Argentina - Catamarca Provincial Reform Adjustment Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P738 1-AR REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON PROPOSED PROVINCIAL REFORM ADJUSTMENT LOAN IN THE AMOUNT OF US$70.7 MILLION TO THE ARGENTINE REPUBLIC TO SUPPORT THE PROVINCE OF CATAMARCA August 21, 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 CAS Country Assistance Strategy CPI Consumer Price Index DGI Direcci6n General Impositiva (National Tax Department) DGR Direcci6n General de Rentas (Provincial Revenues Department) DVP Direcci6n Validad Provincial (Provincial Road Department) EFF Extended Fund Facility ENOHSA Ente Nacional de Obras Hidricas de Saneamiento (National Water Agency) ENRE Ente Regulador de Catamarca (Provincial Regulatory Agency) GDP Gross Domestic Product IDB Inter-American Development Bank LPR Letter of Provincial Reform NBI Necesidades Basicas Insatisfechas (Unsatisfied Basic Needs) OSP Obra Social Provincial (Provincial Health Insurance Fund for Workers) PRESSAL Provincial Health Sector Reform 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 TOR Terms of Reference VAT Value Added Tax Vice President Mr. David de Ferranti Country Director Ms. Myrna Alexander Sector Director Mr. Emesto May Task Manager Mr. Mark Hagerstrom  FOR OFFICIAL USE ONLY ARGENTINA FOR OFFICIAL USE ONLY PROVINCIAL REFORM ADJUSTMENT LOAN - CATAMARCA TABLE OF CONTENTS Page Number I. THE SETTING 1 Recent Economic Performance and External Shocks I The Provincial Context 3 Individual Provincial Reform Programs 9 II. THE REFORMING PROVINCE OF CATAMARCA 1 5 Background and Recent Reform Efforts 15 The Reform Program of the Province of Catamarca 17 Public Finance and Administration 18 Education 22 Health 24 Private Sector Development 25 III. THE PROPOSED LOAN 27 Loan Objective and Rationale 27 Lessons Learned from Previous Operations 27 Role of the National Government 28 Collaboration with Other Operations and Technical Assistance Needs 28 Coordination with Multilateral Institutions 30 Loan Description 30 Borrower and Loan Amount 30 Tranche Disbursement 31 Letter of Provincial Reform 31 Conditions of Tranche Release 31 Program Implementation 31 Disbursement, Procurement and Auditing 31 Monitoring Indicators 32 Environmental Concerns 32 Participatory Aspects 33 Benefits and Risks 35 IV. RECOMMENDATION 36 This Report is based on the findings of a team composed of Mark Hagerstrom (mission leader), Raul Benitez, William Experton, Alexandre Abrantes, David Rosenblatt, Marcelo Becerra (Consultant), Olympia lcochea, Fabio Bertranou (Consultant), Asif Faiz, Gerard Liautaud, Yoko Katakura, and John Wilkins (Consultant) that visited Argentina in July/August 1999. Other team members included the following consultants: Richard Bird, Mark Fairless, Oscar Libonatti, Fedetico Mejer, and Luis Perez. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.  ANNEXES A. Letter of Provincial Reform B. Matrix of Conditionality C. Matrix of Gender Issues and Actions D. Documents in the Project File E. Statements of Loans and Credits F. Country at a Glance G. Overview of Revenue-Sharing H. Overview of the Provinces I. Overview of Provincial Debt Map - IBRD 29348  ARGENTINA PROVINCIAL REFORM ADJUSTMENT LOAN - CATAMARCA LOAN SUMMARY Borrower: The Argentine Republic Implementing Agencies: Subsecretaria de Programaci6n Regional, Ministerio de Economia, Puiblicas, the Provincial Coordinating Unit and provincial ministries and agencies Beneficiary: Provincial Government of Catamarca Povertv: The Province of Catamarca belongs to the part of Argentina with the worst social and economic indicators. Its per capita income, at $4,500, is about half the national average, and 17th out of 24 provinces. 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. Amount: US$70.7 million Terms: The single currency loan in U.S. dollars, repaid in 15 years, including five years of grace at the Bank's standard variable interest rate Commitment Fee: 0.75 percent on undisbursed loan balances, beginning 60 days after signing, less any waiver Onlending Terms: Identical to those contracted by the Argentine Republic with the Bank Schedule of Disbursements: (in US$ Million) Dis. Cum. First Tranche 2nd quarter FY2001 25.7 25.7 Second Tranche 2nd quarter FY2002 20.0 45.7 Third Tranche 1 st quarter FY2003 25.0 70.7 Economic Rate of Return: Not applicable Project Identification No.: P044447   REPORT AND RECOMM ENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON PROPOSED PROVINCIAL REFORM ADJUSTMENT LOAN IN THE AMOUNT OF US$70.7 MILLION TO THE ARGENTINE REPUBLIC TO SUPPORT THE PROVINCE OF CATAMARCA 1. I submit for your approval the following memorandum and recommendation on the proposed loan to the Argentine Republic for US$70.7 million to support fiscal adjustment and structural reform of the Province of Catamarca. 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: dollar exchange rate fixed by Argentine law). TiHE 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 investmnent, 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 estimated $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 Govermnent'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), 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 After growth of 6.6 percent in the first half of 1998, growth fell to -0.6 percent in the fourth quarter of 1998. For that year as a whole, GDP growth was 3.9 percent. 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 recovery. 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 3.1 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 even larger declines for imports (particularly capital goods). Inflation remains extremely low, with deflation during 1999. See the Bank's most recent Poverty Assessment for Argentina, Report No. 19992-AR, dated March 23, 2000. 2  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 $7.2 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 $4.3 billion, almost twice the deficit in 1998. In total the consolidated public sector fiscal deficit amounted to about 4.1 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. IMF Programn. 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 is $4.7 billion (1.6 % of GDP) and a binding incremental public sector debt target for both the provinces and the Federal Government of $5.4 billion. There are also indicative targets for the consolidated provincial governments, including a deficit of $2.2 billion in the year 2000, and for the aggregate level of the provincial spending to be in balance by the year 2003. 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 deficit target and by supporting second generation reforms in these provinces and other provinces, focusing on health and education spending. 9. The incipient economic recovery has been slower than expected. GDP growth in the first quarter of 2000 was a mere 0.9 percent (year-on-year). The unemployment rate deteriorated to 15.4 percent in May. The slower than expected growth led the federal government to enact additional expenditure cuts during the second quarter of the year. Through the second quarter 2000, the IMF targets were met; however, there was a spike in the federal deficit during July. The slower than expected recovery has made the fiscal situation more complicated for the province, as well. THE PROVINCIAL CONTEXT 10. 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. 3  Table 1: Argentina: Allocation Of Responsibilities by Government Levels Exclusively Central Central and Provincial Provincial and Municipal Govemment Governments Municipal 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, transport Preventive Health Water and Sewerage drainage Trade regulation Economic Regional and local Mail and telex development roads Justice and Security Land Use Housing Fire Control Passenger and cargo terninals Electricity and gas ____ ___ ___ ___ ___ energy__ _ _ _ _ _ _ _ __ _ _ _ _ _ _ _ _ _ _ 11. During the l980s, 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 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. 12. 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 reforns 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. 4  13. With a more favorable macroeconomic environment beginning in late 1996, and 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 $3.8 billion in 1999, similar to the 1995 level relative to GDP during the Tequila. 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 are estimated to be about $3.4 billion on the stock of provincial debt of $18 billion. Since 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 Govermment -2545 -5889 -4341 -4170 -7348 -4700 Provincial -3530 -1840 -1377 -2359 -4269 -2200 Administrations Total -6075 -7729 -5718 -6529 -11617 -6900 Shares of GDP (%o) Federal Government -1.0 -2.2 -1.5 -1.4 -2.6 -1.6 Provincial -1.4 -0.7 -0.5 -0.8 -1.7 -0.8 Administrations Total -2.4 -2.8 -2.0 -2.2 -4.3 -2.4 Excludes privatizat. revenues Main Challenges in Provincial Reform 14. 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 fimctions. 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. 15. Over the past ten years, the Governrnent's strategy progress from ensuring macro- economic stability, installing a competitive policy framework for the productive sectors, 5  and providing basic security for the population to a strategy increasingly emphasizing second generation reforns, 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 governnent and among the provinces (the system of co-participation). At issue are 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 to 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 hard (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 problerns 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. 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. An overview of the system of revenue- sharing and issues to be faced in the reforrm effort are provided in Annex G. * Heterogeneity among Provinces. There is no uniform solution. The situation in the 24 provinces remains highly disparate. There are well perforning 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, Cordoba and the Province of Buenos Aires, have undergone varying degrees of adjustment in the early 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 performnance and high debt. The general characteristics of the provinces are presented in Annex H. 6  * 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. An overview of the debt situation in the provinces is presented in Annex I. * Regional Dimensions of Poverty. Poverty rates are substantially higher in provinces in the north, particularly in the Northwest (46%) and Northeast (49%). Conversely Buenos Aires (including the City and Province) and five Patagonian provinces in the southem 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 Cordoba, 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 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 7  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 16. 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)2, supported with important analytical work.3 As a result: a 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 (pactosfiscales) 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); * 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 2 All of these operations were rated either satisfactory or highly satisfactory by OED. 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  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 Il)4 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 17. 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), based on their previous reform performance under the First Provincial Reform Loan (PRL I) and the difficulties that they continued to face. Reform Goals and Actions 18. The provincial reform program 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 reforn program are common and include three basic components: public finance, education, and health. 19. Reforms inpublicfinance are focused on achieving a sustainable fiscal situation and 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 4Including 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  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 by 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. 20. 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. 21. 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 seeks 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 also 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; * Improving the incentives for quality improvement; 10  * Increasing the participation of the private sector; and, * Reducing administrative costs. 22. 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 lowest have to wait more than 24 hours for a consultation, as compared to only 45 percent of those in the upper quintile. Proposed health reforrns 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. 393 1-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 reforn 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); * 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 23. Of the four pilot provinces for PRL II, the loans for Salta and- Tucuman have been complete and been 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.5 The ICRs note that overall, fiscal performnance 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 S Reports Nos. 20699 and 20698, both dated June 30, 2000. 11  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 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 and the final of three tranches were cancelled in both cases. ICRs are now underway. 24. 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 reforms: 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, politically, 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 PJ?LII 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 to put into place and even longer to begin showing results. The lesson is that engagement by the Bank should be at least for two years. This is all the more crucial because conditionality went beyond merely the enacting of new measures, but required that new systems be effectively up and running. 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 prior to any change in administration. 12  - 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 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 reforrns were enhanced in those cases were 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 exarnple, 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 reformns 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 TA operations would not contribute to the long-term needs of improving federal-provincial relations. 25. In sunmmary, 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 reforn programs, together with continuing support for reform in revenue- sharing, have been identified in the FYO 1 -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. 13  Government Strategy and Bank Assistance 26. The new 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 refonning 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 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. A commitment by the Federal Government to assist smaller provinces in improving the terms of their debt stock. (See Annex I). * 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 organization to serve as point for the debate over the new revenue sharing law, fiscal coordination, monitoring, and tax harmonization. 27. In order to help achieve an overall fiscal balance in the provinces by the year 2003, the Government has asked the Bank in the FY01 -04 CAS to step up its efforts under the model piloted by the PRLllprovinces. The first province under this new phase would be Catamarca, which would incorporate the lessons from the pilot provinces of PRLII and also benefit from participation in the Governnent's debt relief program. 14  While a relatively small province, Catamarca is seen as providing a powerful demonstration effect for other provinces, given its historically poor performance and its most recent reform efforts (see below). The Government has also requested that the Bank take the lead in providing reformn support to the country's larger provinces, including Buenos Aires, Cordoba, and Santa Fe, followed by several intermediate provinces. Through these efforts, we would be directly supporting fiscal and social sector reform efforts in provinces representing about 60 percent of Argentina's poor (as measures by NBI). 28. The 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 Government has a two year window for lasting changes to the system and already 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.6 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 FY01 -04 would also provide for Bank support to assist in transitional measures in other provinces, if and when the revenue sharing system is reformed. THE REFORMING PROVINCE OF CATAMARCA BACKGROUND AND RECENT REFORM EFFORTS 29. Catamarca is a small, poor province of the Argentine Northwest. It belongs to the part of Argentina with the worst social and economic indicators. Its per capita income was approximately $4,500 in 1997, about half the national average, and 17th out of 24 provinces. Catamarca also ranks poorly as regards social indicators. Almost one-fourth of the population cannot meet their basic needs, according to the Basic Unsatisfied Needs (NBI) measure used in Argentina, as compared to a national rate of 16.5 percent. 7 The child mortality rate in 1995 was 26.1 per 1000 births, well above the national average of 22 per 1000, with high rates of birth and teenage pregnancies, as well as a high prenatal mortality. In education, Catamarca has a school attendance level that is well below the national average. The net school attendance rate for primary education is only 63 percent, which points to high repeater and absenteeism rates. Secondary education situation is even worse at only 51 percent. Moreover, based on national evaluations, the quality of education in Catamarca is considered the worst in the country. While 71 percent of the population benefits from access to piped water systems (as compared to 76 percent nationwide, low for a country at Argentina's level of income), only 32 percent are connected to sewage systems. Finally, the Province also compares unfavorably in other 6 Including the recent report, Argentina: Provincial Tax and Revenue-Sharing Reform, green cover Report No. 19395-AR, dated June 30, 1999. 7The NBI measures, inter alia, access to housing, potable water and social services. 15  infrastructure services. For example, it has one of the country's lowest road densities (0.05 km/sq. km compared to the national average of 0. 1). 30. During much of the past twenty years, the Province's fiscal performance has been dismal, with poor management and controls, and excessive current expenditures stemming from the massive incorporation of workers into the public sector. This has resulted in high levels of indebtedness. Poor fiscal performance is compounded by inefficiencies in spending, which lower the effectiveness and quality of public services. Thus, in contrast to its poor health indicators, the Province's spending on public health is at par with the national average (about $300 per capita); and, in contrast to poor educational outcomes, Catamarca has one of the country's highest unit costs (expenses per pupil), which is only partially explained by the need to service a dispersed population. Despite sufficient production capacity, inefficiencies in the public water company results in rationing at times and poor quality services. Poor collection and high cost leave little for needed expansion and investments in water supply and sewerage, and annual transfers from the provincial treasury of about $10 million are needed just to cover the operational deficit. Despite low road density, Catamarca devotes about 6 percent of its budget to the sector, one of the highest levels among provinces. Still, spending on roads is inefficient and compromises the Province's ability to maintain and improve the road network. Finally, the provincial bank, which in the past served to help finance the fiscal deficit, requires periodic recapitalization to cover large losses, with $56 million in support from the provincial treasury since 1992. 31. Beginning with a federal intervention in the early 1990s,8 the Province has undertaken a series of reforrns to improve its public sector performance, with the support of the First Provincial Reform Loan and The First and Second Provincial Development Projects (PDP I and I1), financed by the Bank. Among the main achievements to date has been the implementation of a modem system for financial management, patterned on the national system, and the privatization of the energy distribution company, tourist and casino facilities, and the bus terminal. The implementation of voluntary retirement programs for personnel, as well as privatizations made it possible to reduce staff by 15 percent. On the revenue side, institutional strengthening of the provincial tax agency (DGR) helped to increase local tax collections by 78 percent between 1995 and 1998. As a part of this process, the provincial cadastre was updated, making it possible to both increase the number of real estate taxpayers and improve the equity of tax values. Finally, the provincial pension was transferred to the national government wvith the support of the Bank, relieving a fiscal burden and contributing to national macroeconomic reforms. As a result, the deficit in current spending was improved from 19 percent of current revenues in 1995, to a positive balance of 2 percent by 1998, and personnel costs relative to current revenues declined from 83 percent- in 1995 to 53 percent in 1998. The performance in relieving the debt burden was less successful, although the debt stock relative to current revenues declined from 83 percent in 1995 to 78 percent in 1998. s The intervention was prompted by civil disarray resulting from a combination of poor fiscal management and political turmoil stemming from a high profile criminal investigation. 16  32. Reforms in education were also begun with both the implementation of the federal educational reform at EGB9 and Polimodall