A'~~~~~~~~~t~W. Ka OMFAL t= OPLYo. ~ :~ .tf:. -IRA~~~~~~A ''' VINCUL ~DEVUt3T PcrC. UovER 21, 190

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized ^jx -A :: I-t -o r =t z A-k 7 o; I Ka OMFAL t= OPLYo. ~ :~ A'~~~~~~~~~t~W -IRA~~~~~~A ''' VINCUL ~DEVUt3T PcrC UovER 21, 190 _J~_; * ~ ~~~~~~~~~~~~ ~ _..tf:. Iafrastructure A"d Ioery Opert tom DtV%siou Country Department IV I Latin A.wica and the arilbbean lgion LtAk _C ricl 'lb COMIO a" UN SMbl *' om. IN w,, Th aul aj~d miumy be Eind byr.~.h p h S

2 CurXenc nt-auta A November R US DolR ar h a Fre. Market Rate US$ 1 5,375 FiscalYear January 1 - Decesber 31 Weights Metric n Measuras System Glossary of Abbreviations and Acronys ceu Project Central Execution Unit CFI Federal Investment Council (Consojo Federal de Inversiones) FAIP Financial Action and Investment Plan FEDEI Special Fund for Electrification of the Interior (Fondo Especial para Elotrificacion del Interior) FIkL Foundation for Latin American Economic Studies (Fundacion de Investigaciones Economicas Latinoamericanas) FNIS Financial Management Information Systea FONAVI National Housing Fund (Fondo Nacional de la Vivionda) GDP Gross Domestic Product GPP Gross Provincial Product MBDEC National Institute of Statistics and Censuses (Instituto Nacional de Estadistica y Censos) INF International Monetary Fund PEU Provincial Project Execution Unit PBS Provincial Planning and Budgeting System NFS Provincial Governrent Finance Study POK Provincial Project Operations Manual RSS Revenue Sharing System SCAT Undor Secretary for Administrative and Technical Coordination, Kinistry of Economy (Central Govenuent) (Subsecretaria de Cordinacion Administrative y Tecnica) TFFD Transitional Fund for Fiscal Disequilibria

3 - i - FOR OFFICIAL USE ONLY ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table of Contents Page No. LOAN AND PROJECT SUMMARY iii I. HI THE SECTOR..1 TH EC O i..... Importance of the Provincial Public Sector The Spatial Distribution of Population, Product and Poverty.. 2 Government Structure for the Provision of Public Services... 2 Intergovernmental Fiscal Relations Sector Development Issues and Objectives Sector Lending Strategy and Rationale for Bank Involvement... 6 II. THE PROJECT. 8 Project Origin Project Objectives Project Description Project Costs and Allocation among Beneficiaries Expenditures Eligible for Financing under the Project Financing Plan Implementation Arrangements Procurement Disbursement Accounts and Audits Financial Impact Economic Impact and Analysis Social Impact Environmental Impact Project Risks and Safeguards III. AGREEMENTS TO BE REACHED AND RECOMMENDATIONS This report is based on the findings of the appraisal mission that visited Argentina August 16-24, The mission comprised Messrs. James Hicks (Mission Leader, LATIE) and Lubomir Ficinski (Consultant). Messrs. Malcolm Rowat (LA4DR), and Eduardo Abbott (LEGLA) joined the mission during parts of its duration. Mr. David Vetter (LA4IE) also contributed substantial inputs to this report, based on his participation in previous missions. 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.

4 - ii - Table of Contents (Continued) Page No. LIST OF ANNEXES ANNEX 1: Spatial Distribution of Pooulation- Product and Poverty.. 29 ANNEX 2: Recent Evolution of the Provincial/National Revenue Sharing System ANNEX 3: Provincial Government Finance ANNEX 4: Financial Action and Investment Plans (FAIP) ANNEX 5: Assessment of the Financial Impact of the Proiect and the Debt Canacity of the Provinces ANNEX 6: Detailed Description of Project Components ANNEX 7: Project Implementation Schedule ANNEX 8: Proiect Economic and Social Impact ANNEX 9: Assessment of Environmental Impact ANNEX 10: Proiect Operations Manual ANNEX 11: Orpanization and ResRonsibilities of the Central and Provincial Executing Units ANNEX 12: Supervision Plan ANNEX 13 Estimated Schedule of Disbursements ANNEX 14: Selected Documents in Project File MAP IBRD 20450

5 v iii - ARGENTINA PROVINCIAL DEVELOPMENT PROJECT LOAN AND PROJECT SUMMARY Borrower: Argentine Republic. Implementing Agencies: Ministry of Economy of the Central Government, the 23 Provinces, and the Municipality of Buenos Aires. Amount: Terms: US$ million. Repayment in 17 years including five years of grace, with interest at the Bank's standard variable rate. Relendine Terms: Except for approximately one percent of the loan that would finance institutional development in the national Ministry of Economy, all proceeds of the Bank loan would be onlent to part3cipating provinces, with each province's revenue sharing serving as a guarantee for repayment of subsidiary loans. For onlending to provinces, the Ministry of Economy would enter into a Financial Agency Agreement with an appropriate financial institution (Financial Agent), satisfactory to the Bank. The terms and conditions of subsidiary loans would be established in Subsidiary Loan Agreements between the Government and each participating province. These terms and conditions would be essentially the same as the Bank loan, including the foreign exchange risk, as well as the costs of (a) the Financial Agent and (b) the Central Execution Unit's expenditures financed under the project, in order to ensure that provincial project components would not result in a fiscal burden for the Central Government. Proiect Obiectives and Description: The Government has agreed with and endorsed the conclusions and recommendations of the Bank's sector report, "Argentina: Provincial Government Finance Study", including the proposed strategy for provincial fiscal reform and improved expenditure efficiency. Thus, the project's overall obiective would be to provide financial support and incentives for provinces to undertake their own adjustment programs (own-source revenue enhancement and expenditure control) consistent with the national adjustment program. This would be achieved through providing Bank financing only to provinces that meet strict financial performance and other eligibility criteria. The proposed operation would finance civil works, goods and consultants necessary to implement Provincial Financial Action and Investment Plans,

6 - iv - to be proposed by provinces and approved by the Central Government's Ministry of Economy anc the Bank, based on financial and other provincial eligibility criteria designed to implement the project's objectives. Thus, the project would finance a "time-slice' of eligible provincial expenditures, and its components would be: (a) It.stitutional. Development, (about 10 percent of total project costs) including technical assistance, training and equipment to attain the project's objectives at both the Central and Provincial Government levels; (b) Project Administration, (about 9 percent of total project costs) for the recurrent costs of project implementation at the national and provincial levels; and (c) Physical Investments, (about 81 percent of total projec. costs) encompassing public infrastructure (e.g., roads, bridges, drainage, water supply and sanitation) and facilities (e.g., schools, health posts, bus terminals). These investments would include maintenance programs, rehabilitation of existing works, completion of unfinished works, and new investments. Access by provinces to financing of physical investments would be conditioned to provincial financial performance and verification that the investments are economically efficient, financially sustainable, institutionally manageable, and environmentally sound. It is estimated that maintenance and rehabilitation would be by far the largest part financed by this component. Benefits: Risks and Safeguards: There are three main benefit areas: (a) fiscal, as the project wo'tld provide incentives to improved provincial financial performance, thus contributing to the national adjustment program's objective of reducing the public sector deficit; (b) institutional, with improved capacity of provinces to plan, program, implement and monitor efficiently resource mobilization and allocation; and socioeconomic, with improved infrastructure and service delivery, as well as the creation of about 110,000 person years of low-skilled construction employment, especially important during the difficult adjustment period. The main project implementation risks are: (a) lack of initial interest of the provinces in doing the fiscal reforms required; (b) discontinuity in political commitment to the project; and (c) unfavorable macroeconomic conditions during its execution. The project has a built-in mechanism for managing these risks in that it allocates resources based on performance. Those provinces which enter earlier and perform better (i.e., develop the institutions, generate current account surpluses and adapt to the macroeconomic environment) would receive more resources under the project.

7 Estimated Project Costs: (in USS millions of December 1990) F.E.C. as % of Comnonet Local Foreign Total 3 of Total Total Costs I. Institutional Development A. Central Government 1. Consultants Goods B. Provinces 1. Consultants Goods Sub-Total I II. Physical Investments A. Infrastructure 1. Maintenance Rehabilitation Completion New Works Sub-Total II.A B. Facilities 1. Maintenance Rehabilitation Completion New Works Sub-Total II.B Sub-Total II III. Project Administra TOTAL PROJECT COST Financing Plan: IBRD IDB Provinces Estimated Disbursements: (Bank Fiscal Years) Annual Cumulative Economic Rate of Return: At least 12 percent.

8 I. THE SECTOR The Imnortance of the Provincial Public Sector 1.01 Reducing the public sector deficit is of fundamental importance for success of Argentina's medium-term adjustment program, and to address the underlying structural problems and sources of instability in its economy. There have been three major sources of this dpficit: (a) the Central Government itself, including the official banking and finance entities, as well as social security; (b) the public sector enterprises; and (c) the provincial governments As shown in the Provincial Government Finance Study (Report No. 8176, distributed to the Board on April 16, 1990), the provinces have been responsible for the largest and fastest growing portion of this deficit. While provincial expenditures rose rapidly over the period, reaching over 11.2 percent of GDP in 1986, total own-source provincial revenues actually dropped from a high of 5.6 percent of GDP in 1980 to only 5.0 percent of CDP in For example, the total fiscal deficit of the provinces in 1986 before transfers from the central government was 6.2 percent of GDP (about US$4 billion), much higher than the public sector enterprises and social security combined. After transfers, the provinces showed a slight fiscal surplus, but at the expense of helping transform the national administration's before transfer surplus of 5.4 percent of GDP into a fiscal deficit of 4.6 percent of GDP after transfers Data from case studies of six provinces show that their combined fiscal deficit more than doubled in 1987 to US$1.1 billion (1.8 percent of GDP) after transfers, as own-source revenues declined and expenditures, especially for salaries, continued to rise. For all 23 provinces and the Municipality of Buenos Aires, the total fiscal deficit in 1987 after transfers was estimated at over US$2.8 billion or about 4 percent of GDP. The decline in own-source revenues stems partly from the rise of inflation and the resulting Olivera-Tanzi effect, but also from the increasing inefficiency of the provinces in collecting taxes, as well as the reticence of taxpayers to pay taxes and fees for services of ever deteriorating quality Besides controlling the fiscal deficit, provincial governments are important in efforts to improve the efficiency and equity of Argentina's public sector, as they are increasingly important providers of public services, especially of health and education. Expenditures of Argentina's provincial governments in 1986 amounted to 11.2 percent of GDP (or US$7.8 billion). Investments accounted for US$1.6 billion in 1986 (2.6 percent of GDP) of these provincial expenditures, slightly more thari the total investments of all public enterprises and about 60 percent more than the central government's investments (including all of its decentralized entities and special accounts). The new Government's strategy of decentralization should substantially increase this importance Despite its fundamental importance to macroeconomic policy formulation and implementation, provincial public finance has not received the attention that its importance in national fiscal policy requires. This is partly because the provinces are difficult and costly to study, in that they are numerous (22), institutionally complex, extremely heterogeneous, and

9 -2- spatially dispersed. Furthermore, there have been serious gaps in adequate, up-to-date data on provincial government finance It is clear that provincial goverdnments cannot be ignored in the national effozt to reduce the public sector's fiscal deficit and to improve its efficiency and equity. At both the national and provincial levels, there is a broad governmental awareness of the need for fiscal reform and increased provincial financial autonomy. The Spatial Distribution of Ponulation. Product and Povertv 1.07 Although spatial concentration of both population and product in Argentina remains high in the four largest provinces (Buenos Aires, Cordoba, Mendoza and Santa Fe) and the Municipality of Buenos Aires, the rates of growth during tne 1970s tended to be higher in the other provinces, especially those with rich endowments of petroleum, natural gas and mineral deposits (i.e. the "resource frontier"). For example, the Gross Provincial Product (GPP) of the Province of Neuquen grew at a annual rate of 11.6 percent during the 1970s. Although the general economic malaise of the 1980s retarded both growth and spatial decentralization of economic activities and population, the total concentration of GPP in these largest provinces and the Federal Capital dropped from 82.5 percent in 1970 to 78.4 percent in For population, the drop was less dramatic, but still important: 72.4 percent in 1970 versus 70.4 percent in 1985 (for details, see Annex 1) Although the percentage of households with unsatisfied basic needs is higher in the provinces with smaller populations and lower per capita products, such as Formosa (47 percent) and Santiago del Estero (49 percent), over half of the total number of poor households lived in the three largest provinces (Buenos Aires, Santa Fe and Cordoba) The extreme diversity of the provinces of Argentina in terms of population, product and poverty can be seen by comparing the provinces of largest and smallest population size: Buenos Aires and Santa Cruz. The population of the Province of Buenos Aires (12.9 million in 1985) is about equal to that of Chile, living in an area about the size of Italy. The economic product of this province is about twice that of Ecuador. On the other hand, the 134,000 inhabitants of Santa Cruz live in an area the size of the United Kingdom, giving the province a demographic density of only a half a person per square kilometer. However, due to its very high endowments of natural resources, the per capita product of Santa Cruz (US$2,972) was nearly twice that of Buenos Aires (US$1,657) in The percentages of households with unsatisfied basic needs is about the same for both provinces (about 20 percent), but the absolute number in Buenos Aires was about 100 times greater. Government Structure for the Provision of Public Services 1.10 The Argentine State is organized in three political-administrative and territorial jurisdictions: the central, provincial and municipal levels. Within this federal organization, all governmental powers formally emanate from the provinces. Formally, provinces delegate limited powers to the Central Government and retain for themselves all other authority. Provinces

10 - 3 - are autonomous entities governed by their owm Constitutions. Municipalities are organized as part of each province's system of government The Central Government is empowered to meet the main general needs of the Argentine society and to provide for the common interest of the different territorial subdivisions. There are also "concurrent powers" entrusted by the Constitution to both the Central Government and the Provinces, and even to municipalities by provincial delegation. Because of the diversity of Provincial Constitutions, and a historically strong interpretation of the Central Government's authority in practice, there is a great deal of diversity among the provinces with regard to service delivery authority and responsibility. In general, however, responsibilities for service provision may be illustrated as follows: exclusively Central Government -- defense, foreign affairs, inter-province transportation and trade regul.cion, mail and telecommunications; Central and Provincial Governments -- higher education, preventive health, justice, security, economic development, major passenger and cargo terminals, housing, electric and gas energy; Provincial and Municipal Governments -- elementary and secondary education, primary health care, water and sewerage, regional and local roads, fire control; and predominately Municipal Governments -- solid waste collection and disposal, local streets and drainage, parks, markets, cemeteries and land use planning and control. Recently, some of the larger provinces have begun to delegate more of their responsibilities to municipalities As provided in the National Constitution, the Certral Government has the following sources of revenues: (a) resources allocated to it exclusively and on a permanent basis (taxes on foreign trade and profits from the postal service); (b) resources allocated permanently in conjunction with the Provinces (domestic taxes); and (c) resources allocated temporarily and on a shared basis with the Provinces (direct taxes in cases of national emergency). Categories (b) and (c) have contributed approximately 80 percent of total Central Government tax revenues, and have formed the basis for the Central/Provincial Governments' revenue sharing system. The most important provincial revenues are the turnover tax (gross sales tax), real estate tax, vehicle tax and transfer tax ("sellos"), as well as the revenue transfers received from the Central Government, as described below (see Annexes 2 and 3 for details). Intergovernmental Fiscal Relations 1.13 Argentina's system of fiscal federalism has evolved through many years of conflict between the Central Government and the provinces (Annex 2). The revenue sharing system has evolved within this context, reaching a benchmark with the enactment of the previous revenue sharing law of 1973 (Ley ), which gave the provinces considerably more resources than they had received in the past, with distribution among the provinces determined by criteria defined in the law. With the enactment of this law, revenue sharing as a percent of total provincial revenues rose from 39 percent in to approximately 47 percent in the period. Provincial tax effort dropped initially in response to this influx of resources from the Central Government, but then began to recuperate.

11 With this transfer of resources came the idea of transferring public service delivery responsibilities from he Central Government to the provinces. In 1978, primary education was transferred to some provinces, as were medium-size hospitals. In , primary education for adults, water, irrigation, electricity and some national hospitals were also transferred to the provinces. In 1989, secondary schooling became a provincial responsibility. These transfers of responsibility were normally not preceded by studies of the fiscal implicatior7 for the provinces, let alone plans for assuring that adequate resources were available to provide the decentralized services The formal revenue sharing system was interrupted from the end of 1984, when the previous revenue sharing law expired, until January 1988, when the current law was implemented. From , a series of ad hoc agreements substituted the revenue sharing law The prevailirg revenue sharing law (passed in 1987 and made effective in January 1988) represents an important step towards more responsible federalism in Argentina in the sense that it makes total transfers to the provii,ces more transparent and predictable. In the period before this law, a chief means of transfers to the provinces were Discretionary Grants (Aportes del Tesoro Nacional). These grants generally rewarded fiscal irresponsibility, as those provinces which ran up high fiscal deficits tended to get more resources from the Central Government in the form of discretionary grants The present revenue sharing law has changed the "rules of the game" regarding fiscal transfers. Discretionary grants are limited to only one percent of total shared taxes, and the percentage of the total revenues from shared taxes going to the provinces as a whole (i.e., primary distribution), and also the percentages going to each province (i.e., secondary distribution) are fixed by the law. Hence, the only variable left in the revenue sharing system is total shared tax revenues; the other parameters used in the system are legally fixed constants. In the primary distribution, the percentage of total shared taxes going to the provinces rose from 48.5 percent to percent under the new law. Furthermore, shared taxes are to be deposited, within 48 to 72 hours of their collection, directly into the accounts of the provinces in the Banco de la Nacion Argentina in accord with the percentages used in secondary distribution Any additional transfers to provinces must now be approved by Congress. This makes the revenue sharing system transparent and raises the political cost to Provinces of requesting financial assistance of the Central Government. The law is valid for two years, but under its provisions, the law will be extended automatically until a new one is adopted. As passage of revenue sharing laws has been difficult in Argentina, the current law could well stay in effect for some time to come The criteria used in dividing the total revenues of shared taxes among the provinces are weighted against the provinces with largest populations (i.e., Cordoba, Santa Fe and especially Buenos Aires), given that the main objective is territorial redistribution. For example, the province

12 of Buenos Aires received enly 46 percent of what it would have received if revenue were shared according to population, while Catamarca received over three times what it would have received on the basis of its population. Although the criteria promote territorial redistribution, they tend to transfer resources away from areas with the greatest numbers of poor families (e.g., Buenos Aires, Cordoba and Santa Fe) Although well designed to meet its objective of providing a transparent and more predictable transfer of funds to the provinces, implementation of the new revenue sharing law has been plagued by two main problems: (a) shortfalls in the total resources transferred due to a decline in the collection of shared taxes and (b) the continued rise of the fiscal deficits of the provinces. The former has resulted essentially from problems cf national -ax administration and macroeconomic instability; the latter from provincial financial mismanagement Although the new revenue sharing law reduced uncertainty by legally deiining both primary and secondary distribution, the sole remaining variable (the collection of shared taxes) turned out to be quite unstable, resulting in a significant shortfall during both 1988 and Although a number of laws have been passed to compensate for the revenue shortfall, all have been tied to tax incrc-.ses and have defined strict criteria for secondary distribution (see Annex 2). Thus, improving inter-governmental fiscal relations can complement adequate macroeconomic policy at the national level by helping to reduce the consolidated fiscal deficit of the provincial public sector, but it is obviously no substitute for it The Government is committed both to improving further intergovernmental fiscal rel.ations, as well as to inducing the provinces to increase their own fiscal effort and to improve their expenditure efficiency. In September of 1989, the national Ministry of Economy encouraged the provincial Ministers of Economy to institute a Forum of Ministers in which they would discuss their problems among themselves and with national authorities. In recent legislation proposed by the Ministry of Economy and approved by Congress, the Ministry will monitor the performance of provinces receiving assistance for fiscal disequilibria and use criteria for allocation of this assistance among provinces that provide incentives for these provinces to develop and implement plans to reduce their fiscal deficits (see para. 2.03). Sector Development Issues and Obiectives 1.23 To be successful, a policy for provincial fiscal reform and improved expenditure efficiency must encompass two dimensions: national and sub-national. (a) At the national level, there must be in place a system of intergovernmental transfers that are predictable, transparent, financially sustainable, and that provide incentives to provincial fiscal autonomy. Further, the provision of credit to provincial banks by the Central Bank must continue to be rigorously controlled.

13 - 6 - (b) The sub-national level of the strategy must include the entlre sub-national public sector, not only provincial central administrations, but also their indirect administrations, including public enterprises, as well as direct and indirect municipal government administrations. A broad approach to the entire sub-national public sector is necessary because in Argentina's federal system, fiscal reform is only as strong as the weakest link in the system. National public sector deficit reduction efforts will fail if provincial government finances are not sound, and these, in turn, will not be sound if provincial enterprises and/or municipalities generate deficits that demand provincial 'bail-outs" that eventually work their way up to the Central Bank or the National Secretary of Finance. Sector Lending Strategy and Rationale for Bank Involvement 1.24 Given the objectives and scope described above, the proposed design criteria and actions required for the lending strategy are summarized below The criteria for design of the strategy may be grouped in two broad categories: intergovernmental transfers and provincial financial management. Implementation of an improved system of intergovernmental transfers is the responsibility primarily of the Central Government, while responsibility for improved provincial financial management rests with the provinces, although the Central Government may provide valuable assistance to them. A fundamental Drerequisite for success in formulating and implementing a strategy for provincial fiscal reform and improved expenditure efficiency is a transparent (sanctioned through legislation and implemented through the budgetary process) and disciplined process for access to credit by the subnational public sector. This requires that the Central Bank maintain strict controls on rediscounts by provincial banks, thereby not allowing its funds to be used by provincial banks to finance irresponsibly their provincial government deficits. Furthermore, prudential regulation is required in many provinces in order to have adequate discipline and control over the provincial banks' operations. Without these disciplinary measures, the strategy will be doomed to failure.' 1.26 The system for the transfer of revenues from the Central to Provincial Governments should be based predominantly on a revenue sharing system that is legally mandated and formula-driven. This is based on the normative position that a revenue sharing system should provide sufficient revenues to provinces so that, when combined with a reasonable revenue effort by the provincial governments, these may at least adequately operate and maintain their existing services. The overall system of intergovernmental 1 For a discussion of the reforms recommended for the Central Bank, and for the financial system in general, see The World Bank, Argentina: Reforms for Price Stability and Growth, World Bank Country Study, 1990, Chapter IV.

14 transfers should provide, therefore, not only a reliable source of revenues to provinces, but also strong incentives to improved provincial revenue performance. Discretionary grants should form a small part of resources flowing from the Central to Provincial Governments, basically limited to providing support in emergencies such as flooding. New provincial investments should be financed by provincial savings in current account and by responsible borrowing. Given this normative framework, the strategy for provincial fiscal reform should include an intergovernmental transfer system that: (a) is predictable; (b) is transparent; (c) provides transfers in sustainable and equitable quantities; and (d) provides incentives to provincial fiscal autonomy Within the national framework described above, the strategy requires that provincial governments adopt financial management practices that promote: (a) provincial financial autonomy; (b) management efficiency; (c) public accountability; and (d) expenditures that support sustainable economic development The Government has requested broad Bank support for implementation of its adjustment program, including assistance for reforms of the national public sector as a whole, including national public enterprises (to address the first two deficit sources noted in para. 1.01), and the proposed Provincial Development Project (third source). Thus, the proposed project would be a key element of international assistance to support the Government's adjustment program. As part of this support, the proposed Bank loan would substitute for the inflation tax, given the short-term provincial investment and financing needs (see Annexes 3 and 5). This is because provincial governments have no access to alternative foreign or domestic credit (save for arrears to domestic suppliers and contractors) other than provincial banks, whose deficits until 1988 were routinely covered by the Central Bank, but which currently are under tighter Central Bank control. As inflation falls to desirable levels, increased availability of foreign resources could permit additions to planned investment up to the full foreign amount without adding to inflationary pressure The proposed project also should be understood to be the first stage of a longer term strategy for adjustment in the financial relationships between the Central and Provincial Governments. It would assist the Government in moving from having a substantial proportion of provincial investments financed with national resources resulting in excessive fiscal and quasi-fiscal deficits to the financing of provincial investments with provincial savings and official borrowing under the proposed project. However, as (a) the economy stabilizes and resumes growth, (b) the financial sector is strengthened, and (c) provincial financial management is improved, the strategy seeks at its final stage to have provincial investments entirely financed with provincial savings and competitive borrowing through the financial sector.

15 -8- II. THE PROJECT Project Origin 2.01 The proposed project builds on the operational experience gained through partial implementation of the Argentina: Municipal Development Project (Loan No AR, approved by the Board on March 22, 1988), as well as the sector work resulting in the "Argentina: Provincial Government Finance Study" (PGFS, Report No AR, distributed to the Board on April 16, 1990). Project preparation has benefitted from Project Preparation Facility Advances approved January 4, 1990 (P-145-AR) and September 27, 1990 (P-161-AR) The Municipal Development Project became effective March 3, 1989, and as of September 30, 1990, US$ 5.0 million of the total loan of US$ million had been disbursed. Disbursements have been severely hindered by the periods of hyperinflation (mid 1989 and early 1990) when practically all LCB procurement was halted. Despite this difficulty, however, political and institutional commitment to the project (with fiscal discipline objectives similar to the proposed project) has remained high. The last supervision mission for this project (August 1990) indicates that the project's successful implementation will accelerate as progress toward price stabilization is achieved and maintained. For example, the 1990 Investment Plans approved by the Bank for the participating provinces (Buenos Aires, Cordoba, La Pampa, Neuquen and Santa Fe) provide for 221 sub-projects with about US$ 40 million total costs. By mid-1990, about 77 sub-projects, representing approximately US$ 18 million in total costs, had been completed, were being executed or were at an advanced stage of the procurement process As for the PGFS, it was delivered to the Government in November 1989, and its conclusions and recommendations have been endorsed fully by the Government (including authorization of publication as a Red Cover Report). The Government has taken concrete measures to implement the report's recommendations, including substantial progress in implementing the Provincial Financial Management Information System (FMIS) and through modification of the criteria for allocation among provinces of the proceeds of the "Transitional Fund for Fiscal Disequilibria", enacted in 1988 to assist provinces in adapting to the new revenue sharing law during a period of high inflation and shortfalls in projected shared national revenues (Oliveira-Tanzi effect). With legal modifications introduced in 1990, allocation among provinces of the Fund's proceeds has been brought in line with the PGFS's recommendations. Currently, the Ministry of Economy monitors, through the FMIS, implementation of deficit reductions in each province targeted for assistance through the Fund on a quarterly basis, and if progress is not satisfactory, the province loses its Fund allocation, which is then distributed among all other provinces according to the shares in secondary revenue sharing (for details, see Annex 2). In summary, the Government already is implementing strong measures consistent with recommendations of the PGFS and the objectives of the proposed project. Ministry of Economy officials emphasize, however, that international assistance is vital to broaden these reforms. speed their implementation, and to support adeguate intergovernmental coordination in implementation of macroeconomic policies.

16 -9- Proiect Obiectives 2.04 The overall objective would be to provide financial support and incentives for provincas to undertake their own adjustment programs (ownsource revenue enhancement and expenditure control) consistent with the national adjustment program. This would be achieved through providing Bank financing only to provinces that meet strict financial performance and other eligibility criteria (see paras ). Specific project objectives are to: (a) (b) (c) implement appropriate financial management reforms that will transform provincial governments from generators of excessive public sector deficits to generators of surpluses that may finance public infrastructure and services necessary to promote economic development; strengthen provincial governments' capacity to plan, program, finance, execute and monitor expenditure programs that are economically efficient, financially sustainable, institutionally manageable, and environmentally sound; and provide financing for institutional development and physical investments that are consistent with the national adjustment program and that will promote economic development. Project Description 2.05 The proposed operation would finance civil works, goods and consultants necessary to implement Provincial Financial Action and Investment Plans (see para. 2.10), to be proposed by provinces and approved by the Central Government's Ministry of Economy and the Bank. Thus, the project would finance a "time-slice" of eligible provincial expenditures, and its components would be detailed during project implementation. However, a profile of expected components, based on past and projected provincial investment expenditures, is presented in Annex The project would have two main components: (a) (b) Institutional Development, (about 10 percent of total project costs) including technical assistance, training and equipment to attain the project's objectives at both the Central and Provincial Government levels. Training and technical assistance would focus on such areas as the creation or improvement of: maintenance planning and administration; information systems; planning and budgeting systems; general organization and management; inventory controls; improvement of cadastres and billing systems; revision of legislation; personnel policy; and project preparation and evaluation, including analysis of environmental impacts. Physical investments, (about 81 percent of total project costs) encompassing public infrastructure (e.g., roads, bridges, drainage, water supply and sanitation) and facilities (e.g.,

17 schools, health posts, bus terminals). These investments would include maintenance programs, rehabilitation of existing works, completion of unfinished works, and new investments. It is estimated that maintenance and rehabilitation would be by far the largest part financed by this component. (c) Proiect Administration, (about 9 percent of the total project costs) for the recurrent costs of project implementation at the national and provincial levels. Project Costs and Allocation among Beneficiaries 2.07 Total project costs are estimated at US$ 575 million equivalent, excluding land, duties, taxes and interest charges. The proposed Bank loan would finance 35 percent of these costs, as summarized in Table 1. Table 1: ESTIMATED PROJECT COSTS (in USS millions of December 1990) F.E.C. as % of Comionent 1/ Local Foreign l of T.ofITotal Total Costs I. Institutional Development2/ A. Central Government 1. Consultants Goods B. Provinces 1. Consultants Goods Sub-Total I II. Physical Investments A. Infrastructure 1. Maintenance Rehabilitation Completion New Works Q Sub-Total II.A B. Facilities 1. Maintenance Rehabilitation Completion New Works Sub-Total II.B Sub-Total II III. Project Administra TOTAL PROJECT COST I/ Because the proposed project would finance a time slice of provincial investments, these estimates of cost allocation are not precise. 2/ Including US$ 1.5 million for repayments of the PPF Advances.

18 Costs are expressed in US dollars because of the instability of the national currency. For the total project, foreign exchange costs are estimated at 43.1 percent, with approximately 39 percent for the Institutional Development Component and 48 percent for physical investments All provinces, tha Municipality of Buenos Aires and the Territory of Tierra del Fuego (henceforth cited collectively as "provinces") potentially would be eligible to participate in the project. However, actual access to project funding would be conditioned to each province meeting project participation eligibility criteria to be clearly specified in the Project Operations Manual (POM, see para. 3.02(a) and Annex 10) All operational procedures (including provincial financial performance criteria, expenditures eligible for financing, procurement, disbursement and audit guidelines) would be specified in the POM, as propo.td by the CEU, agreed with the Bank and incorporated into the legal documents. The POM also would provide detailed guidelines to the provinces for preparation of their Financial Action and Investment Plans (FAIPs). Each province's FAIP would determine if, and for what purposes, it may participate in the project. Approval by the CEU and the Bank of a province's FAIP would be required for any project support to the province. The FAIP would include, inter alia, the sub-project's institutional arrangements (including the Provincial Execution Unit) and a concrete action plan for (a) maintaining a current account surplus 2 or (b) provincial revenue enhancement and/or expenditure reduction that would result in a current account surplus during the FAIP implementation period The amount of project financing to be provided to any province with an approved FAIP would depend on its financial management performance. The Government's policy is to provide equal, potential access for all provinces to international assistance. Therefore, the initial, potential allocation of Bank and IDB loan proceeds would be according to each province's quota in the secondary distribution of revenue sharing. Table 2 presents this initial allocation based on provincial executed budgets for In order to receive its full quota, a province's FAIP would demonstrate that the province has met all of the following financial eligibility conditions. (a) (b) (c) A current account surplus during the last executed budget period. An acceptable plan to consolidate all extra-budget debt in the formal provincial budget within three years, or except as the Bank may agree, within a maximum of five years. Total existing and proposed provincial debt must not result in a total debt service (amortization, interest and other financing charges) obligation greater than 15 percent of total provincial current revenues. 2 See Annex 3 for the operational definition of the current account surplus/deficit.

19 Table 2: INITIAL ALLOCATION OF LOAN PROCEEDS AMONG PROVINCES (in USS millions of December 1990) Revenue Sharing Distribution of Bank/lDB Loan Current Secondary Total Loans = USS N Groups of Account Distribu. Quota Quota Pool Provinces Surplus/Deficit (x) (X) (USSN) (USSM) TOTAL ADVANCED Federal Capital Buenos Aires (3.8) Cordoba Mendoza Santa Fe (181.4) LOW DENSITY Chubut (2.2) La Pampa Neuquen Rio Negro Santa Cruz (5.5) INTERMEDIATE Entre Rios Salta (13.2) San Juan San Luis Tucuman (8.4) UNDERDEVELOPED Catamarca (34.7) Chaco Corrientes (11.9) Formosa (10.8) Jujuy (45.4) La Rioja (25.6) Nisiones Santiago del Estero T. del Fuego NOTES: The Federal Capital and Tierra del Fuego currently do not participate in the Revenue Sharing System. Their percentage shares would be agreed with the Bank prior to signing the Loan Agreement.

20 (d) Negative net variation in short term assets and liabilities must not exceed 20 percent of total revenues Provinces that meet all of the above conditions would be eligible for their full initial quotas, while provinces that do not meet these conditions would be eligible for only half their quotas. For example, based on the current account status presented in Table 2, Mendoza, with a current account surplus, could receive its full quota (4.24 percent of the $ 400 million equivalent in loan proceeds). Santa Fe, however, with a deficit, could receive only half of its potential quota, with the other half going to a "pool" to be held by the Central Government until provinces fully commit the resources of their initial quota and then would be eligible to receive additional loans from the pool on a "first come, first served" basis. Provinces that did not participate in the initial quota allocation also would be eligible to receive financing from the pool. However, any province may receive financing from the Dool only if it meets all of the financial eligibility conditions above. Based on the 1989 data, about 70 percent of loan proceeds would be allocated initially on the quota basis, with the remaining 30 percent allocated to the pool. To provide further incentives to provincial fiscal performance and project execution, the initial allocation based on quotas would be valid for only the first two years after signing of the Loan Agreement, and all uncommitted loan proceeds originally allocated by quota would be transferred to the pool. In summary, the quota allocation would provide equal eligibility opportunity for all provinces to have access to project financing (including the poorer provinces with unsatisfactory financial performance at the project's beginning), while allocation of the pool's financing would be based solely on the basis of overall financial and project implementation performance Continuation of a province's access to project financing would depend on its financial management performance. For example, if a province has an approved FAIP and fully meets all of the financial eligibility criteria of para. 2.11, it may receive project financing (as part of the initial quota or from the pool). However, if during implementation of sub-projects financed under the project, a province fails to continue to meet all of these criteria, then the POM would provide that all uncommitted subsidiary loans for eligible sub-projects (see para. 2.31) would be cancelled and transferred to the pool. In the case of a province that does not meet initially all of the financial eligibility criteria but has an approved FAIP for limited financing under the project (para. 2.15), the POM would provide that adequate progress in meeting the targets (as laid out in the FAIP) for improving its financial management status would be a condition of continued financing under the project; if this progress is not adequate, then uncommitted subsidiary loans would be cancelled and transferred to the pool In summary, the allocation of project financing among provinces would depend on actual provincial financial performance, with the criteria for judging this performance laid out in the POM, and with the specific measures to meet these criteria established in approved FAIPs. The proposal of FAIPs by provinces and their approval by the CEU and the Bank would be a dynamic

21 process, without a strict, yearly cycle of proposals and approvals. Especially during the irnitial part of project implementation, it is important that the CEU be flexible in receiving new FAIP proposals, because the proposed process would be an innovation in central/provincial relationships. The CEU would provide intensive support to the provinces in preparing their FAIPs, especially during the initial period of project implementation and for those provinces with the most serious financial problems, and the CEU would be slructured accordingly (see para. 2.24). Successful implementation of this process also would require intensive monitoring of provincial performance (para. 2.32). Expenditures Eligible for Financing Under the Project 2.15 Provinces with current account surpluses would be eligible for financing of any investments (maintenance, rehabilitation, completion of works or new investments) that are part of an approved FAIP and that meet economic, financial, technical, institutional and environmental appraisal standards as laid out in the POMI. Provinces with a current account deficit would not be eligible to receive financing for new investments, and project financing for maintenance, rehabilitation and completion of unfinished works would be conditioned strictly to each component's tangible contribution to moving the province from a current account deficit to a surplus according to financial performance targets and timetables approved in the FAIP Because of the broad institutional objectives of the project, flnancing would not be limited to specific sectors. In principle, the project n'ouid finance any provincial service or infrastructure that is technically rourd, economically efficient, financially sustainable and environmentally adeauate. 3 However, to be eligible any expenditure must be part of an approved FAIP, with justifi.ations and appraisal performed according to the procedures laid out in the POM (see Annex 10). The POM also would include clear limitations to eligible provincial services and infrastructure, defined as those that: (a) the province is legally mandated to provide; (b) are procured under the authority of the province; and (c) when financed through user charges or service fees, the province is autonomous to establish such cbarges or fees In many provinces, reduction or elimination of discretionary transfers to municipalities with current account deficits would be an important part of improving their financial performance. In those cases, provircial technical assistance for municipalities, targeted to eliminate these deficits and subsequent discretionary transfers, would be eligible for project financing if part of an acceptable FAIP. However, this technical 3 Excluding, of course, expenditures prohibited by Bank policy, such as ler.d, taxes, duties, military or para-military goods, public office or other buildings not directly related to productive purposes.

22 assistance financed under the proposed operation would not be provided to municipalities eligible to participate in the ongoing Municipal Development Project (Loan 2920-AR) The Government is implementing a significant decentralization of the public sector, with increasing transfer of responsibility from the central to provincial governments, and it has requested Bank support in many sectorspecific areas for which provinces would be the primary executing agencies. To ensure proper coordination and policy consistency between the proposed operation and other, sector-specific projects at the provincial levei, the following were agreed (3.01(j)). (a) (b) When there exists an effective, sector-specific project with Bank financing (e.g., water, health, education, transport) with uncommitted funds for potentially eligible provinces, then those provinces would not receive financing for that sector under the proposed project (ensuring compliance with sectoral policies agreed by the Ministry of Economy and the Bank). All provincial, sector-specific projects would provide financing only to provinces with FAIPs acceptable to the Ministry of Economy and the Bank when the sectoral project would require provincial counterpart financing (including guarantees) of any kind (to ensure that the fiscal objectives of the proposed project are sustained). Financing Plan 2.19 Parallel financing by the World Bank and IDB is proposed, with each institution providing 35 percent of total project costs. The aggregate level of external financing (70 percent) is justified because of (a) the need to provide strong incentives to improve provincial financial management performance to meet the project's objectives, (b) the strong long-term institutional development impact the project is expected to promote, and (c) the absence of alternative, domestic development financing available in Argentina during this initial stage of implementation of its adjustment program The financing plan is presented in Table 3. The Bank loan would be made at the Bank's standard variable interest rate with repayment in 17 years, including five years of grace.

23 Table 3: FINANCING PLAN (in USS millions of December 1990) Source Amount Percent IBRD IDB Provinces TOTAL Cofinancing with the Inter-American Development Bank (IDB) is proposed. Although cofinancing would be on a parallel basis, the Government and both tanks have agreed on project objectives and general operational procedures. The IDB's Executive Directors are expected to consider its proposed loan at approximately the same time as the Bank's Executive Directors. If, however, IDB financing is not approved within one year after the proposed loan is declared effective, the Bank would agree with the Government to increase the Bank's financial participation up to 60 percent of total project costs. Implementation Arrangements 2.22 The borrower would be the Argentine Republic, and its Ministry of Economy, through the Central Execution Unit (CEU) would be the national executing agency. The CEU would be responsible for overall project management, including orientation and assistance to provinces (directly and through the POM) in preparation of their FAIPs, approval of the FAIPs, monitoring of FAIP implementation, and all financial and reporting transactions with the Bank (see Annex 12). The CEU also would implement directly the Central Government's Institutional Development Component, including the provincial government Financial Management Information System, technical assistance to strengthen its performance, and studies to support improved financial relationships between the Central and Provincial Governments. Details of the proposed organization, staffing and responsibilities of the CEU are presented in Annex The CEU would be subordinated to the Under Secretary for Administrative and Technical Coordination (SCAT), and the SCAT's Under Secretary would be the CEU's General Coordinator. The General Coordinator would be assisted by an Executive Coordinator fully dedicated to project implementation. The General Coordinator would inform and discuss all relevant project aspects with a Consultive Board, which would be the existing Forum of Ministers (see para. 1.22). The Ministers of this Board would be responsible for the implementation of the project within each of their provinces through the Provincial Execution Unit (PEU) Besides implementing the Central Government's component of the project and in order to be able to evaluate, supervise, support and coordinate the sub-projects of the provinces, the internal structure of the CEU would reflect the two main steps involved in project implementation: first, increase revenues and expenditure efficiency; and second, use the resulting current account surplus for justified investments and to amortize loans. In

24 other words, the institutional design would reflect the project's two main objectives: structural reform of the public sector and a sound program of capital expenditures. The CEU's Institutional Development Program Division would be responsible for evaluating and supporting Provincial Financial Action Plans, and the Investment Program Division for evaluating and supporting provincial investment program. The CEU would include an environmental professional to monitor and support environmental screening and assessment as part of the FAIPs. The Financial Management Information System Division, besides being a permanent body necessary to provide data for provincial and national fiscal planning, would also monitor provincial progress toward fiscal autonomy during project implementation. The Administrative Division would carry out the normal administrative routines of the unit as well as cover the project's specific administrative requirements for Bank financing (SOEs, management of the Special Account, etc.) Each PEU would be responsible for formulation, implementation, and supervision of its FAIP. Actual execution of physical investments would be undertaken by government agencies according to procedures established in the Project Operations Manual (See Annex 10). As the objectives of the provincial sub-projects are the same, and to meet adequately the needs of their implementation, the basic structure of the PEUs would reflect that of the CEU, even though the political and administrative organization of the provinces varies greatly The PEU would be subordinated to the provincial minister with a seat in the Forum of Ministers who would be its General Coordinator. This would support national and local coordination, spread of innovations and lessons learned in problem solving, and homogeneity of procedures in project implementation. The General Coordinator would be assisted by an Executive Coordinator fully dedicated to FAIP formulation and implementation. The General Coordinator would inform and discuss all relevant aspects of the FAIP with a "Consulting Board" in order to achieve the necessary political, technical and administrative support for the sub-project implementation. The board would be appointed and presided over by the Governor, who would be assisted by the General Coordinator. The composition of this Board would vary in the different provinces due to their different political and administrative organization, but a typical composition would be ministers, chief executives of public enterprises and decentralized entities, representatives of the legislative body (if possible, the President of the Budget Commission) and the private sector The PEU would perform the following key functions: promotion of provincial institutional development; proposal, evaluation and monitoring of financial reforms and investment programs (including environmental screening and assessment); design and permanent implementation of Financial Management Information Systems; and administrative control (including Bank reporting requirements). For the proposed organization and staffing of the PEUs, see Annex 11. ; Approximately 35 professional and support staff would be required for the CEU and about 30 total staff for each PEU, or about 700 total PEU staff. Thus, about 750 total staff would be dedicated to the core management

25 of the project, including preparation and review of FAIPs, supervision of their implementation and the reporting requirements of the Bank. While this would be a sizable number, it is not excessive considering the size of the project (US$ 575 million total cost), national dimension, and the need for up to 25 executing agencies. Furthermore, as provinces recover and improve their financial status, permitting total provincial investments to return to levels of the mid-1980s, the CEU and PEUs would propose and supervise provincial investment programs on the order of US$ 1.5 billion per year (see Annex 3). Total project costs provide US$ 50 million for project administration (no Bank financing). Considering a five year implementation period, this would average about US$ 13,000 per staff, including salaries, travel and other overhead. Staff for the CEU and PEUs are expected to be obtained from existing agencies, and would be supported by consultants financed under the project as needed. Actual investment execution, operation and maintenance would be undertaken by provincial line agencies, such as the Ministry of Public Works for transport investments, while the PEU would ensure that the investments are part of an approved FAIP implemented in accord with the project's Loan Agreement and the POM. In summary, staffing of the CEU and PEU is expected to be obtained by existing personnel, supported by consultants, and the CEU and PEU responsibilities are expected to be assigned to existing agencies of the respective Ministries of Economy. Adequate staffing and support to (a) the CEU would be a condition of loan effectiveness (para. 3.02(a)), and (b) the PEU as a condition of disbursement for any province (para. 3.03(a)) There are important distinctions between the CEU and PEUs regarding their objectives and functions. The PE-Us would have a permanent function within provincial governments, providing improved planning, budgeting and supervision of financial management for the provinces as an overall institution. Therefore, the project would seek to strengthen PEUs as part of the project's objectives to implement provincial financial management reforms and to strengthen financial management capacity. Although the CEU would have some permanent functions (e.g., information system for monitoring provincial financial management performance), most of the short-term functions of the CEU's operation would have transitory objectives. The proposed project would assist the Government in implementing a structural adjustment in the financial relations between the Central and Provincial Governments. In the past, a substantial proportion of provincial investments have been financed with national resources, resulting in excessive fiscal and quasi-fiscal deficits that clearly are not sustainable. The Government seeks to move, over time, from these destabilizing practices to a policy under which provincial investments would be financed by provincial current account savings, leveraged bv provincial borrowings through a competitive, domestic financial sector. The Government has requested international assistance in financing this transition. Under the proposed project, the Bank's resources would be onlent by the Ministry of Economy to provinces, primarily in substitution of the inflation tax (para. 1.28). Given that provinces essentially have no alternatives for non-earmarked, long-term financing for development investmenws, this medium-term lending function of the Ministry of Economy would provade signific4nt incentives for provinces to meet the project's eligibility criteria and tilerefore contribute to the Government's mediun-term stabilization program. However, the role of the Ministry of Economy as a "financial intermediary" clearly is limited and transitory because this

26 sustained function would be provided by the financial sector. Therefore, much of the CEU's role also would be limited and bransitory, in support of a transitory onlending function. It follows that the CEU should not be fully staffed by permanent civil servants. Although formal authority and responsibility for the CE.U must rest with an official of the Ministry of Economy, it would be cor.sistent with project objectives to have substantial CEU professional and supl)ort functions performed by consultants financed under the project. Also, the need for CEU consultants financed under the project would decrease over time, and eventually eliminated as the transitory role of "financial intermediary" for the Ministry of Economy is eliminated As a formal manifestation of agreement with the proposed project's objectives, scope and participation criteria, Development Policy Letters would be received by the SCAT from at least 13 provincial governments as a condition of negotiations (para. 3.01(b)). These letters should include: (a) (b) the provincial government's agreement with project objectives, eligibility criteria, and other operational procedures contained in the draft POM reviewed during the pre-appraisal mission; and preliminary components of the province's FAIP including analysis of its status regarding the project's financial eligibility criteria (para. 2.11). The PPF Advances are expected to support the above and other efforts, so that eligible provinces may have the plans, studies, draft legal agreements, etc. in place in order to begin project implementation soon after loan effectiveness Except for approximately one percent of the loan that would finance institutional development in the national Ministry of Economy, all proceeds of the Bank loan would be onlent to participating provinces, with each province's revenue sharing serving as a guarantee for repayment of subsidiary loans. For onlending to provinces, the Ministry of Economy would enter into a Financial Agency Agreement with an appropriate financial institution (Financial Agent), satisfactory to the Bank, as a condition of effectiveness (para 3.03(c)). The terms and conditions of subsidiary loans would be established in Subsidiary Loan Agreements between the Government and each participating province. The execution of Subsidiary Loan Agreements with at least three Provinces, representing an initial allocation equivalent to not less than 25 percent of the amount of the Bank loan would be a condition of effectiveness (para. 3.03(b)). The terms and conditions of these Agreements would be essentially the same as the Bank loan, including the foreign exchange risk, as well as providing for recovery of the administrative cost of the Financial Agent and the cost of CEU consultants, in order to ensure that provincial project components would not result in a fiscal burden for the Central Government. These costs are not expected to exceed one percent of the amount of sub-loan disbursements. For subsidiary loans resulting from the initial quota of loan proceeds allocation (para. 2.11), the Subsidiary Loan Agreements would stipulate that each participating province would pay the loan commitment fees as follows: (a) in direct proportion to that province's participation in the sum of all Subsidiary Loan Agreements undertaken as part

27 of the initial allocation by quotas; plus (b) this same proportion of the loan amount to be allocated through the pool. As provinces receive loan proceeds under the initial quota, their total obligation for commitment fees would decrease accordingly. For subsidiary loans flowing from the "pool", Subsidiary Loan Agreements would provide that each province would pay the commitment fees in direct proportion to its subsidiary loan's participation in the total of the pool. In cases where provinces make sub-loans to beneficiaries (e.g., provincial enterprises), similar subsidiary loan agreements would be made to ensure that the full costs of the Bank loan are recovered by final beneficiaries, following the procedures established in the POM Adequate Bank supervision of the proposed project would require detailed, ex ante review of all provincial FAIPs. These FAIP would include investment proposals in many sectors, and their adequate review would entail evaluation of their consistency with general and sectoral development policies in discussion with or agreed with the Bank. The project's supervision plan is summarized in Annex 12. Successful implementation of project objectives also will require intense monitoring of actual performance by both the CEU and the Bank. The Government already has made substantial progress in implementing its Provincial Financial Management Information System (partially financed by the PPF Advances), and it proposes to monitor provinclal financial performance and evaluate compliance with FAIP agreements on a quarterly basis. The Bank also would monitor implementation of FAIPs through its supervision missions. In addition, the Government and the Bank agreed to hare annual reviews to exchange views on the status of project implementation, particularly regarding (a) the CEU and PEUs performance in project implementation procedures agreed with the Bank, and (b) adjustmenits in the POM that ma: be required to improve implementation of project objectives (para. 3.1(d)). Procurement 2.33 Procurement would be undertaken by the CEU and up to 24 provinces, and approximately 78 percent (US$ 362 million) of total physical investments are expected to be allocated to goods and works for maintenance and rehabilitation investments. Procedures would be consistent with parallel financing by the Bank and IDB (para. 2.38). ICB would be based on the Bank and IDB's "Sample Bidding Documents" for the procurement of works and goods, and LCB would be based on model bidding documents for the procurement of works and goods. All of these models would be included in the POM, and approval of the POM by the Borrower in terms satisfactory to the Bank would be a condition of effectiveness (para. 3.02(d)) Contracts for civil works expected to exceed US$ 3.0 million (to account for approximately US$ 160 million, or 28 percent of total project costs) and for goods exceeding US$ 250,000 (to account for approximately US$ 10 million, or two percent of total project costs) would be awarded on the basis of ICB procedures in accordance with Bank guidelines. Contracts for works expected to cost between US$ 25,000 and US$ 3 million (to account for approximately US$ 279 million, or 49 percent of total project costs), and between US$ 25,000 and US$ 250,000 for goods (to account for approximately

28 US$ 24 million, or four percent of total project costs), would be awarded on the basis of LCB procedures agreed with the Bank. Procurement for goods and works costing less that US$ 25,000 (to account for approximately US$ 16 million, or three percent of total project costs) would be done through international or local shopping involving at least three price quotations. Consultant services, expected to cost approximately US$ 36 million, or six percent of total project costs, would be procured in accordance with Bank guidelines. These arrangements are summarized in Table 4. Although following procurement procedures in accordance with Bank guidelines would be new for many provinces, considerable experience has been gained in the five provinces implementing the Municipal Development Project. To spread this experience as broadly as possible, the project preparation activities financed under the PPF Advances include regional seminars on Bank procurement policies and procedures. Table 4: PROCUREMENT METHOD (in US$ millions) Project Element Procurement Method Total ICB LCB Int./Local Other Cost ShoDRin Civil Works Maintenance (18.5) (3.7) (22.2) Rehabilitation (37.4) (68.7) (106.1) Completion and New Works (22.4) (15.9) (33.3) Goods Maintenance Equip. & Goods (2.1) (2.3) (1.8) (6.2) TA Equip. & Goods (2.2) (6.6) (0.4) (9.2) Consulting Services (18.0) (18.0) Project Administration (0.0) (0.0) TOTAL (64.1) (112.0) (5.9) (18.0)(200.0) Notes: Figures in parentheses are the respective amounts financed by the Bank. Because the proposed project would finance a time slice of provincial investments, these estimates by element and method are not precise.

29 Except for execution of maintenance programs (for which some provinces may justify force account procedures as the most efficient and economical), it is expected that rehabilitation, completion of works and new investments would be undertaken through contracts with private firms in accordance with Bank guidelines. On an exceptional basis, force account procedures could be used by provinces to execute directly civil works, with total procurement of goods (except related to maintenance) not to exceed 10 percent of the total cost of civil works (rehabilitation, completion of unfinished works and new investments) in each province on an annual basis. The Bank would finance equipment and materials for works executed under force account, but it would not finance salaries, installations or works executed under force account. Furthermore, the total cost of goods purchased to support a given civil work (including maintenance) executed under force account would not exceed US$150,000 equivalent, and all goods purchased under force account procedures would be procured in accordance with the procedures summarized in paras To ensure that the agreed procurement process is properly carried out, the CEU and the Bank would review ex-ante all procurement procedures, documents, bid evaluations and contract awards for ICB procurement of goods and works during the entire project implementation period. In addition, at least during the first year of project implementation, the CEU would review ex-ante the procedures for all other procurement of goods, works and consulting services in each province. Bank staff also would review ex-ante the first two LCB procedures for works and the first two LCB procedures for goods, previously revieved by the CEU, each year of project implementation. Prior Bank review of procurement procedures of works and goods is summarized in Table 5. In all cases, however, the Bank would review LCB, international and local shopping, force account and consultant procurement procedures on an ex-post basis by sampling, and if it were determined that procurement was not made following agreed procedures, then no expenditures for such items would be financed out to the proceeds of the loan, the Bank would cancel the corresponding loan amount, and the Special Account would be reimbursed accordingly by the Borrower (para. 3.01(e)). Table 5: SUMMARY OF PROCUREMENT REVIEW PROCEDURES Category Procedure Prior Bank Review Works Less than US$25,000 Shopping US$25,000-US$3 million LCB First 2 each year More than US$3 million ICB All Goods Less than US$25,000 Shopping US$25,000-US$250,000 LCB First 2 each year More than US$250,000 ICB All

30 Disbursement 2.37 For withdrawal of the proceeds of the proposed Bank loan, the following categories and disbursement percentages are proposed: (a) (b) (c) (d) 100 percent of total expenditures for consultant services and audits, including travel expenses related to these services; 100 percent of foreign expenditures for works and goods under all categories; 75 percent of local expenditures for works and goods purchased locally; and 100 percent of the amounts due to the Bank under the PPF Advances (para. 2.01) The preceding categories and disbursement percentages are based on the understanding that IDB would provide co-financing, on a parallel basis, with equivalent categories and disbursement percentages. As part of its annual review of project implementation, the Bank would evaluate its participation in total project financing. If the Bank's overall participation substantially deviates from 35 percent of total project costs, it would request the CEU to adjust the distribution of its commitments to new subsidiary loans with proceeds of the Bank and IDB loans accordingly until each agency's financing participation is consistent with the project's financing plan. However, if IDB financing is not approved within one year after the proposed loan is declared effective, then the Bank would agree with the Government to increase the Bank's financial participation up to 60 percent of total project costs (para. 2.21) A Special Account, in US dollars and with an initial deposit of approximately US$ 12 million dollars (estimate of average disbursements for four months), would be established in the Account Bank as would be provided in the Financial Agency Agreement (para. 2.31) between the Financial Agent and Account Bank and the Central Government which would be a condition of effectiveness (para (c)). The Special Account would be managed by the CEU. All disbursements against contracts for less than US$ three million for works, and for less than US$ 250,000 for goods and services, would be made on the basis of certified Statements of Expenditures (SOEs). The documentation for SOEs would not be sent to the Bank but would be retained by the CEU and made available for inspection by Bank staff. All other disbursements would be made against standard documentation Formal agreement by the Central Government and a participating province for implementation of the province's FAIP would be made through a Subsidiary Loan Agreement, satisfactory to the Bank. The FAIP would include specific sub-projects that would be potentially eligible for project financing, but at the time of FAIP approval and the signing of the Subsidiary Loan Agreement, detailed appraisal of each sub-project may not be completed and approved. Therefore, each sub-project must have specific Bank approval

31 (based on its full technical, economic, financial and environmental appraisal) before that sub-project would be eligible for disbursements from the Loan Account. Additional details regarding proposed disbursement procedures are provided in Annex As the first project of this nature and scope, there is no specific regional disbursement profile to apply for the proposed project. However, based on recent experience in Argentina a disbursement period and regional profile of six years is proposed (Annex 13). The time required to commit and disburse the loan will depend on the provinces' financial capacity to provide counterpart funding and institutional capacity to propose, appraise and execute sub-projects that are economically efficient, financially sustainable and environmentally sound. From the perspective of financial capacity (see Annex 5, Table 5.2), in 1989, 12 of 23 provinces produced current account surpluses (without grants). Summing these surpluses provides a total of US$ 360 million. Although of course not all of this amount should be considered as available for meeting the provincial counterpart requirement (US$ 175 million), it provides an order of magnitude regarding the provinces' capacity to invest and to service debt. The sum of the real investments (works and goods) in these 12 provinces was US$ 485 million in 1989, down from US$ 815 million in 1988 (Annex 6, Table 6.2). Considering a six year project implementation period, the proposed project's financing for real investments (US$ 465 million) would represent Bank financing for about 16 percent of the total real investment program, assuming that only 12 provinces were eligible for investment financing and no improvement in current account surpluses. These data suggest that provincial counterpart funding does not present the largest risk to project implementation. Rather, the key to implementation success and timely disbursements lies with the institutional capacity to design, implement and supervise investments that are consistent with Bank guidelines Regardins provincial institutional capacity to generate timely disbursements, approximately 52 percent (US$ 242 million, Table 4) of total physical investments (Table 1) are expected to be allocated to provincial maintenance programs and rehabilitation investments implemented under LCB procedures, and these would have less demanding appraisal requirements than larger, new investments (see Annex 10). It may be expected, therefore, that relatively small maintenance and rehabilitation investments may be implemented quickly while larger projects are under preparation. Technical assistance to be financed under the project is expected to support this process, and the PPF Advances also are expected to support the institutional arrangements necessary for project implementation to be initiated quickly. Based on a six year disbursement profile, and assuming that the loan would become effectime approximately March 15, 1991, then the project's estimated completion date would be June 30, 1996, and the proposed closing date would be December 31, If the project is executed more rapidly than the six year regional profile, the shorter execution period would increase the benefits of the project, and indicate that the provinces have potential to mobilize efficiently more resources for investments.

32 Accounts and Audits 2.43 Annual audits of the Special Account, of the project account for the CEU component and of the project accounts for each participating province would be performed by private, independent auditors satisfactoty to the Bank, under terms of reference also satisfactory to the Bank (para. 3.01(h)). The audit reports would be delivered to the Bank not later than four months after the end of each year, and project account audits would include, inter alia, separate opinions on (a) sources and uses of account funds, (b) SOEs, and (c) compliance with all Bank agreements, including implementation of financial and other eligibility criteria established in the POM. Financial Impact 2.44 Beneficial financial impact is at the very core of the project's objectives. Through targeted technical assistance, and through conditioning access to project financing to improvements in provincial financial performance as an incentive to these improvements, the project seeks to support the large potential for improved financial management at the provincial level, as identified in the PGFS. For example, reforms in all provinces resulting from a 15 percent reduction in expenditures and a 15 percent increase in revenues would result in a fiscal gain of about US$ one billion in one year (Annex 5, Table 5.1). Economic ImDact and Analysis 2.45 The overall rate of return for all civil works components except community facilities was estimated based on the projected investment profile for potentially eligible provinces, using the results of Project Completion Reports for each type of component. The results show an economic internal rate of return of 19 percent for these components that represent about 60 percent of the total eligible investment cost (See Annex 8). As a minimum, the economic rate of return for components with full benefit-cost analysis would be 12 percent For completion of unfinished works and new investments estimated to cost US$ 2 million or more, the POM would require a full economic appraisal, with a rate of return estimate. 5 For investments estimated to cost less than US$ 2 million, and for maintenance operations and rehabilitation investments, the POM would indicate that the least cost alternative for a given service level specification would be acceptable (Annex 10). Social ImDact 2.47 Successful implementation of the proposed project would have two main social impacts: construction employment generation; and increased equity in provincial tax administration (Annex 8). Using the estimate of 30 percent s For paved provincial roads, benefit-cost analysis would be done for investments costing US$3 million or more.

33 as the cost of labor in total works' cost (US$ 449 million), and the average monthly wage of construction workers at roughly US$ 100 equivalent, project implementation would generate about 110,000 person years of construction employment. This would have an especially important impact during a period of high unemployment, particularly among unskilled workers that could work in construction, expected during the adjustment period. The project also would support measures to increase the efficiency of tax collection, and this generally would also increase equity by eliminating tax evasion and free riding. Environmental Impact 2.48 As a sector operation with multiple executing agencies and without a specific investment program at this time, an Environmental Assessment has not been done. Rather, the project would seek to ensure that the CEU and PEUs establish and maintain an adequate institutional capacity to screen investments with potential environmental impacts and put in place remedial measures, when necessary. Thus, the POM (Annex 10) would include the environmental screening and assessment guidelines consistent with the Bank's environmental policy, and the CEU and Bank staff would monitor implementation of these guidelines (para. 3.01(i)). In addition, the project would finance technical assistance needed to improve the institutional capacity of provincial governments to do environmental assessments and to implement remedial measures. Project Risks and Safeguards 2.49 The main risks are (a) lack of initial interest of the provinces in doing the fiscal reforms required for participation eligibility (b) lack of continuity in political commitment to the project during its implementation, and (c) other factors over which the provinces have little or no control, such as: macroeconomic instability, declines in the prices of export products and crop failure. In other words, some of the provinces may not be interested; those that do decide to enter may not show high levels of commitment and efficacy; and "exogenous" factors might inhibit good performance The project would have a built-in mechanism for managing these risks in that it would allocate project resources based on performance. Those provinces which begin project implementation earlier and perform better (i.e., develop the institutions and generate current account surplus) will receive more resources. In this sense, the different provinces can be seen as elements of a "portfolio" in which the risks of non-performance due to the above mentioned internal and external factors varies considerably. In other words, the "portfolio" is diversified, increasing the probability of good performance on average for the project as a whole. Furthermore, it is expected that the incentives for revenue and expenditure reforms provided by the project's proposed eligibility criteria would stimulate the diffusion of innovations attained in more successful provinces to less successful ones.

34 III. AGREEMENTS TO BE REACHED AND RECOMMENDATIONS 3.01 During negotiations, the following assurances were obtained: (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) the project will be carried out in accordance with the Project Operations Manual, satisfactory to the Bank, and it will not be amended without the Bank's prior consent (para. 2.09); the Central Execution Unit will be designated and adequately staffed and )therwise supported in the implementation of its responsibil.ty under the project (para 2.22); except for proceeds used to finance the Institutional Development Component of the Central Government, all of the proceeds of the Bank loan will be onlent to eligible provinces under terms and conditions equivalent to the Bank loan, with each participating province's revenue sharing serving as a guarantee for repayment of subloans (para 2.31); the Government and the Bank would have annual reviews to exchange views on the status of project implementation (para. 2.32); procurement will be carried out in accordance with Bank guidelines (paras ); if the Bank's overall financing participation substantially deviates from 35 percent of total project costs, the CEU would adjust the distribution of its commitments to new subsidiary loans with proceeds of the Bank and IDB loans accordingly until each agency's financing participation is consistent with the project's financing plan (para. 2.38); the Government will open and maintain, in US dollars, a Special Account (2.39); the Special Account and Project Accounts will be audited according to procedures and with auditors acceptable to the Bank (para 2.43); and the CEU and PEUs will carry out environmental protection measures, as provided in the Project Operations Manual in a manner consistent with the Bank's environmental policy (para. 2.48). the Government will provide proper coordination and policy consistency between the proposed operation and other, proposed sector-specific projects at the provincial level (para. 2.18).

35 The following would be Conditions of Effectiveness: (a) (b) (c) (d) (e) the establishment and adequate staffing (including civil servants and consultants) of the CEU and of the PEUs in the provinces referred to in (b) below (para. 2.28); the execution of Subsidiary Loan Agreements with at least three provinces, representing an initial allocation of loan proceeds equivalent to not less than 25 percent of the amount of the Bank's loan (para. 2.31); the execution of the Financial Agency Agreement between the Government and the Financial Agent and Account Bank (paras and 2.39); approval of the POM by the Borrower in terms satisfactory to the Bank (para. 2.33); and satisfactory legal opinions on the validity of the actions and Agreements referred to in (a) to (d) above Special Condition of Disbursement in respect of each province would be: (a) establishment and adequate staffing of the PEU (para. 2.28); (b) (c) execution of a satisfactory Subsidiary Loan Agreement (para. 2.31); and satisfactory legal opinion on the validity of the Subsidiary Loan Agreement. Recommendation 3.04 With the above assurances and conditions, the proposed project would be suitable for a Bank loan of US$ million equivalent, to be repaid over a period of 17 years, including five years of grace, at the Bank's standard variable interest rate and fees.

36 Annex 1 Page 1 of 8 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT SRatial Distribution of Population. Product and Poverty 1. Although both population and product are still highly concentrated in the Federal Capital and the Province of Buenos Aires, the tendency over the period was for both population and product to grow more rapidly outside of these two areas, especially in what might be called the "resource frontier" - the sparsely populated provinces of the periphery with rich endowments of natural resources. The CFI 1 Stratification of Provinces 2. Many CFI studies stratify the provinces in four groups: Advanced Low Density Intermediate Underdeveloped Buenos Aires, Cordoba, Mendoza, Santa Fe and the Federal Capital (Municipality of Buenos Aires). Chubut, La Pampa, Neuquen, Rio Negro and Santa Cruz. Entre Rios, Salta, San Juan, San Luis and Tucuman. Catamarca, Chaco, Corrientes, Formosa, Jujuy, La Rioja, Misiones and Santiago del Estero. These four groups are relatively homogeneous with regard to population size, economic product and poverty levels, but the names of the four groups are confusing. For example, Formosa has low demographic density, but is classified as "Underdeveloped" and not "Low Density. I More descriptive names for these same CFI regions would be: Advanced Intermediate Low Density Underdeveloped High Population and Gross Provincial Product(GPP) Intermediate Population and Per Capita GPP. Small Population and High Per Capita GPP. These are provinces on the "Resource Frontier", such as Chubut, Neuquen, etc. Low Per Capita GPP and High Poverty. 1 CFI (Consejo Federal de Inversiones) is a rather unique public institution that is financed by a percentage of total provincial revenue sharing, and its Board of Governors is comprised of the Governors of all the provinces. Thus, it is national is scope, but provincial in focus.

37 Annex 1 Page 2 of 8 Note that the last category uses slightly different criteria than the others in that it includes all provinces with low per capita product and high relative poverty levels, even those with populations of small and intermediate size. One way to think of this process of classification, then, is that the poorest provinces are first grouped into one group, and the rest are, in turn, classified by population and per capita product. The provinces of the Intermediate Group had populations ranging from 500,000 to 1.1 million in 1985 and per capita GPP in the middle third of the distribution. Population. Product and Poverty by Province and CFI Group2 3. Of the total estimated population of 30.6 million in 1985, 21.6 million (70.5 percent) lived in the Advanced Group. See Table 1.1. The 36,000 inhabitants of Tierra del Fuego are excluded. Almost 40 percent of Argentina's total population lived in the Province of Buenos Aires alone in Well over half of the population lives in the three largest provinces: Buenos Aires, Santa Fe and Cordoba. The population of the Province of Buenos Aires is about the same as that of Chile, living in an area about the size of Italy (307,571 square kilometers). However, 63.6 percent of this population is concentrated in the Municipalities of Gran Buenos Aires located in the Province of Buenos Aires (excluding the Federal Capital). The total population of the Gran Buenos Aires and the Federal Capital was 10.6 million in 1985 (34,6% of the total population of the country). However, the annual rates of population growth of the other groups were much higher during the 1970s. For example, the rate of population growth for the Low Density Group was almost twice that of the Advanced Group. 4. The total population of the five provinces of the Low Density Group was only 1.4 million in 1985, about half that of the province of Santa Fe in the same year. For example, the province Santa Cruz, the second largest in area, is about the same size as the United Kingdom, yet had a population of only 115,000 in 1980, giving it a demographic density of only a half a person per square kilometer. However, these provinces are quite important in economic terms, due mostly to their high production of oil, minerals and other primary products. The total population of the 5 provinces of the Intermediate Group was 3.6 million (11.8 percent of the National total). The 8 provinces of the Underdeveloped Group had a total population of 4.0 million (13.6 percent of the National total), ranging from 180,000 in La Rioja to 780,000 in Chaco. 5. Although the percentage of households with unsatisfied basic needs tends to be higher in provinces with smaller populations and lower per capita products, such as Formosa (46.8 percent) and Santiago del Estero (45.8 percent), the concentration in absolute terms is highest in the Advanced Group, especially its three largest provinces. For example, of the 1.6 million households with unsatisfied basic needs, 59.5 percent lived in the Advanced Group, with 35.9 percent located in Buenos Aires, 8.4 percent in Santa Fe and 7.5 percent in Cordoba. The Underdeveloped Group had 20.5 percent of the total, and the other two regions combined 19.9 percent. Thus, efforts to redistribute among the provinces, as in revenue sharing, can run at odds with the objective of interpersonal distribution, as they tend to distribute away from the areas where the absolute concentrations of the poor are the highest.

38 Annex 1 Page 3 of 8 6. Gross Provincial Product (GPP) is very highly concentrated in the Advanced Group (78.4 percent in 1985, almost exactly the same as 1980).2 The GPP of all eight provinces of the Underdeveloped Group was less than that of Santa Fe in 1985, as was the total GPP of the Intermediate Group. The fastest growing provinces during the period were outside of the Advanced Group, especially on the "resource frontier" due mostly to the increase in gas and oil production. For example, Neuquen's GPP grew at 11.6 percent per annum during the 1970s. However, stagnation set in for most of the provinces in the first half of the 1980s, especially for the Underdeveloped Group which showed a decline of about 1 percent per year. The biggest loser, however, was the Federal Capital for which GPP dropped at about 2.8 percent per year. Over the 1970/85 period, the annual rates of growth for the different groups were: Low Density (4.1 percent); Intermediate (2.7 percent); Underdeveloped (2.7 percent); and Advanced (1.3 percent). The sectors which were most dynamic in the Low Density group over this same period were public utilities (16.2 percent per year); manufacturing (5.6 percent); producer services (5.6 percent), although the other sectors also were more dynamic than the national average. 7. In terms of per capita GPP, the Province of Buenos Aires ranks in twelfth position with a per capita GPP of US$1,675 in 1985, about half that of the Provinces of Santa Cruz, Chubut or Neuquen. The three poorest provinces (Formosa, Santiago del Estero and La Rioja) had per capita GPP of less than US$1, For a discussion of the methodology used in calculating the Gross Provincial Product, see: Consejo Federal de Inversiones, Producto Bruto Geo-rafico: , Buenos Aires, CFI, This publication is currently available for most of the provinces.

39 ANNEX 1 Page 4 of ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 1.1 Population by Provincial Group and Provinco: Groups Population ('100) Relative Absolute Annual Area Inhabitants Provinces Distribution Change Growth (sq. km.) per sq. km Rates 1980 (satim.) ('000) 70/80 TOTAL 28,349 27,920 30, , ,768, ADVANCED 16,916 19,858 21,6eC , , Capital Federal 2,972 2,928 2, (60) ,614.1 Buenos Aires 8,776 16,8e6 12, , , Cordoba 2,060 2,408 2, , Mendoza 978 1,196 1, , Santa Fe 2,136 2,466 2, , LOW DENSITY s84 1,214 1, , Chubut o ,6e8 1.2 La Pampa , Neuquen 1S , Rio Negro 263 8a , Santa Cruz , INTERMEDIATE 2,666 3,224 3, , Entre Rion , Salts 510 6ea , San Juan s , San Luis , Tucuman , , UNDERDEVELOPED 2,914 8,625 4, , Catamarca , Chaco 6e , Corriontes l , Formosa , Jujuy , La Rioja , Misiones , Santiago del Estero , Source: INDEC, Census of Population 1970 and Estimates for 1985 done by extrapolation of geometric rate.

40 ANNEX Page 5 of 8 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 1.2 Households with Unsatisfied Bnle Needs by Provincial Group and Province: 1980 Groups Absolute X of X of Accumulated Provinces Provincial National X X Total Total TOTAL 1,686, ADVANCED 948, Federal Capital 67, Buenos Aires 668, Cordoba 118, Mendoza 66, Santa Fe 132, LOW DENSITY 88, Chubut 18, Le Pampa 10, Neuquen 17, Rio Negro 30, Santa Cruz 6, INTERMEDIATE 232, Entre Rion 61, Salta 58, San Juan 26, San Luis 14, Tucuman 72,668 a UNDERDEVELOPED 326, Catamarca 16, Chaco 67, ? Corrientes 66, Formosa 28, Jujuy 88,88s La Rioja 11, Misiones 50,6, Sgo. dol Eatero 56, Source: INDEC, La Pobreza en Ia Argentina.

41 ANNEX 1 Page 6 of 8 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Tablo 1.8 Gross Provincial Product by Provincial Group and Province: Millions ot US$ ot July 1988 Groups Relative Distribution Absolute Changes Annual Rates Provinces /80 80/85 70/80 80/86 70/86 TOTAL 46,622 59,719 59, ,197 (480) ADVANCED 38,391 46,954 48, ,68 (499) Capital Federal 18,222 16,705 13, ,483 (2,116) Buenos Aires 15,760 19,022 20, ,271 1, Cordoba 8,025 4,816 4,468 e ,292 1S Mendoza 2,279 2,260 2, (19) Santa Fe 4,114 5,650 5, , LOW DENSITY 2,097 3,800 3, ,708 as Chubut 6e s (109) La Pampa e Neuquen e8a (84) Rio Negro l Santa Cruz (63) INTERMEDIATE 3,405 4,875 6, , Entre Rios 1,183 1,319 1, (102) Salta , San Juan 889 S San Luis l Tucuman 967 1,684 1, UNDERDEVELOPED 2,829 4,090 8, ,460 (186) Catamarca as Chaco (78) Corrientes 688 8s (78) Formosa Jujuy La Rioja o (6) Misiones 8a8 628 S5l (47) Santiago del Estero (86) Source: CFI.

42 ANNEX 1 Page 7 of 8 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 1.4 Gross Provincial Product per Capita Provincial Group and Province: US1 of July 1988 Groups Annual Provinces Growth Rates 70/860 TOTAL 1,992 2, ADVANCED 2,270 2,3a Capital Federal 4,448 6, Buonos Aires 1,795 1, Cordoba 1,488 1, Mendoza 2,848 1, Santa F. 1,927 2, LOW DENSITY 2,429 8, Chubut 2,948 8, La Pampa 2,151 2,a Nouquen 2,139 4, Rio Negro 2,189 2, Santa Cruz 8,258 8, INTERMEDIATE 1,282 1, Entre Rion 1,468 1, Salts 1,280 1, San Juan 1,011 1, San Luis 1,298 1, Tucuman 1,288 1, UNDERDEVELOPED 902 1, Catamarca 762 1, Chaco 828 1, Corriontee 1,186 1, Formosa Jujuy 1,176 1, La Rloja Uisiones 769 1, Santiago del Estero Source: Soo tables 1.1 and 1.8.

43 ANNEX Page 8 of 8 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 1.6 Annual Rate oa Change of Gross Provincial Product by Sector, Provincial Group and Provinco: U Croups Total Agricul- Mining Manufac- Public Cons. Producer Co-mrce Finance, Personal Provincoe ture tur Utilities Services Insurance Services TOTAL o ADVANCED Federal Capital Buenos Aires Cordoba O Mendoza Santa Fe LOW DENSITY Chubut La Pampa Neuquen Rio Negro Santa Cruz INTERMEDIATE Entre Rio* o.o 8.2 Salta San Juan Son Luis Tucuman UNDERDEVELOPED Catamarca Chaco Corrientes Forwoa Jujuy La RioJo Miniones Sgo. del Estero Source: CFI.

44 Annex 2 Page 1 of 11 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Recent Evolution of the Provincial/National Revenue Sharing System 1. The PGFS argued that the Revenue Sharing System (RSS) should be predictable, transparent, provide transfers in sustainable and equitable quantities, and also provide incentives to provincial fiscal autonomy. This Annex will analyze the impact of changes in the laws governing the RSS during the period in terms of these criteria. Revenue Sharing Law 2. The Revenue Sharing Law (Ley 23548/88) has not been altered. The national taxes shared include: income tax, capital tax, net worth tax, value added tax (VAT), foreign exchange transaction tax and stamp duty. Thus, in 1988, about 60% of the total tax revenues of the Central Government were shared with the provinces. As discussed (see paras ), the revenue from the shared taxes dropped precipitously in real terms in both 1988 and 1989 due to the rapid rise of inflation and the resulting Olivera-Tanzi effect, as well as a decline in the efficacy of in the collection of shared taxes. To make up for this shortfall, the Central Government made advances on the amount to be shared with the provinces. In addition, a number of supplementary laws have been enacted to compensate for this shortfall in shared taxes and to assist some of the provinces in adapting to the new system. These advances and laws are discussed below. Advances on Revenue Sharing 3. After the period of hyperinflation in June/July 1989, the Central Government allowed advances on the amounts to be transferred to make up for the shortfall in tax revenues. These advances were allocated with the following weights: (a) 65% on the criteria for secondary distribution in revenue sharing and (b) 35% in accord with the total salary bill of each province. This "reward" for provinces with the higher payrolls is certainly questionable in terms of the criteria defined above, but the total amount of the benefit is relatively low (i.e., equal to the interest rate on the amount of the advance in excess of that which would have been received using only the secondary distribution criteria). As these advances were not tied to any increase in revenues, they added to the fiscal deficit of the Central Government. Transitional Fund for Fiscal Disequilibria (TFFD) 4. In May of 1988, Congress enacted this legislation to assist 15 provinces that were experiencing problems in adapting to the new revenue sharing system with revenues garnered from a surcharge on cigarettes, a tax on

45 Annex 2 Page 2 of 11 fixed-term deposits, and a tax on the transfer of public bonds. Although this represented a departure from the distribution defined in the revenue sharing law, it was a transitional measure, enacted by Congress and financed by a tax increase. This, then, represented a distinct improvement over the past situation, where the provinces with fiscal problems bargained directly with the Minister of Economy of the Central Government for discretionary grants straight from the general fund. 5. In 1989, this law was extended but the amount going to the 15 provinces was reduced to 55.66% with the remainder distributed to all 22 provinces using the criteria for secondary distribution defined in the revenue sharing law (23548/88). Thus, the TFFD became a way of making up for the shortfall of shared national tax revenues due to hyperinflation, as well as to assist the 15 provinces with continuing fiscal deficits. 6. In 1990, the law was once again extended with 60% going to seven provinces (Tucuman, Salta, La Rioja, Jujuy, Catamarca, San Juan and Corrientes) and 40% to all 22 provinces using the criteria for secondary distribution. However, this time the seven provinces of the first group would receive the amounts stipulated only if they satisfied a number of conditions including: adhesion to the National Economic Emergency Law and the Reform of the State Law; maintenance of salary levels at or below those for equivalent positions at the national level; and the implementation of a financial action plan to reduce the fiscal deficit. Starting in April 1990, the national Ministry of Economy makes quarterly reports on the progress of these provinces in reducing their fiscal deficits. If no progress is made, the funds originally set aside for the province will be redistributed among all 22 provinces using the criteria for secondary distribution of the revenue sharing law. Hence, the law provides not only incentives for control of fiscal disequilibria, but also penalties for provinces which do not take positive steps for reducing their deficits. These measures are consistent with the recommendations of the PGFS. Fund for Financing the Social Security System 7. This Law (Ley ) distributes revenues from the tax on fuels, piped gas and on telephone use to the Central Government (90%) and the provincial governments (10%) for payment of social security benefits. Secondary distribution among the provincial governments is done based on the distribution of beneficiaries in the provincial social security systems. Fund for Earthauakes and Disaster Areas 8. Law (extended in 1988 for three years) allocates a two percent tax on deposit accounts to eleven provinces affected by natural disasters in accord with percentages set in the law. The Bonos 9. The shortfall of shared revenues in 1988 in conjunction with

46 Annex 2 Page 3 of 11 increasing provincial deficits led to a financial crisis in December of The resulting law involved tax reform, an effort t- control the fiscal loss from Industrial Promotion and the issuance of two.onds: the Bono El Saneamento Financiero Provincial (hereafter, Bono Provincial) and the Bono Federal. Bono Provincial (Title I). The Bono Provincial of A$ three billion (about US$200 million) was a non-negotiable bond of the Central Government transferred to the provinces using the same percentages established for secondary distribution in the revenue sharing law. The provinces should repay the loan to the Central Government in two years with one of grace, with interest determined by the Central Bank plus monetary correction. Payments will be automatically deducted from the shared revenues of the provinces. Most provinces transferred the bonds at face value to the provincial banks in payment of their debts. This Bono is a good example of how convoluted intergovernmental relations in Argentina can be: it was issued by the central government, but "marketed" by the provinces, to be paid by the Central Government, using resources discounted from the resources of the provinces from revenue sharing. The Bono Federal (Title V). This bond of A$ two billion (US$130 million) was to have been issued by the government, which was to receive 42.3 percent and the provinces 57.7 percent with secondary distribution among the provinces using the percentages for secondary distribution from the revenue sharing law. However, due to the economic crisis, the bond was never marketed by the Central Government. The Overall Impact of the RSS 10. Inflation of about 400 percent in 1988 and about 5,000 percent in 1989 in combination with a lack of efficacy in the collection of shared taxes led to a significant shortfall of expected shared tax revenues in both years. This, together with the continued very high fiscal deficits in some provinces led to all of the above measures. Even adding on the amounts from the TFFD and the Bono Provincial did not compensate for the shortfall in shared taxes in 1988, which dropped by almost eight percent in real terms in the 1987/88 period. Although the new Revenue Sharing Law clearly represents a considerable improvement in intergovernmental fiscal relations, it clearly cannot compensate for the lack of an adequate macroeconomic stabilization policy at the national level. 11. Tables summarize the revenue sharing status of provinces in 1989, in comparison with Note the decline of 22 percent in total shared taxes (Table 2.1). This is compensated for in part by the increase of 50 percent in the TFFD and by the Provincial Bonds (Table 7.2). The total amount transferred via all of these measures was almost exactly the same for this period in 1988 and In both years, the TFFD benefitted the poor performers the most with Salta, Tucuman, La Rioja and Jujuy receiving the "lion's share" of the total. The conditionality of the TFFD law for 1990

47 Annex 2 Page 4 of 11 (para. 6) should drastically reduce the premium for poor performance. Royalties 12. Royalties are paid to the provinces producing natural gas or petroleum. There has been much conflict over the method used in establishing the base prices for these products. In 1987, Decree 631 established that the prices would be adjusted by the general wholesale price index. This system was suspended from July 1988 through May 1989, but reinstated in May The reform of this system of royalties should be part of the reform of energy policy at the national level. Among the alternatives being considered are: the payment of the royalties in kind (e.g., barrels of oil or cubic meters of gas) that the province could then sell on the market, the transfer of subsoil property rights to the provinces, and other methods of calculating the price of the products.

48 ANNEX 2 Page 5 of 11 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Tablo 2.1 Porcontage Incr es by Type of Transfer to the Provinoe January through December: Provinces Revonue Rovenue Sharing Revonue Sharing Revenuo Sharing Sharing plus all other pluo all other plus all other Transfers except Transfers and Transfors plus Social Security Social Security Bonds and Advence Buenos Air"s Catamarca C0rdoba O.86 Corrionteo Chaco Chubut Entre Rlos Formosa Jujuy La Pampa La RioJo Mondoza Misionos Neuquon Rlo Negro Salta W Son Juan San Luls Santa Cruz Santa Fe S. del Estero C Tucumin S TOTAL Source: Ministry of Economy, Subsecretary of Provincial Relations, Sltema de Informacion Financiers Provincial, Buenos Air" (May 1990).

49 ANNEX Page 6 of 11 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 2.2 Porcentage Increaso by Type of Transfer to the Provinceo January through December: Provinces Revenue Disc. Ebrg. Financial SUB- Social Provincial TOTAL Sharing Grant Fund Disequil. TOTAL Security Bond Fund (Lay Fund System (A.T.N.) 22916) Buenos Aires Catamarca C6rdoba Corrlentes Chaco Chubut Entre RIo* Formosa Jujuy La Pampa La RIoja Mendoza Misiones Neuquen R-o Negro Salta Son Juan San Luis Santa Cruz Santa Fe S. del Estero Tucumin TOTAL Source: Ministry of Economy, Subsecrotary of Provincial Relations, Sistema de Informacion Financiors Provincial, Buenos Aires (May 1990).

50 ANNEX Page 7 of 11 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 2.8 Revenue Sharing and Othor Klnds of Transfers to the Province. Percentage of Total Provinces Revonue Revenue Sharing Revonue Sharing Revenue Sharing Sharing plus all other plus all other plus all other Transfers except Transfers and Transfers plus Social Security Social Security Bonds and Advances Buenos Aires Catamarca C6rdobe 8.0W Corrientes Chaco Chubut Entre Rlos Formosa Jujuy La Pampa La Rloja Mendoza Misiones Neuquen Rlo Negro Salto San Juan San Luis Santa Cruz Santa Fe S. del Estero Tucumin TOTAL W Source: Ministry of Economy, Subsecretary of Provincial Relations, Slstema de Informacion Financiors Provincial, Buenos Aires (May 1996).

51 ANNEX 2 Page 8 of ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 2.4 Revenue Sharing and Other Kinds of Transfors to tho Provinces Excluding Royalties January through December 1988 Millions of US$ of December 1989 (a) Provinces Revenue Emerg. Disc. Financial SUB- Socitl SUB- Provincial TOTAL Sharing Fund Grant Diseqult. TOTAL Security TOTAL Bond (LOy Fund Fund System 22918) (A.T.N.) Buenos Aires Catamarca C6rdobs Corrientes Chaco Chubut Entre Rio Formosa Jujuy La Pampa La Rioja Mendoza Misiones Neuquen Rio Negro Salts San Juan San Luis Sante Cruz Santa Fe S. del Estero Tucumhn TOTAL Source: Ministry of Economy, Subsecretary of Provincial Relations, Sistema do Informacion Financiers Provincial, Buenos Aires (May 1990). Note: (a) Free exchange rate USS = 1, Australes. Adjusted to real values on monthly basis. For this reason, the values will not coincide exactly with those of other tabloe adjusted on an annual basis.

52 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 2.5 Revonue Sharing and Other Kinds of Transfers to the Provinces Excluding Royalties January through December 1989 Millions of USS of December 1989 (a) Provinces Revenue Disc. Emorg. Financial Sesmic SUB- Social SUB- Advances Provincial TOTAL Sharing Grant Fund Disequil. A Natural TOTAL Security TOTAL on Revenue Bond Fund (Ley Fund Disaster System Sharing (A.T.N.) 22916) Fund Buenos Aires Catamrca C6rdoba Corri;ntes Chaco Chubut n Entre RIoz a Formosa Jujuy e La Pamps La Rioja Mendoza Misiones Neuquen RIo Negro Salto San Juan San Luis Santa Cruz Santa Fe S. del Estero o S Tucumdn o TOTAL Source: Ministry of Economy, Subsecretary of Provincial Relations, Sistma de Informacion Financier& Provincial, Buenos Aires (May 1990). Note: (a) See note (a) of Table 2.4.

53 ANNEX Page 10 of 11 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 2.6 Revenue Sharing and Other Klnds of Transfer* to the Provinces Excluding Royalties January through December 1988 Percentage of Total Provinces Revenue Emerg. Disc. Financial SUB- Social SUB- Provincial TOTAL Sharing Fund Grant Disequil. TOTAL Security TOTAL Bond (Ley Fund Fund System 22916) (A.T.N.) Buenos Aires " Catamarca Cordobn Corriontes Chaco Chubut Entre RIos Formosa 8.e Jujuy La Pampa La Rioja Mendoza Misiones Neuquen Rlo Negro Salta San Juan San Luis Santa Cruz Santa Fe S. del Estero Tucumin TOTAL Source: Ministry of Economy, Subsecretary of Provincial Relations, Sistema de Informacion Financiera Provincial, Buenos Aires (May 1990).

54 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 2.7 Revenue Sharing and Other Kinds of Transfers to the Provinces Excluding Royalties January through December 1989 Percentage ot Total Provinces Revenue Disc. Emerg. Financial Sesmic SUB- Social SUB- Advances Provincial TOTAL Sharing Grvnt Fund Disequil. & Nat. TOTAL Security TOTAL on Revenue Bond Fund (LOy Fund Disaster System Sharing (A.T.N.) 22916) Fund Buenos Aires 22.0W B Catamarca W 3.17 O Cordoba SS Corrlontes Chaco Chubut Entre R1os Formos Jujuy La Pampa La RloJa O Mendoza Misiones Neuquen R1o Negro Salto San Juan San Luis Santa Cruz Santa Fe S. del Estero Tucumin TOTAL W9.00 o Source: Ministry of Economy, Subsecret.ary of Provincial Relations, Sistema de Informacion Financiera Provincial, Buenos Aires (May 1990).

55 Annex 3 Page 1 of 4 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Provincial Government Finance Operational Definition of the Current Account Surplus and Other Indicators 1. In defining current account surplus, discretionary grants of any type (i.e., ATN, FDR, FEDEI, etc.) are not counted as current revenue, but all automatic revenue sharing is counted as current revenue, including coparticipacion, royalties, coparticipacion vial, etc. 3 See Table 3.1. In other words, only automatic or formula driven revenue sharing will be counted as current revenue. Current account surplus is, then, equivalent to current account surplus without grants or own saving (item 13 in Table 3.1). This table also defines the other basic indicators used in this report. Insritutional Structure of Provincial Goverrnent 2. In Argentina's Federal System, the institutional structure of each province is different, but all are composed of the same general institutional elements: --General Administration (Administracion General) --Central Administration (Administracion Central) --Consolidated Decentralized Entities (Organismos Descentralizados Consolidados). These normally have some administrative autonomy, may have some independent sources of revenue, but are still included in the provincial budget. --Special Accounts (Cuentas Especiales). These are separate accounts established by law in which revenues from sources specified in the law can be transferred for uses that are also specified in the law. Although both the sources and the authorized users of the resources are defined by the law, the province also may transfer additional resources to these accounts from the general fund. These special accounts tend to be much less important at the provincial level than the national level. --Unconsolidated Decentralized Entities (Organismos Descentralizados No Consolidados). These have some administrative autonomy, normally have their own sources of revenues such as fees, tariffs and taxes, but do not appear in the budget of the General Administration, although their 3 All definitions are in accord with IMF guidelines: International Monetary Fund, A Manual on Government Finance Statistics, Washington, D.C., 1986.

56 Annex 3 Page 2 of 4 individual budgets normally appear in the provincial government's budget document. --Provincial Public Enterprises (Empresas Provinciales). These are public enterprises in the usual sense of the term. Their budgets and financial statements normally do not appear in the provincial government's budget documents. --Social Security Entities (Organismos de Prevision Social) Eventually the accounting system for the public sector should show the "gross" accounts for each of these elements of the public sector for each level of government. The accounts should be consolidated for the current account surplus, total deficit/surplus and investment at each level of government and, then, for the public sector as a whole. The development of consolidated public sector accounts for the entire provincial public sector (including the unconsolidated decentralized entities and public enterprises) is essential to better fiscal management at the national and sub-national levels. See Annex 6, "Institutional Development". 3. Although all of the provinces have this basic structure, there is no consistency in the way in which different provinces treat the same type of activity. For example, the water companies and other public utilities are treated as Consolidated Decentralized Entities in Salta, Chubut and Santiago del Estero, but as Unconsolidated Decentralized Entities in Buenos Aires and Santa Fe. Cordoba's water company is a public enterprise. Evolution of the Current Account SurRluses of the Provinces: Table 3.1 shows that own saving has been quite variable over the years, ranging from a deficit of US$ 1.6 billion in 1984 to surpluses of about US$ 300 million per year in 1985 and These data also point to some encouraging trends. Despite 1989 being one of the most traumatic years in Argentine history, with hyperinflation during the middle of the year, current revenues increased by 13 percent as compared to the average, while current expenditures increased only five percent when compared to this average, and they decreased by 12 percent from the previous year. This resulted in a small 1989 current account surplus and contributed to a substantial reduction of the overall need for financing. It should be noted, however, that these improvements resulted in a sharp drop in 1989 for gross fixed capital formation and that the net decrease in short term assets and liabilities, although less than half that of the previous year, remained high (over 60 percent of the need for financing). Further analysis of these trends, and the potential impact of the project, are presented in Annex 5.

57 Annex 3 Page 3 of 4 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 3.1 Revenues, Expenditures, and Financing. All Provinces (a) Millions of USS of December 1989 (b) CURRENT REVENUES 3, , , , , , , Provincial Sources 1, , , , , , , Tax 1, , , , , , , Non-tax National Sources 1, , , ,63.5 3, , , Federal Revenue Sharing (c) 1, , , , , , , Highway fund RoyaLties Others CURRENT EXPENDITURES 4, , , , , , , Personnel 2, , , , , , , Good and services Interest payments Transfers 1, , , , , , , Municipalities Provincial Enterprises Social Security Other Transfers CAPITAL REVENUES GRANTS (Current and Capital) 2, , Current (Aportes del Tesoro Nacional) 2, , Capital Regional DeveLopment Fund (FDR) Electricity Fund (FEDEI) Other CAPITAL EXPENDITURES 1, , , , , , , Real Investement 1, , , , , , Investement existing assets Financial investement Notes: (a) Includes Municipality of Buenos Aires and Tierra de Fuego. (b) Adjusted to real values on an annual basis. For this reason, the values will not coincide exactly with those of other tables adjusted on a monthly basis. (c) Ad hoc revenue sharing during treated as Federal Revenue Sharing.

58 -51 - Annex 3 Page 4 of 4 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 3.1 (Continued) Revenues, Expenditures, and Financing. All Provinces (a) Millions of USS of December 1989 (b) TOTAL REVENUES AND GRANTS ( ) 6, , , , , , , TOTAL EXPENDITURES (2 + 5) 6, , , , , , , OVERALL DEFICIT/SURPLUS OR NEED FOR FINANCING (7-6) 9. NET BORROWING (10-11) , FINANCING , Use of credit Housing Finance Fund (FONAVI) Others From previous exercises 11. AMORTIZATION OF THE DEBT NET VARIATION IN SHORT TERM ASSETS AND LIABILITIES ( 9-8 ) (856.4) (424.1) (398.8) (776.9)(1,001.1) (307.3) 13. CURRENT ACCOUNT SURPLUS WITHOUT (1,081.7)t1,627.2) (442.0) (411.2) 7.4 GRANTS (OWN SAVINGS) (1-2) 14. CURRENT ACCOUNT SURPLUS WITH 1, (136.6) RECEIPTS OF CURRENT GRANTS (SAVINGS) ( ) Source: Ministry of Economy, Subsecretary of Provinciat Relations, Sistema de Informacion Financiera Provincial, Buenos Aires (May 1990). Notes: (a) IncLudes Municipality of Buenos Aires end Tierra de Fuego. (b) Adjusted to real values on an annual basis. For this reason, the values will not coincide exactly with those of other tables adjusted on a monthly basis. (c) Ad hoc revenue sharing during treated as Federal Revenue Sharing.

59 Annex 4 Page 1 of 2 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Financial Action and Investment Plans (FAIP) Objective 1. The main objective of the FAIP is to show how provincial revenues will be raised and expenditures controlled to produce a current account surplus to be used for new investments (including costs of operation, maintenance and debt service). The first two parts of the FAIP deal with generating the current account surplus, and the third, with the criteria for investing this surplus wisely. 2. The FAIP should ideally cover centralized and decentralized administrations of the provinces and municipalities, as well as their public enterprises. See Annex 3, paras Although the entire sub-national public sector should be covered eventually, effort should focus initially on the General Administration (Central Administration and Consolidated Decentralized Entities) of the provincial government. Increasing Provincial Own-source Revenues 3. This section should cover general measures to increase the efficiency in the collection of tax and non-tax revenues, such as improved accounting controls and information, computer systems and software, etc. Ways of improving human resources for revenue collection should also be addressed, such as via training programs, recruitment from other provincial government departments, training programs, etc. In some cases, it may be more efficient to contract services from the private sector, such as in the case of collection of delinquent accounts or for billing. (See Chapter III of the PGFS). Controlling ExRenditures and Increasing Efficiency 4. The FAIP should show how public resources will be allocated with greater efficiency. Expenditures on personnel, goods and services, and transfers should receive special attention, due to their great importance. (See Chapter V of the PGFS.) Investment Priorities and Justification 5. This section should show all of the elements necessary for project appraisal as defined in the Operations Manual for the Provinces. See Annex 10 for a detailed description of these requirements. It is expected that the quality of provincial investment planning will improve over time. Initially, simple investments, primarily for maintenance operations and rehabilitation, are expected to be predominant. As the provincial capacity to plan and program investments is strengthened through technical assistance financed

60 Annex 4 Page 2 of 2 under the project, the quality of investment priorities and justification, within and between sectors, should be emphasized and enhanced. Baseline Projections and Estimates of Project Impacts 6. Finally, each FAIP should show baseline projections of revenues and expenditures (i.e., projections without the proposed project) and also projections of the impact of the project on revenues (e.g., increased tax revenues or user fees) and expenses (e.g., maintenance and other costs of operation). For example, an irrigation project would increase future production and, thus, tax returns, and also require expenditures for operation and maintenance. Debt CaDacitv 7. The FAIP should demonstrate that the province has sufficient debt capacity as defined by the project financial performance criteria (see para and Annex 5).

61 Annex 5 Page 1 of 6 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Assessment of Financial Impact of the Project and the Debt CaDacity of the Provinces Financial Impact 1. As the amount and velocity of disbursements for civil works and goods will hinge on the capacity of provinces to generate current account surpluses for subsidiary loan counterpart funding, it is important to do simulations of this capacity. Using the 1989 budget estimates for all provinces as a baseline, the impact of different percentage increases in provincial tax and non-tax revenues and of reductions in expenditures on the current account surplus of each province may be estimated (Table 5.1). The first column in Table 5.1 shows the current account surplus without grants (i.e., own-saving) of each province in The remaining columns present the change in this surplus given the percentage "improvements": increases in revenues and reductions in expenditures. For example, the second column of Table 5.1 shows the current account surpluses of the provinces given a 10% increase in revenues and a 10% reduction in expenditures. The impact of such a small relative change on total current account surplus is quite striking for provinces with relatively minor current account disequilibriums. For example, this slight improvement pushes the Provinces of Buenos Aires from a US$4 million current account deficit to a US$163 million surplus. However, such small relative improvments are not sufficient to put provinces with very high current account deficits (e.g., Santa Fe, La Rioja, Catamarca and Jujuy) "in the black." 2. Summing the provinces with current account deficit with those with surpluses underestimates the total potential for servicing debt due to the reform efforts, because only those with surpluses will be able to effectively participate in the investment program. For this reason, Table 5.2 shows the increment of current account surplus for only those provinces with surpluses in 1989: an improvement of 10% results in a current account saving for those provinces with surpluses of US$832 million (Second Column of Table 5.2), up from US$360 million in Improvements of 10% are not at all unrealistic. They would depend first on the political will to undertake the reforr. strategy recommended here, as well as on technical assistance in implementing the proposed financial management improvements. 3. The increase in current account savings due to a 10% improvement in financial management alone (about US$472 million) would be sufficient to cover about one-half of total real investment in 1989 (US$975 million, down about two thirds from the five-year average due to hyperinflation). The modest capital revenues and existing grant funds could also be used to help finance provincial investments. Or, provinces could finance part of their investment program with the current account savings and part with long-term

62 Annex 5 Page 2 of 6 borrowings, if available. A rough estimate of the total impact of this improvment on the capacity to operate, maintain and service the debt of an infrastructure investment is the present value of this annual increase in current account surplus over the term of the loan (15 years). The present value of an annuity of US$472 million at a annual rate of discount of 12% for 17 years is US$3.4 billion. 4. As noted in Annex 3, there are signs of encouraging trends in provincial financial status since A brief indication of how these trends relate to the potential financial impact of the proposed project is presented below. (a) (b) The new revenue sharing law became effective in 1988, after a hiatus in the revenue sharing system from 1985 to 1987 (see Annex 2). The PGFS concludes (Chapter VII, para. 7.10) that the new revenue sharing system is a significant improvement over the previous, predominantly ad hoc arrangement for intergovernmental fiscal transfers, in that the new system provides transfers that are predictable and transparent for both the Central and Provincial Governments. Despite a sharp drop in grants in , provincial savings and own savings improved over this period. This indicates that provinces are responding to the improved discipline of the revenue sharing system (as well as closer control over Provincial Banks, as noted below) and are beginning to implement current revernue and expenditure reforms, as recommended in the PGFS, Chapters III and IV. Long term borrowing (greater than one year), as reflected by net borrowing, as well as short term borrowing, as partially reflected by the net variation in short term assets and liabilities, have fallen sharply. This indicates that the stricter controls by the Central Bank on rediscounts and overdrafts by provincial banks are taking effect. These controls have limited the capacity of the provincial banks to provide loans and overdraft facilities to provincial governments, as they have done on a significant scale in the past (see Section B of Chapter V, PGFS). Also, Provinces have not been able to obtain substantial credit from commercial financial institutions. As noted in para. 1.25, strict control of the provincial banks by the Central Bank is a fundamental prerequisite for implementing the strategy for reform proposed in the PGFS. (c) Although borrowing has fallen, the most recent data (Table 5.2, indicate that there is a substantial potential for provinces to leverage their current account savings to increase their investments and meet their need for financing. In 1989, 12 of the 23 provinces (including the Municipality of Buenos Aires) produced current account surpluses (without grants), compared to only seven in Summing the 1989 current savings of these 12 provinces provides a total own saving of US$ 360 million, 22 percent greater than the total net borrowing for that year. This indicates that

63 Annex 5 Page 3 of 6 Debt Capacitv the recammendations of the PGFS regarding current account discipline and financing of provincial investment programs are realistic and achievable. It also indicates that provincial counterpart funding for proposed sub-loans should not provide a significant obstacle to project implementation, and that through technical assistance and the FAIP process, project benefits may be extended to provinces presently having current account deficits. 5. After determining the current account surplus, the next step is to determine whether the amount eligible using this criteria falls within the limits for debt capacity established in para According to the fragmentary data available, the total long-term debt of the provinces is quite low, as they have not have access to such credit for a long time, "borrowing" more from suppliers and on a very short term basis. See Chapter V of the PGFS. The information system on the debt of provincial government should be improved to provide detailed information on all of the sources of short- and longer-term financing, as well as guarantees (see Annex 6).

64 - 57- ANNEX 5 ARGENTINA Page 4 of 6 PROVINCIAL DEVELOPMENT PROJECT Table 5.1 Sensitivity Analysis of the Impact of Percentage Increases In Revenues and Reductions In Expenditures Current Account Surplus without Grants (Own Savings) by Provincial Group and Province Millions of US$ of December 1989 (a) Groups Provinces Impact of Percentago Increases in Revenues and Reductions In Expenditures X 11.0X 12.0X 13.0% 14.0% 15.0% TOTAL (b) ADVANCED (53.2) Federal Capital Buenos Aires (3.8) Cordoba Mendoza Santa Fe (181.4) (134.8) (130.1) (125.6) (120.8) (116.2) (111.6) LOW DENSITY Chubut (2.2) La Pampa Neuquen Rio Negro Santa Cruz (6.6) INTERMEDIATE Entre Rios a Salta (18.2) San Juan San Luis Tucuman (8.4) UNDERDEVELOPED (77.1) Catamarca (84.7) (27.8) (26.6) (26.8) (26.1) (24.8) (2386) Chaco Corrientes (11.9) Formosa (10.8) (0.9) Jujuy (45.4) (80.8) (28.8) (27.8) (26.8) (24.8) (22.7) La RioJa (25.6) (18.7) (18.0) (17.8) (16.6) (15.9) (16.2) Misiones Santiago del Estero Source: Ministry of Economy, Subsocretary of Provincial Relations, Sistama de Informacion Financiers Provincial. Buenos Aires, Note: (a) Value In Australes of December 1989 divided by the commercial rats of exchange (luss * A/. 1,100.48). (b) Excluding Tierra del Fuego.

65 ANNEX kage 5 of 6 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 6.2 Sensltlvity Analysis of the Impact of Porcentage Incroaseo In Revenues and Reductiono In Expenditures Currant Account Surplus without Grants (Own Saving) (For Provinces with Surpluses Only) by Provincial Group and Province, 1989 Millions of US2 of D cember 1989 (a) Groups Provinces Ipact of Percentage Increass In Rovenues and Reductions In Expenditures S.6O TOTAL (b) , ,096.0 ADVANCED Federal Capital Buenos Aires Cordoba Mendoza Santa Fe LOW DENSITY Chubut La Pampa Neuquen Rio Negro Santa Crus S INTERMEDIATE Entre Rios Salts t7.6 San Juan San Luis Tucumn UNDERDEVELOPED Catseaeca Chaco Corrientes Formosa Jujuy La Rioja Misiones Santiago del Eatero Source: See Table 5.1. Note: (a) Value In Australes of Deceber 1989 divided by the comercial rate of oxchange (1US8 u A/. 1,100.48). (b) Excluding Tierra del Fuego.

66 ANN EX 5-59 Page b of 6 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Table 6.8 Current Account Surplus without Grants (Own saving) by Provincial Group and Provine-: Milions of US$ of December 1989 (a) Groups Provinoes TOTAL (1,081.7)(1,827.2) (442.0) (411.2) 7.4 ADVANCED (438.3) (616.6) (168.1) (336.6) (53.2) Federal Capital (0.9) (74.1) Buenor Aires (112.1) (62.7) (6.8) 66.2 (129.8) (186.1) (3.8) Cordoba (107.7) (162.2) (41.0) (38.0) 26.6 Mendoza (56.9) (79.0) 25.5 (88.1) (21.1) (13.1) 21.7 Santa Fe (160.7) (268.6) 2.7 (13.9) (89.1) (168.8) (181.4) LOW DENSITY 49.1 (31.7) Chubut (11.1) 8.1 (2.2) La Pampa (24.8) (30.3) Nouquen e Rio Negro (10.1) (43.7) 4.7 (2.0) (0.8) (18.4) 53.4 Santa Cruz (0.3) (5.6) INTERMEDIATE (292.9) (401.9) 47.4 (10.0) (191.7) (62.2) 21.2 Entre Rios (76.3) (48.2) (17.1) 16.5 Salta (61.7) (111.9) (3.6) (42.2) (86.0) 11.6 (13.2) San Juan (69.6) (82.6) 4.6 (4.4) (8.8) (34.5) 4.6 San Luis (27.4) (51.2) Tucuman (67.9) (108.0) (5.7) (11.7) (101.4) (27.2) (8.4) UNDERDEVELOPED (399.6) (577.0) (36.5) (46.3) (166.8) (113.0) (87.1) Catamarca (39.2) (74.0) (34.7) (10.1) (24.7) (7.7) (34.7) Chaco (81.2) (91.3) 7.3 (8.1) (33.2) (24.2) 8.4 Corrientes (50.6) (t87.9) (42.7) (36.1) (32.4) (16.3) (11.9) Formosa (56.8) (72.7) (1.4) (12.8) (16.7) (28.4) (10.8) Jujuy (60.7) (86.1) (26.0) (35.3) (46.4) La Rioja (31.4) (52.6) (9.3) (28.4) (66.9) (27.7) (26.6) Misionee (40.1) (69.9) (11.5) (2.2) 21.6 Santiago d^l Fetero (86.1) (72.5) Te-rra del Fuego (9-9) Source: See Table 6.1. Note: (a) Value In Australea of Dee-mber 1989 divided by the commercial rate of exchange (luss = A/.1,110.48).

67 Annex 6 Page 1 of 7 ARGENTINA PROVINCIAL DEVELOPMENT PROJECT Detailed Description of Project Comnonents A. Institutional Development 1. The PGFS made a number of specific recommendations for a strategy to implement reforms at the Central and Provincial levels of government. To be successful, implementation must be actively pursued by both levels. Project implementation would require strong technical and management skills at the Central (CEU) and Provincial Government (PEU) levels; these requirements are detailed in Annex 11. The present Annex presents guidelines for longer-term institutional development that would be initiated under the proposed project as the first stage of a medium-term strategy for structural reforms in intergovernmental financial relationships. Central Government 2. The elements of this component at the Central Government level cover four basis areas: monitoring the revenue sharing system; analysis of the comparative advantage of each level of government in the financing and delivery of public infrastructure and services; implementation of provincial financial management information system; and development of a long-term strategy for sustainable financing of sub-national governments' expenditures. 3. Monitoring of the Revenue Sharing System. Although the current Revenue Sharing System (RSS -- sistema de coparticipacion), regulated under the December 1987 legislation, may be criticized on several grounds, it is a vast improvement over the chaotic transfer system prevailing before it went into effect in To its merit, the current RSS fully meets two of the criteria for intergovernmental fiscal relations recommended in the PGFSA 1, in that it provides shared revenues that are transparent and predictable for both Central and Provincial Governments. The RSS also appears to be fiscally sustainable, although significant criticisms may be made regarding the system's equity, in that its inter-jurisdictional redistribution of revenues results in a flow of potential resources away from provinces with the greatest number of households with unsatisfied basic needs. In addition, to the extent that all provinces recognize that national revenue sharing will be the only guaranteed intergovernmental transfer to be received from the Central Government, the RSS also provides incentives to provincial fiscal autonomy. A/ There should be in place a system of intergovernmental transfers that are predictable, transparent, financially sustainable, and that provide incentives to provincial fiscal autonomy. PGFS, op. cit., Chapter VII.

68 Annex 6 Page 2 of 7 4. Although the PGFS recommended that the basic RSS currently in place not be changed in the near-term for all of these reasons, it advocated that the Central Government implement a system for monitoring the efficacy of the system, taking into account the criteria noted above (predictable, transparent, sustainable, equitable, and promoting provincial fiscal autonomy). Basic inputs for monitoring and evaluation of the RSS could be provided by the Provincial Financial Management Information System, described below. It is very important, however, that the continual evaluation of the RSS, and eventual changes to improve it, not be done solely on the basis of provincial financial management; rather, it should be made in the broader context of national fiscal policies for stabilization and economic development. 5/ 5. Intergovernmental ComDarative Advantage. The Government of Argentina has embarked on a strong policy for decentralization of the public sector, with transfer of infrastructure and service delivery responsibility to provinces (and municipalities). However, this policy has not been supported with detailed analysis on intergovernmental comparative advantage regarding financing and delivery. To date, the political decision has been made to decentralize service delivery, and adjustments in the RSS have been made to finance these. However, there is a knowledge gap regarding, for example, tax devolution as an alternative to the RSS if lower levels of government are more efficient administrators of certain taxes, or scale economies for certain services indicating that decentralization would be inefficient. The proposed component would help fill this gap. 6. ImRlementation of the Financial Management Information System. In order to provide data essential to macroeconomic planning, as well as to monitor provincial progress toward fiscal autonomy, the Central Government is moving to establish a Provincial Financial Management Information System (FMIS). Work has begun with resources from a Project Preparation Facility to cover the period, for which no data were available at the Central Government. Baseline date for the FMIS would be provided by the provinces through their PBSs. Initially, the PBS would be the FAIP to begin the process, but a more comprehensive expenditure planning and budgeting system would be implemented over time. The PBS would be the key instrument for the planning, programming and control of provincial revenues and expenditures, and it would also be the primary instrument for analysis of provincial eligibility for project financing in that it would provide information on the economic efficiency and financial sustainability of the provincial plans. 7. The data on the debt of provincial governments would be improved to provide detailed information on all of the sources of short- and longerterm financing, as well as guarantees. Both the direct and indirect administrations should be covered. Furthermore, in terms of short term l/ See Argentina: Tax Policy for Stabilization and Economic Recovery, World Bank Country Study, 1990.

69 Annex 6 Page 3 of 7 credit, the data would show: for what the payment is owed (i.e., personnel, social security, suppliers, contract services) and to whom it is owed (municipalities, decentralized entities and the National Treasury, national public enterprises, private firms, etc.), and if it is in arrears. This system would permit a much clearer analysis of provincial floating debt, which most officials recognize as a serious problem but one that is now very difficult to address due to the lack of adequate data. There should also be up-to-date information on the extent to which resources from revenue sharing have been used as guarantees for loans. 8. The FMIS would serve two key functions. First, it would provide the Central Government with a necessary input for national fiscal policy. Also, it would provide the base on which to identify provincial needs for technical assistance for improved financial management, and to design such assistance programs. Very useful experience in the design and implementation cf such information systems currently is available in the five provinces (Buenos Aires, Cordoba, La Pampa, Neuquen and Santa Fe) that are implementing the Bank-financed Municipal Development Project (Loan 2920-AR), where runicipal financial management information systems are being developed at the provincial level. The experience with the new budgeting system in the province of Mendoza is also most interesting, showing how much can be done when there is a strong commitment to fiscal reform. 9. Strategy for Sustainable Financing of Provincial Exgenditures. The financing strategy would be designed to address three basic needs for the overall strategy for reform of intergovernmental financial relations: (a) to immediately provide strong national incentives to provincial fiscal autonomy; (b) to provide financing for capital improvements programs in the near-term for those provinces that generate current account savings; and (c) to promote, in the medium- and long-term, the transition of the financing of provincial capital investments from earmarked, segmented sources of funding to competitive, non-segmented financing through domestic financial markets. 10. The proposed project would be an initial step in the design and implementati--i of the financing strategy, moving away from supporting provincial expenditures with national deficit financing, and toward the provinces eventually financing their investments with their own savings and with borrowing obtained through the national financial markets. Currently, however, Argentina's financial markets are unstable and segmented, and they are not efficiently mobilizing domestic savings and allocating resources. The proposed Public Sector Reform Loan for Argentina specifically would address strengthening of the financial sec ot 11. As Argentina's financial...rkets attain acceptable levels of domestic savings mobilization and of efficient resource allocation, financing of provincial investment programs with official sources of credit could be phased out, with the provinces thereafter competing for funds in non-segmented financial markets.

70 Annex 6 Page 4 of 7 Institutional Development for the Provinces 12. With technical assistance provided under the PPF Advances and under the proposed project, provincial governments would begin immediately to formulate FAIPs, and to initiate the design of Provincial Planning and Budgeting Systems (PBSs). 13. Financial Action and Investment Plans. Provincial FAIPs would be the first step in moving toward provincial financial autonomy. See Annex 4 for additional discussion. 14. Provincial Planning and Budgeting System. After an initial period (about one year) of implementation of the FAIP, provinces would move to implementing their PBS. The recommendations of Chapter VI of the PGFS provides guidelines for this system. 15. The PBS would be a key tool for provincial planning, budgeting and control. It also would be fundamental for monitoring the effectiveness of provincial management, not only by provincial authorities, but also by the National Secretaria de Hacienda as it monitors macroeconomic policy and evaluates whether the province is eligible for project participation. Key elements of the PBS would include: (a) (b) planning and control of provincial revenues; expenditure priorities, including (i) maintenance and rehabilitation (ii) personnel policies that provide adequate professionalism and performance (iii) new investments, with projects costing greater that an amount agreed with the Secretaria de Hacienda subject to a competent benefit/cost analysis to ensure economic efficiency; (c) (d) (e) (f) reliable projections of total and incremental (with and without a proposed investment) revenues to ensure financial sustainability; strategies for financing investment costs, including own savings and borrowings; and financial and service delivery relationships with decentralized provincial agencies and enterprises, as well as municipalities. strategies for maximizing the impact on private sector investment. 16. With regard to this last element, strategies for maximizing the

71 Annex 6 Page 5 of 7 impact of public expenditures on private investment should be developed. Provinces should analyze their comparative advantages or "vocations" for different kinds of activities (i.e., those that they could stimulate without subsidies), such as in the primary sector as well as in industry and tourism. The resulting development strategies could serve as a substitute for Industrial Promotion in which industries are induced at tremendous fiscal and economic opportunity costs to locate in places where they have little or no competitive advantages. The study should begin with an analysis of the components of the province's comparative advantage (natural resources, climate, social and economic infrastructure, etc.), and, then, identify potential activities for investment and barriers to their development. For example, the "vocation" of a province might be agriculture, but it lacks key transportation and storage facilities to assure their adequate development. The possibility of provision of such infrastructure by the private sector should always be analyzed. Possible forward and backward linkages should also be explored. For example, the highest priority might be irrigation, which could in turn produce demands for processing of the increased production, as well as for inputs. Ways of informing the private sector of these opportunities should be developed. B. Physical Investments 17. As the proposed operation would finance a "time slice" of provincial investment programs, details of eligible provincial physical investments for maintenance, rehabilitation, completion of unfinished works, and new investments would be available only during project implementation. However, with support from the PPF Advance, a profile of recent provincial investments has been assembled (Table 6.1), and this provides a good indication for estimating future priorities. In 1989, total provincial (central and decentralized administrations) investment was approximately US$ 975 million. Excluding the General Administration, Social Security and Social Welfare (predominantly housing) sectors that would not be eligible for project financing, the provinces invested about US$ 505 million. Of this sub-total, 79 percent of investments were concentrated in four sectors: roads 49 percent; Irrigation and Drainage 13 percent; Education Energy 10 percent; and 7 percent.