governing political parties. While the new administrations have slowly begun to take ownership of many of the reforms, after first rejecting them outright, there was a loss in the reform momentum and questions of sustainability persist. The lesson is that reforms have a better chance of being sustainable if they are fully in place, not just enacting new measures but institutionalizing new arrangements, prior to any change in administration. - Ownership: While all the governors were committed to the reforms, in one of the provinces the executive branch did not enjoy the support of the legislative branch. As a result, the reform effort was implemented using executive decrees that could easily be rescinded by a new administration. The lesson is that ownership needs to be as broad based as possible and that commitment to the reform program requires the support of the legislative branch, particularly if it is controlled by an opposition political party. At the sector level, those with a reform champion with vision appeared to perform better during 12  implementation, and the overall programs benefited when the program coordinator had a direct link to the governor and political weight vis-a-vis the cabinet. - Institution Building/Participation: The reforms introduced institutional arrangements that affect incentives governing policymaking and service delivery. While they combined mechanisms of voice, competition and hierarchy into service delivery reforms, in some cases there were no clear signals within the public administration to ensure allegiance to these reforms. The lesson is that complementary accountability and transparency mechanisms would help to ensure improved implementation and greater sustainability. The legitimacy of the reforms were enhanced in those cases where a participatory process was followed involving stakeholders such as teachers, medical staff, and parents and where an effort was made to inform the general public on the nature of the reforms. This was the case, for example, with the implementation of the new subsidy formula to private schools in Salta. The participatory approach facilitated the resolution of the constraints that appeared during its implementation and provided options to resolve the potential conflicts. Also, this approach guaranteed the legitimacy of the new formula. The lesson is that project preparation should be informed by a social assessment and that participatory mechanisms be provided during implementation. - Coordination with other operations: Rather that developing separate TA operations for each province, the program relied on the availability of technical assistance through a number of ongoing sector investment operations for the provinces through the Federal Government. While this approach helped in developing a stronger link between provincial reforms and the federal ministries, at times delays in providing technical assistance lead to problems in maintaining the momentum of the reforms. However, at the federal level, experience with the reform efforts of the PRLII provinces enhanced federal efforts to support reforms in other provinces and helped to make clearer how the federal ministries themselves need to modernize to fulfil their new role in a decentralized environment. The lesson is that careful planning beforehand is required to ensure that TA is available when needed, but that separate provincial TA operations would not contribute to the long-term needs of improving federal-provincial relations. 27. In summary, the provincial reform approach piloted under PRL II is emerging as a powerful vehicle for promoting needed sector reforms in health and education as well as fiscal sustainability, and appears to be a fundamental complement to the Bank's efforts in these areas at the national level and sector level investment programs. Individual provincial reform programs, together with continuing support for reform in revenue-sharing, have been identified in the FYOI-04 CAS as the main pillars for the Bank's continued support for provincial reform in Argentina, with a renewal of the series of provincial reform loans which were interrupted by the external shock in 1998-99. Government Strategy and Bank Assistance 28. The new Federal Administration is giving top priority to provincial reform and, as noted above, has included specific benchmarks for this effort under its new agreement with the Fund. Its two-track strategy would seek to continue the dialogue and improving the environment for reforming the current system of co-participation, while further improving the incentives of the current system and supporting the reform efforts of individual provinces. To support improvements in provincial finances, the Federal Government would exercise its 13  authority to limit external debt and borrowing from the domestic banking system by the provinces. This would help to enhance the hard budget constraints and builds on earlier efforts to enhance the transparency of the system and to reduce discretionary transfers. It is also implementing a program of debt relief for about one-third of the smaller provinces willing to put in place fiscal measures to control spending. Specifically, the new administration reached agreement with the provinces as follows: * Primary Distribution of Revenue-Sharing in 2000-01. In order to support efforts to close the fiscal deficit of the Federal Government, instead of transferring a share of actual federal taxes (the so-called automatic transfers), a fixed amount of $16.2 billion would be shared (about equal to the average of 1998-99). An additional $1-1.5 billion in discretionary transfers would be subject to possible cuts. * New Revenue-Sharing Law. Agreement to submit reform legislation in 2000. * Fiscal Solvency. Commitment for provinces to enact laws similar to the new Federal law establishing a timetable to achieve a zero deficit by 2003. * Debt Restructuring. Commitment by the Federal Government to assist smaller provinces in improving the terms of their debt stock. * Provincial Pension Systems. Agreement of the Federal Government to help finance transitional deficits of reformed provincial systems. * Transparency. Commitment to improve presentation and dissemination of provincial fiscal accounts. * Tax Administration. Agreement to move toward greater collaboration, including a common taxpayer ID and data sharing. * Federal Fiscal Authority. Agreement to create an organization to serve as point for the debate over the new revenue sharing law, fiscal coordination, monitoring, and tax harmonization. 29. The Federal Government's strategy to step up provincial reform is designed to provide a more favorable environment and the political support necessary for reforming the system of revenue sharing. This is a fundamental policy issue which is exceedingly complex and difficult to resolve. As noted above, the Federal Government has a two year window for lasting changes to the system and has been able to reach an understanding on some principles, most notably the need to smooth these transfers overtime, and to have a more independent body to monitor the system. Through advisory services and ESW, the Bank has been providing the analytical bases for this effort.5 Under the SSAL, the Government prepared a detailed technical proposal, initiated a round of public debate on the subject, and began to work towards a consensus with the provinces. The high case scenario for the proposed Argentina CAS FY0 I-04 would also provide for Bank support to assist in transitional measures in other provinces, if and when the revenue sharing system is reformed. 5 Including the recent report, Argentina: Provincial Tax and Revenue-Sharing Reform, gray cover Report No. 19395-AR, dated June 30, 1999. 14  II. THE PROVINCE OF CORDOBA The Challenge 30. Located in the middle of Argentina, C6rdoba is the country's third largest province, with a population of 3.1 million. Its economy is based on agriculture and industry (especially auto manufacturing) as well as education and domestic tourism. Although about average with a per capita income of $7900, C6rdoba faces serious challenges. Its competitive position in the global economy is threatened by its high costs of doing business as fiscal instability, high taxes, a large overhang of debt, and inadequate human and physical infrastructure have tarnished its attractiveness to investors and undermined potential growth. Moreover, despite its relative affluence, social indicators lag significantly, pockets of severe poverty dot both urban and rural areas, and unstable economic performance and poor public administration have hurt social programs. 3 1. Over the last decade C6rdoba has been plagued by volatile fiscal performance. Booms followed by busts have been aggravated by ad hoc and short-term policy responses and poor management and controls. Indebtedness increased sharply even as service standards declined. While revenues grew strongly at the beginning of the 1990s (up 75 percent between 1991 and 1994), expenditures grew even more rapidly, especially on personnel. Deficits were financed by large borrowings from the Provincial Bank of C6rdoba (BPC). When the Tequila crisis struck in early 1995 and revenues fell, arrears to suppliers and personnel emerged. A new Administration implemented emergency measures later that year by reducing salaries by 30 percent (in return for a reduction in the work day), cutting staff, and severely limiting capital spending. The Province even issued "certificates of cancellation of debt" (CECORs) to clear salary arrears. These near-money instruments could be used to pay taxes at par or discounted heavily in the secondary market. As a result of these measures the deficit declined from 9 percent of revenues in 1995, and a small surplus was recorded in 1997. However, the Province reversed direction again as the 1999 elections approached. Spending increased, revenues fell, and the deficit ballooned to nearly five percent of revenues that year. Arrears reemerged and total indebtedness resumed its rise, with the Government forced to seek short term financing from private banks, unable to turn to the nearly bankrupt BPC. The result of this performance has been to reduce growth, undermine the ability to pursue more effective social sector policies, increase debt burdens, deter investors, and divert the provincial debate from long term strategy to short term crises. Tentative efforts at structural reforms were still-born or quickly smothered by emergency responses to unanticipated crises. The Reform Program of C6rdoba 32. In 1999 a new administration from the opposition party was elected on an explicitly stated platform of comprehensive reform. Its goal is to improve the Province's competitive position in the global economy and lay the basis for sustained growth through an ambitious program to stabilize government finances, improve public services, and strengthen human capital formation. The vision is to create a model provincial administration by redefining the state--reducing the size and tax burden of government, redirecting its efforts more to the social sectors, and improving the efficiency and transparency of its services to citizens. The program, a combination of first and second generation reforms, has three main components: 15  (i) strengthening public finances (including privatization or concessioning of several state enterprises, tax reduction accompanied by strengthened tax administration, pension reform, a clean up of municipal finances, and debt reduction): (ii) modernizing public administration (including reforms in financial management, civil service, and business processes and organizational structure); and (iii) social sector reform (health, education, and social protection). The Province is now asking for Bank support to carry out this strategy, both through a provincial reform operation and technical assistance. The latter may be provided through existing operations such as the Second Provincial Development Project (PDPII) and a loan from the pending Inter-American Development Bank (IDB). 33. The Administration has already moved on its election promises in several areas by commencing a reduction in provincial tax rates, initiating reforms in revenue collection, introducing new information technology to strengthen personnel management and financial reporting, and securing omnibus legislation authorizing the fiill reform agenda. Three laws (covering Citizen Charters, Modernization of the State, and Private Incorporation into the Public Sector) passed as a package will permit a comprehensive redirection in the economic, social, and govemance framework of C6rdoba. A New Legal Framework for Reform Three laws, passed as a package in April, 2000, permit a notable redirection in the economic, social, and governance framework of C6rdoba. Law No. 8835, "Citizens' Charter", has two main parts, creating a framework for: (1) Citizens' Charters that enunciate: (i) citizen rights in front of the state including rights to education, health, security, solidarity, and information; (ii) the state's responsibilities to perform its functions and deliver services according to principles of quality, efficiency, courtesy, collaboration, private participation, availability of services, transparency and information accessibility; (iii) users' rights to quality and efficient public services; (iv) creation of a regulatory agency for water, electricity and transport; and (v) consumer rights and a conflict resolution system for consumer protection; and (2) the fight against corruption by (i) creation of Anti-Corruption Office responsible for the prevention and investigation of conducts violating the Inter-American Convention against Corruption; and (ii) creation of anti-corruption and economic crimes courts. Law No. 8836, "Modernization of the State", establishes the principles for a new public administration, by supporting (i) budget honesty through fiscal equilibrium, and limits on current expenditures and public indebtedness; (ii) creation of a public information system for government finances and operations (Estado Cristalino-Crystal State); and (iii) state restructuring through the creation of a Restructuring Unit, a provincial public sector employees census, requiring government personnel to use and display their credentials, the re-assignment of personnel, early retirement programs, voluntary severance programs with transfer of personnel to the private sector to permit the restructuring of the administration, and changes in the culture of service delivery in C6rdoba. Additionally, the law addresses specifics issues such as the creation of a real property agency to sell public assets and the deregulation of Notary Publics and Professional fees. Law No. 8837, "Incorporation of Private Capital into the Public Sector", authorizes the privatization and/or concessioning of the C6rdoba Provincial Bank, the electricity company, and the Provincial lottery/gambling agency, as well as permitting outsourcing of other functions. 16  A. STRENGTHENING PUBLIC FINANCE 34. Over the next five years C6rdoba faces a major fiscal challenge. It needs to reestablish fiscal stability, while simultaneously confronting: (i) rising pension costs; (ii) the financial burden of BPC; and (iv) a large stock of debt. Consequently, building a sustainable fiscal position is a pillar of the Government's reform agenda. Throughout its termn, the Government aims to maintain a current account surplus (now mandated by law) while reducing its stock of debt. These objectives will be pursued through a combination of short and long-term measures. Tight spending controls (using a highly centralized cash based system) are already being applied to nearly all goverrnent operations, with freezes in hiring and wages, and cuts in selected agency budgets. During this period, however, the Government will maintain spending for vital social services in health, education, and social protection. Longer-term stability will be fostered through policy and structural reforms to reduce the size of government through privatization and outsourcing, as well as a major reform in public administration to increase its efficiency. These efforts will also aim at improving the service delivery capacity of government by improving transparency, streamlining procedures, and, in general, changing the culture of the public sector. 35. Tax Reform. C6rdoba's revenues are largely derived from federal revenue sharing and two Province-administered taxes. Although the former is the largest source of income, it has been frozen for 2000 and 2001 based on transfers in 1998 and 1999. Federal Chart I Trends in Revenues 3,000.0- 2,500.0 - u ,000 - - - 0 federal transfers 0 other own-source a' 1500.0 - 1L-|||- _li_!el U property taix a 1,000.0 mg gros s receipts 500.0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 authorities hope to reach agreement with the provinces on a new transfer formula for 2002 onward, but until then any growth in income will have to come from provincial taxes. The gross receipts tax, imposed as a fixed percent of sales, is the largest source of provincial based tax revenue. The Province also derives significant revenues from a property tax, which is imposed on an ad valorum basis in both urban and rural areas. To improve the business climate, strengthen C6rdoba's competitive position vis-a-vis other provinces, and signal to citizens and investors alike a new approach to government, the Province has initiated a program of phased reductions in tax rates. In the third quarter of 1999, rates for property taxes were cut 30 percent as was the gross receipts tax for small businesses. Cuts in the gross receipts tax for larger scale businesses were made in December 1999 and April 2000. At present, only firms with billings over $480,000 pay the unreduced tax rate. Fiscal conditions permitting, the Government intends to extend the tax cut to this last group. 17  3 6. In the short term, the Province intends to compensate for the reductions in tax rates by increasing collections of over-due accounts. An amnesty on penalties and interest has been successful--at least with respect to the property tax. Roughly $680 million in overdue taxes (nearly all from property taxes) wvere declared and rescheduled and will be paid over the next four years. The collection of arrears, of course, provides only a one-time injection of revenues. The Government has issued a decree publicizing its intention that there will be no further Provincial tax amnesties, and has submitted legislation to that effect to reinforce the message to taxpayers. 3 7. To fill the revenue gap over the longer term the Government is reforming a woefully inadequate tax administration. As detailed in a separate IMF study requested by the authorities in 1999, there was widespread under-reporting of gross receipts, auditing is sporadic, monitoring of collections is spotty, and enforcement actions are weak. In response, the Province has embarked on a comprehensive reform program including establishing systems for monitoring large taxpayers' payments and liabilities, reconciling the amount declared by taxpayers with the amounts deposited by banks in the Province's account, adopting a uniform taxpayer identification system, and improving coordination with federal tax officials. Significant steps have already been taken within the tax units through business process reengineering, installation of new information technology systems permitting cross checking of federal and municipal data banks, staff training, and drafting of new legislation to streamline and accelerate judicial review of tax cases. IDB resources will support some of these efforts. The Province has already also stepped up enforcement against firms that are delinquent on the payment of the gross receipts tax. Approximately 1000 taxpayers have been notified of impending sanctions, well over 100 have been closed for periods ranging from three to five days, and criminal suits and foreclosure proceedings have been initiated against several companies-small, but new and psychologically telling steps in C6rdoba. 3 8. Expenditure Control To achieve an overall balance during its term of office, the province also intends to restrain spending. Staffing is to be reduced in most sectors and wages are to remain frozen. The Province, nevertheless, confronts two financial challenges. The first is the cost of selling the provincial bank. As detailed below, the bank is thought to have a negative net worth of at least $600 million. This debt must be liquidated before the bank can be sold. Cordoba intends to finance this operation through the sale of the state Chart 2 Trends in Expenditures 3,000.0 2,500.0 ______ * capital works o 2,000.0 - mF 1 [X 1| 9 EL ZL ;3 _..CL w i; _. ; l {3 other transfers a 1,500.0U~~ >85->LLEL L iiL-L- L 0 subsidies to retirees 1, o0 transfers to muns a ~~~~~~~~~~~~~~~~~~~~~~~~0 interest E1,000.0 500 0 (0t 2| @t ! g W E u i v - g ] *goods, services 500.0 E3personnel 0.0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 power company, the concessioning of the state lottery, and the proceeds of the proposed Bank loan. 18  39. C6rdoba's other challenge is the increasing cost of subsidies to the pension system. Cordoba's public employee pension plan is a defined benefit/defined contribution system, in which the Province is legally required to make up any difference between inflows and outflows. Historically, the plan has not made a major claim on general revenues (other than for mandatory employer contributions). While benefit levels are high, contribution levels are high too, and have been sufficient to cover outflows on a cash flow basis. This will cease to be the case as C6rdoba faces a large backlog of active staff who are due to retire over the next several years. Provincial obligations to the retirement plan are projected to increase rapidly within the decade in the form of mandatory employer contributions and subsidies to cover the system's cash flow deficit. 40. In line with a general agreement with all provinces, the Federal Government has offered to finance the Province's pension deficit. Federal assistance would be phased in, beginning in 2000. A major condition is that the provincial system be made consistent with national parameters. This would imply a significant cut in both contributions and benefits. (Existing retirees, however, would have their benefits maintained.) The immediate effect of the reform would be a net increase in pension costs to the Province. Because the drop in employee contributions would go into effect immediately while the Province continued to pay the existing retirees at the old benefit levels, net payments by the Province would increase with this effect later offset by increasing federal subsidies. The Province is currently discussing reform options with the Federal Government. A decision on which is the best option and firm commitment are not expected for some time, as significant actuarial analysis of the options is required. Given that the financial viability of the present system is not in danger in the medium term, the Government has the time to study the problem in details. In the meantime, the authorities will receive training on the Bank's PROST system with the goal of using this system to help decide on the specifics of their pension reform and will undertake the needed studies. The IDB will fund technical assistance for this effort. 41. The Provincial Government is committed to achieving an overall balance (i.e, revenues sufficient to cover all recurrent and capital expenditures other than amortization) by the year 2003. Continued increases in public savings are therefore critically important to fund needed capital expenditures. Adherence to the overall fiscal targets will be closely monitored by the federal government in order to assist achievement of national macroeconomic targets. Details of the province's fiscal strategy are provided in Annex C. 42. Municipal Government Finance. C6rdoba has 400 municipal level governments, far exceeding the national average on a per capita basis. These municipalities suffer from limited local capacity in managing expenditures and collecting revenues (aggravated by their protection of prerogatives despite the economies of scale that could be achieved through consolidation of smaller localities). With overstaffing, few funds are available for other than salaries, which account for 85 percent of spending. Problems in generating own resources are due in part to unwillingness to confront taxpayers, as well as poor capacity to determine property ownership and taxes, bill clients, manage revenues or monitor payments. Expenditure management also suffers from technical deficiencies and a tradition of providing public employment to meet social objectives. Moreover, the municipalities have accumulated significant levels of debt (especially with the publicly owned provincial bank), worsening the overall fiscal situation of the Province. 19  43. To address these problems the new Provincial Administration signed a Fiscal Clean-up Pact (Pacto de Saneamiento) with all municipal governments in 1999. In exchange for the Province assuming existing municipal debt ($250 million) through the issue of 16 year bonds to be repaid through garnishing three percent of federal revenue sharing flows, the local governments agreed to a comprehensive series of reform initiatives. These include: (i) creation of new regional entities which will consolidate several governmental functions for groups of municipalities; (ii) financial and tax administration reforms (involving cadasters, tax registries, financial management systems, budget transparency procedures, pension reforrn, debt registry, procurement reform, etc.); and (iii) technical assistance from the Province to support these initiatives. The program has already begun, building on pilot efforts sponsored under the Bank-financed Municipal Development I and II projects, but sustained progress is required so that local governments avoid rebuilding arrears and debts. To support the technical bases for the irnprovements, the Province has initiated a program with the IDB to fund technical assistance, including hardware/software and training, in implementing financial and tax administrative reforms. Additionally, there are plans to include municipal employees in the training program and initiate a local economic development program through the Provincial Ministry of Production. 44. Privatization and Outsourcing. A major step in fiscal reform has been taken through legislation authorizing the incorporation of private capital into several sectors. The Government has decided to downsize the state by privatizing the Provincial bank, and concessioning the electricity distribution company and the Province's gambling monopoly. The fiscal impact of these operations will not be known until after completion of the privatization/concessionings, but can be expected, based on already established precedents in Argentina, to positively affect fiscal performance and sector efficiency. Technical assistance from PDPII (depending on the Province's access to funds remaining in this operation) may support the first two efforts, which are being carried out in line with Bank procurement rules and with the supervision of Bank technical experts. 45. Bank of the Province of Cordoba. BPC is one of the three largest remaining state owned provincial banks in Argentina with more than $1.5 billion in deposits and total assets of about $2.2 billion as of June 1999. Due to a long history of weak management resulting in high administrative costs and poor portfolio performance, its reported capital was only $58 million (a debt: equity ratio of 36:1) and its net income was negative. Given a record of questionable lending practices, and reputation for weak loan recovery, the Government feared that the bank would continue to lose money and require repeated public sector recapitalization if it remained publicly owned. 20  Table 3: C6rdoba Provincial Bank Balance Sheets (millions of pesos) .__________________________________________ 1995* 1999** Assets Cash 74 351 Govt bonds 47 211 Loans 1098 859 Credits to financial intermediaries 224 523 Other assets 218 _212 Total 1661 2155 Liabilities L _ Deposits 798 1722 Debt to financial intermediaries 622 304 Other liabilities 65 72 Subtotal 1485 2097 Equity 176 58 Total 1661 2155 Profitabilitv Indicators Return on equity -13 % -5 % Return on assets -2%