IMPLEMENTATION COMPLETION AND RESULTS REPORT (IBRD-77000) ON A LOAN IN THE AMOUNT OF US$100 MILLION TO THE REPUBLIC OF PARAGUAY FOR A

Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank Report No: ICR00001966 IMPLEMENTATION COMPLETION AND RESULTS REPORT (IBRD-77000) ON A LOAN IN THE AMOUNT OF US$100 MILLION TO THE REPUBLIC OF PARAGUAY FOR A FIRST PUBLIC SECTOR PROGRAMMATIC DEVELOPMENT POLICY LOAN October 5, 2011 Poverty Reduction and Economic Management Argentina, Paraguay, Uruguay Country Management Unit Latin America and the Caribbean Region

CURRENCY EQUIVALENTS (Exchange Rate Effective October 5, 2011) Currency Unit = Guaraní (G$) G$1.00 US$0.00024 US$1.00 G$4,190.00 FISCAL YEAR January 1 December 31 AGPE ANDE CEP CPS DPL FEPASA HRM IBRD IFI IMAGRO IPR ISR LAFE M&E MECIP MOP NLTA PDO PEFA PETROPAR PREM SET SFP SICCA SOE UMEP USAID VAT ABBREVIATIONS AND ACRONYMS Auditoría General del Poder Ejecutivo (Office of the Executive s Internal Auditor) Administración Nacional de Electricidad (National Power Authority) Consejo de Empresas Públicas (Council for State-Owned Enterprises) Country Partnership Strategy Development Policy Loan Ferrocarriles del Paraguay Sociedad Anónima (Paraguay Railways) Human Resources Management International Bank for Reconstruction and Development International Financial Institution Impuesto a la Renta de Actividades Agropecuarias (Agricultural Income Tax) Impuesto Personal a la Renta (Individual Income Tax) Implementation Status Reports Ley de Administración Financiera (Financial Administration Law) Monitoring and Evaluation Modelo Estándar de Control Interno para las Entidades Públicas del Paraguay (Paraguay Standard Model of Internal Control) Ministerio de Obras Públicas (Ministry of Public Works) Non Lending Technical Assistance Project Development Objective Public Expenditure and Financial Accountability Petróleos Paraguayos (Paraguayan Oil Company) Poverty Reduction and Economic Management Subsecretaría de Estado de Tributación (Under-Secretariat of State Taxes) Secretaría de la Función Pública (Public Administration Secretariat) Sistema Integrado de Control de Cumplimiento de la Carrera Administrativa (Integrated System for the Consolidated Control of the Administrative Career) State-Owned Enterprise Unidad de Monitoreo de las Empresas Públicas (SOE Monitoring Unit) United States Agency for International Development Value-Added Tax Vice President: Pamela Cox Country Director: Penelope Brook Sector Manager: Arturo Herrera Project Team Leader: Alexandre Arrobbio ICR Team Leader: Alexandre Arrobbio

PARAGUAY First Public Sector Programmatic Development Policy Loan CONTENTS Data Sheet A. Basic Information B. Key Dates C. Ratings Summary D. Sector and Theme Codes E. Bank Staff F. Results Framework Analysis G. Ratings of Program Performance in ISRs H. Restructuring Table of Contents 1. Program Context, Development Objectives and Design... 1 1.1 Context at Appraisal... 1 1.2 Original Program Development Objectives (PDO) and Key Indicators... 3 1.3 Revised PDO and Key Indicators with Reasons/Justification... 3 1.4 Original Policy Areas Supported by the Program (as approved)... 3 1.5 Revised Policy Areas... 4 1.6 Other significant changes... 5 2. Key Factors Affecting Implementation and Outcomes... 6 2.1 Program Performance... 6 2.2 Major Factors Affecting Implementation... 7 2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization... 9 2.4 Expected Next Phase/Follow-up Operation... 9 3. Assessment of Outcomes... 10 3.1 Relevance of Objectives, Design and Implementation... 10 3.2 Achievement of Program Development Objectives... 10 3.3 Justification of Overall Outcome Rating... 24 3.4 Overarching Themes, Other Outcomes and Impacts... 24 3.5 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops... 25 4. Assessment of Risk to Development Outcome... 25 5. Assessment of Bank and Borrower Performance... 26 6. Lessons Learned... 28 7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners... 29 Annex 1. Bank Lending and Implementation Support/Supervision Processes... 30 Annex 2. Beneficiary Survey Results... 31 Annex 3. Stakeholder Workshop Report and Results... 31 Annex 4. Summary of Borrower's ICR and/or Comments on Draft ICR... 32 Annex 5. Comments of Co-financiers and Other Partners/Stakeholders... 32 Annex 6. List of Supporting Documents... 33 Annex 7. Policy Matrix for Paraguay s First Public Policy Programmatic Development Policy Loan... 34 Annex 8. Level of Fulfillment to date of Triggers for PDPL2 and Indicative Medium- Term Actions for PDPL3... 36 MAP 38 ii

A. Basic Information Country: Paraguay Program Name: Paraguay Public Sector Reform Program ID: P113457 L/C/TF Number(s): IBRD-77000 ICR Date: 10/05/2011 ICR Type: Core ICR Lending Instrument: DPL Borrower: REPUBLIC OF PARAGUAY Original Total Commitment: USD 100.00M Disbursed Amount: USD 100.00M Revised Amount: USD 100.00M Implementing Agencies: Ministry of Finance Cofinanciers and Other External Partners: B. Key Dates Process Date Process Original Date Revised / Actual Date(s) Concept Review: 12/18/2008 Effectiveness: 08/26/2009 08/26/2009 Appraisal: 03/13/2009 Restructuring(s): Approval: 05/05/2009 Mid-term Review: Closing: 03/01/2011 03/01/2011 C. Ratings Summary C.1 Performance Rating by ICR Outcomes: Satisfactory Risk to Development Outcome: Moderate to Significant Bank Performance: Satisfactory Borrower Performance: Satisfactory C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings Quality at Entry: Satisfactory Government: Satisfactory Quality of Supervision: Satisfactory Implementing Agency/Agencies: Satisfactory Overall Bank Overall Borrower Satisfactory Performance: Performance: Satisfactory C.3 Quality at Entry and Implementation Performance Indicators Implementation Performance Indicators QAG Assessments (if any) Rating: Potential Problem Program at any time (Yes/No): No Quality at Entry (QEA): None Problem Program at any time No Quality of Supervision (QSA): None iii

(Yes/No): DO rating before Closing/Inactive Satisfactory status: D. Sector and Theme Codes Sector Code (as % of total Bank financing) Original Actual Central government administration 33 33 General agriculture, fishing and forestry sector 17 17 General industry and trade sector 33 33 Other social services 17 17 Theme Code (as % of total Bank financing) Corporate governance 16 16 Other public sector governance 20 20 Public expenditure, financial management and procurement 32 32 Tax policy and administration 32 32 E. Bank Staff Positions At ICR At Approval Vice President: Pamela Cox Pamela Cox Country Director: Penelope J. Brook Pedro Alba Sector Manager: Arturo Herrera Gutierrez Nicholas Paul Manning Program Team Leader: Alexandre Arrobbio Alexandre Arrobbio ICR Team Leader: ICR Primary Author: F. Results Framework Analysis Alexandre Arrobbio William V. Mayville Maria Cecilia Zanetta Program Development Objectives (from Project Appraisal Document) The overall development objective of the Programmatic Development Policy Loan (PDPL) is to contribute to the effectiveness and efficiency of the public sector while maintaining a stable macroeconomic policy framework. This will be achieved by: (i) improving revenue collections and the equity of the tax system; (ii) improving the effectiveness of Central Administration internal and financial control; (iii) exerting effective SOE oversight to ensure sound and transparent financial management; (iv) improving the efficiency and equity of social capital expenditures; and (v) contributing to the professionalization of the civil service. These objectives are inter-related and address three main public sector outcomes: revenue stability, accountability, and public sector efficiency. iv

Revised Program Development Objectives (if any, as approved by original approving authority) (a) PDO Indicator(s) Indicator Baseline Value Original Target Values (from approval documents) v Formally Revised Target Values Actual Value Achieved at Completion or Target Years Indicator 1 : Increase Tax/GDP Ratio by at least 0.9% of GDP Value (quantitative or 11.90 %* 12.8 % 13.5% Qualitative) Date achieved 12/31/2008 03/01/2011 12/31/2010 Achieved: Tax collections exhibited a sustained increase during the 2008-2010 Comments period. This is remarkable, given the drop in GDP in 2009 as a result of the (incl. % international financial crisis. The original target was exceeded two years ahead achievement) of schedule. Indicator 2 : Increase in PEFA Rating for internal control and external audit (PI-20 and PI- 21) for 50 percent of the ministries and Secretariats are rated C Value (quantitative or Qualitative) 2008 IFA rating was D+ for PI-20 and PI-21 2010 IFA rating is C for PI-20 and PI-21 2010 IFA rating is expected to be C for PI-20 and PI-21 the Central Administration as a whole Date achieved 12/31/2008 03/01/2011 02/15/2011 Achieved: 5 out of 11 ministries representing 70% of the overall budget, have Comments established internal control norms and committees; staff has been trained in (incl. % the implementation of MECIP; their respective internal control units have achievement) adequate HR Indicator 3 : Annual publication of audited 2010 financial statements for each SOE Value (quantitative or Qualitative) No annual audited financial statements in line with international standards available for SOEs Annual publication and audited financial statements for each SOE from 2010 Audited financial statements for eight of the nine SOEs accounting for 99% of overall SOE expenditures were published in 2009 Date achieved 12/31/2008 03/31/2011 02/15/2011 Achieved: 4 of the 9 SOEs have already published their 2010 audited financial Comments statements, and 4 are expected to have them published soon. The ninth SOE, (incl. % which is being liquidated, is audited by the Office of the Executive s Internal achievement) Auditor (AGPE). Indicator 4 : Increase of beneficiaries of conditional cash transfers from Tekopora Program Value (quantitative or Qualitative) 13,679 beneficiaries 100,000 beneficiaries 83,100 beneficiaries Date achieved 12/31/2008 03/31/2011 12/31/2010 Comments Largely achieved: The Tekopora program is expected to reach its target by

(incl. % achievement) 2012. The selection process, based on both geographic selection & a door-todoor census, targeted the very poor. Roughly 40% of households in extreme poverty are covered under the program Percentage of the paved road network that receives periodic maintenance Indicator 5 : Value (quantitative or 25% maintenance 50% 45% Qualitative) Date achieved 12/31/2008 03/31/2011 12/31/2010 Largely achieved: The maintenance of the paved road network has improved Comments substantially resulting from newly earmarked budgetary allocations for road (incl. % maintenance, as well as the implementation of performance-based maintenance achievement) contracts. Indicator 6 : Value (quantitative or Qualitative) Percentage of personnel recruitments and promotions that are based on merit and professional skills Over 10,000 new 100% of new recruitments and recruitment is promotions were Merit-based personnel based on clearly based on clearly selection processes are specified meritbased selection based selection specified merit- rare criteria criteria between 2008 and 010. Date achieved 12/31/2008 03/31/2011 12/31/2010 Comments (incl. % achievement) Undetermined: Because there is no centralized information on recruitments and promotions, it is not possible to determine the proportion selected using meritbased criteria. (b) Intermediate Outcome Indicator(s) Indicator Baseline Value Original Target Values (from approval documents) Formally Revised Target Values Actual Value Achieved at Completion or Target Years G. Ratings of Program Performance in ISRs No. Date ISR Archived DO IP Actual Disbursements (USD millions) 1 06/23/2009 Satisfactory Satisfactory 0.00 2 12/14/2009 Satisfactory Satisfactory 99.75 3 02/28/2011 Satisfactory Satisfactory 99.75 H. Restructuring (if any) Not Applicable vi

1. Program Context, Development Objectives and Design 1.1 Context at Appraisal 1. Upon assuming office in 2008, the Lugo administration articulated its overall strategy in the Strategic Economic and Social Plan for 2008-2013. This Plan aimed to achieve a sustainable and equitable economic growth path, and to improve effectiveness and efficiency of the public sector, while addressing the urgent needs of Paraguay s most vulnerable groups. Given Paraguay s institutional context, public sector reform was a key priority of this Plan. The new administration, however, confronted significant challenges while pursuing these goals due to the effects of the international financial and economic crisis as well as Paraguay s specific structural and institutional constraints. 2. The Government s Plan was complemented by prudent macroeconomic policies aimed at creating fiscal space for priority spending programs, particularly in social areas. To achieve this, the Government committed itself to keeping inflation in the single digits. It also committed itself to gradually increasing tax collections through a better tax administration and the introduction of new taxes, as well as improving the efficiency of public spending. The plan also envisaged important reforms to state-owned enterprises (SOEs) to help address their poor performance in terms of service delivery and their lack of financial and managerial transparency. 3. Enhancing the performance of Paraguay s public sector was a necessary condition for enhancing governance and transparency while achieving equitable economic growth. Two decades of institutional reform under the new constitutional framework achieved a simplified tax scheme, the appointment of a new Supreme Court, and the approval of a Financial Administrative Law (LAFE). However, major subsequent public sector reform initiatives addressing high levels of inefficiency and ineffectiveness, high politicization, and widespread corruption within the public sector were systematically blocked. These included civil service reform, the privatization of loss-making SOEs, and more recently, the tax reform in 2004. The 2008 election of a reform-minded administration provided new momentum to the efforts of reform, focused on raising the public sector s weak performance in the delivery of social services and in capital expenditure. 4. The operation was prepared in a context of an uncertain economic outlook for Paraguay. Following a period of unprecedented economic expansion and prudent macroeconomic policy between 2004 and 2008, the international economic crisis posed a serious threat to the Paraguayan economy through lower commodity prices and reduced demand for Paraguayan exports, especially soy and meat. In addition, the country experienced a severe drought which further devastated the agriculture sector. In response, the government decided to implement an Anti-Crisis Plan for 2009, which aimed at safeguarding priority social and investment spending programs, maintaining liquidity in the financial system and ensuring access to credit by the productive sectors. Despite the reorientation in short-term economic priorities, the Government remained committed to the macroeconomic objectives set out in the Government Plan, including a gradual increase in tax collections through better tax administration and the introduction of new taxes; an improvement in the efficiency of public spending, and reforms of the state-owned enterprises (SOEs). 1

5. While the crisis had a significant impact in the short run, the Government quickly implemented a comprehensive Anti-Crisis Plan, and the economy rebounded strongly. GDP contracted by 3.8 percent in 2009, largely due to a fall in agricultural production. Paraguay s external position, on the other hand, remained relatively stable, due to the fact that imports fell even more than exports, and remittances declined by less than 1 percent. The Government s Anti-Crisis Plan was instrumental in maintaining domestic demand and investment, and in limiting the effects on the poor (see PDO 3.1). The policy response included: (i) injection of liquidity into the financial system; (ii) fiscal expansion to safeguard priority social and investment spending programs; (iii) provision of financing to productive sectors through the state-owned development agency; and (iv) mobilization of external financing from International Financial Institutions (IFIs) to ensure adequate resources for the Government Plan. As a result, economic growth began picking up in the last quarter of 2009, and reached a record 15.3 percent in 2010. On the fiscal side, and despite the stimulus, the Government maintained a small surplus thanks to better than expected tax collections, which showed that the improvements in tax administration and tax policy that began in 2004 had paid off. The fiscal stimulus was gradually reduced in 2010 and tax receipts continued to improve. The maintenance of fiscal discipline even during the crisis helped put public debt ratios back on a downward trend beginning in 2010. Key Macroeconomic Indicators (% of GDP, unless otherwise indicated) 2006 2007 2008 2009 2010 Real GDP (% change) 4.3 6.8 5.8-3.8 15.3 Consumer price inflation (% change, eop) 12.5 6.0 7.5 1.9 7.2 External current account balance 1.4 1.4-1.8 0.3-3.2 Central Government revenues 18.3 17.6 17.3 19.6 19.2 o/w tax revenue 12.0 11.4 11.8 13.0 13.4 Expenditure 17.8 16.7 14.8 19.6 17.8 Current expenditure 13.7 12.9 12.2 15.0 14.0 Capital expenditure 4.2 3.8 2.7 4.6 3.8 Primary balance 1.5 1.8 3.1 0.7 1.8 Overall fiscal balance 0.5 1.0 2.5 0.1 1.4 Public sector gross debt 24.8 25.1 20.5 22.2 18.8 o/w foreign currency denominated debt 22.2 17.5 15.1 14.6 12.6 Source: Ministry of Finance and Central Bank of Paraguay. Rationale for Bank s involvement 6. The Public Sector Programmatic DPL series was conceived within the context of the Bank s FY09-13 Country Partnership Strategy (CPS) to support the Government Plan, mainly for Public Sector Reforms, and the Anti-Crisis Plan. Specifically, the operation supported the Government Plan s overall objective of achieving sustainable and more equitable growth by providing direct support to three of its pillars: (i) macroeconomic policy; (ii) stateowned enterprises (SOEs); and (iii) state modernization. The operation also supported the Anti- Crisis Plan aimed at creating fiscal space to soften the impact of the crisis through an increase in public investment and prioritized social expenditures. 2

1.2 Original Program Development Objectives (PDO) and Key Indicators (as approved) 7. The short-term objective of the PDPL was to: (i) safeguard the proportion of budgeted social expenditure during execution, as part of the Anti-crisis Plan; and (ii) pave the way for reform in the areas supported by the loan. 8. The Program Development s overall medium-term objective was to contribute to the effectiveness and efficiency of the public sector while maintaining a stable macroeconomic policy framework. This, in turn, was to be achieved by focusing on four policy areas. The corresponding project-specific PDOs and Key Outcome Indicators are described below: 1 Paraguay s First Public Sector Programmatic Development Policy Loan PDPL1 Program Development Objectives (PDOs) and Key Outcome Indicators Policy Area 1. Tax System PDO 1 - Improving revenue collections and the equity of the tax system. Tax/GDP ratio increases by at least 0.9% by 2012-2013 (i.e., to 12.8% in 2012). The elimination of credits on VAT deductions from IMAGRO has an impact equivalent to 0.75% of GDP. The designation of 114 VAT withholding agents has an impact equivalent to 0.15% of GDP. Policy Area 2. Public Sector Financial Control PDO 2.1 - Improving the effectiveness of the Central Administration s internal financial control. PEFA indicators for internal control and internal audits (PI-20 and PI-21) for 50% of the ministries are rated C. PDO 2.2 - Exerting effective oversight of state-owned enterprises (SOEs) to ensure sound and transparent financial management. Annual publication of audited financial statements for each SOE from 2010. Definition of medium-term financial targets for SOEs by the Holding. Policy Area 3. Expenditure Management PDO 3 - Improving the efficiency and equity of social and capital expenditures. Improvements are verified by the coverage of the social safety net through the increase of beneficiaries of the conditional cash transfers from the Tekoporá program to 100,000 families in extreme poverty. The quality of public infrastructure has improved, as reflected by the proportion of the paved road network that receives periodic maintenance. Policy Area 4. Human Resources Management PDO 4 - Contributing to the professionalization of the civil service. 100% of new recruitment is based on merit and skills. 1.3 Revised PDO (as approved by original approving authority) and Key Indicators with Reasons/Justification N/A 1.4 Original Policy Areas Supported by the Program (as approved) Policy Area 1 - Tax System 9. The policy goal was to improve the tax system in order to finance the Government s strategic social priorities in the medium term. The Government planned a series of measures to gradually reinforce both tax policy and tax administration. Immediate measures focused on continuing efforts to improve tax administration and correcting distortions in existing taxes, specifically the agricultural income tax (IMAGRO) and Value-added Tax (VAT). Medium-term focus was placed on the implementation of the personal income tax (IPR), adjusting the rates of excise taxes on tobacco and alcohol products, and continuing to strengthen the tax administration. 1 The Key Outcome Indicators were also identified as Medium Term Outcomes in the Policy Matrix. 3

Policy Area 2 - Public Sector Financial Control Internal financial control 10. The policy goal was to improve the effectiveness of the Central Administration s internal financial control. Given the ineffectiveness of internal control, the reform aimed to significantly improve accountability and to ensure that funds were used for their intended purposes. Three main lines of action were targeted for the Central Administration over the medium term: (i) expansion of financial management information systems to all spending units; (ii) implementation of a standardized internal control framework throughout all spending units in line with international practices to ensure the effectiveness, professionalism and independence of the internal audit function; and (iii) improvement and strengthening of the control environment through further professionalization and harmonization of financial administration units (UAFs) and spending units. State-owned Enterprises (SOEs) 11. The policy goal was to establish the Government s oversight of SOEs and improve their governance. Given the SOEs poor service delivery performance, their lack of financial and managerial transparency, and the ineffective institutional settings for managing this substantial proportion of public expenditures, the Government s medium-term goal was to establish a new institutional framework to ensure: (i) adequate ownership and supervision of SOEs; (ii) effective control of the execution of objectives and specific goals associated to an action plan, agreed which each enterprise; and (iii) transparent SOE reporting of financial management, business planning, and investment. Policy Area 3 - Expenditure Management 12. The policy goal was to strengthen social and capital expenditures as critical priorities in the anti-cyclical measures against the crisis. The intention was to increase and safeguard those social and capital expenditures which were associated with a significant stimulus impact and pro-poor orientation, while gradually improving the allocation and execution of these expenditures in the medium term. Social and capital expenditures in Paraguay were low by regional standards and chronic budget under-execution negatively impacted the performance of public service delivery. The need to overcome this challenge was seen as especially critical in the context of the 2008 international economic crisis. Policy Area 4 - Human Resources Management 13. The policy goal was to strengthen and implement the institutional framework for human resource management. Focus was placed on establishing a more meritocratic and professional civil service. The main short-term actions were linked to strengthening the Public Administration Secretariat (Secretaría de la Función Pública - SFP). Medium-term objectives included reform of the current Civil Service Law (No. 1626/00) and the introduction of a civil service based on a merit-based career system. 1.5 Revised Policy Areas N/A 4

1.6 Other significant changes 14. Originally conceived as the first in a series of three operations, PDPL1 supported fiscal management and public sector reforms. The series, under the FY09-FY13 Country Partnership Strategy (CPS), was to be executed sequentially from FY09 to FY11, with a tentative envelope of US$100 million for PDPL1, followed by two operations of US$50 million each i.e., PDPL2 and 3 accounting for nearly 40 percent of the indicative CPS envelope. The time taken to complete policy changes and actions and related triggers for PDPL 2 exceeded the maximum period allowed between PDPL operations; thus, PDPL 2 and 3 were cancelled. Despite this, PDPL1 conditions have been met; a significant proportion of triggers for PDPL2 and 3 have been fulfilled; 2 programmatic medium-term outcomes have been largely achieved; and a selfstanding DPL that builds upon the series of PDPL is currently under preparation. 15. The delays in completing PDPL2 triggers and the resulting formal cancelation of PDPL2 and 3 are attributable to both the program strategy and implementation challenges: The Program was built upon an ambitious strategy. Both the Government and the Bank decided to adopt an ambitious strategy for the design of the program, particularly for the fulfillment of the ambitious triggers of PDPL2 in the area of SOEs, with a view to incentivize outcome achievements and mitigate risks of reform fatigue and institutional constraints. The intention of both the Government and the Bank was to generate an effective impact on the results of this budget assistance program. Actual delays for PDPL2 were attributable to two SOE related triggers that could not be fulfilled before 2011. On the one hand, the Government experienced resistance against the regular publication of independent financial audits of SOEs. On the other, it needed to build a strong consensus within the executive to consider the relevance of adopting a law defining the new institutional framework before submitting it to Congress. In absolute terms, the duration of the SOE oversight reform has been reasonably short. As a comparison, the introduction of similar SOE oversight reforms in France and the United Kingdom took two and four years respectively. 3 In Ukraine, after five years of reform, there seems to be no effective government coordinating agency for SOE oversight. 4 Retrospectively this approach worked and a challenging reform of SOE oversight was accomplished in a relatively short period of time. It is likely that with a less ambitious matrix (in terms of time), the push for reform would have faded after some progress, and significant outcomes in SOEs oversight would not have been achieved. Reform delays are also attributable to Paraguay s structural governance constraints. The legislative branch has a strong role within Paraguay s power structure, including attributions more usually held by the Executive. The scope of legislative powers, compounded with party fragmentation in Congress significantly undermined overall Government effectiveness, especially given the Executive s ability to embark on reform initiatives. Therefore, submitting new legislation required building strong consensus. Finally, given the 2010 impressive economic recovery, the Government preferred to delay the PDPL as a counter-cyclical fiscal measure. Paraguay s economy grew at an impressive rate of 15 percent in 2010, and once most PDPL2 triggers had been fulfilled (at 2 See Annex 8 of the present ICR. 3 OECD (2005). Corporate Governance of State-Owned Enterprises: A Survey of OECD Countries. 4 Bank source. 5

the end of 2010), the Government decided to adapt the planning of budget assistance to the new economic conditions. 2. Key Factors Affecting Implementation and Outcomes 2.1 Program Performance PDPL1 (Tranche 1) Amount Expected Release Date Actual Release Date Release Single Tranche US$100 million August 26, 2009 August 26, 2009 Regular PDPL1/Tranche 1 List of conditions from Legal Agreement/ Program Document 1. Government has derogated the provision that allowed big landowners to use what they paid for VAT as fiscal credit against the agricultural income tax. 2. Government has adopted decree to designate exporters and large businesses as withholding agents of the VAT. 3. Government has (i) issued a decree to upgrade the Office of the Executive s Internal Auditor (AGPE) to ministerial level, and to give AGPE the authority to establish a standard internal control model (MECIP) also to determine the criteria for the selection of internal auditors throughout the Central Administration; and (ii) adopted the MECIP as the internal control model to be used by all public sector entities. 4. Government has issued a decree to establish a Council for State-owned Enterprises (CEP) to ensure, inter alia, (i) public sector oversight of SOEs, and (ii) the definition of a Government policy for SOE reform. 5. Ministries of Finance, Public Works and Industry and Trade, and the State Attorney s Office have signed an inter-institutional agreement, defining strategic areas to improve the corporate governance structure of SOEs. 6. Ministry of Finance maintains, in the 2009 Financial Plan, the increased proportion of social spending (including for social safety net programs) over total Central Administration expenditures mandated in the 2009 budget (as compared to the 2008 budget), focusing on financing social programs that have proven efficient and equitable. 6 Status 16. The Government has met all the conditions for PDPL1 as described in the Program Document. Project implementation and disbursement took place smoothly and without any major issues. Those conditions are: The Government has derogated the provision that allowed big landowners to use what they paid for VAT as fiscal credit against the agricultural income tax. This has eliminated significant distortions in the tax system caused by VAT credits for large land owners. In addition, a more technically robust Under-Secretariat of State Taxes (SET) has implemented a series of measures, including tightened fiscal controls and more extensive tax retention mechanisms, that have effectively helped reduce tax evasion and non-compliance. Using Decree 1164 (2008), the Government has designated exporters and large businesses as withholding agents of the VAT. This has significantly strengthened the tax administration by increasing the number of withholding agents for VAT from 98 to 754 between 2008 and 2011, in particular in areas where tax evasion is most rampant, and enhancing SET s detection of fraud and tax non-compliance. The Government has undertaken a series of actions to develop an internal control system in Paraguay. The Office of the Executive s Internal Auditor (AGPE) was upgraded through a decree to ministerial level to give it the authority to establish a standard internal control model and to determine the criteria for the selection of internal auditors throughout Met Met Met Met Met Met

the Central Administration. Consequently, the AGPE has adopted the internal control model MECIP (Modelo Estándar de Control Interno para las Entidades Públicas del Paraguay) as the model to be used by all public sector entities and sustained progress is being made toward its implementation at the institutional level. The Government has established an effective institutional framework for oversight of SOEs. This was achieved by issuing a decree to establish a Council for State-owned Enterprises (CEP) to ensure public sector oversight of SOEs. Some of the specific outcomes include annual external audits of SOEs and their publication, which constitutes a significant step toward enhanced transparency and accountability. This, together with the implementation and ongoing monitoring of results-based management contracts, is expected to bring about improvements in the SOEs financial performance and service delivery over the medium and long term. There are already some indications of these improvements, including significant reductions in current expenditures in the state oil company, PETROPAR, and an increase in capital expenditures as a proportion of total expenditure in the state-owned electricity company, ANDE. The Ministries of Finance, Public Works and Industry and Trade, and the State Attorney s Office have defined strategic priorities for SOE corporate Governance. This was achieved by signing an inter-institutional agreement defining those strategic priorities. The Ministry of Finance has kept the increased proportion of social spending (including for social safety net programs) over total Central Administration expenditures in the 2009 Financial Plan. This spending was mandated in the 2009 budget (as compared to the 2008 budget). Social expenditures, specifically education, health, housing, social promotion and protection, increased both in absolute terms and as a proportion of total expenditures during the 2008-2010 period with respect to the 2006-2007 average. The 25 percent increase in 2009 is particularly noteworthy, as it helped contain the impact of the financial crisis. 17. In 2010, while preparing PDPL2, the Government fulfilled a significant proportion of triggers for PDPL2 and PDPL3. In November 2009, after the execution of PDPL1, the preparation of PDPL2 was initiated in parallel with the implementation of a Bank-funded Non- Lending Technical Assistance (NLTA) and a Trust Fund Project, both supporting the Government Action Plan. These Technical Assistance activities and the sequencing framework provided by the PDPL Matrix contributed to fulfilling a significant proportion of Triggers for PDPL2 and PDPL3, as shown in Annex 8. This provided clear impetus for building-up a consensus around the main priorities for the reform of the framework for oversight of SOEs, and for overcoming resistance to enhanced transparency of SOEs financial statements. However, given that the time to fulfill these triggers exceeded the maximum period allowed between PDPL operations, PDPL2 and PDPL3 were cancelled and a self-standing DPL that builds upon the series of PDPL is currently under preparation. 2.2 Major Factors Affecting Implementation 18. Several factors affected implementation, in addition to those identified during appraisal. Some of the risks, including the prevalent international financial crisis, the fragmentation of the Government s political alliance, weak technical capacity, and poor interinstitutional coordination, were adequately envisioned at appraisal and effectively mitigated. Other factors affecting implementation, including those causing the delays in PDPL2 and PDPL3, are described below: 7

Calculated risk regarding the scope of SOE reforms: It is important to point out that the delays and eventual cancellation of the PDPL2 and 3 were the result of a strategic decision taken by the Bank and the Ministry of Finance to push for ambitious reforms in the SOE sector. It was mutually agreed to link SOE-related policy changes to PDPL2 to help maintain the momentum toward reform and enhance the visibility of the reforms. While this decision had a positive impact in terms of the implementation of these policies, it generated delays in the implementation of PDPL2 beyond the maximum period allowed between DPL operations. Need to build consensus over public sector priorities and reform strategy in tax systems and administration and internal control: Project preparation built upon the extensive sector work conducted by the Bank and other donors. This sector work, in turn, helped build consensus for the priorities for public sector reform. In addition, the Bank worked closely with the outgoing authorities in the Ministry of Finance to jointly identify the main challenges ahead, and Bank Policy Notes were prepared for the incoming administration. The Bank and the Government also organized grant-financed activities and workshops aimed at generating legislative and public opinion consensus around the need for reform. As a result of consensus building and the sustained reform efforts that had been in place for over a decade, reforms related to tax administration and internal financial controls exhibited significant maturity. As indicated in Section 1.6 (Other significant Changes) time to reform SOE oversight was longer than formally foreseen by the Program design: SOEs in the Paraguayan economy account for roughly 10 percent of GDP or 30 percent of country public expenditure. SOEs also play a critical role in the provision of basic services, including electricity, water and gas distribution. Given their poor service delivery performance, their lack of financial and managerial transparency, and the ineffective institutional settings for managing the substantial share of SOE public expenditures, the Government acknowledged the need to enhance oversight of their performance. However, the development of an adequate SOE oversight framework in such an institutional context was complex and required capacity building; implementation of institutional mechanisms and decision-making processes between the SOE Council and the Directorate of SOE Monitoring. The implementation of this reform also faced not unexpected resistance from SOEs that had previously benefited from significant discretionary management practices, coming from the lack of effective state oversight, and transparency mechanisms such as the publication of audited financial statements. For example, PETROPAR, the largest and most powerful SOE, posed resistance to having its financial statements externally audited. At the same time, the Government focused on ensuring the sustainability of the newly established institutional framework for SOE oversight through the development of a supporting legal framework. However, the consensus-building process around the new legislation took longer than planned. Over-ambitious civil service reform: In contrast with the other areas of reform, the civil service reforms envisioned under the PDPL program proved to be highly challenging and over-ambitious in a political sense. In practice, the PDPL was designed to introduce substantive civil service reform initiatives during the phases of PDPL2 and 3 which were cancelled. Consequently, despite the efforts of the SFP to increase the professionalization of the civil service and the significant progress made in terms of the number of merit-based promotions and recruitments, these are still not obligatory. Challenges such as these reveal the difficulty of coordinating inter-ministerial policies in the context of Paraguay s governance and as such, reforms to the civil service are still pending and any achievements made under this operation could be easily reversed. 8

Strong sense of Government ownership: The ownership of the project on the part of the Ministry of Finance led directly to the achievement of PDOs; fostered the country s dialog on development priorities; and made it possible to adapt to changes in internal and external factors that were affecting the program s implementation. Sustained engagement on the part of the Bank in Paraguay: As in most countries, Paraguay s path toward reform has been long and uneven. Some pieces of legislation that are the cornerstone of the reform process were approved a decade ago, including the Financial Administration Law (1999) and the Tax Reform Act (2004). Likewise, the reforms supported under the 2003 Economic Recovery Adjustment Loan (Loan No. 7210-PA) and the 2005 Financial Sector Adjustment Loan (Loan No. 7187-PA) provided the foundation for reforms supported under DPL I. Although momentum for reform subsided during the late 2000s, the Bank continued its engagement with Paraguay s Ministry of Finance through fiduciary assessments and other non-operational tasks. This sustained engagement made it possible for the Bank to respond quickly and effectively to the new administration s request for support of its reform program under PDPL1. 2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization Monitoring and Evaluation (M&E) Monitoring and Evaluation (M&E) Design Overall, the DPL program benefited from a strong M&E system, with clearly defined triggers for PDPL3&4 and a robust set of medium-term outcomes (Key Outcome Indicators). Only three Key Outcome Indicators exhibited some limitations: The number of Tekoporá beneficiaries was not subject to external verification; Two tax indicators i.e., reductions in IMAGRO credits and the number of VAT retention agents were expressed in terms of their estimated impact as a percentage of GDP. A more objective definition would have been preferable. The percentage of recruitments and promotions that were conducted using merit-based criteria could not be determined, as centralized data on the total number of recruitments and promotions does not exist. Monitoring and Evaluation (M&E) Implementation The Bank regularly monitored progress under the PDPL series through periodic CPS implementation reviews and Bank supervision missions. The Ministry of Finance, the main counterpart agency for the loan, provided effective overall monitoring and evaluation of the loan and collected the data needed to assess implementation progress from agreed sources. Monitoring and Evaluation (M&E) Utilization The M&E system proved useful as a basic pulse-taking tool to assess progress toward implementation of both the PDPL series as well as the Government s Plan. 2.4 Expected Next Phase/Follow-up Operation (if any) 19. A free-standing DPL focusing on Public Sector Reforms is currently being prepared. This new operation will build on the achievements of the most successful policy areas of the PDPL series. However, there are significant differences between the two operations. On the one hand, Paraguay experienced economic improvements subsequent to the international crisis. This has allowed the Government to concentrate more on public sector reforms while the PDPL series was aimed at both public sector reforms and equitable fiscal management of the crisis. On the other hand, the Government is more pragmatic vis-a-vis inter-ministerial coordination, and is more strategic in selecting a limited number of policy areas with more effective results and higher impact. 9

3. Assessment of Outcomes 3.1 Relevance of Objectives, Design and Implementation 20. The objectives of the PDPL series continue to be consistent with those of the Government as well as the Bank. Specifically: PDPL1 directly supported the priorities outlined by the Government in its Strategic Economic and Social Plan, which is still the roadmap for the Lugo administration. PDPL1 also supported the Government s Anti-Crisis Plan, which was effective in providing the fiscal room necessary to pursue the Government s Plan. The PDPL series constituted the centerpiece of the 2009-2013 Country Partnership Strategy (CPS). The three cross-cutting themes addressed by the CPS program i.e., governance, poverty reduction, and equitable growth received support under the PDPL series and still remain key country priorities in 2011. The PDPL series was grounded in extensive sector work, which helped ensure its relevance. 3.2 Achievement of Program Development Objectives 21. PDPL1 has largely achieved its PDO and medium-term outcomes in three of the four policy areas it supported. In Policy Area 1, it has contributed to: i) improving revenue collection and the equity of the tax system. In Policy Area 2, the operation has contributed to: i) improving the effectiveness of the Central Administration s internal and financial control; and ii) strengthening the oversight of SOEs to ensure their sound and transparent financial management. In Policy Area 3, the operation contributed to protecting budgetary allocations for social and capital expenditures during the financial crisis, while marginally enhancing their overall efficiency and equity. While some progress was made in the professionalization of the civil service under Policy Area 4, the task ahead in this arena remains considerable. 22. The level of achievement of the PDPL1 is particularly noteworthy considering that the medium-term outcomes were programmed for 2011-2013, taking into consideration the implementation of the PDPL2 and 3. As noted earlier, these operations were eventually canceled due to delays in the implementation of the reforms related to enhanced SOE oversight and a decision on the part of the Government to focus more narrowly on a limited number of high-impact policy areas under the orbit of the Ministry of Finance within a separate selfstanding DPL operation. However, their cancellation did not preclude the implementation of the core programmed reforms albeit with some delays in the case of SOE oversight. As a result, medium-term outcome indicators for the programmatic series have been largely achieved. Policy Area 1 - Tax System PDO 1 To improve revenue collection and the equity of the tax system Rating: Satisfactory 23. The Government has continued to move toward a more efficient and effective tax administration and a more equitable tax system, a process that was set in motion in the 10

early 2000s. Significant distortions in the tax system have been eliminated, such as VAT credits for large land owners. In addition, a more technically robust Under-Secretariat of State Taxes (SET), has implemented a series of measures, including tightened fiscal controls and more extensive tax retention mechanisms, that have effectively helped reduce tax evasion and noncompliance. The successful implementation of these measures resulted in a remarkable increase in tax collections, both in absolute terms and as a proportion of GDP, even during the financial crisis. All the Key Outcome Indicators associated with this PDO have been largely achieved or exceeded (see Annex 7 Policy Matrix). Policy Framework 24. The tax system experienced important improvements over the last decade. First, the Administrative Reorganization and Fiscal Adjustment Law, which was approved in 2004, set the stage for important changes in Paraguay s tax system, including the adoption of the Personal Income Tax (IPR), and a more effective tax administration. In 2006, the Under-Secretariat of State Taxes (SET) initiated aggressive modernization of its tax administration system, including process re-engineering; the design and implementation of a new information management system; organizational restructuring and human resources strengthening. 25. As part of the reform program supported under PDPL1, the Government s goal was to continue to gradually improve revenue collection and the equity of the tax system. An important change was the introduction of modifications to the existing tax system to eliminate distortions, such as those exceptions which allowed big landowners to deduct Value Added Tax (VAT) payments from the agricultural income tax (IMAGRO) and making the IRP permanent. Although the latter had been introduced by law in 2004, its implementation was postponed by Congress. Another significant improvement was the strengthening of the tax administration by increasing the number of withholding agents for VAT, focusing on large taxpayers mainly exporters and enhancing SET s detection of fraud and tax non-compliance. Major Actions Implemented 26. In 2008, Decree 238 contributed to the reduction of tax distortion. It eliminated the exception, which allowed owners of large real estate properties to treat money paid in consideration of VAT for goods and services acquired to be used in connection with the agricultural activity of the relevant property as a deductible expenditure from their agricultural income tax. Conversely, the permanent adoption of the IRP is still pending, as its adoption continues to be postponed by Congress. 27. Tax administration has been strengthened through institution-building measures, the adoption of decrees expanding their control capacity, and enhanced enforcement. First, SET s institutional capacity has been substantially strengthened, as both budgetary and personnel resources have been assigned to the SET to endow it with the institutional and technical capacity needed for an efficient and effective tax administration. Second, Decree 1164 (2008) designated exporters and other large businesses as VAT withholding agents. As a result, the number VAT withholding agents increased from 98 to 754 between 2008 and 2011, amply exceeding the 144 that were originally anticipated. Third, Article 194 from Law N 2421 (2004) was implemented, which requires that individuals present a Tax Compliance Certificate to apply for passports, mortgages, purchase of vehicles, etc. The number of certificates issued increased from zero in 2008 to 122,000 and 280,000 in 2009 and 2010, respectively. Fourth, SET has strengthened its 11

focus on detection of tax fraud and non-compliance. This is illustrated, for example, in the increased number of large taxpayers subject to audits and internal controls, which quadrupled from 20 to 81 between 2008 and 2010. Finally, substantial efforts have been made on the part of both the SET and the Ministry of Industry and Commerce to increase monitoring of maquila industries by adopting enhanced reporting instruments (i.e., Form 107) and also by implementing more intense internal controls and verifications, which increased from zero to 49 maquila internal controls between 2008 and 2010. Table1: Summary of Medium-Term Outcomes for Tax System Policy Area 1. Tax System 12 2008 2009 2010 Major Actions Implemented Number of internal controls for maquila industries 0 40 49 Number of audits targeting large taxpayers 20 40 81 (*) Number of VAT withholding agents 98 572 754 40 Number of Tax Compliance Certificates issues 0 122,169 280,105 Achieved Outcomes Tax revenues / GDP 11.5 12.9 13.5 12.8 Number of taxpayers 471,518 513,998 557,944 Tax revenues from maquila industries (G$ Millions) 1,226 1,833 3,310 Tax revenues from maquila industries as a proportion of 0.014% 0.02% 0.03% overall tax revenues (%) VAT revenues collected through withholding agents Amount (G$ million) 97,034 448,077 707,579 As % of GDP 0.13% 0.63% 0.84% Granted vis-à-vis requested tax credits (G$ millions) 71% 49% 51% IMAGRO credits for VAT payments Amount (G$ millions) 659,969 475,867 356,831 As % of GDP 0.89% 0.67% 0.42% (*) There were a total of 32 audits and 49 internal controls in 2010. Note: Shaded cells denote Key Outcome Indicator included in the Policy Matrix. Source: SET (2011) Target Value (PDPL) Key Outcomes 28. The process of tax reform and modernization that began in 2004 has continued to make sustained progress between 2008 and 2011, as reflected in a significant increase in both the tax base and tax revenues. Some of the specific outcomes include: Tax revenues increased as a proportion of GDP, from 11.5 percent in 2008 to 13.5 percent in 2010, exceeding the 12.8 percent anticipated for 2012. The number of tax payers has increased by over 18 percent between 2008 and 2010. Tax collection from maquila industries increased by a factor of 2.7 between 2008 and 2010, making it one of the fastest growing taxes in Paraguay. The increase in the number of VAT withholding agents by a factor of 7.7 between 2008 and 2010 had an estimated impact on the collection of VAT revenues equivalent to 0.84 percent of GDP in 2010, compared to an anticipated target of 0.15 percent. The ratio between granted and claimed tax credits (in G$ million) has decreased substantially, from 71 percent to 51 percent between 2008 and 2010. In absolute terms, the amount of granted tax credits decreased from G$275 million to G$188 during the same period equivalent to a 32 percent reduction.