PROJECT INFORMATION DOCUMENT

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Project Name: Region: Sector: Task Manager: Project ID Number: Borrower: Guarantor: Implementing Agency: Environmental Category: PROJECT INFORMATION DOCUMENT PE Programmatic Decentralization and Competitiveness Structural Adjustment Loan (DecSAL) Latin America and the Caribbean Region Multi-Sector Fernando Rojas (LCC1C) PE-PE-P LEN-BB Republic of Peru not applicable Ministerio de Economía y Finanzas Jr. Junín 319 Lima Republic of Peru not applicable Date PID Prepared: 16 October, 2003 Auth Appr/Negs Date: October, 2003 Projected Board Date: 2 December, Country and Sector Background: Peru has been going through rapid political reforms during the past two years. The return to fuller democracy after the Fujimori administration has led to a drive for greater transparency and reduction of corruption. The Congress, courts, political parties, media and civil society have been taking advantage of the new political environment to participate actively in policy making and keep a vigilant eye on public management. The Congress has often been the leading force in movements towards deepening democracy and strengthening the rule of law. It has taken initiatives on major reforms and quickly responded to the Executive Branch's reform initiatives, albeit often modifying them significantly. Within this setting, one of the most deeply felt demands of the Peruvian population is to reduce the concentration of state power by decentralizing public functions and resources to lower levels of government and communities. In response, the Toledo government in 2002 proposed a number of reforms, several of which the Congress has enacted. Major laws were passed regarding regional governments, basic decentralization, fiscal responsibility, participatory budgeting, and public sector reform. Other reforms along with their supporting regulations are being prepared as well. In total, these reforms are changing the way in which Peru's public sector operates.

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3 2. Objectives: The Government of Peru has requested a programmatic structural adjustment operation for assistance to its decentralization of public functions and resources, in tandem with measures to help ensure continued sound public finances and economic growth. In response, the proposed loan has three specific objectives: (i) protect fiscal sustainability during Peru's transition to a more decentralized state; (ii) assist strengthening management and fiscal capacity at subnational levels for their progressive assumption of service responsibilities; and (iii) support the creation of a better regulatory and investment environment for upgrading Peru's regional competitiveness. An underlying objective of the proposed Loan is to enrich and extend the Government's overall program of accelerated reforms over the past two years. This has been facilitated by the country's recent track record of prudent macroeconomic management, supported by an IMF Stand-By Arrangement (approved by the IMF board in February 2002). Peru's GDP growth of 5.3 percent in 2002 was the highest in LAC, and its inflation rate of 1.5 percent at the end of 2002 was the second lowest in the region. The combined fiscal deficit in 2002 declined to -2.1 percent of GDP, down from -2.3 percent in In addition, the country's currency is stable and current account deficit is low. These accomplishments and other measures have enabled the economy to substantially improve, contributing to poverty reduction. The proposed Loan is nonetheless intended to support further reforms aimed at sustaining a sound macroeconomic environment and high economic growth. 3. Rationale for Bank s Invovlement: The proposed Decentralization and Competitiveness Loan (DECSAL) has been designed to build on and advance the policy dialogue which the Bank s Programmatic Social Reform Loans (PSRLs) created. It would also help provide a better institutional and financial framework for social program reforms now underway. One direct link is that the proposed operation will provide the fiscal discipline needed to give adequate resources for social reform objectives and ensure that they are effectively used. Another is that the DECSAL's civil service reform component would directly tie with the PSRL's teacher reform component. Moreover, both operations have participatory and transparency elements. Public sector reform and decentralization issues will also be tackled through: (i) the Decentralization and Municipal Development Technical Assistance Loan; (ii) the Justice Services Modernization Project; and (iii) the Second Urban Property Rights Project. 4. Description: The proposed Loan would support the following key elements of the Government's reform program over the next three years: Ensure fiscal sustainability in the new decentralized context Expand the tax base and strengthen tax administrations Finance subnational governments in direct proportion to their abilities to discharge the responsibilities they will assume Ensure hard budget constraints at regional and local levels by, among other measures, establishing a new regime for subnational borrowing

4 Ensure gradual transfer of resources and responsibilities following a rigorous accreditation process of fiscal and management capacities Stimulate efficient use and maintenance of public assets for resource mobilization and development Reinforce budgeting, accounting and reporting standards at all levels of government for improved monitoring, evaluation and planning Institutionalize community and private sector participation and reinforce transparency in the interest of democratic benefits and higher allocation efficiency Support gradual reform of civil service at subnational levels Reduce logistic costs and modernize/concession program in infrastructure: ports, access roads and multimodal terminals Improve the quality and mix of Peruvian products, through a comprehensive quality and innovation program coordinated with the private sector Improve the functioning of the labor market, reducing labor costs Promote and facilitate export development Improve the business environment and business climate Integrate small and medium enterprises into the supply chain and into export consortiums Provide decentralized service support to the (macro) regions 5. Financing: Source [Total in US$million] IBRD: US$150.0 million Total Project Cost: TBD 6. Implementation: While implementation of the measures would be the responsibility of a wide array of agencies, coordination would be under the Ministry of Finance. Implementation progress would be measured against the objectives and indicators in the Letter of Development Policy. Loan disbursement would follow the Bank s provisions for fast-disbursing operations, which require no procurement of goods and services. The Government has set three principles to guide implementation: fiscal neutrality, graduality of the decentralization process, and enhancing competitiveness. 7. Sustainability: Although public debt is high, the continuation of strong economic performance and fiscal consolidation should ensure Peru s medium term debt sustainability. The recent rebound in growth and gradual fiscal adjustment have contributed to lower Peru s public debt burden. Vulnerability indicators have improved over the past few years. Public debt ratios, in particular, have decreased: the public sector debt ratio is estimated to decrease from 46.1 percent of GDP in 2002 to 44.3 percent in 2003; and, following a successful Brady bond debt buyback of US$923 million in February 2002, the public external debt service ratio will decrease from 31.6 percent of exports in 2002 to 22.0 percent in Nevertheless, at 44 percent of GDP, Peru s public debt burden is relatively high and the higher debt servicing costs expected over the next few years will require a more aggressive fiscal adjustment in order to stabilize the debt ratio. To be sure, its current debt profile makes Peru less vulnerable to sudden changes in investor sentiment than other Latin American emerging markets. External debt accounts for about 78 percent of

5 total debt and is virtually all medium and long term, with almost three-quarters committed to multilateral and bilateral creditors. However, its structure makes it vulnerable to foreign exchange and interest rate fluctuations: as of end 2002, 85 percent of public debt was denominated in foreign currencies and 57 percent was contracted under variable interest rates. While GDP growth has slightly decelerated in 2003, it is estimated that Peru will most likely be the second-fastest growing economy in the region after Argentina. In the medium term, sustained and broad based growth would be contingent on the continuation of prudent macroeconomic policies, timely implementation of the current structural reform agenda and a favorable external environment. In the medium term, the most likely scenario (the baseline), is predicated on the assumption that real GDP and export growth remain robust, the authorities maintain fiscal soundness, and macroeconomic conditions remain stable, with average (CPI) inflation hovering around 2 percent per year. 8. Lessons Learned from Past Operations in the Country/Sector: The proposed Loan would capitalize on lessons learned by: i) supporting government commitment to protect fiscal sustainability, especially in view of the high pressures for additional government spending that have characterized the first few years of the transition to decentralization in Latin America and elsewhere; ii) enhancing transparency, dissemination and reporting standards to permit effective central government monitoring and evaluation and make possible private sector and civil society participation in planning, budgeting, procurement and supervision at regional and local levels; iii) stressing the gradual, proportionate strengthening of subnational fiscal, administrative and management capacity needed to improve social programs, infrastructure investment and social sectors that are being transferred; iv) introducing efficiency signaling as a condition of budget expenditures and budget transfers as a means to stimulate greater subnational efficiency; and v) involving subnational governments as agents for increasing competitiveness at regional and local levels. 9. Environmental Aspects (Including any Public Consultation): As a structural adjustment program, the proposed operation does not trigger OP 4.01, and, as a consequence, does not require an environmental rating. 10. List of Factual Technical Documents: Background notes as prepared by the team for the Government of Peru as well as the IBRD s Exexcutive Directors. 11. Contact Point: Task Manager: Fernando Rojas The World Bank 1818 H Street, NW Washington, D.C Telephone: (202) Fax: (202) / For Information on Other Project Related Documents Contact: The InfoShop

6 The World Bank 1818 H Street, NW Washington, D.C Telephone: (202) Fax: (202) Web: www. worldbank.org/infoshop Note: This is information on an evolving project. Certain components may not be necessarily included in the final project.