Operation Name Region Sector. Project ID Borrower(s) Implementing Agency

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1 Operation Name Region Sector Project ID Borrower(s) Implementing Agency PROGRAM INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: AB3497 BR - RIO GRANDE DO SUL FISCAL SUSTAINABILITY LATIN AMERICA AND CARIBBEAN Sub-national government administration (60%);General public administration sector (40%) P Date PID Prepared November 29, 2007 Estimated Date of March 31, 2008 Appraisal Authorization Estimated Date of Board April 31, 2008 Approval STATE GOVERNMENT OF RIO GRANDE DO SUL STATE SECRETARY OF FINANCE OF RIO GRANDE DO SUL 1. Key development issues and rationale for Bank involvement Located in the extreme south of Brazil, Rio Grande do Sul is the fourth largest state economy in the country and the fifth largest in population. The state s GDP in 2006 was R$ 156 billion (US$ 72 billion). Rio Grande do Sul has enjoyed high socio-economic indicators in the Brazilian context. However, despite the privileged position that Rio Grande do Sul holds in the Brazilian context, economic and social development has deteriorated since the mid-1990 s. Rio Grande do Sul s participation in national GDP fell from 8.1 percent in 1996 to 7.4 percent in In addition, state growth has been more erratic, with large expansions followed by strong recessions, mainly linked to climatic effects on water resources (rainfall) and exchange rate movements. Public finances difficulties seem to be a relevant factor behind the poor economic and social performance of Rio Grande do Sul in the last decade. Continuous fiscal deficits and explosive indebtedness have significantly hampered the ability of Rio Grande do Sul to foster economic growth and to continuously pursue the high welfare standards enjoyed by its population in the past. RGS debt of roughly R$ 33.7 billion (or 254 percent of state net current revenues) is among the highest in Brazil. Debt service is projected to consume percent of net real revenue per annum in the medium term. The lack of fiscal space has eroded the government s ability to attenuate the high volatility of economic growth with counter-cyclical policies. Moreover, firms are looking outside Rio Grande do Sul to conduct their business and skilled residents are increasingly emigrating. On the social front, the fiscal crisis has deteriorated the quality of public services delivery, which explains why quality of life indicators are beginning to recede relative to the rest of Brazil. The development objective of this proposed operation is to assist the government of Rio Grande do Sul (RGS) to attain a fiscally sustainable path in the medium term leading to enhanced economic growth and development. The goal of achieving fiscal sustainability to enhance economic growth prospects for RGS is based on the following principles: A shared understanding of the fiscal and debt challenges facing RGS; State ownership of the program: measures under the program come from the authorities own initiatives as delineated through its Multi-Year Plan ( ) or are designed in collaboration with Bank staff, following technical analyses; and Full integration of the package of measures affecting fiscal and debt outcomes and projections.

2 Rationale for Bank Involvement.The Bank s Brazil Country Assistance Strategy for (and the forthcoming Brazil Country Partnership Strategy, ) is based on a foundation of sound macroeconomic management and fiscal reforms, efficient public sector management and good governance with pillars focusing on a more equitable, sustainable and competitive Brazil. This proposed operation would reinforce Brazil s federated public sector to further strengthen macroeconomic conditions, especially by shoring up the fiscal situation in the fourth largest state in the nation. In this manner, the proposed operation is fully consistent with the CAS/CPS foundation and the objectives of the Bank s strategy agreed with Brazil. Moreover, Bank support must meet the criteria for engagement with states, which is being agreed with Brazil under the forthcoming Country Partnership Strategy (CPS) for For example, the Bank will only engage with states that have approval to borrow following national procedures (such as formal requests to, and approval from an inter-ministerial committee) and formal evaluation and approval from the STN. The Bank s engagement thus far has been to identify the reasons that led to the difficult fiscal circumstances and to analyze with the authorities possible areas of fiscal reform and debt restructuring that could reverse the current fiscal trajectory. Thus far, reviews and analysis in the areas of pensions, debt restructuring, public sector management, and overall fiscal policies, have led to a set of possible measures that could contribute to setting RGS on a fiscally sustainable path. The proposed operation would pursue these activities and provide both financial support for debt restructuring operations and technical assistance in critical areas leading to fiscal sustainability for growth. To the extent that Bank support can contribute to solving this fiscal sustainability puzzle, these efforts may also provide some demonstrative clues to improve the fiscal circumstances in other Brazilian states. 2. Proposed objective(s) To achieve the overall objective of this proposed operation which is to support the government of Rio Grande do Sul (RGS) to attain a fiscally sustainable path in the medium term leading to enhanced economic growth and development, four components of debt and fiscal reforms designed to culminate in a sustainable fiscal path were designed. These components encompass: Debt restructuring: the purpose of this component is to smooth the profile of debt service generated by the extra-limite debt, reduce the debt stock in net present value terms, increase debt duration, and improve the state s cash flow. Fiscal adjustment - revenue enhancement and expense control: the debt restructuring component alone be insufficient to achieve fiscal sustainability. Fiscal sustainability will require a strong, consistent, and continuous fiscal adjustment effort directed to enhance revenue and curb the increasing trend in current expense. Social security reforms: the DPL operation would support the state government s adjustment efforts to control social security deficits which are the one of the most relevant sources of fiscal disequilibrium. Public sector management reforms: the enhancement of the efficiency of expenditure management is a necessary condition both to guarantee the sustainability of fiscal adjustment efforts and to improve the provision of public goods and services. The activities under this component will focus on enhancing planning capacity of the state government and establishing a results-based management model. When combined as a package, immediate and medium-term fiscal saving and improved debt parameters would ameliorate the fiscal and debt crisis facing Rio Grande do Sul.

3 3. Preliminary description The program would support fiscal reforms and debt restructuring operations designed to move RGS to a sustainable fiscal path. These measures would include pension reforms, revenue enhancements, spending restraint, and public sector management reforms. Combining these measures with debt restructuring operations, and setting the data, including projections based on these measures, into an internationally recognizable fiscal framework, will simplify the analysis of medium-term fiscal sustainability. The operation would likely comprise a two-tranche adjustment loan, totaling US$1 billion. The first tranche of the adjustment loan would be conditioned on a series of fiscal adjustment measures, social security and public sector reforms undertaken or currently underway. The second tranche would have an estimated disbursement date at 2010, subject to subsequent reform conditions being met. Institutional Arrangements: The operation would have counterparts in two state secretariats, broadly reflecting the main components of the proposed operation: Finance (SEFAZ), Planning and Management (SEPLAG). In addition, the state secretariats of Administration, Social Development and Justice and Education will also play a relevant role in the implementation of the measures directed to resume fiscal sustainability. The primary coordinator would most likely be SEFAZ. Loan Components: Debt restructuring: within this category the loan resources will be directed to the repayments of principal of the state debts that are (a) the most expensive, (b) that promote debt service uneven profile and (c) that generate greater net present value gains. Fiscal Adjustment: Within this category the project concept envisages actions relating to (a) reducing the ratio of consolidated net debt to net current revenues, (b) generating positive operating and primary balances, (c) increasing tax collection, (d) reducing personnel spending as a fraction of net current revenues and, (e) increasing the ratio of investment to net current revenue. Social security reform: within this component the project will support reforms directed to the (a) increase of social security contributions, (b) reduction of social security benefits and (c) reduction of medium and long run current social security deficits through changes in state legislation and/or administrative measures. Public sector management: the DPL operation will support activities directed to the (a) enhancement of planning capacity; c) increase service delivery efficiency, including in social and environmental programs, (d) introduction of results based management of programs and human resources, and (e) improvement of service delivery through the partnership with non-governmental providers of services through OSCIPs (Organização da Sociedade Civil de Interesse Público), Civil Society Organizations with Public Interest in social areas. 4. Environment Aspects Not Applicable. The proposed project does not involve any activities that are likely to have any environmental impacts. 5. Tentative financing Source: ($m.)

4 Borrower 0 International Bank for Reconstruction and Development Total 1.000

5 6. Contact point Contact: Fernando Blanco Eduardo Somensatto Title: Economist LSCPE Lead Economist LSCPE Tel: Fax: Location: The World Bank The World Bank SCN Quadra 2 Lote A, H Street N.W Brasilia, DF Washington, DC (I4-405)