Public Information Document for Project P075192

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Information Document for Project P Project Name: Region : Sector: Project: Borrower: Beneficiaries: Implementing Agency: GOVERNMENT OF KARNATAKA Mr. G.Gurucharan Secretary, Project Monitoring Unit Phone ; Fax Date PID Prepared: December 15, 2003 INDIA Third Karnataka Economic Restructuring Loan/Credit South Asia Poverty Reduction and Economic Management P GOVERNMENT OF INDIA State of Karnataka Appraisal Mission: October 1, 2003 Board Date: June 24, 2004 (probable date 1. Country and Sector Background India has made significant progress in improving the living standards of its citizens since launching wideranging economic reforms in Real GDP growth averaged 5.8 percent during the 1990s, and poverty fell significantly, though the exact degree of decline is debated. India is expected to register growth of around 6% in the fiscal year 2003/04. After slow and uneven growth (4.3%) last year, due in part to a bad drought resulting in negative agricultural growth, growth is expected to pick up this year with a better monsoon and continued industrial recovery. The service sector has remained the main source of growth while growth in the industrialsector has slowed down since the late 1990s. Medium-term growth prospects in India depend critically on the pace of structural reform and fiscal consolidation. Recent Bank and IMF reports (the Bank s 2003 Development Policy Review and the IMF s 2003 Article IV report) argue that the current rate of reforms and growth put at risk the achievement of the 10th Five Year Plan ( ) target of 8% average GDP growth and poverty reduction from 26% in 2000 to 21% by 2007 and to 11% by Accelerating India s economic growth will require considerable improvements in infrastructure and the investment climate, along with improvements in health, education and other services to set India on a higher growth trajectory. Fiscal consolidation remains elusive, and India s debt/gdp ratio continues to increase. The recent passage of the Fiscal Responsibility and Budget Management Bill, which mandates elimination of the current account deficit of the central government by March 31, 2008, is an encouraging development. Nevertheless, further efforts will be needed to address fiscal imbalances both at the center and in the states. In spite of the high fiscal deficit, India s vulnerability to an external crisis is presently limited by its large reserves, equivalent to 15 months of imports, and its low level of external public debt. Both the capital and the current account are in surplus on the back of strong remittances and exports in services (See Annex E). Interest rates are currently low, but there is a risk that an increase in interest rates, both internationally and in India, could significantly raise the Government s debt service burden. The high fiscal deficit in India is also accompanied by a poor composition of expenditure with wages, pension, interest and subsidy crowding out capital and maintenance spending. Reorienting public spending towards public investment and non-wage operations and maintenance will be necessary for infrastructure to develop and growth to accelerate. There is an increasing recognition of the importance of state reforms to solve India s national economic problems, including the large national fiscal deficit (where the states share is now close to one-half). More and more states are embracing reforms, and significant progress is being made in a number of important areas to strengthen the incentives facing states to undertake fiscal reforms. A number of reform- 1

2 linked facilities have been established, and hard-budget constraints have been improved in the power sector with improved payment mechanisms introduced for central suppliers. Reforms in some states outpace those of the central government, and several state governments have shown considerable determination in backing reforms in the face of opposition and strikes. India will shortly be entering into a period of elections at both the state and national level. Elections in 4 states are due in late 2003, and national and several state elections (including for Karnataka) are due in the second half of State of Karnataka Karnataka is a state of some 53 million in the south of India. Karnataka has a number of strengths, including a good growth record (though the recent India-wide economic slow down has also affected Karnataka), a fiscal position that has been stronger than that of many states, a capable bureaucracy, and stable political leadership and stability. But Karnataka is still a relatively poor state, with per capita income (at $410) around the national average. Rural poverty, while declining in the state over the midnineties, is still above the all-india average. Although Karnataka saw a eleven percentage point improvement in literacy, a slow down in population growth, and above-average improvement in infant mortality in the nineties, it has a long way to go to catch up to the comparator states of Tamil Nadu and Kerala, as well as Maharashtra and, on the issue of population growth, Andhra Pradesh. Also, statewide figures mask significant disparities: parts of Karnataka are quite developed; others, especially in the north, are backward. Karnataka is India s second most arid state: drinking water is scarce and of low quality, and agriculture is mostly unirrigated.. 2. Project s Objectives and Description The Government of Karnataka s Economic Restructuring Program (KERP) The Government of Karnataka (GoK) has launched a comprehensive Economic Restructuring Program (KERP) with a focus on the eradication of poverty through economic growth tempered with equity. This vision has been followed by the development of a comprehensive reform program based on a consultative process in partnership with the private sector and other stakeholders. Karnataka has embarked on a major program of fiscal and governance reform, and has established itself as a leader in these areas in India. GoK s overall strategy is two-pronged: (i) to rationalize and refocus the role of the state; and (ii) to enhance the effectiveness, transparency and accountability of the state in carrying out its more focused role. Sectoral reforms are also being implemented in the power, roads, water, education, health and agriculture sectors. Power sector reforms are particularly important given the sector s significance for both growth and fiscal sustainability. Here, the Government s reform strategy is to privatize power distribution, promote competition, and improve the finances of the power utilities. The state has experienced consecutive droughts in the past three years. While 2000/01 was a good year in terms of economic growth and rainfall for Karnataka, the next two years (2001/02 and 2002/03) were both low rainfall years (in fact in 2002/03, Karnataka experienced one of the worst droughts in 30 years). Even in 2003/04 so far, several districts have received deficient rainfall. Despite these successive negative shocks, Karnataka has been able to substantially improve its fiscal position, and its debt stock has started to stabilize. The four cross-cutting components of KERP are: The fiscal and public expenditure reforms include a multi-year framework for fiscal adjustment, as well as reforms to improve fiscal transparency, tax and expenditure policies, public expenditure 2

3 management, and financial accountability, with the objectives of restoring the state s financial health, creating additional fiscal space for high priority development expenditures, and promoting more efficient and transparent management of the government s financial resources. Administrative reforms focus on improving service delivery, increasing government efficiency and reducing corruption. The private sector development component focuses on improving the business environment through deregulation and liberalization and on privatization or closure of public sector undertakings. The poverty monitoring and statistical strengthening component supports the better use of data in policy making, especially to reorient policy towards poverty reduction goals, through the development of a poverty and human development monitoring system, increased emphasis on program evaluation, and strengthening of the state s statistical system. In addition to these fiscal and governance reforms, KERP also focuses on two sectors viewed as critical to Karnataka s development prospects: the power sector and the education sector. The power sector is important because, as it currently functions, it is a huge fiscal drag and constraint on industrial growth. The education sector is important to promote human development. As noted earlier, Karnataka has been successful in accelerating growth, but less successful in accelerating human development. Health sector reforms are being dealt with separately under a health project currently under preparation. Education reforms are incorporated into the Karnataka Economic Restructuring Program. The Bank s Karnataka Economic Restructuring Loans (KERL) Since 2001, the Bank has been supporting the KERP through a Programmatic Structural Adjustment Loans (PSAL). So far two Karnataka Economic Restructuring Loans (KERLs)/credits have been provided under the PSAL: KERL1, approved in June 2001 for US$150 million and KERL2, approved in March 2002 for US$100 million. KERL1 supported the development of key policy, institutional and legal framework for the medium-term reform program, as well as key initial reform steps, while KERL2 supported the implementation of key measures to advance the Government s reform program. The Bank is now preparing KERL3 for $200 million, which is the third operation in this series of five adjustment loan/credits to support GoK s efforts in developing and implementing multi-year reforms that are designed to stabilize the fiscal situation, improve governance, and foster an enabling environment for structural reforms and sectoral investments. The overall objective of KERL3 is to consolidate progress in core parts of the state government s KERP such as fiscal, governance, private sector development and power reform, while also advancing the agenda of human development through a focus on school education. In the course of 2002/03, the Government of Karnataka has taken a number of important steps to significantly advance its reform agenda. Some of the key reforms and achievements of the Government in 2002/03 include: an improved fiscal position; passage of the Fiscal Responsibility Act; closure of a number of public enterprises under the state s public sector restructuring policy; and improved public expenditure management. Karnataka has also seen substantial service delivery improvements in the last few years. A wide-range of agencies with a significant public interface have adopted a rubric of reforms involving the issuance of citizens charters, user feedback, business process re-engineering, and computerization. 3. Rationale for Bank's Involvement The India Country Assistance Strategy (CAS), discussed by the Board on April 5, 2001, highlights support for reforming states as one of the central thrusts of the Bank s strategy in India. The recent CAS 3

4 update (November 2002) further reinforces this strategy. The proposed operation has been structured to further support growth-oriented fiscal adjustment and structural reforms, with a focus on governance. It is justified on the basis of the state s need for financial assistance to proceed with a growth-oriented stabilization and structural reform program. The state-level reforms will contribute to the overall macroeconomic stability in India and complement the reforms initiated by the central government. In this context, external financial and technical assistance, which can be targeted at individual states, can significantly strengthen the incentives for reforms and complement the efforts by the Government of India. Karnataka is one of India s leading reforming states. It is India s fastest growing state, and has the equal highest credit-rating of any rated state. Bank s backing for the reform program in Karnataka helps provide support for implementation based on the lessons of international experience. Success with respect to the Government s fiscal and governance reform program will improve the enabling environment for Bank-supported (and other) sectoral investments in priority social and infrastructure spending such as roads, rural water and sanitation supply, and education. The additional financing which the Bank can provide will help ensure that high-priorityexpenditures are protected and expanded rather than crowded-out at a time of fiscal stress. It also provides financial backing for the state s reform program, and in particular helps fill the financing gap which arises from fully funding the power sector deficit on budget, an important component of the state s power sector reforms. 4. Financing Total US$200 million equivalent. IBRD US$100 million. IDA US$100 million equivalent.. 5. Implementation Arrangements Karnataka s strengths include a capable bureaucracy, traditionally strong fiscal position, and good growth potential. A credible track-record in reforms has been established by the Government of Karnataka. Karnataka continues to implement many difficult reforms, and thereby helps to generate competition and reform momentum across Indian states. In general, there are three factors which lead to the conclusion that reforms are likely sustainable in Karnataka. (i) Success helps. The fact that, Karnataka is on a rapid growth trend, and has a track-record of improving service delivery and reducing poverty, all make it more likely that the state will be able to sustain reforms. Reformers in Karnataka are in the fortunate position of being able to point to the fruits of reform rather than being forced to resort simply to the promise of a better tomorrow. (ii) Government and private sector are willing partners in development. Karnataka has benefited from having an active private sector and civil society willing to work with the government, and from having a government willing to involve the private sector and NGOs. Public-private partnerships have evolved in a range of disparate areas in Karnataka (urban services, education, infrastructure, citizen surveys). (iii) A legislative approach to reform provides durability. More than any other reforming Indian state, Karnataka has adopted a legislative approach to reform. GoK has enacted a number of laws to provide statutory backing to its reform measures such as the Electricity Reform Act; Anti-Power-Theft Act; Right to Information (RTI) Act; Transparency in Public Procurement Act; Ceiling on Government Guarantees Act; Fiscal Responsibility Act; and The Industries Facilitation (Single Window Clearance) Act. Although laws are only as useful as their implementation, it is hard to deny that legislative backing is extremely important in a country such as India with a well-developed legal framework. Certainly, in Karnataka, its reform legislation is having an impact. 4

5 Impact on the poor. The reforms supported under KERL3, and more broadly under KERP, are expected to make a significant contribution towards meeting the twin strategic challenges facing Karnataka of maintaining rapid growth, and accelerating human development. Specifically: Karnataka s deregulation and liberalization initiatives will improve the investment climate, especially for small and medium enterprises (SMEs) and for farmers. Business deregulation will help generate non-farm employment, of great benefit to the poor, but where performance has been lagging in Karnataka. Karnataka s governance reforms seek to improve the delivery of public services at local levels (e.g., through citizen charters, user surveys, and performance monitoring). The governance reforms should also reduce corruption and harassment, which tend to hurt the poor disproportionately. Already service delivery improvements are reducing harassment and corruption, including in rural areas, e.g., through the computerization of millions of farmers land records. Karnataka s fiscal reforms will enable a greater share of resources to be focused on poverty-related expenditures. The Medium Term Fiscal Plan (MTFP) seeks to reorient public spending towards high priority development spending (primary and secondary education, primary health care, drinking water, basic infrastructure) that will provide basic social services to the poor and help agricultural growth. The education reforms will lead to a bigger and better school education system for Karnataka s school children. The emphasis being given to improving poverty monitoring and evaluation will help the government to better track poverty, and to adjust its policies and programs accordingly. This includes the Poverty and Human DevelopmentMonitoring System (PHDMS), as well as the independent evaluation initiative of GoK. The PHDMS tracks progress with respect to poverty and social indicators in a disaggregated manner wherever feasible (e.g., disaggregated by gender, backward regions, rural/urban, and caste). Negative impacts on retrenched workers through the public enterprise reforms are being mitigated by severance packages. GoK has also developed a training and counseling program for displaced workers. Various surveys have indicated that power sector reforms are pro-poor. World Bank field-level research indicates that power reforms in India will benefit farmers, especially marginal and small farmers, since the quality gains from reform will more than offset the cost of increased tariffs. Increasing user charges is a progressive, though controversial, policy since the poor do not consume electricity: they neither use it in their houses nor can afford pump-sets on their farms. (About 50% of Karnataka s rural households make no use of electricity. There is also a life-line tariff, which about 20% of Karnataka s consumers benefit from.) An incidence analysis of Karnataka s electricity subsidy to farmers indicated that 90% of the subsidy went to farmers above the poverty line. Karnataka s broader reform program is also pro-poor. Special attention is being paid to sectoral reforms in areas of great importance to the rural poor, in particular education, and rural water supply. With support from the Bank, GoK has launched three new community-based pro-poor rural investment programs to assist the state s farmers and rural residents: rural water supply, rural watershed development, and rural community tanks management(two of these projects have been approved by the Bank. The third (community tanks) is under preparation). Karnataka has launched a women s empowerment project, which has led to the establishment of 75,000 women s self-help groups, covering 1.5 million families. GoK has also recently designated women to be the sole beneficiary of various government programs, such as for housing and land distribution. 7. Environment Aspects 5

6 GoK is committed to promoting environmental sustainability, and has taken a range of initiatives in this regard over the past few years. The Bank has been involved in with GoK in a number of activities to improve environmental management in the state over the past several years, from support to strengthening the Karnataka Pollution Control Board (KPCB) under the Industrial Pollution Prevention Project to a sector-wide environmental assessment of the power sector, followed by an extensive analysis of longterm environmental issues in power sector development. Last year, GoK launched the preparation of its first comprehensive State of the Environment Report and Action Plan (SOEAP), with World Bank assistance. The Report, which has been developed with the involvement of multiple stakeholders throughout the state representing various segments of the society, is expected to be complete by the Fall of It will identify the key environmental issues facing the state, assess their causes and necessary policy responses, and recommend a set of policy and institutional measures and other actions for addressing the priority environmental concerns. A follow-up program of Bank assistance to GoK for implementing the key recommendations to further raise capacity and performance of state institutions responsible for environmental management is under discussion. Environmental considerations have been incorporated into the public enterprise reform program. 8. Contact Points: Task Team Leaders: Paramita Dasgupta and Stephen Howes The World Bank 70 Lodi Estate New Delhi Telephone: (91) Fax (91) Note: This is information on an evolving project. Certain activities and/or components may not be included in the final project. 6