Document of The World Bank FOR OFFICIAL USE ONLY Report No. 19398-BR IMPLEMENTATION COMPLETION REPORT BRAZIL RIO GRANDE DO SUL STATE REFORM LOAN (Loan. No. 4139-BR) June 16, 1999 Poverty Reduction and Economic Management Brazil Country Management Unit Latin America and the Caribbean Regional Office 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 Bank authorization. CURRENCY EQUIVALENTS Currency Unit - Real (Rs5) EXCHANGE RATE December 1997 RsS1.1156 = USSI December 1998 Rs$1.2079 = USSI June 1999 Rs$i76 = USSI WEIGHTS AND MEASURES Metric System FISCAL YEAR lanuarv I - December 31 ABBREVIATIONS AND ACRONYMS AGERGS - State Regulatory Agency (Agencia Estadual de Reglracho dos Sen,icios Piblicos Delegados do Rio Grande do Sul) ANEEL - National Electricity Agency Rgincia .Vacional de Energia Fjgctricaj ARO - Credit Advance on Budget Revenues (Anrecipacdo de Receirta Orqamentar.aj CAP - Port Authority (Conselho de Autoridade Porruariaj CEEE - State Power Company (Companhia Estadual de Energia Elecrrica, CEF - Federal Mortgage Bank (Caixa Econdmica Federal) CEU - Central Executing Unit CGTEE - Thermal Generation Electric Power Company (Companhia de Geraqdo Termica de Enereia Eletrica) CORSAN - Rio Grande do Sul Sanitation Company (Companhia Riograndense de Saneamenro) CRT - Rio Grande do Sul Telecommunication Company (Companhia Riograndense de Telecomunica,oes) DAER - State Department of Transportation (Departamento Autonomo de Estradar de Rodagem) DNER - Federal Deparment of Transportation (Departamento Vacional de Estradas de Rodagem) DEPRC - State Department of Rivers, Ports and Canals (Departamento Estadual de Ris Portos e Canais) GDP - Gross Domestic Product ' ICMS - Sales Tax on Goods and Services (Imposto de Circulaqdo de Mercadorias e Servi,os) IDB - Inter-American Development Bank IGP-DI - General Price Index - Domestic Supply (Indice Geral de Pre,os - Disponibilidade Inrerna) PDV - Voluntary Dismissal Programs (Programa de DemissOes Voluntarias) PRG - Port of Rio Grande (Porto de Rio Grande) PROES - Incentive Program to Reduce the States' Public Sector Participation in Banking Activity (Programa do Incenuvo a Reduqdo da Participacdo do Setor Pziblico na Atividade Bancaria RECs - Rural Electricity Cooperatives RGS - Rio Grande do Sul SAL - Structural Adjustment Loan SUPRG - Port Superintendence (Superintendencia do Porto de Rio Grande) SWC - State Water Company SRL - State Reform Loan Vice President Shahid Javed Burki Country Director Gobind T. Nankani Task Manager Mauricio Carrizosa IMPLEMENTATION COMPLETION REPORT BRAZIL FOR OFFICIAL USE ONLY RIO GRANDE DO SUL STATE REFORM LOAN (Ln. 4139-BR) Contents Preface ...............i Evaluation Summary .i Part I. Project Implementation Assessment A. Statement of Objectives .......... ................. 1 B. Achievement of Objectives ...........................4 C. Major Factors Affecting the Project .......................... 10 D. Project Costs .......................... 12 E Project Sustainability ........ .................. 13 F. Bank Performance .......................... 14 G. Borrower Performance .......................... 15 H. Assessment of Outcome .......................... 16 I Future Operations .......................... 17 J Key Lessons Learned ........ .................. 17 Part II. Statistical Tables Table 1: Summary of Assessment .......................... 20 Table 2: Related Bank Loans/Credits ............... ........... 21 Table 3: Project Timetable .......................... 22 Table 4: Cumulative Loan Disbursements: Estimated and Actual ........ .................. 23 Table 5.a: Project Costs ......................... 24 Table 5.b: Project Financing ......................... 25 Table 6: Status of Legal Covenants ........... .............. 26 Table 7: Bank Resources: Staff Inputs ......................... 29 Table 8: Bank Resources: Missions .......................... 29 Table 9: Policy Matrix .......................... 31 Table 10: Evolution of Fiscal Accounts 1996-98 ........................ 33 Table 1: Expenditure Review Targets .......................... 34 Table 12: Proceeds from Privatizations ......................... 35 Table 13: Road Concessions ......................... 36 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. 2 Appendices: A. Public Expenditure Reviews ....................... 36 B. Privatizations of State Companies ....................... 44 C. Concessions of Ports ....................... 55 D. Concessions of Roads ....................... 63 E. Mission's Aide Memoire ......... .............. 70 F. Borrower's Contribution to ICR ....................... 76 G. Map ....................... 86 IMPLEMENTATION COMPLETION REPORT BRAZIL RIO GRANDE DO SUL STATE REFORM LOAN (Ln. 4139-BR) Preface This is the Implementation Completion Report (ICR) for the Rio Grande do Sul State Reform Loan in Brazil. The Loan, in the amount of US$125 million equivalent, was approved March 4, 1997, became effective June 30, 1997, and closed on its original closing date, December 31, 1998. Final disbursement took place December 9, 1998, when a balance of US$20 million was canceled. The draft ICR was prepared by Cecilia Zanetta (consultant), with the participation of Philip Gray (PSDPP) and Ben Darche (consultant) and under the supervision of Mauricio Carrizosa, Task Manager (LCSPR). The draft was reviewed by Suman Bery (LCC5A), Jacques Cellier (LCSFP), Beth Anne Dabak (LEGOP), William Dillinger (LCSPR), Gordon Hughes (ENV), Eloy Vidal (EMTTI), Carlos Velez (LCSFP), Jose Augusto Carvalho (LEGLA), Morag Van Praag (LOAEL), and Fernando Rojas (LCSPR). This ICR is based on information in the project files and discussions with government officials of the State of Rio Grande do Sul and with technical staff of the project implementation unit. To develop a more comprehensive perspective in terms of the impact of the privatizations, meetings were held with several of the stakeholders in each sector, including the corresponding regulatory agencies, the concessionaires, and consumer groups. The discussions and meetings took place from March 15, to March 19, 1999, when a Bank mission visited Rio Grande do Sul. Implementation of the project took place during the Borrower's previous administration. The ICR was prepared with the new administration that took office in January 1999. The new administration, which espouses a different development strategy, contributed to the ICR by providing its own evaluation of the project's initial preparation and execution (see Appendix F) and by providing its views, background material, and ample support to the ICR mission whenever needed. IMPLEMENTATION COMPLETION REPORT BRAZIL RIO GRANDE DO SUL STATE REFORM LOAN (Ln. 4139-BR) Evaluation Summary Introduction 1. The Brazil state reform loans, including the Rio Grande do Sul (RGS) State Reform Loan, were primarily designed to extend to the state governments some of the structural reforms that were already being implemented at the federal level. Reducing the states' fiscal deficits, addressing the high level of indebtedness of the larger Brazilian states, and improving the provision of services at the state level were all critical elements in the economic reforms that were being pursued under the Plano Real. 2. The Bank worked closely with the federal government in identifying and developing alternative options to address the states' debt crisis. It also provided substantial technical assistance to a group of reform-minded state governments in the diagnosis and design of their overall reform programs, particularly in relation to pension systems, privatizations, concessions and their regulatory environment, and the fiscal adjustment component. The Bank also developed four lending operations (Rio Grande do Sul, Rio de Janeiro, Mato Grosso, and Minas Gerais) that provided both technical and financial support to individual states as they undertook a set of reforms aimed at stabilizing their public finances and increasing their efficiency as providers of public goods and services. 3. The Rio Grande do Sul Reform Loan was the first one of these operations. As discussed below, the objectives included fiscal adjustment and privatization. The other operations placed less emphasis on fiscal adjustment and thus were called State Privatization Loans. This was the result of emerging evidence that states would not adjust fiscally in the absence of appropriate incentives and tools, including a hard budget constraint from the federal government, constitutional amendments relating to administrative and social security reform, and re-negotiation of state debts. However, the selected states continued to display strong interest in the Bank's association with their privatization programs, which became the main focus of all four operations. 4. Privatization in the four states was pursued as a result of a desired shift in the role of the state. With privatization, the state governments aimed at reducing their fiscal exposures with regard to losses in the provision of infrastructure services, improve investment capacity and service coverage in infrastructure sectors, enhance economic efficiency in the operation of these sectors, and help meet the governments' financing ii needs. These development objectives were the fundamental justification for the Bank's support of the states' privatization programs. Project Objectives 5. The specific objectives of the project were: a) to improve the state's fiscal condition; and b) to improve the efficiency in the delivery of the state government's services through (i) the privatization of the state's telecommunication and power companies; and (ii) the concession of ports, road maintenance, and water production and distribution. Objective (b) became the chief objective of the operation because originally expected federal actions to support objective (a), including passage of administrative reform and effectiveness of the debt refinancing agreement, did not materialize To accomplish the objectives, the project was designed as an investment loan of US$125 million to be disbursed in three time slices following the successful implementation of a set of key reforms.' The conditions required for disbursement included: a) actions aimed at enhancing the state's fiscal performance; and b) the privatization and concessioning of state services (see Policy Matrix, Table 9). There was a fourth floating disbursement of US$20 million to be disbursed at an unspecified time provided the concessioning of water services had taken place. An important omission from the Program was the State's bank (Banrisul), which the authorities were not prepared to privatize. 6. Two Project Reviews were programmed before the second and third time-slice disbursements to assess the state's compliance with the agreed actions. The Project Reviews included a review of the state's expenditure performance to assess whether it was consistent with the intentions stated by the RGS government in its Reform Program Letter to the Bank. The Bank was to assess performance based on a series of targets, including the debt stock/revenue ratio, personnel expenditures/revenue ratio, and the types and levels of investment. Implementation Experience and Results 7. Achievement of Project Objectives: Overall, the RGS Reformn Loan was highly successful in terms of the privatization of the power and telecommunication state-owned enterprises, the concessioning of roads and port terminals, as well as the establishment of an adequate regulatory framework that allows the state to monitor the quality of privately-provided services. The public sector of RGS has been substantially reconfigured as a result of the privatizations and concessions supported under the RGS Reform loan. The main impacts thus far resulting from reducing the role of the state in the provision of services include: a) reductions in the size of the public sector, both in terms of personnel and operating expenditures; b) high levels of private investment in infrastructure - specifically in telecommunications, roads and ports -, to improve both access and quality I At the time the Brazil state loans were being prepared, sub-national governments were not eligible for structural adjustment operations (SALs) under the Bank's policies. However, the project's innovative design overcame this limitation by combining the traditional investment loan with agile disbursement mechanisms and a set of comprehensive, well-defined policy conditions. iii of services2; c) efficiency gains in the delivery of services (particularly through savings in labor expenditures), thus contributing to the overall competitiveness of the state's economy; and d) less potential for state bail-outs of non-performing public companies. The privatization proceeds were maximized by the government's privatization strategy, amounting to Rs$4.9 billion. The privatization of the water company was not implemented; thus the US$20 million amount corresponding to that activity was canceled. 8. The performance was not satisfactory in terms of the project's overall fiscal objectives, as the state's public finances have not shown any significant improvement. Specifically, the RGS government's intentions, as stated in its Reform Program Letter to the Bank, were to reduce spending in personnel, increase tax collection, develop a sound investment program, and reduce the stock of debt. These objectives have been only partially achieved, as there has not been significant improvement in terms of personnel expenditures and the reduction in the stock of debt. 9. Despite lack of progress on the fiscal front, the privatization actions have been a positive development on their own merits. As a result of these privatizations, Rio Grande do Sul can expect larger investments and growth in the infrastructure sectors and better and more efficient service delivery. Moreover, the privatizations will have a fiscal benefit in reduced exposure to financial losses in the delivery of infrastructure services. 10. Major Factors Affecting the Project: The project was implemented at a fast pace, with the privatizations and concessions taking place on or ahead of schedule. The state complied only partially with the agreed fiscal targets. Despite the failure to fully meet the fiscal targets, the Bank approved the disbursements for the second and third time-slices based on two reasons. First, the failure to improve the state's fiscal performance was largely caused by factors beyond the control of the state, including the delayed approval of a constitutional amendment removing tenure privileges to public employees, delays in signing the debt agreement with the federal government (which delayed a key incentive for fiscal adjustment), and the impact of a newly-enacted federal law granting state-tax exemptions to exports. Second, the privatizations and concessions had been implemented highly successfully, surpassing the initial scope of the program.3 This was considered to compensate for the weak level of achievement of fiscal targets. Although having "soft" fiscal targets added flexibility to the implementation of the project4, it also introduced a considerable level of discretion into the assessment of fiscal compliance. The fiscal targets also provided a basis for dialogue with the state on fiscal matters. Other factors affecting the project included regulatory and other constraints on 2 Nevertheless, the privatizations have not yet resulted in significant changes in the level of reported customer satsifaction. This could reflect higher tariffs as well as the recent general power blackouts (See Annex B). 3 The critical action that surpassed the initial scope of the program was the full privatization of CRT, the telecommunications company, whereas the initial program envisaged the sale of only 35% of its capital. 4 Fiscal targets under the projects were defined in the Government's Letter of Development Policy. The Minutes of Negotiation defined the variables to be monitored during the project reviews. iv privatization of the water sector, disputes on two of the nine road concessions, and the constitutional restrictions on personnel expenditures. 11. Project Sustainability. The privatizations are likely to be sustained in the medium and long term, provided that the independence of the regulatory agency with respect to the executive branch is maintained.5 The sustainability of the concessions is also likely, although more dependent on the final delimitation of responsibilities of the regulatory agency. Nevertheless, it is important to point out that structural changes, such as those brought about by the privatization and concession programs implemented in RGS, typically require a long period (perhaps eight to ten years) to be accepted and consolidated. The radical changes in the political orientation of the RGS government following the last election are likely to make more difficult the consolidation of the privatizations and concessions and could possibly undermine the final outcome despite the initial success in the implementation of these programs. 12. The sustainability of the state's overall fiscal performance is less certain, as an adequate system of incentives to induce widespread reform among Brazilian states is not yet fully in place. For the states to be fiscally responsible in the long run, it is still necessary to remove the barriers posed by unsustainable pension benefits, as well as eliminate sources of quasi-deficit financing, including federal bail-outs and periodic debt re-negotiation agreements6. It is important to acknowledge that, in the absence of a set of incentives encouraging fiscal adjustment, the financial gains from privatization programs are likely to be used for deficit financing. In such case, the sale of state-owned enterprises can result in a loss of a state's net worth. This is likely to have been the case in Rio Grande do Sul, where capital receipts (loans, privatization) exceeded capital expenditures (investment, debt amortization, and capitalization of the state's bank). 13. Assessment of Bank's and Borrower's Performance: The Bank played an important advisory role to the states and the federal government through technical assistance and sector work, particularly in relation to the state debt crisis and the overall reforms strategies in each of the sectors. The Bank's performance was highly satisfactory with respect to the sectoral and technical aspects of project identification and preparation. Its performance was also highly satisfactory during supervision, working closely with the state in monitoring the implementation of the specific reforms and performing a pulse- taking function of the evolution of the fiscal situation. The Borrower's performance was highly satisfactory regarding project preparation and the implementation of privatizations 5 The current government is currently challenging at the Federal Court the right of the previous government to nominate the members for fixed terms which do not coincide with the term of government, and more broadly, the notion that the agency should be "independent" of the executive branch of government. 6 Much progress is being made through debt rescheduling agreements between the federal and each state government. These agreements force fiscal adjustment at the state level because debt repayment is collateralized by the states own revenues and constitutional transfers. Furthermore, the Federal Government has submitted legislation to Congress that will introduce a greater measure of fiscal responsibility at all government levels. v and concessions. The borrower's commitment to the privatizations and concessions program was strong, not only because of the revenues it provided, but also because of the expected improvements in service delivery. Its performance with regard to fiscal objectives, where the state's commitment was low and the federal incentive framework was inadequate, was below expectations. Summary of Findings, Future Operations, and Key Lessons Learned 14. Overall, the outcome of the project was satisfactory. The main objectives of the project (privatizations and concessions) were attained. The state's fiscal performance, however, did not improve. The loan's specific achievements include: a) the privatization of the telecommunication company; b) the privatization of two energy distribution company and the transfer to the federal government of a thermal generation plant; c) the concessioning of ports; d) the concessioning of nine road poles representing 20 percent of the state's road network; and e) the establishment of a regulatory agency. The RGS Reform Loan successfully capitalized on the window of opportunity that opened as the result of having reform-minded administrations at both the state and federal levels. Nevertheless, privatization of the water sector failed, chiefly due to well-known regulatory and political constraints, which the project's design acknowledged in tying this privatization to a floating tranche. 15. The following lessons, which are relevant for future state reform projects beyond Brazil, can be learned from the implementation of the RGS State Reform Loan: 16. Sub-national governments are key elements within the framework of a country's overall reform program. The medium- and long-term sustainability of a country's reform program depends on encouraging state governments to become fiscally responsible and efficient providers of services. 17. Capitalizing on potential windows of opportunity. Having reform-minded administrations at both the federal and state governments opens a significant window of opportunity for reform. To capitalize on such opportunities, the Bank's technical assistance and sector work are critical at early stages, during the design of the reform program. 18. For the reforms to be sustainable, a consistent system of incentives has to be in place at the national level. Pension fund and tax reforrns, as well as the elimination of sources of unsustainable financing, including federal bail-outs, are key prerequisites for broader state reform, particularly fiscal adjustment. 19. An adequate regulatory framework at the federal level is a pre-requisite for the successful implementation of state-level privatization and concession programs. In the case of Brazil, legislation conducive to increasing private sector participation in the provision of most services at the state level had been passed the federal level, thus laying the ground to the successful implementation of the privatizations and concessions components. The only exception has been in the water and sanitation sector, where the vi lack of definition in terms of granting authority and a weak regulatory framework hampered the state's efforts to privatize the water company. 20. Focusing on those sub-national governments that are most willing and able to implement major reforms. This will mitigate in part the risk of reforms being stalled. 21. Operations should concentrate on a few, significant reforms that are hard to reverse. Also, the state government should be able to implement the reforms during its own mandate. 22. Quick-disbursing loans supporting a well-defined set of reforms can be effective tools in promoting structural adjustment at the sub-national level. Thus, the newly-approved structural adjustment instrument, where the Bank can undertake fast disbursement operations directly to sub-national governments, provides a useful tool. The experience of Brazil's state reform loans helped trigger the development of this instrument. 23. Reform loans should support the state's own reform program, thus maximizing the state's ownership of the project. No lending operation can provide per se incentives for reform. It can only support the implementation of reforms for which there is a genuine interest on the part of the state. Strong state interest in privatization and weak state interest in fiscal adjustment help explain the different outcomes in the two areas. 24. Despite the irreversibility of privatization reforms, the project raises the question on whether greater consensus can be achieved with respect to these reforms. While the privatizations are unlikely to be reversed, they remain controversial within the state. Possibly a better job of documenting and ensuring the benefits from privatization needs to be undertaken to ensure a wider support for the reforms, which would in turn reinforce their success. 25. As a condition for disbursement, the Bank should continue to require the actual sale of public enterprises as opposed to their being "ready for sale." Although this condition might be unpopular with Borrowers, it minimizes the likelihood of the reform actions being reversed. 26. Governments should be encouraged to ensure that the composition of the regulatory agencies is politically balanced. The general tendency to make appointments that are partisan threatens the sustainability of privatizations and concessions over the medium run, particularly under changing government administrations. 27. Implementation confirms, as expected during project preparation, that development of regulatory agencies is likely to be a slow process. The slow process of regulatory delegation from other powers, politicization, and internal differences of opinion on whether the agency should be independent of the executive, remain important vii obstacles to a faster development of the agency. 28. Severance payments are relatively small compared to the savings in payroll expenses. Although the potential savings in terms of reduced salary and pension bills are potentially very high, governments are usually cash-strapped and cannot afford to pay more attractive packages. As a consequence, take-up rates are low and a potential source for reducing the long-term burden on state governments remains largely untapped. Upon approval of administrative reforms in 1999, the possibilities of attaining these savings will have been enhanced. Part I: Project Implementation Assessment A. Statement of Objectives 1. Towards the early 1990s, the performance of Brazil's economy had deteriorated significantly, relative to the impressive performance recorded during the post-war period until the early 1980s. Inflation, now chronic, continued to rise, reaching peaks of 81 percent and 47 percent per month (IGP-DI) in 1990 and 1994 respectively. Low rates of economic growth and investment had resulted in economic stagnation and even greater income disparities. Successive stabilization plans had been introduced during the 1980s, most of them with price and wage freeze components. However, they all failed to contain prices over sustained periods of time as they were not accompanied by the structural reforms needed to reduce the role of the state in the economy, downsize the public sector, and tackle the large fiscal and quasi-fiscal deficits, all key factors underlying the deterioration of the economy. 2. As clearly pointed out by the Bank's sector work, the poor performance of Brazilian states has contributed to exacerbating macroeconomic instability.' Its negative impact on the overall economy was twofold. First, Brazilian states play an important role in the provision of services, being responsible for about one third of Brazil's public spending. However, they have been ill-prepared to fulfill their responsibilities and have also been a chronic source of fiscal imbalance and inefficient spending, mainly as a result of substantial overstaffing, inadequate administrative controls and weak state budgeting mechanisms. Second, as a result of fiscal mismanagement, the indebtedness of Brazil states had reached crisis proportions, amounting to US$110 billion in 1995, almost half of which was in default. 3. In 1994, the Cardoso administration began a wide range of structural reforms, including the privatization of national public enterprises and the liberalization of economic activities, to complement the stabilization plan initiated under the previous administration -- the Plano Real.8 Constitutional amendments were also being sought to reform the social security system, administrative rules, and taxation. The successful implementation of these reforms was critical to ensure economic adjustment and to sustain the low-inflation regime that was achieved through the Plano Real. 4. The state governnents posed a serious threat to the sustainability of the Plano Real. On the one hand, the reforms already being implemented at the federal level had to be extended to the state governments, given their high share of the public sector expenditures. However, under Brazil's federal system, states are highly autonomous and most of the needed reforms were outside the jurisdiction of the federal government. The 7 "Brazil State Debt: Crisis and Reform," November 14, 1995. Report 14842-BR. 8 The Plano Real was developed under Itamar Franco's administration, with President Cardoso (then Minister of Finance) being one of its main architects. 2 federal government also faced a difficult choice in terms of how to handle the state debt, most of which was owed by the economically most important states in the country to federal agencies, including the federal treasury, the Central Bank and the Banco do Brasil. Forcing the defaulting states into bankruptcy could have a crippling effect on the national economy and the financial system. On the other hand, allowing the state debt to keep on growing would have equally adverse consequences, forcing the federal government to dramatically reduce its own spending, raise taxes, or resort to inflationary financing. 5. In its efforts to consolidate the price stability achieved under the Plano Real, the federal government sought the Bank's assistance to develop an overall strategy towards the states aimed at: a) developing a debt workout to defuse the immediate debt crisis; and b) extending the structural reforms to the state governments.9 The Bank worked closely with the federal government in identifying and developing alternative options to address the state debt crisis. It also provided substantial technical assistance to a group of state governments in the diagnosis and design of their overall reform programs, particularly in relation to pension systems, privatizations, concessions and their regulatory environment, and the fiscal adjustment component. The Bank also developed four lending operations that provided both technical and financial support to individual states as they undertook a set of reforms aimed at stabilizing their public finances and increasing their efficiency as providers of public goods and services. The Rio Grande do Sul Reform Loan was the first of these operations that was approved. 6. The State of Rio Grande do Sul (RGS) is one of the largest states in the country, accounting for 7.5 percent of Brazil's GDP. Although RGS's level of economic development is above Brazil's average, its recent economic performance had been disappointing, with a GDP per capita growth of -- 1.5 percent in 1995. RGS faced much of the same challenges as many other Brazilian states, including large fiscal deficits, excessive levels of public employment, poor tax collection, low levels of investment in infrastructure, and inefficient service delivery. The state resources were also being drained by inefficient public enterprises, insolvent state banks, and insufficiently- financed state pension funds. With a reform-minded administration recently elected, the state had undertaken a series of reforms aimed at reversing the deterioration of the state's infrastructure and its public sector. The overall objective of the RGS Reform Loan was to support the state in the implementation of these reforms. 7. The RGS Reform Loan 's objectives, as stated in the Staff Appraisal Report (SAR, January 24, 1997), were: a) to improve the state's fiscal condition; and b) to improve the efficiency in the delivery of the state government's services 9 Another key component in resolving the debt crisis is also the elimination of incentives for irresponsible state borrowing, including the elimination of defacto federal guarantees of all private lending and an ingrained tradition of debt renegotiations and bail-outs on the part of the federal government. 3 through: i) the privatization of the state's telecommunications and power companies; and ii) the concession of ports, road maintenance, and water production and distribution. Objective (b) became the major focus of the operation, as well as of the other SRLs that followed. This occurred because key conditions for achieving objective (a) became limited by the absence of an enforceable debt agreement and of constitutional reforms facilitating flexibility in personnel expenditures, including wages and retirement benefits.'" 8. To accomplish these objectives, the project was designed as an investment loan of US$125 million to be disbursed against three time-slice project costs following the successful implementation of a set of key reforms. The first time-slice disbursement of US$50 million was programmed to take place shortly after the loan was declared effective (see Table 3). The second and third time-slice disbursements of US$50 million and US$25 million respectively were expected to take place by mid FY96 and before the end of FY98, provided that the state was in compliance with the agreed policy actions and conditions. The conditions required for disbursement included: a) actions aimed at enhancing the state's fiscal performance; and b) the privatization/concessioning of state infrastructure services (see Policy Matrix, Table 9), including telecommunications, water, energy, roads, and ports . There was a fourth floating disbursement of US$20 million to be disbursed at an unspecified time provided the concessioning of water services had taken place. 9. The Bank advised the Government to also privatize the State Bank, Banrisul. Nevertheless the Government was not prepared to undertake this privatization, due to likely political opposition, to concerns about difficulties in selling the Bank, and to a desire to maintain the Bank as an instrument of state economic policy. Failure to agree on privatization of the Bank resulted in a smaller amount of Bank financial support for the State's program. The bank remains in state ownership and is unlikely to be privatized in the near future. 10. Two Project Reviews were programmed before the second and third time-slice disbursements to assess the state's compliance with the agreed actions. The Project Reviews included a review of the state's expenditure performance to assess whether it was consistent with the intentions stated by the RGS government in its Reform Program Letter to the Bank. In this Letter, the RGS government indicated its intention to enhance '0 The loan's design incorporated these contingencies. The minutes of negotiation subjected compliance with personnel expenditures and debt targets respectively, to passage of administrative reform and the provisions of the debt agreement. Administrative reform is likely to pass only in 1999. The debt agreement became effective only in November 1998. The RGS government is challenging the vailidity of the agreement. 4 the efficiency of public expenditures and to achieve fiscal restraint through a series of actions, including reducing personnel costs and improving tax administration. The Bank was to assess performance based on a series of targets, including the debt stock/revenue ratio, personnel expenditures/revenue ratio, and the types and levels of investment (see Table 10). 11. The project's design effectively supported the objectives. At the time the Brazil state loans were being prepared, sub-national governments were not eligible for structural adjustment operations (SALs) under Bank policies. However, the project's innovative design overcame this limitation by combining the traditional investment loan format with an agile disbursement mechanism and a set of well-defined policy conditions. The floating disbursement that was designated for the water concessions also proved to be an effective mechanism to account for the higher uncertainty regarding that particular component. Conditionality regarding privatization (effective sale rather than bringing to point of sale) also proved appropriate. Conditionality on fiscal adjustment, while appropriate, was limited in its effect to delays in achieving debt refinancing agreements and approving needed constitutional reforms. B. Achievement of Overall Project Objectives 12. The RGS Reform Loan has been highly successful in terms of the privatization of the power and telecommunication state-owned enterprises, the concessioning of roads and port terminals, as well as the establishment of an adequate regulatory framework that allows the state to monitor the quality of privately-provided services. The privatization of the water company was not implemented; thus the US$20 million amount corresponding to that activity was canceled. The performance was less satisfactory in terms of the project's overall fiscal objectives, as the state's public finances did not show a significant improvement. 13. Macroeconomic Policies: Partial Achievement. One of the objectives of the reforms supported by the RGS Reform Loan was to improve the state's fiscal position to ultimately contribute to improve the country's overall fiscal performance. Specifically, the RGS government's intentions, as stated in its Reform Program Letter to the Bank, were to reduce spending in personnel, increase tax collection, develop a sound investment program, and reduce the stock of debt. These objectives have been only partially achieved, as there have not been significant improvement in terms of personnel expenditures or in reducing the stock of debt (see Table 10). 14. Specifically, the Reform Letter presented by the State describing its reform program specified five fiscal targets: i) growth in net current revenues; ii) personnel expenditures as a percentage of net current revenues; iii) stock of debt/revenue ratio; iv) productivity of investment; and v) consistency of investment levels and investment financing with debt-revenue targets. Achievement of these targets was partial (see Table 11 and Annex A). In 1997, the state did not meet three of these targets: growth in revenues, reductions in personnel expenditures, and declines in debt/revenues ratio. By 5 1998, the targets with regard to reductions in personnel expenditures and declines in the debt/revenue ratio had not yet been met"1. However, the growth in net current revenues surpassed the corresponding target by 7 percent, mainly due to a growth in transfers and a rebound in ICMS during the second semester. As a result of a comprehensive debt agreement with the National Government, the stock of bonds was reduced significantly, although the total stock of debt has increased with respect to 1996, despite the proceeds from the privatizations and a Rs$1.645 billion debt forgiveness by the federal government. The increase in debt has been mainly the result of three factors: a) excessive primary deficits (i.e., 20.3 percent and 23.2 percent of net current revenues in 1997 and 1998 respectively); b) an increase in borrowing from PROES to assist in the restructuring of the state financial institutions; and c) the due-interest burden on the high levels of accumulated debt. Personnel expenditures as a proportion of net current revenues have decreased from 85.4 percent in 1998 to 81 percent in 1998, but mainly as a result of an increase in revenues due to transfers. 15. Financial Objectives: Substantial Achievement. The privatizations and concessions supported under the RGS Reform Loan generated significant financial gains for the state. Specifically, the privatization of telecommunications and energy state enterprises implemented under the RGS Reform has generated proceeds amounting to Rs$4.9 billion (see Table 12). The state's privatization strategy seems to have been predominantly oriented towards maximizing the sales value of the companies sold.12 In this regard, the government's actions have been very successful, in part because the sales were undertaken prior to the devaluation of the Real and the full impact of the Asian crisis. Indeed, the privatization of the electricity distributors, as measured relative to the minimum reserve price and size of the companies, was one of the most successful in the country. An additional impact of the sale of two distributors and the thermal generator has been the transfer of 2,500 employees to the successor companies. 16. In terms of the port concessions, the major immediate impacts are the positive revenue impact -of the terminal lease payments and the fiscal impact of reducing personnel costs. The total rental income from private lease contracts have doubled between 1997 and 1998, from Rs$3.7 million to Rs$7.4 million. Rental income from private parties now covers about 30 percent of the port's operating costs. In terms of personnel, the number of employees at the Port Superintendence (SUPRG) has been "1 There was technical compliance with the loan conditions because achievement of the targets under the project, which was assessed with information through May 1998, was subject to two events that did not materialize: a) the reduction of personnel expenditures was contingent on approval of administrative reforms, which did not materialize; b) the reduction of the stock of debt was contingent on finalization of the debt agreement, which did not occur until late in 1998. As the debt agreement was not finalized during the life of the loan, the debt agreement did not constrain investment expenditures or investment financing. Although efforts to increase revenues did not take place, revenues were also adversely affected by federal legislation exempting exports from the ICMS tax, the main item in states' revenues. 12 The maximization is of course subject to the parameters given by the regulatory environment, particularly with regard to tariffs, emerging competition, including, for example, an established cellular service competitor, and the likely introduction of parallel networks that compete with the existing fixed- line incumbents. 6 reduced from 1089 employees at the beginning of 1996 to 302 by the end of 1998. As a result, current expenditures for SUPRG have decreased from about Rs$27 million in 1996 to Rs$24 million in 1999, a decline of approximately 10 percent in three years. Reduction in personnel expenditures are expected to continue over the next few years as the payment obligations resulting from the voluntary dismissal programs reach their end. (They are currently the largest expenditure item, accounting for 63 percent of current expenditures.) 17. The financial impact of the roads concessions occurs mainly in terms of the state's savings on road maintenance, which are now the responsibility of the concessionaires. These savings are discussed below under "Physical Objectives." 18. Physical Objectives: Substantial Achievement. The reforms introduced under the RGS Reform Loan have been conducive to higher levels of investment in infrastructure, with both public and private funds. In terms of public investments, which were subject to the project reviews, the state's capital expenditures increased from Rs$500 million in 1996 to Rs$1.346 billion in 1998 (in real terms). These higher levels of capital investments were partly financed with the privatization proceeds. Investments were primarily focused on road maintenance, basic health and education facilities, and municipal investments, all of them with high economic and social returns (see Table 11). The only questionable investments were two low-interest rate loans to GM and its feeder companies and Ford for Rs$253 million and Rs$307 million respectively, as incentives to locate their assembly plants in the state. As opportunely pointed out by the Bank, it is questionable whether these loans are justified in terms of the economic and social benefits they will bring to the state. The assistance has also been questioned by the newly-elected government. 19. In terms of private investments, one of the objectives pursued through the privatization of the state companies and the concessioning of roads and ports was to channel private investments into infrastructure. The roads and port concessions have been very successful in this regard. Investments in road maintenance are expected to amount up to Rs$2.2 billion over the 15-year concession term, almost twice as much as was projected during the technical studies (see Table 13). In the case of the port concession program, the lease contract also allows the private terminal operators to expand their facilities to keep pace with the growth in cargo. 20. The privatization of the telecommunications company has resulted in a considerable increase in the number of cellular and fixed connections, and public phones, with a rate of increase of 261 percent, 67 percent and 125 percent respectively. Investments reached Rs$924 million in 1998, with further investments of Rs$587 million and Rs$426 expected for 1999 and 2000. At the same time, quality of service does not seem to have suffered unduly, unlike the systems in Sao Paulo and Rio de Janeiro where the quality of service declined as a result of the increase in the number of new connections. In the case of the distribution power companies, access to setvice is virtually complete in urban areas at 99.5 percent, and relatively high in the rural areas at 7 86 percent. Despite the failed concession attempt, the water company has taken some actions to improve its service delivery. The major difficulty has been in extending its sewerage network and treatment facilities, now serving only 18 percent of the state population. No public investments are likely to take place, however, given the federal government's strong policies with regard to state-owned water companies. 21. Public Sector Reform: Substantial Achievement. The RGS public sector has been favorably reconfigured as a result of the privatizations and concessions supported under the RGS Reform loan. The main impacts resulting from reducing the role of the state in the provision of services include: a) reductions in the size of the public sector, both in terms of personnel and operating expenditures; b) higher levels of private investment in infrastructure (specifically in telecommunications, roads, and ports) to improve both access and quality of services; c) efficiency gains in the delivery of services, particularly through savings in labor expenditures, thus contributing to the overall competitiveness of the state's economy; and d) less potential for the need of state bail-outs of non-performing public companies. 22. The state government implemented a voluntary departure program for state or state-enterprise employees, during the first half of 1996. The program was very successful in RGS relative to other Brazilian states, achieving a total reduction of almost 11,400 employees, equivalent to 6.6 percent of the total number of state employees in 1996. Severance payments, which were small relative to the payroll and pension savings, were one of the expenditures financed under the RGS Reform Loan.'3 23. In the area of public services, two major privatizations were undertaken, namely, the state-owned telecommunications company - CRT --, and two electricity distribution companies representing approximately two-thirds of the state's territory. A further component of the electricity company, its thermal generation assets, representing 490 MW of capacity, were transferred to the Federal Government as part of a debt-swap agreement. An additional component of these reforms was the establishment of a cross- sectoral regulatory agency, known as AGERGS, which was to be responsible for regulating the public services in the State. The failed privatization of CORSAN was the unsuccessful part of the privatization program. 24. The government's strategy was to sell the companies as "clean" as possible in terms of debt and number of employees. Through the program of voluntary dismissals, the state also achieved significant reductions in the number of employees in public enterprises. As a result, all companies now shown notable gains in productivity. Specifically, the number of employees per 1,000 connections fell from 4.0 in 1996 to 3.0 in 1997 in the telecommunication company. Similar improvements in productivity have been achieved in the power and water companies, with the number of connections per 1 3 "Brazil: From stability to growth through public employment," Report No. 16793-BR, World Bank, Feb. 1998; and "Programa de Demissoes Voluntarias (PDV): Avalia,ao da Experiencia Recente dos Estados Brasileiros, " Coordenacdo Geral de Acompanhamento de Estados, Ministerio da Fazenda, Sept. 1997. 8 employee rising from 284 and 299 in 1995 to 567 and 412 in 1998 respectively. 25. The concessions of ports and roads have been equally successful, with almost 90 percent of the port and more than 20 percent of the state's road network now being in the hands of private operators. The specific achievements of the individual privatizations and concessions are described below. 26. Telecommunication Company: Unlike the other states, where telephone service was until recently provided by federally-owned subsidiaries of the Telebras system, RGS owned 85.4 percent of its local telephone company, the Companhia Riograndense das Telecomunicaqoes (CRT). The main objective of its privatization was to meet the considerable unmet demand (estimated in January, 1997 to be around 700,000 fixed lines and 300,000 cellular connections), as well as develop more sophisticated services such as data transmission, video conferencing and internet access. The privatization of CRT was undertaken in two tranches, 35 percent being sold in December 1996 to a consortium headed by Telef6nica de Espana. The group paid Rs$681 million foT the stake. The remainder of the government's shares were later sold to the same consortium in June 1998 for Rs$1.176 million. This additional divestiture was not part of the original program agreed with the government under the loan. The result has been a considerable increase in the number of cellular and fixed connections and public phones, and substantial investments are taking, beginning with Rs$923 million in 1998. At the same time, the quality of service seems to have remained constant or improved marginally, despite stable levels in the degree of customer satisfaction. 27. Energy Company: The privatization of two of the distribution entities that were sold when CEEE was restructured was also successful, generating significant revenues for the state, happening as it did fortunately before the devaluation of the Real in January 1999 greatly decreased the dollar value of assets in Brazil, and reduced access to the international capital market. Although there has been some move to increase the number of connections, the numbers are not large in comparison with the increase in connections in telecommunications. Quality of service and productivity have also improved, particularly in terms of reduced duration and frequency of interruptions. Nevertheless, reported customer satisfaction has declined, partly as a result of the recent national blackouts (Annex B). In terms of regulatory and other issues, the companies seem concerned with what they regard as "unfair" competition with the rural cooperatives that have been expanding into urban areas. CEEE has also suffered because of the fact that it still maintains excess liabilities (the distribution companies were sold largely free of debt), and the previous govermment took some of the capital it had otherwise promised to reduce these liabilities and used it for other purposes. The company is now suffering financially as a result. 14 "Brazil: From stability to growth through public employment," Report No. 16793-BR, World Bank, Feb. 1998; and "Programa de Demissoes Voluntarias (PD V): Avalia9ao da Experiencia Recente dos Estados Brasileiros, " Coordena,do Geral de Acompanhamento de Estados, Ministerio da Fazenda, Sept. 1997. 9 28. Water Company: The failed attempt to partially privatize CORSAN was the most unsuccessful of the reform efforts of the government. Despite extensive discussions and a review of possible reform options, the government's final decision to sell 49 percent of the government's stake was shelved as the election approached. Consequently, there are currently no plans to significantly reform CORSAN, and hence it is likely to remain inefficient and starved of funds with which to invest in sewerage. These difficulties are likely to be exacerbated by possible moves of certain municipalities to opt out of CORSAN's service provision. 29. Road Concessions: DAER successfully awarded 9 "concession poles" to the private sector in its innovative road concession program. Concessionaires will invest approximately Rs$2.2 billion for the rehabilitation and maintenance of about 2,500 km. of state roads (approximately 30 percent of its paved network) over the 15 year term concession contract term. However, there are two concessions that have been awarded but not implemented because of disagreements with the Government (see Annex D). If these concessions do not proceed, the state will still have fiscal savings of up to Rs$1.7 billion for 20 percent of its paved network over the term of the concession contract. The concession program should also provide broader benefits to the state's economic development through improved road conditions and lower vehicle operating costs (less wear and tear on autos and trucks). The concession projects appear to be sustainable in the future, although conflicts have already arisen between the new RGS government and concessionaires regarding tariff adjustments and the interpretation of the financial- economic equilibrium clause in the concession contract. How these conflicts are managed will depend on another potential problem between the authority of AGERGS to set tariffs and the tariff adjustment and dispute resolution mechanisms provided in the concession contract. The concession contract gives DAER a major role in these activities. The primary lesson leamed is the need to develop more detailed, unambiguous, and transparent concession contracts that provide better definitions of critical clauses, such as the financial-economic equilibrium, and that are more consistent with the law that established AGERGS. 30. Port Concessions: The Superintendencia do Porto do Rio Grande (SUPRG) successfully awarded concessions to most of its remaining publicly-operated terminals and facilities by the end of 1997. It entered into concession agreements" for the Petroleum and Container Piers and the Wheat and Soy Terminal which comprise over 76 percent of the port cargo movements. SUPRG was not able to find sufficient interest in the Refrigeration, Liquid Bulk and Storage Warehouse, which remains under public operation. The latter facilities only provide a small amount of the port's total cargo movements. With the completion of the above concessions, the port is over 90 percent operated by private parties, with almost 100 percent of its cargo movements provided by private operators. In the aftermath of privatization, the National Association of Industries considered Porto Rio Grande (PRG) as one the three best performers of the 13 largest Is The concession agreements are called "Rental Contracts," which have an initial term of 15 years, renewable for another 15 years. They are long-term leases that allow the contractor to expand the facilities based on business growth. 10 Brazilian ports. Private operations will keep Porto Rio Grande (PRG) competitive with other large regional ports (Buenos Aires, Montevideo, Santos and Paranagua). Private operators can keep the port competitive through better use of port resources, management of the flexible work rules created under the 1993 port reform law, and access to capital for investment in port facilities, as contemplated in the leasing contracts. The ability of the private operators to invest in new facilities will allow PRG to continue to expand its facilities to accommodate the increasing growth in general cargo and containers. The PRG experienced an average annual growth rate of 7 percent per year in general merchandise and over 26 percent growth rate in containers between 1995 and 1998, the years when the major terminal facilities were transferred to private operators. 31. Regulatory Agency: As part of the privatization process, the Government established a regulatory agency, AGERGS, whose council is a "representative" one where three members are appointed by the Government (although one of the nominations was rejected by the Legislative Assembly during the nomination process), two members are nominated by consumer groups, one by the concessionaires, and one which is due to be appointed by the employees of the agency. The process of establishment of the agency was a gradual one because many of its powers were to be delegated to it by other authorities, such as the federal regulatory authorities. The agency has started to monitor the quality of infrastructure services, resolve disputes, and conduct other regulatory activities regarding the services over which it has responsibility. Its activities are, however, presently overshadowed by a larger political dispute about the question of whether fixed terms are appropriate for commissioners of a regulatory commission, or whether their mandate should be determined by political decisions. The politicization of the debate seems to have been caused in part by the political background of a number of the appointed commissioners. The consequence of the political debate about the regulatory agency is a court case in which the current government is seeking to annul the appointment of the government-appointed commissioners and appoint its own. AGERGS has been slow to receive delegated powers (it only recently received an agreement to regulate certain aspects of electricity supply in the state from the Federal regulatory authority, ANEEL) and is now embroiled in a dispute with the Government about whether certain commissioners should be removed prior to the end of their appointments. C. Major Factors Affecting the Project 32. The loan was implemented at a fast pace, with the three time-slice disbursements disbursed roughly when anticipated (see Table 3). Although an investment loan, the RGS Reform Loan operated very much like a structural adjustment operation (SAL), disbursing "for" reforms and "against" a number of eligible expenditures. As in the case of successful SALs in general, the strong commitment of the state administration towards the privatization and concession reforms being pursued was key to the successful implementation of the privatization component supported by the loan. In this way, having the life of the loan coincide with the mandate of the state administration was an optimal strategy. Other factors affecting the implementation of the project are described 11 below: 33. Swift implementation of privatizations and concessions. The level of compliance of the conditions for disbursement was highly satisfactory for the privatizations and concessions but less satisfactory in terms of the state's fiscal performance. Specifically, the progress towards the privatizations was made at a fast pace, with the telecommunication company being privatized as anticipated and the two distribution companies were privatized several months ahead of schedule. Furthermore, the telecommunication company was fully privatized, in lieu of the partial privatization envisaged under the agreed program. The road concessions were also completed earlier, with the state bidding all nine poles simultaneously rather than in two stages as required by the loan conditionality. 34. Partial achievement offiscal targets. As discussed above, compliance with fiscal targets was met only partially. Specifically, the target related to growth in revenues was not met in 1997, and those related to reductions in personnel expenditures and declines in debt/revenue ratio were not met in 1997 or 1998. Despite the failure to fully meet these targets, the Bank approved the disbursements for the second and third-time slices based on two reasons. First, the more modest improvement of the state's fiscal situation was largely caused by factors beyond the control of the state, including the constitutional amendment protecting tenure of public employees, delays in signing the debt agreement with the federal government, and a newly-enacted federal law granting state-tax exemptions to exports. Second, the privatizations and concessions had been implemented highly successfully, at a faster rate and with a wider scope, which was considered to compensate for the shortcomings in meeting fiscal targets. 35. Level of discretionality in the project's Fiscal Reviews: The fact that the fiscal targets were not directly stipulated in the loan agreement -- they were instead defined in the Letter of Reform -- had both positive and negative consequences. On the one hand, it provided the flexibility necessary to proceed with disbursements despite the shortcomings in the state's fiscal performance which, by nature, depends on a variety of factors beyond the control of the state, such as macroeconomic conditions. The targets also were intended to provide, as they in fact did throughout the preparation and implementation process, a basis for dialogue on fiscal issues with the state. On the other hand, it added an amount of discretion into the assessment of conditionality compliance, possibly having the effect of weakening the fiscal conditionalities. (It would have been arguably less justified to stop disbursements, given the success of the privatizations and concessions.) 36. The failure to reform water and sanitation services: It was clear throughout the preparation of the loan that the reform of the water company would be more difficult. This fact was taken into account in the design of the project by setting aside a single floating tranche of US$20 million for the accomplishment of the water reform component of the loan. The difficulties faced by RGS regarding the implementation of water and sanitation reforms were very much the same as in the other Brazilian states, including unclear definition of granting authority, weak regulatory framework, high capital costs of 12 service expansion, cross-subsidy systems across municipalities, and strong vested interests in maintaining public ownership of the company. 37. Problems with the roads concessions: The state awarded the nine concession poles, but only seven of these are currently in operation because of events that occurred during the concession process. Two concessions, Pelotas and Santa Maria, were awarded but suspended. In the Pelotas concession, three municipalities wanted to extend the amount of secondary roads maintained by the concessionaire. A financial feasibility study was done to evaluate the financial impact on the concessionaire's rate of return. Because of increased concessionaire investment, the consultants recommended adding another toll plaza to the "concession pole" to maintain the "financial-economic equilibrium" of the concession contract.'6 DAER and the concessionaire still have not reached an agreement on this issue. In the Santa Maria concession, the state was responsible for re-surfacing two segments of the highway network included in this concession pole. The state did not complete the work, so the concessionaire did not begin its improvements. DAER is studying various options to resolve this impasse, such as re- negotiating the contract, imposing penalties on the concessionaire, or canceling the concession contract. 38. Constitutional restrictions: As noted above, reductions in personnel expenditures have fallen short of expectations and, at 81 percent of current revenues, they pose a structural barrier to achieving an improved fiscal performance that can be sustained over the medium and long terms. Constitutional amendments were required to implement two critical reforms, the administrative and social security reforms. The administrative reform, removing mandatory tenure in civil service, was not passed during the life of the loan. However, even after its likely passage in 1999, the new government is unlikely to take actions to capitalize on this newly-acquired flexibility. The social security reform would allow states to reduce social security benefits by removing the provision requiring that retiree benefits equal to 100 percent of their last salaries, reducing cumulative benefits, introducing a minimum age requirement, and making provisions for the verification of contributions. In the case of RGS, pension expenditures account for 34 percent of current revenues and continue to rise. The critical constitutional amendment eliminating the 100 percent rule was not passed and it is unlikely to be approved in the short and medium terms. D. Project Costs 39. The loan was designed to help finance expenditures related to the Government's reform project. The costs of the project comprised expenditures in four areas: a) goods, works, consultant services and training; b) severance payments; c) grants; and d) 16 Brazilian Federal and Rio Grande State concession laws provide for the concessionaire to maintain a "reasonable" rate of return on its investment. If circumstances change that disrupt that return, it has the right to further compensation to return to the financial-economic "equilibrium" indicated in the concession contract. There are significant issues associated with this concept which are discussed in Annex D. 13 incremental recurrent cost of reforms on a declining basis. The loan disbursed chiefly against expenditures on severance payments and grants during 1997 and 1998. Although total project costs were not systematically accounted, data of the cost of several components indicate that the state incurred considerable expenditures to implement its reform program and that the RGS Reform Loan provided highly-needed financial support (see Table 5.a and 5.b). E. Project Sustainability 40. The privatizations of the telecommunication and power distribution companies are likely to be sustained over the long run, as privatizations are generally difficult to reverse and the Government is in no condition to repurchase these companies. The sustained adequacy of privatization will depend on the sustainability of the regulatory agency, and specifically on whether it overcomes the legal challenge the current government has placed at the Federal Court. The government is challenging the right of the previous government to nominate the AGERGS council members for fixed terms which do not coincide with the term of government, and more broadly, the notion that the agency should be "independent" of the executive branch of government. 41. The sustainability of the concessions is also likely, although more dependent on the final delimitation of responsibilities of the regulatory agency. As pointed out above, the concession contracts lack definition with regard to a number of aspects, including those factors that might affect the contract's financial-economic equilibrium."7 This lack of definition leaves room for conflicting views between the concessionaires and the government, which will most likely be resolved in the courts. 42. Nevertheless, it is important to point out that structural changes, such as those brought about by the privatization and concession programs implemented in RGS, typically require a long period (perhaps eight to ten years) to be accepted. For instance, even now 10 ten years after the privatization of water and other utilities in England and Wales, the majority of the population neither understands nor sympathizes with the reasons for privatization and many people still refer to the "Gas, Electricity, or Water Board." In the case of RGS, the radical changes in the political orientation of the government are likely to make more difficult the acceptance of the privatizations and concessions and possibly undermine the final outcome of such programs despite the initial success in their implementation. 43. The sustainability of the state's overall fiscal performance is less certain, as an adequate system of incentives to induce widespread reform among Brazilian states is not yet fully in place. Although the states have now more flexibility to "right-size" their administrations after the passage of the administrative reform, the pension fund reform is still pending. It is unlikely that the Cardoso administration will attain the broad political support required to pass the corresponding constitutional amendment in the short and medium terms. In the meantime, unfunded pension liabilities continue to drain the state's 1 7 See footnote 4 for a brief description of the financial-economic equilibrium concept. 14 finances, amounting to 34 percent of current revenues. The conflict between the states and the federal government regarding state debt is also unresolved, as illustrated by the actions recently taken by the states of Minas Gerais and RGS. Even after the last re- negotiation, debt service from the former "divida mobiliaria" is still high (in RGS, debt service obligations amounted to 26 percent of current revenues in 1998). As a result, the state continued to be a generator of public deficit in 1998 and, given the history of federal bail-outs and debt renegotiations, it could well fail to undertake needed reforms in the near future. Nevertheless, a stronger budget constraint emerging from a firm federal enforcement of the debt refinancing agreement (which collateralizes debt service with revenue sharing) could finally put an end to the state's unsustainable deficit financing. Furthermore, the recent devaluation of the Real amidst fears of a macroeconomic crisis, together with the recent re-election of President Cardoso on a reform-based platform, offer a window of opportunity for the federal government to push for needed federal reforms while indeed maintaining a strong stand with state governments. 44. It is importarit to acknowledge that, in the absence of a set of incentives encouraging fiscal adjustment, the financial gains from privatization programs are likely to be used for deficit financing. In such case, the sale of state-owned enterprises have been rightly viewed as a loss in the state's net worth, with overall capital receipts (including privatization proceeds) exceeding capital expenditures (Table 10). F. Bank Performance 45. Project Identification: Highly Satisfactory. The Bank correctly diagnosed the need to extend public sector reforms already being implemented at the federal level to the state governments. Only a reduced group of states -- Rio de Janeiro, Mato Grosso, Minas Gerais, and Rio Grande so Sul -- was selected based both on the perceived willingness to privatize their enterprises and reform of their administrations and on their relative fiscal importance. 46. Project Preparation: Highly Satisfactory. The Bank's performance was highly satisfactory with respect to the sectoral and technical aspects of project, identifying an ambitious Policy Matrix that operationalized the major aspects of the state government's reform strategy. The Bank worked in close collaboration with individuals in the national and state governments and maintained a high degree of coordination between the different Bank divisions coordinating actions and specialists in the different sectors. 47. Project Appraisal: Satisfactory. During appraisal, the Bank took into account various risks that could affect the project and set up mechanisms within the project to mitigate them, including a floating tranche tied to the more uncertain reforms in the water sector. Given the size of the states' economies and their wide differences in terms of socio-economic and demographic variables, direct lending to individual states was deemed the most effective strategy -- as opposed to a loan "a la PRL-I" (First Provincial Reform Loan) in Argentina, which spread the risk among several provinces. Although more effective in terms of concentrating resources, this strategy is also more risky, as the 15 likelihood of the reforms being stalled in one particular state are substantial. (The higher level of risk was illustrated by the experience of the Minas Gerais state loan, which was never signed.) 48. An important question being raised by the experience of the RGS Reform Loan is whether it is appropriate to proceed with a state reform loan in the absence of an adequate system of incentives that promotes responsible fiscal performance. Although considerable progress had been made under President Cardoso's reform program, strong incentives for fiscal adjustment at the state level were not yet in place at the time of appraisal. The achievement of the RGS Reform Loan's fiscal objectives was negatively affected by constitutional restrictions on personnel and pension expenditures at the national level. There is little doubt that the gains in efficiency, competitiveness, and private investments in infrastructure that were achieved as a result of the privatizations and concessions merited a Bank operation in RGS. However, a "state privatization loan" might have had a different level of lending than the "state reform loan." 49. Project Supervision: Highly Satisfactory. The Bank worked closely with the Borrower, assessing the overall evolution of the state reform program, as well as monitoring the progress being made towards each of the conditionalities. Individual supervision missions were reported by the Borrower as being highly satisfactory and described as a team effort between the Bank and the Borrower. The Bank provided strong support during the implementation of the loan, moving quickly to accelerate the disbursement of the corresponding time-slice disbursements and providing technical assistance as requested."8 The periodic Bank assessment of the state's finances conducted as part of the Project Reviews provided a close pulse-taking of the state's financial situation. G. Borrower Performance 50. Preparation of the Project: Highly Satisfactory. The RGS Reform Loan was the first of the Brazilian state loans to be approved as a result of the high level of cooperation on the part of the state. In fact, the state played a very active role in the preparation of the project, which was designed to support the state's own reform program. The state had a high level of ownership of the project, particularly in regard to the privatization component. 51. Project Implementation: Satisfactory. The strong commitment of the state government towards privatization and administrative reforms supported under the project was critical to their swift implementation. The RGS State Reform Program was implemented under the State Governor's direction and the Planning Secretariat's 18 The substantial technical support provided by the Bank to the state as they prepared their state reform plans continued during the implementation of the loan. Supervision missions regularly included sector specialists to provide technical advise to the state, even in areas that were not specifically included in the project. (For instance, a financial advisor was incorporated to the Sept., 1997 supervision mission to provide advise at the government's request on the restructuring of the state's public financial system, which was not a project component). 16 coordination. Given the breadth of the program, several participating agencies and public enterprises were involved. In addition to overall program coordination, the Planning Secretariat was responsible for specifically coordinating the water sector reform program and implementing management contracts with the public enterprises. Other key agencies for project implementation were the Finance Secretariat, which took the lead in public finance and debt reforms, the Public Works Secretariat, which coordinated the CRT/CEEE privatizations and roads concessions, and DEPRC, which implemented ports concessions. The supervision of the different components was coordinated by a Project Implementation Unit (PIU) within the Planning Secretariat. This unit was effective in monitoring progress in the different reform areas, documenting the compliance with performance benchmarks prior to release of each time-slice disbursement, and complying with procurement and disbursement agreements. The one area where implementation was weak was due in part to constraints outside of the control of the state, but also due to weak state commitment to fiscal targets. 52. Compliance with Covenants: Satisfactory. Compliance with legal covenants was satisfactory. Over the life of the project, compliance with the stipulated covenants and agreements was generally met. The project expenditures still need to be audited. The bidding documents for the audit have already been finalized, and the Government is ready to invite bids from five auditing firms. The Government expects to complete the audits with regards to 1997 and 1998 expenditures by August 1999. The delay with respect to the contractual date (June 30, 1999) is explained by the processing of a Government request to limit the audit to expenditures invoked for Bank disbursement, given the special nature of the loan (a fast- disbursing mechanism within an investment loan format). H. Assessment of Outcome 53. Overall Rating: Satisfactory. The RGS Reform Loan's objective was to support the successful implementation of a series of reforms aimed at improving both the state's medium-term fiscal situation and the efficiency in the provision of infrastructure and utility services. The project objectives have been met satisfactorily in the area of privatizations and concessions. The fiscal performance of the state, however, has not improved as expected. The loan's specific achievements include: a) the privatization of the telecommunication company; b) the privatization of two energy distribution company and the transfer to the federal government of a thermal generation plant; c) the concessioning of ports; d) the concessioning of nine road poles representing 20 percent of the state's road network; and e) the establishment of a regulatory agency. The RGS Reform Loan effectively provided technical and financial support to the state government in the implementation of its reform program. The RGS Reform Loan successfully capitalized on the window of opportunity that opened as the result of having reform- minded administrations at both the state and federal levels. 54. The experience with sub-national development projects in Argentina and other countries had demonstrated the importance of sub-national governments for the overall 17 success of a country's reform program. From the Bank's standpoint, the RGS Reform Loan was highly innovative, effectively adapting an investment loan format to respond to the needs of reform lending. It was also one of the first operations in which severance payments were considered eligible for financing. The RGS and other Brazilian state loans illustrated the need to have adequate lending instruments to promote reform among sub-national governments. In May 14, 1998'9, adjustment lending operations targeted directly to sub-national governnents becarne possible under Bank policies. 1. Future Operations 55. Based on the experience from this project, there are several relevant lessons to be learned for future operations: a) Re-evaluate the Fiscal Review approach. Having "soft" fiscal targets makes it possible to deal with uncertain macroeconomic conditions and the targets provide a basis for dialogue on the state's fiscal issues. However, having soft targets may perhaps introduce too much room for discretion into the assessment of conditionality compliance. More importantly however, fiscal targets, whether strong or soft, should be accompanied by a strong budget constraint in place, so that governmnents are indeed encouraged to achieve the targets. b) Structural adjustment loans are more appropriate when lending for reform: Although the RGS Reform Loan was highly innovative in its use of traditional investment loans, the disbursement and procurement procedures of these loans are too complex for the fast disbursement objectives of reform loans. c) Provide more technical assistance on concession contracts and regulatory frameworks: In particular, aim for the clear definition of the role of the regulatory entity and definition of concession contracts.20 J. Key Lessons Learned 56. The following lessons, which are relevant for future public sector reforn projects for sub-national governments beyond Brazil, can be learned from the implementation of this State Reform Loan: 57. Sub-national governments are key elements within the framework of a country's overall reform program. The medium- and long-term sustainability of a country's reform program depends on strong incentives encouraging state governments to become fiscally responsible and efficient providers of services. 58. Capitalizing on potential windows of opportunities. Having reform-minded See Adjustment Lending to Subnational Units Final Text (SecM98-96) 20 For a detailed description, see the "Key Lessons of Experience" section in Annex D. 18 administrations at both the federal and state governments opens a significant window of opportunity for reform. To capitalize on such opportunities, the Bank's technical assistance and sector work are critical at early stages, during the design of the reform programn. 59. For the reforms to be sustainable, a consistent system of incentives has to be in place at the national level. Pension fund and tax reforms, as well as the elimination of sources of quasi-deficit financing, including federal bail-outs, are key prerequisites for broader state reform, particularly fiscal adjustment. 60. An adequate regulatory framework at the federal level is a pre-requisite for the successful implementation of state-level privatization and concession programs. In the case of Brazil, legislation conducive to increasing private sector participation in the provision of most services at the state level had been passed the federal level, thus laying the ground to the successful implementation of the privatizations and concessions components. The only exception has been in the water and sanitation sector, where the lack of definition in terms of granting authority and a weak regulatory framework hampered the state's efforts to privatize the water company. 61. Focus on those sub-national governments that are most willing and able to implement major reforms. This will offset in part the risk of reforms being stalled in one state. 62. Operations should concentrate on a few, significant reforms that are hard to reverse. Also, the state government should be able to implement the reforms during its own mandate. 63. Quick-disbursing loans supporting a well-defined set of reforms can be effective tools in promoting structural adjustment at the sub-national level. Thus, the newly-approved structural adjustment instrument, where the Bank can undertake fast disbursement operations directly to sub-national governments, provides a useful tool. The experience of Brazil's state reform project helped trigger the development of this instrument. 64. Reform loans should support the state's own reform program, thus maximizing the state's ownership of the project. No lending operation per se can provide per se incentives for reform. It can only support the implementation of reforms for which there is a genuine interest on the part of the state. Strong state interest in privatization and weak state interest in fiscal adjustment help explain the different outcomes in the two areas. 65. Despite the irreversibility of privatization reforms, the project raises the question on whether greater consensus can be achieved with respect to these reforms. While the privatizations are unlikely to be reversed, they remain controversial within the state. Possibly a better job of documenting and ensuring the benefits from privatization needs to be undertaken to ensure a wider support for the reforms, which 19 would in turn reinforce their success. 66. As a condition for disbursement, the Bank should continue to require the actual sale of public enterprises as opposed to their being "ready for sale." Although this condition might be unpopular with Borrowers, it minimizes the likelihood of the reform actions being reversed. 67. Governments should be encouraged to ensure that the composition of the regulatory agencies is politically balanced. The general tendency to make appointments that are partisan threatens the sustainability of privatizations and concessions over the medium run, particularly under changing government administrations. 68. Implementation confirms, as expected during project preparation, that development of regulatory agencies is likely to be a slow process. The slow process of regulatory delegation from other powers, politicization, and internal differences of opinion on whether the agency should be independent of the executive, remain important obstacles to a faster development of the agency. 69. Severance payments are relatively small compared to the savings in payroll expenses. Although the potential savings in termns of reduced salary and pension bills are potentially very high, governments are usually cash-strapped and cannot afford to pay more. As a consequence, take-up rates are low and a potential source for reducing the long-term burden on state governments remains largely untapped.2" Upon approval of administrative reforms in 1999, the possibilities of attaining these savings will have been enhanced. 21 "Brazil: Fom stability to growth through public employment reform", Report No. 16793-BR, Feb. 1998. 20 Part II: Statistical Tables Table 1: Summary of Assessments A. Achievement of Objectives Achievement of Objectives Substantial Partial Negligible Not Applicable Macro Policies _ Sector Policies / Financial Objectives _ Institutional Development / Physical Objectives I Poverty Reduction _ Gender Issues / Other Social Objectives I Environmental Objectives / Public Sector Management . Private Sector Development _ Other / B. Project Sustainability Project Sustainability Likely Unlikely Uncertain C. Bank Performance Bank Performance Highly Satisfactory Deficient Satisfactory Identification I Preparation Assistance I Appraisal I Supervision _ 21 D. Borrower Performance Borrower Performance Highly Satisfactory Deficient Satisfactory Preparation I Implementation Covenant Compliance I Operation (if applicable) E. Assessment of Outcome Assessment of Outcome Highly Satisfactory Unsatisfactory Highly Satisfactory Unsatisfactory Table 2: Related Bank Loans/Credits Loan Purpose Amount Year of (US$ M) I Approval Status Preceding Operations Loan 4189-BR Mato Grosso State Privatization 45.0 1997 Closing Date: 06/30/00. 55% disbursed as of 06/02/99. Loan 4211-BR Rio de Janeiro State Privatization 250.0 1997 Closed on 12/31/98. 80% disbursed. Balance cancelled. Loan 4211-BR Minas Gerais State Privatization 170.0 1998 Loan not yet signed. 22 Table 3: Project Timetable Steps in Project Cycle Date Planned Actual Date/or Duration Identification (Initial Executive 3/27/96 Project Summary) Preparation 12 months Appraisal 07/15/96 Negotiations 12/16/96 Letter of Development Policy 12/12/96 Board Presentation February, 1997 03/04/97 Signing 6/10/97 Effectiveness 6/30/97 First Time-Slice Release Jan. - Jun. 1997 6/30/97 First Program Review Jun. - Sept., 1997 11/20/97 Second Time-Slice Release Jul. - Dec. 1997 2/17/98 Second Program Review March - June 1998. 6/22/98 Third Time-Slice Release March - Jun. 1998 12/9//98 Cancellation 12/31/98 12/31/98 Loan Closing 12/31/98 12/31/98 23 Table 4: Cumulative Loan Disbursements: Estimated and Actual (US$ Million) FY97 FY98 FY99 Appraisal estimate 50 105 125 Actual 0 74.98 104.98 Actual as % of estimate 0% 71% 84% Date of Final Disbursement: December 9, 1998 Date of Cancellation: US$20 million December 31, 1998 24 Table 5.a: Project Costs Estimated Versus Actual (US$ Million) Appraisal estimate Actual (US$M) (US$M) Categories Local Foreign Total Local Foreign Total Costs Costs Costs Costs Goods, Works, Consultant Services, and Training * Reform-related studies, training, and audits 14.0 18.0 32.0 8.0 12.0 18.0 * Reform-related equipment and rehabilitation 7.0 3.0 10.0 n.a. n.a. n.a. works * High Priority Investments in: Land Management and Rural Poverty Alleviation 34.0 18.0 54.0 33.0 17.0 50.0 Highway Rehabilitation 36.5 33.5 70.0 370.0 406.0 776.0 School and Hospital Rehabilitation 30.0 30.0 60.0 160.0 155.0 315.0 * IDB Tax Project 6.0 24.0 30.0 0.0 0.0 0.0 Severance Payments * "Rightsizing" of the work force 180.0 0.0 180.0 134.0 0.0 134.0 State Enterprises 75.0 0.0 75.0 n.a. n. a. n. a. Other State Entities 105.0 0.0 105.0 n.a. n.a. n.a. Grants 15.0 0.0 15.0 281.0 0.0 281.0 Incremental Recurrent Costs of Reforms on a 10.0 0.0 10.0 n.a. n.a. n.a. Declining Basis Total 332.5 126.5 461.0 1,086 488.0 1,574.0 25 Table 5.b: Project Financing Estimated Versus Actual (US$ Million) Source Total Total IBRD 125.0 105.0 IDB (Tax Project) 19.0 0.0 State of RGS 217.0 1,335.0 Caixa Economica Federal 100.0 134.0 Total 461.0 1,574.0 26 Table 6: Status of Legal Covenants Agreement Section Type of Present Description of Covenant Comments Covenant Status Guarantee Article 11, 5 C Without limitation or restriction upon any of its other Complied with. Agreement Section obligations under this Agreement, the Guarantor hereby 2.01 unconditionally guarantees, as primary obligor and not as surety merely, the due and punctual payment of the principal of, and interest and other charges on, the Loan, and the premium, if any on the prepayment of the Loan as set forth in the Agreement Loan Agreement Article 11, 5 C The closing date shall be 12/31/98 or such later date as The project closed on December Section the Bank shall establish. The Bank shall promptly notify 31, 1998 as planned. 2.03 the Borrower and Guarantor of such later date. Article 111, 5 C The Borrower declares its commitment to the objectives Complied Section of the Project set forth in Schedule 2 of this Agreement, 3.01 and shall carry out the Project in accordance with appropriate administrative, financial, and environmental practice and the provisions of the Project Manual, and shall provide as promptly as needed, the funds, facilities, ____________ _ __ services, and other resources required for the project. Article III, 5 C Except as the Bank shall otherwise agree, procurement of Complied Section the goods, works, and consultants' services required for 3.02(a) the Project and to be financed out of the proceeds of the Loan shall be govemed by the provisions of Schedule 4 of this Agreement. Article Ill, I NYD The Borrower shall, not later than 30 days after the Not yet due. Section disbursement of the proceeds of the Loan in respect of 3.02(b) each of the Authorized Amounts, furnish to the Bank an audit report, by an auditor acceptable to the Bank, on the compliance by the Borrower in respect of procurement of goods and works financed under each such Authorized Amount. Each such report to be prepared in accordance with terms of reference satisfactory to the Bank. Article 111, 9 C The Borrower shall exchange views with the Bank on the Complied with. Section progress in carrying out the Program and the taking of 3.03 (a) actions specified in Schedule 6 to this Agreement, not earlier than September 1, 1997, but not later than December 31, 1997 (the First Program Review). Article III, 5 C The Borrower shall exchange views with the Bank on the Complied with. Section progress in carrying out the Program and the taking of 3.03 (b) actions specified in Schedule 7 to this Agreement, not earlier than March 1, 1998, but not later than June 30, 1998 (the Second Program Review). Article III, 10 C he Borrower shall exchange views with the Bank on any Complied with. Section proposed action to be taken, after the disbursement of the 3.04 Loan, which may have the effect of materially reversing the objectives of the Program, including any actions specified in Schedules 6 and 7 of this Agreement Article IV, I Borrower shall maintain or cause to be maintained Section records and separate accounts adequate to reflect in 4.01(a) accordance with sound accounting practices the operations, resources, and expenditures in respect of the Project of the department, agencies, or enterprises of the Borrower responsible for carrying out the Project. Article IV, I Soon The Borrower shall have the records and accounts Audit of 1997 accounts due Section referred to in para. (a) of this Section and the records and 12/31/98. 4.01(b) (1) accounts for the Special account for each fiscal year audited in accordance with appropriate auditing principles consistently applied by independent auditors acceptable to the Bank 27 Status of Legal Covenants (cont.) Agreement Section Type of Present Description of Covenant Comments Covenant Status Article IV, I Soon The Borrower shall furnish to the Bank as soon as Audit of 1997 accounts due on Section available, but in any case not later than six months after 12/31/98. 4.01(b) (ii) the end of each such year, the report of such audit by said auditors, of such scope and in such detail as the Bank requests Article IV, I NC The Borrower shall furnish to the Bank such other Audit to be delivered on Section information concerning said records and accounts and the 4.01(b)(iii) audit thereof as the Bank from time to time shall reasonably request. Article IV, 10 C The loan agreement has been duly registered by the Complied. Section Central Bank of Brazil. 6.01(a) Article VI, 10 C The project manual has been issued by the Borrower Complied. Section 6.01 (b) Schedule 1, 3 C Only withdrawals, in an aggregate amount not exceeding Complied. para. 3 $62,500,000, may be made for payments made for (a)(1) expenditures made twelve months before the date of this agreement Schedule 1, 3 C No withdrawals shall be made in respect of payments for Complied. para. 3(a) expenditures unless such expenditures have been incurred (ii) on account of a Selected Activity approved by the Bank. Schedule 1, 3 C No withdrawals shall be made in respect of payments of Complied. para. 3(a) expenditures under subprojects for highway maintenance (iii) and rehabilitation or for land management and rural poverty alleviation in excess of $15,000,000 for each subproject, if any subproject is part of a project being financed by the Bank under another loan. Schedule 1, 3 C When the Authorized Amounts reach $50,000,000 in the Complied para. 3 (b) aggregate, the Bank will approve new Selected Activities (I) requiring Authorized Amounts of up to $25,000,000 in the aggregate, only after the First Program Review shall have taken place and the Bank shall be satisfied that actions specified in Schedule 1 .6 to this Agreement satisfactory to the Bank. Schedule 1, 3 C The Bank will approve new selected Activities requiring Complied para.3 (b) Authorized Amounts of up to $30,000,000 in the (ii) aggregate, only after the Second Program Review shall have taken place and the Bank shall be satisfied that actions specified in Schedule 7 have been taken satisfactory to the Bank. Schedule 1, 3 NC Notwithstanding the provisions of (i) and (ii) above, the Little prospect for this reform, para. 3(b) Bank will approve new Selected Activities requiring given the defeat of current (iii) Authorized Amounts of up to $20,000,000 in the governor. Corresponding aggregate, whenever concessions and/or full management amount of loan proceeds service contracts have been awarded to investors which cancelled. are not part of the Brazilian federal, state, or municipal public sector for the operation of water and sewerage systems in areas of the Borrower's territory with a population of at least 800,000 persons in the aggregate. Such systems shall be operated in accordance with environmental targets established on the basis of environmental audits, acceptable to the Bank carried out before the award of the corresponding concessions and/or service management contracts for the operation of such ___________________ ____________ ____________ _____ system s. 28 Status of Legal Covenants (cont.) Agreement Section Type of Present Description of Covenant Comments Covenant Status Schedule 1, 9 C If, after any Program Review, the Bank gives notice to Bank did not give any such para. 4 the Borrower that any action specified in Schedule 6 or 7 notice. to this Agreement has not been taken within 90 days, the Bank may--with further notice to the Borrower and Guarantor--cancel the amount of the Loan referred to in para 3 (b) (i) or (ii) of this Schedule. Schedule 6, 1I C The Borrower's policies regarding public expenditures, Substantially complied with. para. I tax administration improvements, public borrowings, and use of privatization proceeds, as set forth in the Reform Program Letter, have been substantially complied with. Schedule 6, 10 C Control of CRrs management has been transferred to Complied. para. 2 the strategic investor who has acquired 35% of the common shares of CRT's capital Schedule 6, 10 C Concessions have been awarded to firms, which are not Complied. para. 4 part of the Brazilian federal, state, or municipal public sector, for the operation of the container terminal and the wheat-soy terminal in the Borrower's port of Rio Grande. Schedule 6, 10 C Concessions have been awarded to firms, which are not Complied. para. 4 part of the Brazilian federal, state, or municipal public sector, for the maintenance, operation, and improvement of roads under at least three Road Poles. Schedule 6, 10 C The draft study on the Borrower's water and sanitation Complied. para. 5 sector, with recommendations to restructure such sector, increase the degree of private sector participation in such sector, create a competitive environment for the service providers and redefine such sector's social policy, and an action plan to implement such recommendations, has been completed. Schedule 6, 12 C A regulatory agency responsible for the supervision of Complied. para. 6 the Borrower's public services subject to concession or permission has been created and the members of its board have been appointed. Schedule 7, 11 The Borrower's policies regarding public expenditures, Complied para. I tax administration, improvements, public borrowings and use of privatization proceeds, as set forth in the Reform Program Letter, have been substantially complied with. Schedule 7, 10 Concessions have been awarded to firms, which are not No buyers were found for these para. 2 part of the Brazilian federal, state, or municipal public facilities. sector, for the operation of the refrigeration pier, the liquid bulk terminal and the storage facility in the Borrower's port of Rio Grande. Schedule 7, 10 The majority of the voting shares of CEEE's distribution Complied para. 4 company North-East and CEEE's distribution company Center-West has been transferred to investors which are not part of the Brazilian federal, state or municipal I public sector. Schedule 7, 12 C The agency referred to in para. 6 of Schedule 6 to this Complied with in substance. pars. 5 Agreement is fully operational. Covenant Types: Present Status: I = Accounts/Audits 7 = Involuntary resettlement C = covenant complied 2 = Financial performance/generate revenue from 8 = Indigenous people CD = complied with after delay 3 = Flow and utilization of Project funds 9 = Monitoring, review and reporting CP complied with partially 4 = Counterpart funding 10 = Project implementation not covered by categories 1-9 NC = Not complied with 5 = Management aspects of the project or executing II = Sectoral or cross sectoral budgetary or other resource allocation. agency 12 = Sectoral or cross-sectoral policy/ regulatory/institutional action 6 = Environmental covenants 13 = Other 29 Table 7: Bank Resources: StaffInputs" Stage of Actual Project Cycle Weeks US$ Through appraisal 77.8 312.1 Appraisal-Board 30.1 149.2 Board-effectiveness 11.4 35.5 Supervision 43.2 189.5 Completion 7.5 40.9 TOTAL 170.0 727.2 Includes Bank-financed and trust fund consultants. Dollars are direct costs only. 30 Table 8: Bank Resources: Missions Stage of Project Month/ Number Specialized cyle of Project year of Days in staff skills Performance rating cycle persons field represented 1/ Implementation Development Types of Status objectives problems Through appraisal September 1995 9 15 A,B,C,G,J,K,L November 1995 6 10 A,F,G,H,I,M December 1995 3 4 G,H,I January 1996 10 5 B,C,D,G,H,I,J,L February 1996 4 5 G,N,O,Q May 1996 8 12 C,D,G,H,J,P,R July 1996 2 3 G,Q Board approval through effectiveness Supervision July 1997 5 4 A,B,C,D,E ompl ing with fiscal and investment targets. Risk that state will not comply with target for personnel. September 1997 3 4 A,C,F S S Project on track. Ahead of 2fd time- slice disbursements implementation conditionality. November 1997 3 2 A,C,E Project on track for first review and 2 time-slice disbursement. February 1998 3 1 A,B,C S S Number of obstacles to reform water sector and privatize water company. June 1998 2 2 A,B S S Last time-slice June 1998 2 2 A,B disbursement (US$20M) depends on partial privatization of the state water and _ ~~~~~~~~~~~~~~~~~~sanitation company. Completion March 1999 4 5 A,F,H,K 1/Key to specialization: A. Task Manager J Power B. Public Finance K Roads C. Water L Education D. Disbursement/Auditing M Budget Reform E Regulation N Health F Financial Sector 0 Pensions G Sr. Economist P Administrative Reform H Telecommunications Q Division Chief I Port R. Private Sector Development 31 Table 9: Policy Matrix Activity By Board Presentation First Project Review Second Project Review (February, 1997) (June - Sept., 1997) (March - June, 1998) Public Expenditure Review (PER) Review that the State has not Agreed on focus of Public Positive PER: Positive PER: undertaken unproductive investments Expenditure Review (PER), included i) investment expenditures must i) investment expenditures must and that financing of investment in Reform Program Letter: generally be economically or socially generally be economically or socially expenditure is consistent with the i) investment expenditures, their productive; productive; reform program. financing and their economic or ii) overall levels of debt to revenue ii) overall levels of debt to revenue social justification,; must decline in accordance with debt must decline in accordance with debt ii) the debt stock / revenue ratio; agreement; agreement; iii) the personnel cost / revenue ratio; iii) investment levels and investment iii) investment levels and investment iv) policies to increase tax collection. financing must be consistent with financing must be consistent with debt/revenues targets; debt/revenues targets; iv) planned personnel costs reductions iv) planned personnel costs reductions must be implemented. must be implemented. Privatizations and Concessions a) State Telecommunications Sold 35 percent of CRT's voting Satisfactory transfer of key CRT Company shares to private strategic investors. management functions to private, Companhia Riograndense dos strategic investor. Telecomunicacoes (CRT) b) Ports: Concession of facilities in Porto Alegre container pier has been Award of concessions of container Award concessions of refrigeration the Port of Rio Grande that will raise awarded. terminal and wheat-soy terminal in pier, liquid bulk terminal and storage the share of private operators from 50 Bids for Rio Grande container Rio Grande. facility of Rio Grande. percent to 80 percent. terminal have been received and winner has been determined. Bidding documents for wheat-soy terminal have been issued. 32 Policy Matrix (cont.) Activity By Board Presentation First Project Review Second Project Review l (February, 1997) | (June - Sept., 1997) (March - June, 1998) Privatizations and Concessions (cont.) c) Roads: Concession of about 20 Bidder list for first road pole Award concessions of at least three Award concessions of at least four percent of the paved road network in (Gramado) has been approved. poles. additional road poles. nine poles. Bidder lists for other road poles submitted. _____ d) CEEE: Sale of majority voting Law on splitting and privatizing Sell distribution companies North and shares of power distribution CEEE has been approved. West. companies covering about 2/3 of the distribution market. e) Water and Sanitation Sector Privatization options determined. Complete final draft of consultant's Study report on design and implementation of water sector privatization options. f) Regulation of Infrastructure Law approved for establishment of Create regulatory entity and appoint Regulatory entity fully operational. Services cross-sectoral regulatory entity. members of Board. By Board Presentation Disbursement (Floating Date) g) Water Concessions Privatization options determined: Award concessions or full service management contracts of water and (i) direct municipal concessions; sewerage covering municipalities with an aggregate urban population of at ii) full service management contracts; least 800,000 to private operators. iii) privatization of CORSAN. 33 Table 10: Evolution of State Fiscal Accounts 1995-98 (in real terms, Rs$ million) Sources and Uses 1995 1996 1997 1998 Current Revenues 4,641 4,791 4,766 5,290 Net Tax Revenues 3,240 3,305 3,111 3,099 Transfers from Federal Government 902 921 1,018 1,369 Other Current Revenues 500 565 637 822 Current Expenditures 7,026 6,914 6,962 6,152 Personnel 3,843 4,146 4,071 4,282 Active Personnel 2,197 2,509 2,366 2,412 Retirees and Dependents 1,596 1,523 1,571 1,778 Other 50 114 134 92 Interest on Debt 2,574 1,945 2,164 984 Other Current Expenditures 609 823 727 886 Capital Expenditure 628 636 1,058 4,077 Investment 471 500 934 1,347 Debt Amortization 157 136 123 392 Other 2,338 (2) Borrowing Requirement -3,013 -2,759 -3,254 -4,939 Capital Receipts 2,391 2,794 3,702 5,313 Net Borrowing 55 388 296 2,551 Net Privatization 0 700 1,502 1,850 Capitalized Interest 2,310 1,657 1,849 812 Other Capital Receipts 26 50 55 100 Surplus / Deficit -622 36 448 375 Indicators 1995 1996 1997 1998 Growth of Current Revenues n.a. 3.2% -0.5% 11.0% Personnel as % Revenue 82.8% 86.5% 85.4% 80.9% Capital Spending as % of Revenues 13.5% 13.3% 22.2% 32.9% (3) Current Account Surplus as % of Revenues -51.4% -44.3% -46.1% -16.3% Primary Surplus as % of Revenues -6.1% -14.1% -20.3% -23.2% Total Debt Service as % of Revenues 58.8% 43.4% 48.0% 26.0% Stock of Debt as % of Revenues 187.8% 204.4% 239.4% 228.4% (4) Overall Surplus / Deficit as % of Revenues -61.5% -54.7% -65.7% -41.8% Stock of Debt 1995 1996 1997 1998 Negotiable Debt 6,402 7,220 8,436 33 Bonds (1) 6,402 7,220 8,436 33 Contractual Debt 2,316 2,571 2,972 13,383 - Intralimite 0 0 0 10,759 a. Renegotiation 0 0 0 7,186 b. PROES 0 0 0 2,380 c. Other 0 0 0 1,192 - Extralimite 0 0 0 2,624 Total Debt 8,718 9,791 11,408 13,416 (1) This is also considered "extralimite" debt. (2) The Rs$2,380 million correspond to PROES, which funded capital expenditures on Banrisul, the state bank. (3) It excludes Rs$2,380 million from PROES. (4) It excludes Rs$1,335 million from PROES corresponding to portfolio of Caixa Stadual. 34 Table 11: Expenditure Reviews Targets and Actual Performance Indicators Target 12/31/97 12/31/98 Growth in Net Current Revenues 4% -1% 11% Personnel as % of Net Current Revenues 75% 85% 81% Debt/Revenue Ratio (1) 1:1 2.39 2.28 (2) Amount of Investment Financed from Debt 225 56 101 Investment Spending Highways Rs$281 million Rs$550 million Education Rs$53 million Rs$74 million Health and Sanitation Rs$1 11 million Rs$1 18 million Municipal Investments Rs$46 million Rs$23 million Others Loan to GM Loan to Ford and GM (Rs$253.2 million) (Rs$ 306.7 million) (I) The target is to be achieved by the year 2008. (2) Excluding Rs$1,335 million from PROES, corresponding to the portfolio of Caixa Stadual. Otherwise, the debt / revenue ratio increases to 2.58. 35 Table 12: Proceeds from Privatizations Sector Company Date Proceeds (Rs$ million) Telecommunications CRT Ist Tranche (3 5%) 12/96 681 CRT 2nd Tranche (50.12%) 6/98 1,176 Electricity RGE 10/97 895 AES-Sul 10/97 1,635 CGTEE 12/98 508* Total 4,895 * Reduction in state debt via 'Federalization' of company 36 Table 13: Road Concessions Concession Pole Awarded Min. Km. Con. Proposal Concession Concessionaire Maint. Edital Km. Maintained In Operation Investment (1) Pelotas Yes 539.00 551.50 No 279,790.00 Metropolitano Yes 510.00 536.00 Yes 377,425.00 Caxias Do Sol Yes 165.85 173.75 Yes 322,846.00 Vacaria Yes 121.16 132.66 Yes 140,922.00 Grarnado Yes 110.37 131.97 Yes 71,601.00 Carazhinho Yes 209.38 250.40 Yes 253,455.00 Santa Maria Yes 249.21 256.21 Yes 209,973.00 Santa Cruz do Sul Yes 154.49 196.82 Yes 204,771.00 Lajeado Yes 282.31 318.80 Yes 340,142.00 Total All Concessions 2,341.77 2,548.11 2,200,925.00 Total Operating Concessions 1,553.56 1,740.40 1,711,162.00 Total Paved Km. In Network 8,600.00 % Total Paved Awarded to Concessionaires 29.63% % Total Paved in Operating Concessions 20.24% (1) Includes 455,639.00 concessionaire tax payment * Source: DAER "Programa Estadual de Concessao Rodoviaria, Resumo Informativo 37 Annex A: Public Expenditure Reviews Annex A: Public Expenditure Reviews 1. One of the objectives of the reforms supported by the RGS Reform Loan was to improve the state's fiscal position to ultimately contribute to improve the country's overall fiscal performance. Specifically, the RGS government's intentions, as stated in its Reform Program Letter to the Bank, were to reduce spending in personnel, increase tax collection, develop a sound investment program, and reduce the stock of debt. These objectives have been only partially achieved, as there have not been significant improvements in terms of personnel expenditures and the reduction of the stock of debt. 2. Specifically, the Reform Letter presented by the State describing its reform program specified five fiscal targets: i) growth in net current revenues; ii) personnel expenditures as a percentage of net current revenues; iii) stock of debt/revenue ratio; iv) productivity of investment; and v) levels of investment spending. Compliance with these targets has been partial (see Table 1). 3. In 1997, the state did not meet three of these targets: growth in revenues, reductions in personnel expenditures, and declines in debt/revenues ratio. By 1998, the targets with regard to reductions in personnel expenditures and declines in the debt/revenue ratio had not yet been met. However, the growth in net current revenues surpassed the corresponding target by 7 percent, mainly due to a growth in transfers and a rebound in ICMS during the second semester. As a result of a comprehensive debt agreement with the National Government, the stock of bonds was reduced significantly, although the total stock of debt has increased with respect to 1996, despite the proceeds from the privatizations and a Rs$1.645 billion debt forgiveness by the federal government. The increase in debt has been mainly the result of three factors: a) excessive primary deficits (i.e., 20.3 percent and 23.2 percent of net current revenues in 1997 and 1998 respectively); b) an increase in borrowing from PROES to assist in the restructuring of the state financial institutions; and c) the due-interest burden on the high levels of accumulated debt. Moreover, debt service caps will cause the debt to continue to grow, at least in the near term. 4. Personnel expenditures as a proportion of net current revenues have decreased from 85.4 percent in 1998 to 81 percent in 1998, but mainly as a result of an increase in revenues due to transfers. The remaining two targets -- amount of investment financed by debt and the type of investment spending -- were both met in 1997 and 1998. Capital spending in 1998 was substantial and generally consistent with both the ceiling on debt financed capital investment and the guidelines for the sectoral allocation of investment. One exception to this were two loans to GM and Ford, and their "sistemistas" that, as opportunely pointed out by the Bank, are questionable in terms of their economic and social justification. 5. Despite the failure to meet targets, the state was considered to be in compliance 38 Annex A: Public Expenditure Reviews because federal conditions for meeting the targets did not come into place (finalization of the debt agreements and passage of administrative reforms). Moreover, the initial lack of improvement of state revenues was attributed also to an external factor, namely approval of a law granting exemption of the ICMS, the main source of revenues for the states, to exports. Table 1 Summary of Reform Letter Targets Indicators Target 12/31/97 12/31/98 Growth in Net Current Revenues 4% -1% 11% Personnel as % of Net Current Revenues 75% 85% 81% Debt/ Revenue Ratio (1) 1:1 (2) 2.39 2.28 Amount of Investment (3) 934 1,347 Investment Spending Highways Rs$281 million Rs$550 million Education Rs$53 million RsS74 million Health and Sanitation Rs$l 11 million Rs$118 million Municipal Investments Rs$46 million Rs$23 million Others Loan to GM Loan to Ford and GM (Rs$253.2 million) (Rs$ 306.7 million) (I) It does not include Rs$ 1.335 billion for the Caixa Estadual portfolio. (2) The target is to be achieved by the year 2008 (3) The target is that investment levels and investment financing should be consistent with debt/revenue targets. 6. Revenues. The Reform Program Letter sets the target for growth in net revenues in 1997 and 1998 at 4 percent in real terms. This was achieved in 1998, but not in 1987. Based on the final accounts (December 31, 1998), net current revenues have increased significantly during the second half of 1998. This is largely due: (a) a 2.7 percent increase in ICMS revenues as a result of some actions aimed to improve tax administration, (b) an 34.4 percent increase in federal transfers; and (c) a 30.4 percent increase in other revenue. 7. As noted in the First Review, the decline in ICMS revenues during 1997 does not reflect an overall decline in the tax base. According to figures released by the state's Planning Department in early January 1998, the state's GDP grew 5.7 percent during 1997. Growth was particularly strong in sectors which have historically contributed the majority of ICMS revenues. The industrial sector (including manufacturing, construction, and public utilities), for example, accounted for 58 percent of ICMS tax receipts in 1996 and grew 11 percent in 1997. 8. Instead, the decline in 1997 appears to have been due to two factors: federally imposed exemptions and worsening tax administration. The relative importance of these factors was difficult to disentangle. It is clear that federally imposed tax exemptions had an adverse effect revenues during 1997. The Lei Kandir (L.C. 87/96) went into effect in September of 1996. It granted two exemptions to the ICMS. The first one exempted exports from the ICMS. The second one allowed a 100 percent tax credit for ICMS paid 39 Annex A: Public Expenditure Reviews on the purchase of capital equipment. The state argued that most of the growth in the economy occurred in activities that were exempt from the Lei Kandir. According to its analysis, the exemption on exports alone cost the state Rs$236 million in 1997. Without this loss, revenues would have remained constant in real terms. 23 Table 2 Growth in Current Revenues 1996-98 Nominal (Rs$ Million) Real (Rs$ Million) Current Revenues 1996 1997 1998 1996 1997 1998 Tax Revenue 4,195 4,237 4,516 4,629 4,389 4,516 ICMS 3,879 3,857 4,102 4,280 3,995 4,102 Transfers 835 983 1,369 921 1,018 1,369 FPE 206 230 257 227 238 257 IRF 226 250 305 249 259 305 IPI - Exports 271 274 295 299 284 295 Lei Kandir 0 69 297 0 71 297 Other Transfers 132 160 216 146 166 216 Other Revenues 512 614 822 565 636 822 Total Gross Current Revenues 5,542 5,834 6,707 6,115 6,043 6,707 Transfers to Municipalities 1,200 1,234 1,417 1,324 1,278 1,417 Net Current Revenues 4,342 4,601 5,290 4,791 4,765 5,290 Consumer Price Index (July) 132.674 141.330 146.398 Adjustment Coef. (1998) 1.103 1.036 1.000 9. The Second Expenditure Review was based on results through May. At that point, ICMS revenues appeared to have slowed their decline. Reported ICMS revenues in the first five months of 1998 were only 2.4 percent less than in the corresponding period of 1997. After adjusting for some anomalies in the data, revenues appeared to have actually increased by 3 percent.24 This reversal was in part due to the bottoming out of the impact of the Lei Kandir. As the impact of the Lei Kandir was already reflected in 1997 revenues, its marginal impact on 1998 revenues was minimal. 10. Non-tax revenues increased sharply in the first five months of 1998. This was largely due to growth in transfers--particularly Lei Kandir compensation payments. Due to anomalies in the fortnula for Lei Kandir compensation, the state received only Rs$60 million in compensation in 1997--all of it in the last half of the year. In the first five months of 1998, the state received Rs$94 million and expected to continue to receive this 23 Under Lei Kandir, if real ICMS revenues in any twelve month period are not at least five percent above their levels during the period July 1995-June 1996, the Federal Government is required to compensate the state for the difference. Because receipts are calculated on the basis of twelve month periods, the compensation calculation during the first months of 1997 failed to reflect the impact of the Lei Kandil. Once the calculation was based on a full 12 months of post Kandir revenues, the amount of compensation increased. 24 In December 1996, the state obtained an advance payment of Rs$63 million in ICMS revenues due in 1997. As a result, 1996 revenues are overstated by Rs$63 million, and 1997 revenues understated by the same amount. A similar transaction in December 1995 understated 1996 ICMS revenues by R$32 million. 40 Annex A: Public Expenditure Reviews rate of compensation throughout the year. Due to the overall decline in reported tax revenues, constitutionally mandated transfers to municipalities fell. Thus, current revenues net of transfers to municipalities--the indicator to measure revenue performance--increased by 6.7 percent in the first five months of 1998, compared to the corresponding period in 1997. Larger than the target of 4 percent, this condition was considered to be fully met. 11. Personnel Costs. The Reform Program Letter states that expenditures on personnel were to drop to 75 percent of net current revenue in 1997 (from a peak of 87 percent in 1996). Performance in 1997 did not meet this target. Expenditures on personnel ("despesas realizadas") in 1997, including active employees in direct and indirect administration and retired employees, totaled 86 percent of net current revenues. In the first five months of 1998, personnel costs increased 3.5 percent over the corresponding period in 1997 in real terms. As net current revenues grew by 6.7 percent, the proportion of personnel costs to revenue, shrank to 83 percent. The indicator eventually dropped to 81 percent by the end of 1998. Table 3 Evolution of Personnel Expenditures 1996-98 Nominal (Rs$ Million) Real (Rs$ Million) Personnel Expenditures 1996 1997 1998 1996 1997 1998 Active 2,274 2,284 2,412 2,509 2,366 2,412 Retired and Dependents 1,380 1,517 1,778 1,523 1,571 1,778 Other 103 129 92 114 134 92 Total 3,757 3,930 4,282 4,146 4,071 4,282 Personnel as % Net Current Revenues Net Current Revenues 4,342 4,601 5,290 Ratio 87% 85% 81% Consumer Price Index (July) 132.674 141.330 146.398 Adjustment Coef. (1998) 1.103 1.036 1.000 Table 4 Changes in the Number of Employees, 1996-98 1996 1997 1998 Number of Personnel ("000, as of Dec. 31) Active 173.7 168.1 166.1 Retired and Dependents 100.2 105.5 110.6 Total 273.9 273.6 276.7 12. The growth in personnel costs is only due to factors outside the state's control, since the largest component of growth is in payments to retired staff (see Table 3), while declines in payments to active staff are limited by constitutional provisions guaranteeing civil service tenure and prohibiting declines in salaries. This in turn reflects growth in the 41 Annex A: Public Expenditure Reviews number of retirees, as shown in Table 4. Payments to active workers actually declined between 1996 and 1997, again in the first five months of 1998, and increased only slightly by the end of 1998. This reflects a decline in the number of active staff (from 173,000 in January, 1997 to 166,000 in December, 1998) as well as fairly modest "increases in nominal salaries." (In August 1997, the state awarded an 8.7 percent increase to teachers. Further raises of 2.2 percent were awarded in May and June of 1998. Lower-ranking staff of the civil and military police were granted a 23-34 percent nominal increase in August 1997, to be phased in over 17 months.) 13. Reductions in debt stock. / revenue ratio. The Reform Program Letter states that the state's debt/revenue ratio should fall to 1: 1 by the year 2008. This was the target established in the debt protocol signed with the federal governmnent on September 20, 1996, based on the outstanding debt stock at the time and the terms of debt relief established in the debt relief protocol. 14. During 1997, the state's debt stock increased by Rs$2.14 billion in nominal terms. This was attributable to several developments. The most important was the capitalization of interest on bonds. Until November 1998, the state did not have an effective debt refinancing agreement with the federal government. Interest on the bonds therefore continued to be based on the SELIC rate. As the Senate permitted the state to roll over 98 percent of the value of the bonds (including capitalized interest) the stock of bonds grew rapidly. Second, the state borrowed Rs$158 million from CEF to refinance AROs. (Although this is merely a restructuring of debt, it affects the indicator since AROs are not included in the indicator and debt to CEF is.) The third cause was external borrowing (from BIRD and IDB), totaling Rs$107 million. Table 5 Evolution of the Stock of Debt Nominal (Rs$ Million) Real (Rs$ Million) Type of Debt 1996 1997 1998 1996 1997 1998 Bonds 6,543 8,144 33 7,152 8,283 33 Res. 162 357 619 0 390 630 0 Net Negotiable Debt 6,900 8,763 33 7,543 8,912 33 Refinancing (Bonds & Res. 162) 7,186 7,186 PROES (1) 1,045 1,045 PROES Contrapartida 681 681 Eectrobras (Conta Grafica) 694 694 Other Debt 1,973 2,250 2,442 2,157 2,288 2,442 Total 8,873 11,013 12,081 9,699 11,201 12,081 Debt I Revenue Ratio Net Current Revenues 4,342 4,601 5,290 Ratio 2.04 2.39 2.28 Consumer Price Index (December) 134.689 144.765 147.231 Adjustment Coef. (1998) 1.093118 1.017035 1 (1) It does not include Rs$1.335 billion corresponding to the Caixa Estadual portfolio. 42 Annex A: Public Expenditure Reviews 15. The debt picture changed substantially in 1998. On March 30, 1998, the federal government agreed to lend the state up to Rs$1,987 million to finance the merger and restructuring of its two banks. Of this amount, Rs$ 1,034 million was actually contracted. Another Rs$563 million in counterpart funding was borrowed from the state bank (Banrisul) pension fund and BNDES. On April 15, a comprehensive debt agreement was signed, incorporating significant reductions in the stock of bonds and Resolution 162 debt. Out of a total of Rs$9,427 million in outstanding bonds and Resolution 162 debt, the Federal government forgave Rs$1,645 billion outright and agreed to accept another Rs$650 million in assets to reduce the remainder, leaving a debt of Rs$7,132 million. The net effect of these transactions was to reduce the total stock of debt by Rs$1,168 million. 16. The remaining debt was refinanced for 30 years at 6 percent interest (in real terms). Debt service is subject to a ceiling of 13 percent of net current revenues. (The debt service ceiling is reduced to 12 percent in 1998 and 12.5 percent in 1999.) Debt service in excess of that level will be automatically capitalized into the stock of debt, to be paid when debt service falls below the 13 percent threshold. Rough estimates suggested that the amount of debt service subject to the ceiling will equal about 24 percent of net current revenue in 1998. As a result, nearly half of debt service obligations were capitalized into the stock of debt. The stock of debt can therefore be expected to grow until revenues rise considerably. In fact, the total stock of debt reached to Rs$12,081 million By the end of 1998. 17. There has been very little new borrowing in 1998, outside of the debt refinancing agreement discussed above. The only additions to the debt stock arose from disbursements of loans from the IDB (Pro-Guiaba) and IBRD (State Reform Loan and Pro-rural.) 18. Because the debt refinancing agreement was not made effective until November 1998, it was difficult to determine how wide off the mark the state's debt was. Background documents to the comprehensive debt agreement estimate that the debt: revenue ratio will fall to 1: 1 by 2012, but this assumes full implementation of a state adjustment program. In the near term, it seems likely that the debt/revenue ratio will rise, due to the capitalization of debt service permitted by the 13 percent debt service ceiling. Thus far, however, the state has met its debt service obligations under the debt agreement finalized last November25. The state, nevertheless, is challenging the validity of the agreement. 19. Level of Investment. The Reform Program Letter fixes a target for investment at Rs$771 million for 1997 and Rs$767 million for 1998. The intent of this target is to monitor whether investment levels and financing are "consistent with the achievement of 25 Nevertheless, the state and the Federal Government need to resolve the payment of the "conta gr6fica", a down payment by the state to the Federal Govemment, financed by Electrobras, to be reimbursed by the state upon privatization of CGTEE. This privatization however, did not materialize. 43 Annex A: Public Expenditure Reviews overall debt/revenue targets." However, since the debt agreement was not finalized until November 1998, the state was not subject to debt targets during the life of the project. 20. Total capital spending in 1997 totaled Rs$1.485 billion in nominal termns. Very little of this was financed from borrowing. Project borrowing (consisting largely of the IDB-financed Pro-Guiaba loan) totaled Rs$56 million in 1997. The state continued to maintain a low level of debt-financed investment which amounted to only Rs$101 million. As noted above, borrowing for capital works has been confined to IDB/IBRD- financed projects. The total level of capital investment was Rs$ 1.347 billion in 1998. 21. Productivity of investment. The final condition established in the Reform Program Letter refers to the nature and quality of the state investment program. The Letter states that investment spending will be based on the identification of the principal economic and social needs of the state, and that investments will concentrate on the expansion and maintenance of the highway network, investments in health, education, and public security, and investments to support growth in the agricultural and industrial sectors. The intent of this condition is to ensure that state funds, particularly receipts from privatization, are well spent. 22. As shown in Table 1, capital spending in 1997 and 1998 was generally consistent with the guidelines for the sectoral allocation of investment. One exception to this were two loans to GM and Ford, and their "sistemistas" that, as opportunely pointed out by the Bank, are questionable in terms of their economic and social justification. 44 Annex B: Privatization Program Annex B: The Privatization and Regulation of State-Owned Utilities in Rio Grande do Sul A. Introduction 1. The most important part of the state of RGS government's reform program has been the privatization of state-owned companies. In the area of public services, two major privatizations were undertaken-the state-owned telecommunications company, CRT, and two electricity distribution companies, representing approximately two-thirds of the territory of the state. A further component of the electricity company, its thermal generation assets, representing 490 MW of capacity, were transferred to the Federal government as part of a debt refinancing agreement. The failed privatization of CORSAN was the least successful part of the program. An additional component of these reforms was the establishment of a cross-sectoral regulatory agency, known as AGERGS, which was to be responsible for regulating the public services in the State. It has been slow to receive delegated powers (it only recently received an agreement to regulate certain aspects of electricity supply in the state from the Federal regulatory authority, ANEEL) and is now embroiled in a political dispute about whether certain commissioners should be removed prior to the end of their appointments. Table 1: Privatization Proceeds Sector Company Date Proceeds (Rs$Million) Telecommunications CRT Ist Tranche (35%) 12/96 681 CRT 2nd Tranche (50.12%) 6/98 1,176 Electricity RGE 10/97 895 AES-Sul 10/97 1,635 CGTEE 12/98 508* Total 4,895 * Reduction in state debt via 'Federalization' of company 2. Public dissatisfaction with public services led the state to undertake periodic surveys of the population to determine which were the worst offenders and what the key complaints of customers were. Two surveys have thus far been undertaken, the first in 1996, the second in 1998. Postal questionnaires were sent out to around 20,000 people in 1996 and 30,000 people in 1998 in around 95percent of the municipalities in the state in both surveys. 3. Notably and somewhat disturbingly, public opinion as reflected in the surveys, seemed to show that the population is not yet persuaded of the benefits of privatization and in fact the overall level of satisfaction has fallen slightly for the privatized utilities (as well as for other public services). It is important to note, however, that the questionnaire 45 Annex B: Privatization Program did not specify the reason for dissatisfaction, thus, it might also reflect the increase in tariffs. The service, however, that gives the public the most cause for complaint, however, is sewerage where the public registers significantly higher discontent than for the other utility services, although other public services such as health and public security show even higher levels of discontent. Table 2: Survey of Public Services in Rio Grande do Sul: Main Results Public Service Very Satisfied or Regular (%) Very Unsatisfied or Satisfied (%) Unsatisfied (%) 96 98 96 98 96 98 Water 69 66 20 24 11 10 Sewerage 40 39 27 25 33 36 Telephones 51 48 30 32 19 20 Electricity 69 60 25 30 6 10 Public Security 21 20 35 41 44 39 Public Health 15 15 28 38 57 47 4. Quality of service statistics, particularly with regard to the increased level of access to telecommunications, are either remaining static or improving somewhat for the privatized services, however. In electricity, the picture with regard to the quality of service has been more mixed because of a series of nationwide blackouts in recent months. 5. The result has therefore been a very successful privatization program in terms of raising revenue for the state, with little impact thus far on customer satisfaction. Privatization, however, has allowed a dramatic increase in the availability of fixed and cellular telephone service and probably contributed to improvements in operational efficiency. B. Telecommunications 6. Unlike the other states, where telephone service was until recently provided by Federally-owned subsidiaries of the Telebras system, the state government of RGS owned 85.4 percent of its local telephone company, the Companhia Riograndense das Telecomunicacoes (CRT). The main objective of its privatization was to meet the considerable unmet demand (estimated in January 1997, in the MOP) to be around 700,000 fixed lines and 300,000 cellular connections, and to provide revenues for the state. 7. Privatization: The privatization of CRT was undertaken in two tranches, 35 percent being sold in December 1996 to a consortium headed by Telef6nica de Espana, the stake included management rights including the right to appoint the directors. The group paid Rs$68 1 million for the stake. The remainder of the government's shares were 46 Annex B: Privatization Program later sold to the same consortium in June 1998 for Rs$1.176 billion. This later sale was not envisaged in the government's original privatization program. 8. The result has been a considerable increase in the number of cellular and fixed connections and public phones, the rates of increase having been 261 percent, 67 percent, and 125 percent respectively. Quality of service does not seem to have suffered unduly, unlike the systems in Sao Paolo and Rio de Janeiro where quality of service declined notably as a result of the increase in the number of new connections. 9. Operational Results: The improvements in the operating results of the company have been significant in the last few years as shown by the table of financial indicators below. Table 3: Financial Indicators for CRT 95 96 97 Return on assets (%) 0.3 -0.7 3.8 Earnings before interest, depreciation and taxes (Rs$ Million) 178 399 520 10. One of the major reasons for this increase in the financial results is the increase in the productivity of the enterprise: particularly in terms of the reduction in the number of employees. Productivity has increased significantly particularly as measured by the number of employees per 1000 connections which fell by 25 percent from 4.0 in 1996 to 3.0 in 1997, which was mainly due to the increase in the number of connections, although the number of employees did decrease as a result of the voluntary departure program undertaken by the Government in 1996. 11. The company is planning a considerable amount of front-loaded investments, a significant portion of which were undertaken in 1998 as can be seen from the table below, but diminishing over the next couple of years as the backlog of investments, particularly in new lines and cellular phones is eased. Table 4: Planned Investments (Rs$ m) 98 99 2000 Basic Telephony 641 395.2 270.3 Cellular Telephony 105 77 45.1 Public Telephones 27.5 15.4 14.4 Commercial Communications 13 14 14 Operations 31.3 30 30 Systems 77.8 40 37 Other 20.7 15 15 Total 923.5 586.6 425.8 12. Quality of Service: The quality of service has improved marginally in terms of responses to customers as shown below. Informal complaints have, however, been made 47 Annex B: Privatization Programn about the policy of significant contracting out which the critics have argued has led to less experienced technical staff being used to conduct repairs. The actual quality of service statistics, however, bear out the fact that quality of service seems to have improved on balance, particularly with regard to the statistic of timely repairs and direct long distance calling (which customer satisfaction surveys do not yet capture). Table 5: CRT Quality of Service 95 96 97 98 Repairs undertaken in less than 24 hours (%) 88.08 88.36 80.61 91.7 Responses to requests for service within a 94 93.31 90.79 93.26 month of the request (%) Rate of calls completed via DDD (%) 49.75 49.27 51.48 57.25 13. Access: The rate of increase in access has been substantial as shown in the table below. The number of cellular phones in service more than doubled in one year, while the number of fixed lines in operation increased by more than 30 percent. While there is debate about the extent to which this was triggered by the increase in tariffs or the privatization. While it is clear that the increase in users increased prior to the privatization, it is less clear that the increase would have been as sustainable or cost- effective without the infusion of capital and expertise represented by the privatization of CRT. Table 6: Lines in Service 95 96 97 98 Number of phones in service 777,056 946,447 1,161,932 1,578,522 Number of cellular telephones in 77,853 176,241 359,652 635,877 service 14. Tariffs: The concession under which CRT provides service was approved by the Federal regulatory authority, ANATEL. This regulatory authority authorized a rebalancing of the tariff structure of CRT (and other providers in Brazil) as shown in the table below. Table 7: Tariff Rebalancing: Changing Prices for Basic Telephony (Reais) 94 95 96 97 98 Connection charge 1,007 1,007 1,117 300 80 Monthly rental 0.44 2.7 2.7 10 10 Local telephony charge 0.019 0.019 0.036 0.058 0.054 Long distance 0.054 0.066 0.066 0.054 0.054 International 1.57 1.36 1.36 0.95 0.95 15. This essentially allowed a large drop in the connection charge (which previously had included an amount to purchase shares in the local phone company) together with an 48 Annex B: Privatization Program increase in the monthly rental fee and the local telephone charge. At the same time long distance and international calls started to fall in price. This rebalancing was done to unwind the cross-subsidy that existed between local and long distance calls, as well as to improve access to telephone services. 16. Regulatory Issues: The privatizations of the other major portions of the Brazilian telecommunications system have resulted in some temporary declines in the quality of service, as the dramatic increase in the number of lines, combined with antiquated central switching systems has led to a drop in the quality of service. Brazil's justice minister says that he will impose a maximum fine of Rs$2.9 million (US$1.8 million) on the phone companies in Sao Paulo and Rio de Janeiro because of the decline in service quality. 17. One complicating factor is that Telef6nica de Espaha also won the bidding process for the fixed link operations in Sao Paulo, and because of this, has been required to divest itself of a majority portion of its shares in either one or the other of the two concessions that it holds. It is therefore likely to divest itself of a controlling stake in CRT. 18. The other key regulatory issue is likely to be the introduction of competition in the sector, starting with cellular service where a competitor in the 'B Band' is already providing competition to the incumbent operators. An even more significant competitive threat is likely to be the introduction of 'mirror' concessions, where new entrants will be allowed to set up parallel networks to compete with the existing fixed-line incumbents. C. Electricity 19. The RGS power company (Companhia Estadual de Energia Electrica - CEEE) had the concession for power distribution in RGS and generated around 30 percent of its requirements through a mixture of thermal and hydroelectric generation. The company was vertically integrated, owning generation, transmission and distribution assets. The former government divided CEEE into several companies (three distribution companies, one transmission company and two generation companies, one thermal and one hydroelectric). The plan was to sell two of the three distribution companies, transfer the thermal company to the Federal government in return for debt reduction and later sale, and retain the rest in state hands. 20. The three distribution companies were split regionally, with one in the north of the state and part of the Porte Alegre region, with 1,120,000 customers; one in the western part of the state and part of the Porte Alegre region, with 720,000 customers and one in the South-South-East with just over one million customers. 49 Annex B: Privatization Program Table 8: Electricity Distribution Characteristics Region Territory km2 Number of consumers Market MWh North-Northeast 90,718 838,664 4,610,535 Center-west 99,512 803,862 5,771,729 South-SouthEast 73,363 1,088,070 5,060,085 21. Privatization: The restructuring began in through the authorization of Law 10.900 which was passed in December 1996 by the legislative assembly. The restructuring was undertaken by a consortium of Banco Fator, Kleinwort Benson, Deutche Bank Morgan Grenfell, and a number of smaller legal and engineering firms. The consortium bid a relatively low fixed fee of Rs$1.1 million for undertaking the transaction, representing 0.2 percent of the value of the assets sold, less than the typical transaction fee of between 0.5 and 1 percent of the assets sold. In August 1997 the companies began operating as independent companies within CEEE. 22. The government's strategy was to sell the companies as 'cleanly' as possible, in other words, the bulk of the debt was left with CEEE, as were the bulk of the employees in order to maximize the value of the offered companies. The two distribution companies were sold in 1997 for Rs$2.5 billion. The thermal company, representing 490 MW of generation capacity was transferred to the Federal government in December 1998 in return for a reduction of the debt of Rs$508 million. 23. Of the Rs$3.14 billion raised in the process, Rs$ 1.1 billion was left within CEEE to help pay down the liabilities of the company. Rs$2.035 billion went to the State Treasury, Rs$300 million of which was used to pay for a road paving program, and the rest into a Fund for reform of the state to be used in education, health, public security, public debt and strategic investments. 24. Operational Results: The two privatized distributors have increased their labor productivity significantly (although comparisons are difficult because of the fact that the companies did not operate for a long time under the umbrella of CEEE). Overall labor numbers for CEEE as a whole have, however, fallen significantly from over 8,000 to around 2,000 today, increasing labor productivity as shown in the chart below. Around 2,500 employees were transferred to the successor companies, including 1,091 to the Center-West distributor, 868 to the North-North-East distributor, and 631 to the thermal generator. Table 9: Labor Productivity in CEEE 95 96 97 98 Number of consumers per employee 284.3 307.9 365.7 567 Energy sold per employee (MWh) 1471 1789 2258 2762 50 Annex B: Privatization Program 25. Nonetheless, overall financial results for CEEE have declined post-privatization as a result of the fact that costs have not fallen as fast as the revenues diminished as a result of two of the distributors being privatized. 26. Quality of Service: The quality of service has not changed dramatically as a result of the privatization as shown from the data below. The recent blackouts, as a result of nationwide shortages, will probably affect the statistics negatively for this year. Table 10: Quality of Service in Electricity 95 96 97 98 Duration of interruption (hours per consumer). 34.36 28.36 13.3 18.84 Frequency of interruptions exceeding three minutes per 31.8 29.7 15.1 19.3 customer. Complaints per 1000 customers. 107 98.1 96 97.33 Level of losses (% of power consumed and billed). 13.5 11.2 12.1 10.52 27. Access to services is virtually complete in urban areas, at 99.5 percent, while the rate of access in rural areas is lower, it is still relatively high at 86 percent. 28. Tariffs: Tariffs were increased prior to privatization by 9.75 percent in April 1997, to around 8.5 c/kWh and another tariff increase has been requested. 29. Regulatory Issues: One of the key regulatory issues has been a dispute between the electricity distributors and the rural electricity cooperatives (RECs) that operate within their service territory. These RECs receive subsidized power from the distributors, and hence charge a lower tariff than the local distributor. In recent months, however these RECs have been aggressively expanding into suburban areas which the distributors argue is contrary to the exclusivity guaranteed in their concession contracts. This dispute will eventually have to be resolved by either the federal regulator, ANEEL, or the local regulatory authority, AGERGS. 30. In the short run, the sale of assets of the federal electric company (Electrobras) is also likely to have a significant impact on the distributors as well, as new contractual forms, and potentially greater competition in the generation sector start to be felt. In the longer run, Brazil will move to a regime which will allow competition in supply, that is for suppliers other than the local distributor to supply power to customers, paying a rental fee for the use of the distributor's wires. This will have a significant impact in the business in the medium to long term. D. Water and Sanitation 31. The state government controls CORSAN (Companhia Riograndense de Agua y 51 Annex B: Privatization Program Saneamento), the state water company which operates in some 300 municipalities throughout the state. It was clear throughout the preparation of the loan that reform of CORSAN would be more difficult to sell as was recognized through the fact that a single floating tranche of US$20 million was set aside for the accomplishment of the water reform component of the loan. One of the conditions was the preparation of study of reform options which was financed under the World Bank Water Sector Modernization Program. 32. Privatization: The study of reform options came up with a series of proposals that was mirrored in the State Reform Project. These options included: awarding one or more of the integrated systems serving municipalities in the Porto Alegre Metropolitan area to private concessionaires: a) award one or more full service management contracts (FSMC) to private firms for the operation of some of CORSAN's medium and small-size systems serving about 150,000 to 200,000 people; b) award to cooperatives an undetermined number of very small-size systems, mainly in urban areas. c) selling either 51 percent of CORSAN's shares to a group of private investors or selling majority control of a number of CORSAN's proposed geographic regions. 34. The govermment eventually decided to sell a minority stake, i.e., 49 percent of CORSAN. These plans were discussed during the course of the preparation of the loan, and operationalized by the plans to hire an investment bank, in January 1998, but these were blocked by the courts on the grounds that a consultant had already been hired (to do the options study). In any case, the plans for sale were not sufficiently advanced by October 1998 that eventually the idea was shelved until after the elections, and afterwards dropped entirely. 35. The difficulties associated with the sale of CORSAN included: a) lack of clarity with regard to the strategy to be undertaken; b) legal difficulties relating to the fact that CORSAN's business is provided via a large number of concession contracts with municipalities within the state; c) the short time with which the government had to undertake such complex reforms; d) The strong vested interests, mainly by CORSAN's employees, of maintaining public ownership of the company. 36. Future reforms in the sector involving private participation will have to be more carefully planned and incorporate solutions to the political, legal, financial and economic issues faced with reforms in this sector. 37. Operational Results: Meanwhile, some actions have been taken to increase CORSAN's productivity, including reducing the number of employees. The increase iri productivity of these employees as shown in the table below indicate that the number of 52 Annex B: Privatization Program connections metered has increased as well, although CORSAN has not made significant progress on reducing the level of water losses. Table 11: Productivity 95 96 97 98 Connections per employee 299 352 385 412 Water losses (% of water produced) 43 43 41 43 Connections Metered (%) 59 60 61 65 38. Quality of Service: One of the major difficulties that CORSAN has, as with the other SWCs, is in extending its sewerage network and wastewater treatment facilities. Lacking funds to undertake the investments itself, and in the absence of any likely public investments, coverage levels are likely to remain at extremely low levels as shown in the table below for some time to come. Table 12: Access to Services 95 96 97 98 Access to water (% of population) 95.5 98 98.8 99.7 Access to sewerage (% of population) 9 17 17 18 39. Tariffs: CORSAN's tariff structure is standard for a Brazilian water company, including a monthly basic service charge and a per cubic meter (volumetric) charge. To these prices, a charge equal to 70 percent of the volumetric charge for those customers connected to the sewerage network. Table 13: CORSAN's Tariff (Reals) Base Price One Basic Service Minimum Cubic Meter Tariff Social 0.56 2.64 8.24 Domestic 1.18 5.56 17.36 Commercial 1.34 9.91 36.71 Industrial 1.34 19.80 46.60 Public 1.52 19.80 70.30 40. Current Issues: The state is unusual for the fact that a number of the largest municipalities have opted to supply themselves. In particular, the municipality of Porto Alegre has operated as an independent municipal operation for many years, and is now 53 Annex B: Privatization Program being joined by other major towns in the state, such as Novo Hamburgo, which are all now operating their water supply systems as independent municipal companies. 41. As an increasing number of municipalities opt out of CORSAN's service provision, CORSAN will be increasingly left with an unprofitable rump of municipalities, but still have its central overheads to service. Its financial viability may therefore become increasingly untenable. 42. Some factors have been at work in reducing CORSAN's long-term viability, however. These include the fact that major municipalities like Novo Hamburgo have just or are in the process of opting out of CORSAN's service area. Given the federal government's strong policy with regard to the state water companies (i.e., no new money until privatizations and/or concessions are awarded), the pressure on CORSAN is likely to grow over the next few years. E. Regulation 43. As part of the government's privatization program, the government established a cross-sectoral regulatory agency that was designed to regulate the public services provided within the ambit of the state. The regulatory agency, known as the Agencia Estadual de RegulaVao dos Serviqos Ptiblicos Delegados do Rio Grande do Sul (AGERGS) was established by law in March 1997. 44. Within the approximately year and a half that the agency has been operating, it has started to make decisions, for instance ruling on whether public vehicles should pay tolls, made preliminary judgements on the issue of competition between the regional electricity cooperatives and the electricity distributors among other matters. It is also filling out the staff of the agency, publishing information, and generally establishing itself by developing its internal structure and an providing an Ethics Code for staff. 45. The agency was established as a council of seven representatives, three of whom were appointed by the state governnent, two by consumer groups, and one by the concessionaires. A seventh representative is due to be nominated by the staff, but has not yet been appointed as staffing has not been completed. 46. A number of challenges and complexities have beset the agency since its establishment, most notably the hostility of the current government to its existence. As was envisaged when the reforms took place the agency can only really operate as allowed via the delegation of authority from other powers. This is most obvious in the case of electricity where it has signed an agreement with the Federal agency which allows it to regulate some aspects of local electricity provision in the state. 47. The key controversy at present, however, is the legal challenge the current government has placed at the Federal Court. The government is challenging the right of the previous government to nominate the representatives for fixed terms which do not 54 Annex B: Privatization Program coincide with the tenn of government, and wants the right to nominate representatives, and more broadly, challenges the notion that the agency should be 'independent' of the executive branch of government. These challenges are presently compromising the sustainability of the regulatory agency. F. Conclusions 48. The state's strategy seems to have been predominantly oriented towards maximizing the sales value of the companies sold, somewhat at the expense of other goals such as improving service quality or access to services (although increasing coverage was successfully pursued in the case of telecommunications). In maximizing sale value, the governments actions were very successful, in part because the sales were undertaken prior to the devaluation of the Real and the full impact of the Asian crisis. Indeed, the privatization of the distributors, as measured relative to the minimum reserve price and size of the companies, were one of the most successful in the country. 49. The major failure was the problem related to trying to sell a minority stake in CORSAN, particularly due the complex legal issues and political sensitivity of the sector. Combined with a very tight timetable driven by the political calendar, the reform attempt failed. It should be noted, however, that RGS is not unique in this regard and that reform of the water and sanitation sector has been the least successful component of the privatizations in other states, notably Rio de Janeiro with its failed attempt to sell CEDAE. 50. In the public's mind, large increases in some components of the tariff for telephony (notably the fixed monthly charge) particularly and to a lesser extent in electricity, were tied to the privatization. The most clearly welfare-enhancing action (other than the major fiscal benefit from privatization) has been the expansion in the number of fixed lines and cellular phones in the state, reducing the considerable backlog of unmet demand. 51. The sustainability of the reforms will depend in large measure on the sustainability of the regulatory arrangements, and whether consumers start to see real benefits from the reforms (other than the significant expansion of the telecoms system which has been the most visible sign to date). 55 Annex C: Ports Concessions Annex C: Port Concessions A. Introduction and Background 1. The Port of Rio Grande (PRG) plays a significant role in Brazil's export economy. It is the second largest port in Brazil, in terms of container movements, with a 12 percent market share. Historically the port has been the gateway for Brazil's soybeans, exporting about 3.6 million tons of goods in 1980, almost 3 million of which were soy beans or soybean products26. Since 1980, the port has broadly diversified its export products to include other agricultural products, petrochemicals, and other commodities and primary manufactured goods. In 1998 the port exported about 8.2 million tons and imported about 5.7 million tons for an average annual export growth rate of about 7 percent. Container movements also increased substantially growing by almost 100 percent between 1995 and 1998. The increase in trade volume demonstrates the growth of the Brazilian economy and the ability of the PRG to accommodate this growth. 2. The diversification of cargo growth includes such export products as tobacco, resins (plastics), rice, wood, leather goods, shoes, cigarettes, rubber, poultry, paper products. The port has been transformed from a bulk soy exporting port to a major container, liquid and bulk handling facility. 3. The growth in goods movements through the port has been accomplished primarily through major improvements in port operations and investment in capital intensive facilities. In the 1980's many of the export goods arrived by train. The lack of appropriate handling and sorting of train movements lead to significant delays in unloading and loading of ships and distribution of goods to warehouse. This was especially a problem at the Porto Novo which required much more yard handling than the newer Superport. The average car cycle time for Porto Novo was five days vs. 64 hours for the Superport reflecting the higher efficiency of the Superport as a result of improved capital facilities and a reduction in required labor inputs. Another area that required significant improvement was on the ship loading and unloading cycle. Historically, a large percentage of the ships berthed at more than one dock to load. This loading procedure was due to inefficient management rather than the physical port layout. As the port operations shifted from Porto Novo to the Superport, ship loading and unloading times improved, but were still very inefficient relative to ports in the U.S. and Canada.2" 4. To address some of these problems, the PRG began a capital intensive investment program to upgrade the port. It shifted operations from the Porto Novo to the Superport with expanded port, terminal and warehouse facilities. The Superport's new wheat and soy terminal was the most significant early improvement, but the investment in this 26 Marcus, et.al. (1985) "Improving Transportation Performance Without Major Capital Investment: A Preliminary Analysis of Operations in The Port of Rio Grande, Brazil", Transportation Planing and Technology, 1985, Vol. 10. Pp. 219-233. 27 Ibid. 56 Annex C: Ports Concessions facility was still hampered by operational inefficiencies28. As Brazil's export market expanded and the composition of these exports also shifted (from agricultural commodities only to include primary manufactured goods), the Superport also adapted to these changes with the addition of a container terminal, liquid petrochemical, fertilizer and refrigeration facilities. 5. As exports for Brazil's economy became more important, the federal government recognized the need to decentralize its port operations and to make them more efficient. In 1993 it passed a port reorganization law, Lei No. 8.630, that attempts to adapt the organization of the ports to the need to expand port investments and to make them more efficient. The federal government transferred port assets to the State governments, who in turn have the authority to concession out port operations, including investment in new facilities. However, the primary focus of the new law was the reorganization of the port's administrative structure. The law allows for the creation of several new entities including the Adminstraqao do Porto, the Gestdo de Mao de Obra, the Conselho de Autoridade Portuaria and the AdministraVdo Aduaneira. 6. The general purpose of the law was to transfer port assets to the State governments and allow them to make the ports more efficient through changes in the general organization of the port, especially labor rules. This required a new approach to organized labor and the relationship of labor to other port stakeholders such as the shipping owners, import-export companies, multi-modal transportation companies (train, riverboat, and trucks), and general port operators. The State would administrate the port and act in the interests of the general community to provide efficient transportation services for imports and exports. 7. The Administrafao do Porto for the Port of Rio Grande is the Superintendencia do Porto de Rio Grande (SUPRG). It is the State government entity responsible for all port operations and activities and plans for the port's strategic development. It owns the port assets and has the right to offer these assets to private parties for their operation via concession and other types of private sector contracts. The SUPRG can also provide for private operators to invest in new facilities such as an expansion of their warehouse facilities or terminals, including equipment. It also maintains the infrastructure supporting the port (both sea and land side) and sets tariffs for operations and maintenance of the ports. These include charges for use of shipping channels and quays; lights, telephone, roads, etc.; temporary storage facilities; port equipment (e.g. cranes); and other general charges such as tonnage fees. 8. The Gestao de Mao de Obra is the organization that represents the port workers (avulsos). The new law tries to balance the interests of the workers with the Administraqdo do Porto. The Gestao maintains a catastro of eligible port workers that port operators can use. It can also allow these workers to leave the "Gestdo" and work 28 Ibid. 57 Annex C: Ports Concessions permanently for the port operator. The law requires that the port operators allow for collective bargaining and settle labor disputes via arbitration. The changes in labor rules have helped improve the port's productivity and have complemented the leasing of public facilities to private operators. 9. The Conselho de Autoridade Portuarua (CAP) is the advisory body to the SUPRG. It is comprised of the shipping owners, representatives from the SUPRG, port workers, (Gestao), port operators, and local government (state and municipality). It negotiates tariff levels with the SUPRG, provides an opinion on the port budget, and advises the SUPRG on the ports strategic development plans. 10. The reorganization of the Port of Rio Grande's administration, as provided in Lei 8.630, allows for the further efficient development of the port. To complement this law the SUPRG has made an effort to further encourage private sector participation in port operations to reduce labor costs and to improve operating efficiency. These include staff reductions and the concession of major tenninal facilities. 11. In addition to staff reductions, SUPRG extended the participation of the private sector in port operations. The PRG has a long history of private sector involvement in port operations. Some of the major conmnodities companies have leased terminal facilities from the public sector since the late 1970s. As Brazil's exports of soy and soy products grew, the port also provided additional facilities for other cargo. B. Project Objectives, Results and Implementation Experience 12. The Objectives of the Port element of the State Reform Loan (SRL) were twofold: (i) to reduce permanent port personnel in SUPRG and (ii) concession 6 additional port facilities - Wheat and Soy Terminal (including silos and installations), Petroleum and Container Piers, Refrigeration, Liquid Bulk Terminal (34,000 cubic meters for vegetable oils; and two Storage Warehouses). 13. In regards to the first objective, SUPRG has successfully reduced its permanent labor staff primarily with the voluntary departure program (PDV) financed a tax on loading/unloading cargo) from 1089 employees at the beginning of 1996 to 302 by the end of 1998. 14. Current expenditures for SUPRG have also decreased from about Rs$27 million in 1996 to Rs$24 in 1999, a decline of about 10 percent over a three year period. The largest expenditure item, PDV payments, comprising over 63 percent of current costs, will be significantly reduced in the next few years as the voluntary departure program ends. Other significant costs include third party contracts for water and sewer, warehousing, and freight carrying charges. These are variable expenditures that depend on the amount of cargo moving through the port and will increase with growing cargo volume. However, some additional expenditure reductions are possible if the SUPRG 58 Annex C: Ports Concessions successfully bids out its warehousing and intra-port freighting activities to the private sector. 15. The SUPRG entered into concession agreements29 for the Petroleum and Container Piers and the Wheat and Soy Terminal which comprise over 76 percent of the port cargo movements. SUPRG was not able to find sufficient interest in the Refrigeration, Liquid Bulk and Storage Warehouse. These facilities remain under public operation. The latter facilities only provide a small amount of the ports total cargo movements. With the completion of the above concessions, the port is over 90 percent operated by private parties with almost 100 percent of its cargo movements provided by private operators. 16. Operating income from the rental agreements has also increased as port volume grew. Total rental income from private lease contracts doubled between 1997 and 1998 from Rs$3.7 to Rs$7.4 million. Rental income from private parties now covers about 30 percent of the port's operating costs. The recently concessioned facilities including the wheat and soy, petroleum and container terminals generate over 75 percent of the total rental income". C. Future Operations and Sustainability 17. Private sector participation in port operations has been growing steadily since the 1970s. Private companies operate almost all of the ports 19 terminals. The 1993 port modernization law combined with the staff-reduction program and further concessions of the major port terminals have given the PRG significant efficiency gains and has well positioned the port to compete for Brazil and Mercosur's port traffic. The gains made by the port appear to be sustainable as private port operators handle almost all of the port's cargo traffic. Nevertheless, it appears that further gains through private sector operations are presently limited with the current administration. The process for privatizing the warehouses and the refrigeration units has stopped after the SUPRG was not able to attract any interest from the private sector to rent these facilities. It is possible that the private sector does not perceive any gains in operating these facilities and completion of the privatization effort may not be possible, even with government incentives. 18. Another factor that will encourage sustainability of the port operations and the private operations of the port is the structure of the lease contracts. For example, the lease contract between SUPRG and Terminal Graneleiro, S.A. for the Wheat and Soy tertninal gives the company a great deal of latitude to expand its terminal facilities based on growth in wheat and soy cargo movements. The contract encourages the company to invest in new equipment to expand terminal facilities as demand grows and to also 29 The concession agreements are called "Rental Contracts", that have an initial term of 15 years renewable for another 15 years. They are long term leases that allow the contractor to expand the facilities based on its business growth. 30 All operating expense and rental income statistics provided by SUPRG. 59 Annex C: Ports Concessions improve the efficiency of the operations. 19. The lease rental payments also encourage cooperation between the two parties to insure the profitability of the private operation while at the same time providing the SUPRG with reasonable rental payments. The rental payments have a fixed and a variable component. The variable component is based on a percentage of services provided by the company. Services are related -to the movement of goods through the terminal. This percentage is set by the company but reviewed and approved by SUPRG. The contract also provides for a minimum amount of tonnage to move through the terminal as "guaranteed" revenue for the SUPRG, but this amount is fixed after the third year of the contract. 20. Although the contract balances the interests of SUPRG and the company, the language to maintain the economic viability of the contract is rather vague which may cause future problems in the interpretation of the specific clauses. For example, the clause regarding the "economic and financial equilibrium" does not define how this equilibrium will be maintained, but only indicates the factors used to assess the equilibrium. The contract does not define the events that may change the equilibrium, how the equilibrium will be re-established, and who will determine when it is re- established. In addition, there is no indication in the contract of how the company will recuperate any additional investment it may make in expanded port facilities. Further complicating the matter of contract interpretation is the regulation of port activities. 21. The contract makes it clear that the SUPRG has the responsibility to monitor the company and its operations. It does not provide any "performance indicators", but simply states that the SUPRG can intervene if it determines that the company is not operating the terminal properly. This intervention can only occur under "exceptional" circumstances, but these are not defined. 22. The contract also provides for inflation adjustment for the fixed rental payments, but indicates that the payments can be altered based on changes in the Federal Government's political economy, such as the monetary base. It does not indicate the procedure for changing rental payments in the event of a change in the political economy or what constitutes other changes in the "political economy". 23. Another area that may create future contract problems is the contract termination clause. This clause allows the SUPRG to unilaterally terminate the contract based on SUPRG's subjective interpretation of the company's performance, such as "inadequate or deficient operations." The lack of objective performance indicators provides room for political interference and possible termination for reasons other than the company's performance. 24. The lack of clarity in the contract on the issues raised above will require the contract regulator, SUPRG, to interpret events as they unfold. However, it is not clear to what extent the State Regulatory Agency, AGERGS, has the authority to also regulate the 60 Annex C: Ports Concessions contract and intervene in disputes between the company, SUPRG and/or users of the terminal facilities (ship owners). The State law that created AGERGS gives it the authority to regulate port activities which may conflict with SUPRG's regulatory rights provided in the lease contract. D. Other Impacts Associated with the Port Reform Program 25. The major immediate impact of the Port Reform Program is the fiscal impact of reducing personnel costs and the positive revenue impact of the terminal lease payments. Additional positive impacts include further investments in port facilities, expansion of port services and improved port operating efficiencies to support the growth of Brazil's economy. 26. As indicated above, the SUPRG has significantly reduced permanent and temporary personnel in the PRG. In addition, the State is also in the process of reducing personnel in other ports operated by the Departamento Estadual de Rios, Portos e Canais (DEPRC). DEPRC has achieved its goal of reducing total staff by about 70 percent and has encouraged temporary personnel to retire. However, with the recent change in administration, personnel reductions have probably stabilized. 27. Another important impact of the PRG concession program is the investment in new port facilities by the terminal concessionaires. The lease contracts allow the private terminal operators to expand their facilities. This will permit the PRG to keep pace with the growth in cargo and also to modernize its facilities to support a growing economy. However, as previous studies have indicated3", investment in capital facilities does not necessarily mean significant gains in operating efficiency. Changes in the management of the port facilities and improvements in work rules are also necessary to reduce costs and increase productivity. These gains should be possible as the PRG is increasingly operated by the private sector and as the leasing companies are able to shift personnel from the "Gestao" labor pool to direct control by the companies. One example of efficiency gains achieved by improvements in capital facilities and operations management is the container terminal. PRG's container terminal handles, on a monthly average, 28.2 containers per hour, considered by Maersk as one of the most efficient terminals in Brazil.32 E. Key Lessons Learned 28. Marketing Effort for the Refrigeration Terminal and Warehouse Concessions: SUPRG failed to lease its refrigeration and warehouse facilities. This might have been due to the commercial risks associated with these facilities in general or 3\ 1 Marcus, Op.Cit. 32 This is anecdotal evidence provided by the PRG. Container movements per hour depend on the number of cranes and unloading facilities at different ports. It is difficult to compare container movements per crane per hour among ports as this information is not readily available. 61 Annex C: Ports Concessions the terms and conditions of the lease arrangement as indicated in the Edital. In hindsight, the SUPRG might have done a more in-depth marketing analysis to determine the projected commercial uses of these facilities and whether or not there was sufficient interest in the private sector to bid for their use. If the studies showed a lack of commercial viability for these facilities, the SUPRG might have considered alternative uses for this area in the development of its strategic plan. 29. Contract Regulation: One of the potential areas of future conflict is the regulation of the lease contracts. The lease contracts provide for SUPRG to regulate all contract clauses. The contracts do not mention any regulatory or supervisory activity of the State Regulator, AGERGS. The State law creating AGERGS gives this entity jurisdiction to regulate ports, but it is not clear to what extent it can intervene in the lease contracts. This may be a problem if future disputes arise regarding interpretation of the contract, such as the adjustment of rental payments; the permission to construct new facilities; maintenance of the financial-economic equilibrium; and the ability of the SUPRG to terminate the contract. Whenever a new regulator is created (whether in one sector or multi-sectoral), the law should take into account the ability of the concession grantor to amend the existing contracts to accommodate the jurisdiction of the new regulator. However, this is a difficult task, as the bidders on contracts would then have to consider additional regulatory risk and the uncertainty associated with a different contract regulatory structure. The regulatory mechanisms included in the contract should not change, but the entity carrying out the regulatory functions may change. If a concession contract is sufficiently clear and detailed this should not present a problem. Troubles arise when contracts are vague and interpretation of the contract is very subjective. Problems also arise when the government's executive branch implicitly regulates a sector (such as the Ministry of Transport for road concessions) and a new regulator is created in that sector after a concession contract is let. The law creating the new regulatory body should be clear about the transition from the existing regulator to the new regulator. Contracts should be sufficiently clear and detailed to reduce, to the extent possible, regulatory risk, but they may provide for a change in the regulator. In the case of the PRG lease contracts, there are many vague clauses that may have a subjective interpretation depending on the point of view of the regulator. 30. Financial-Economic Equilibrium: One of the problems with the lease contract (and most other concession contracts in Brazil) is the legal requirement to maintain the "financial-economic equilibrium" of the concession contract. However, the port concession contracts (and most others in Brazil) do not contain any events or clauses that define how this equilibrium will be maintained or what happens in the event that there is a "disequilibrium". One of the ways in which the SUPRG can mitigate the "financial- economic equilibrium" risk is to provide for a rate stabilization fund from tariff revenues. This stabilization fund can also be used to adjust tariffs for the PRG to remain competitive with other regional ports. As operating efficiencies for SUPRG activities are improved and port operating expenses reduced, additional tariff revenues can be used to stabilize tariffs in the future or to reduce tariffs to make the PRG more competitive. The additional funds can also be used for capital improvements, but these should be limited to 62 Annex C: Ports Concessions the public infrastructure elements such as quays, dredging, land-side infrastructure (roads, rail and other connections; telecommunications, etc.). 31. Revenues to support the rate stabilization fund can come from tariff revenue that grows unexpectedly as a result of increased cargo activity through the port. Alternatively, tariff revenue can also flow to the fund as the PDV program winds down and current operating expenses are reduced. This additional income may be lost if the current surcharge on loading/unloading is terminated or if port activity declines. In the event that this surcharge is maintained, it can be used to establish the rate stabilization fund and also provide funds for infrastructure improvements. The fund would of course need to be well-shielded from possible government use for other purposes. 32. In regards to mitigating financial-economic equilibrium risk, the rate stabilization program can be designated to provide revenues to the concessionaires in the event that the Federal Government's "political economy" changes and the SUPRG has to reduce or severely limit lease rental payments from the concessionaires. On the other hand, if the equilibrium goes the other direction, i.e. the concessionaires receive "windfall" profits from their operations, lease rental payments should increase. The increased payments can be used to flow into the rate stabilization fund or for infrastructure improvements. However, to determine the extent to which the concessionaire companies are either gaining or losing income as a result of changes to Brazil's "political economy", careful regulation of the companies profits and return on investment is necessary. The SUPRG is not currently set up to calculate this return. It is also not clear that the lease contracts would allow the SUPRG to gather sufficient and reliable data to calculate the return. Nevertheless, the SUPRG (or AGERGS) may consider this as a future step in the regulation of the port and the creation of a rate stabilization fund.33 33 A Rate Stabilization Fund also can be used to provide creditors with additional security for SUPRG debt obligations. 63 Annex D: Roads Concessions Annex D: Roads Concessions A. Introduction and Background 1. The State of Rio Grande do Sul initiated two significant reforms in the road sector: an institutional sector reform of the Departamento Aut6nomo De Estradas de Rodagem (DAER) and a road concession program. The institutional sector reform includes a restructuring of DAER primarily through a reduction of employees and a reorganization of its maintenance operations through third party contracts. The toll road program was initiated by the state as a result of the transfer of federal roads in RGS by the federal government's Departmento Nacional de Estradas de Rodagem (DNER). 2. The agreement for the transfer of the federal roads requires RGS to maintain these highways, but it does not supply any federal funds to cover maintenance costs. However, the agreement provides for the state to collect tolls on these roads through a private concession contract. In addition to the cost recovery incentive provided by the federal road transfer agreement, the state was also interested in improving the maintenance of its state roads. The toll road program is the first step in recovering costs for maintenance of its road network. 3. RGS's toll road program introduced an innovation for bidding on toll road maintenance concessions in Brazil with its concept of "concession poles". RGS analyzed the maintenance cost requirements for its paved road network over a 15 year period. It then projected annual average daily traffic for this time period, and tested alternative tariff levels and project rates of return to determine whether segments of its paved road network could support private sector investment in road maintenance. DAER's objective was to have the concessionaire maintain the longest segment of a network of roads at a uniform tariff level. The result of it's financial feasibility analysis was the creation of nine "concession poles" with each poll including, at a minimum, three secondary roads that fed into an inter-city connecting road. The inter-city connecting roads were, for the most part, formner federal roads transferred to RGS, as these roads carried the minimum traffic to support a private toll road. The secondary roads and the connecting highway formed a "concession pole" which contained toll plazas for collecting tariffs. DAER determnined that nine concession poles would support private sector participation. The nine concession poles were included in the Bank's policy matrix for the State Reform Loan (SRL) in addition to the reduction of DAER personnel that was part of the SRL's administrative and fiscal reforms to reduce the State's current operating expenditures. B. Project Objectives, Results and Implementation Experience 4. The State's objective was to implement nine "concession poles" to cover 22 percent of the paved network. As the Table 1 below indicates, the State achieved these objectives with some minor qualifications. 64 Annex D: Roads Concessions 5. The State awarded the nine proposed concession poles, but only seven of these are currently in operation because of events that occurred during the concession process. The non-perfonning concessions, Pelotas and Santa Maria were awarded, but suspended. In the Pelotas concession, three municipalities wanted to extend the amount of secondary roads maintained by the concessionaire. A financial feasibility study was done to evaluate the financial impact on the concessionaire's rate of return. Because of increased concessionaire investment, the consultants recommended adding another toll plaza to the "concession pole" to maintain the "financial equilibrium" 3 of the concession contract. DAER and the concessionaire still have not reached an agreement on this issue. 6. In the Santa Maria concession, the State was responsible for re-surfacing 2 segments of the highway network included in this concession pole. The State did not complete the work so the concessionaire did not begin its improvements. DAER is studying various options to resolve this impasse such as re-negotiating the contract, imposing penalties on the concessionaire, or canceling the concession contract. 7. The chart also demonstrates that the State achieved the goal of transferring rehabilitation and maintenance responsibilities for 22 percent of its network to the private sector. This amounts to over Rs$2 billion (in 1997 Reais) over the 15 year concession term. The Edital for the nine concessions required a minimum of 2,341 km. to be maintained by the concessionaires, but the winning bidders offered to maintain 2,548 km. almost a 9 percent premium over the baseline. If only the 1740 km. of the functioning concessions are considered, the State still has transferred over 20 percent of its paved operating network to the private sector. The total investment for these seven operating concessions is over Rs$1.7 billion, a major savings for the state budget over the 15 year concession period. 8. The Rs$2.2 billion expenditure by the concessionaires over the duration of the concession is twice as high as the Rs$1.1 billion estimated by DAER in the preliminary technical and economic studies prepared for the bidding. The average rate of return of the concessions estimated by the concessionaires in their proposals, 19.04 percent, was slightly higher than the return estimated by DAER's projections for the bidding. This appears to indicate that concessionaire's traffic growth projections are substantially higher than those projected by DAER. This poses the risk to DAER that the concessionaires will not achieve their indicated rates of return and will look for ways to adjust the financial-economic equilibrium to achieve their returns. This is potentially a significant issue that may have an impact on the concessions in the future and the willingness of the concessionaires to expend the anticipated amounts for rehabilitation and maintenance. Indeed, one of the concessionaires has expressed its concern about the 34 Brazilian Federal and Rio Grande State concession laws provide for the concessionaire to maintain a "reasonable" rate of return on their investment. If circumstances change that disrupt that return they have the right to further compensation to return to the financial "equilibrium" indicated in the concession contract. There are significant issues associated with this concept which are discussed below. 65 Annex D: Roads Concessions changes that have occurred since the release of the bidding. They claim that the delays in beginning the concession caused by the government will have an impact on the contract's financial-economic equilibrium35. 9. The concessionaire claims that the delays in the awarding and signing of the concession contracts and the start of the concessionaire roadwork resulted in a transfer of the road to the concessionaire that was in worse condition than the condition assumed in the bidding . This will require the concessionaire to make additional investments that were not contemplated to achieve the rehabilitation and maintenance requirements indicated in the Edital36, or bidding document. From the concessionaire's perspective, the financial and economic conditions that were indicated in the Edital have changed which should allow the concessionaire to readjust the financial-economic equilibrium. The concession contract does not have a transparent, quantitative definition of financial- economic equilibrium, but only reflects the general concept in the State Law that allows the concessionaire a reasonable rate of return on his investment. Without a specific quantitative method to define changes in the financial-economic equilibrium, the concession contract is exposed to subjective interpretations of when this equilibrium changes, such as the logic presented by the concessionaire in the above example. This is one of the major problems with the road concession; the lack of a detailed concession contract that provides more than general guidelines. It may also have an impact on future operations and sustainability. 10. DAER effectively executed the preparation, award and implementation of the concession program. However, because of the innovative concession pole approach, DAER did require more time and resources to implement the concession than has been the experience with other concessions in Latin America. DAER spent about US$12 million for the technical and economic studies to ascertain the appropriate fixed tariff levels and minimum amount of roads to maintain for the Edital. The engineering work required DAER to develop detailed plans for the improvements it required for more than 2,800 km. or roads. Although the engineering work was important, DAER might have considered shifting some of the resources from engineering to preparation of more detailed concession contract, although it is not clear if more resources would have changed the legal approach toward this document. The general concession contract prepared for the RGS road concession was not substantially different from other road concession documents used in Brazilian road concessions financed by local banks. These 35 See footnote I for a brief description of the financial - economic equilibrium concept. 36 Output measures are included in the concession contract by reference to the Edital. The Edital provides the pavement output measures such as number and width of any holes; length and width of pavement cracks; the smoothness of the surface, etc. The Edital is considered as a legal document, but it is subordinate to the concession contract. As the concession contract does not specifically indicate the pavement quality measures, it is not clear to what extent the concessionaire has to comply with the quantitative measures indicated in the Edital, especially if the 3 year workplan, required by the concession contract and approved by DAER, does not contain quantitative pavement quality output measures. This issue demonstrates one of the concession's shortcomings - a concession contract that provides generai guidelines and is imprecise will require a subjective interpretation by the Regulator. 66 Annex D: Roads Concessions contracts would most likely require modifications for projects financed with international bank loans. 11. The bidding and award process also had delays as some of the losing firrns protested the results. These delays on some of the concession poles resulted in changed circumstances, which may have a future impact on the financial-economic equilibrium as discussed above. C. Future Operations and Sustainability 12. One of the major issues confronting the road concession program is the potential legal conflict between the concession contract and the AGERGS mandate to regulate road concessions in respect to tariff adjustments. The contract allows for an annual tariff increase due to inflation. It provides a specific formula and inflation indices which are used to adjust the previous year's tariff. This mathematical formula is transparent and should not create any disputes3". However, the concession contract also allows for the revision of the Basic Tariff if events disrupt the concession's financial-economic equilibrium. The contract does not specify what these events are, but leaves this judgement up to DAER and the concessionaire. As indicated above, this is a significant problem, as both sides will most likely have very different views regarding events that disrupt the project's financial-economic equilibrium. In the cases where DAER and the concessionaire do not agree on a Base Tariff adjustment, the concession contract provides for the regulatory agency, AGERGS, to act as a mediator to resolve the conflict. The contract implies that DAER has the right to set the tariff and that AGERGS only intervenes if there is a dispute between DAER and the concessionaire with AGERGS acting only in a mediating capacity and not in a final tariff judgement capacity. The law creating AGERGS, however, gives it the power to establish the road concession tariff. The language in the concession contract reflects the historical role of the government as the authority in establishing rates for public services. This conflict between the role of the State Government and the role of AGERGS to establish tariff levels will most likely be resolved in the courts, which will take time.3" In the meantime, the government will continue to impose its will on the concessionaire whose only recourse is to seek remedies in the courts unless both sides can arrive at a compromise. 37 Although the mathematical calculation of the inflation adjustment is clear, the concessionaire has the political risk that the government will not allow the increase. In fact, the government has not allowed for the inflation adjustment for 1999 tariffs over the February, 1996 Base Tariff level indicated in the contract. The Base Tariff ranges from $R 3.00 for a passenger car to $R 5.00 for commercial vehicles with an additional SR 2.50 for each additional axle up to a maximum of $R 15.00. Most concessionaires began collecting tariffs late last year at the Base Tariff level, but they have not been allowed to adjust the Base Tariff for 1999 to reflect the inflation increase between February 1996 and December, 1998 as indicated in the concession contract. 38 The present government considers some aspects of the law that created AGERGS as unconstitutional and currently is pursuing a case that will most likely end up in the national Supreme Court. The State feels that AGERGS is an organ of the Executive Branch and as such the Executive Branch has the right to re-appoint the government representatives on the AGERGS board. The case is proceeding through the courts and will most likely take several years before it is resolved by the Supreme Court. 67 Annex D: Roads Concessions 13. Further diluting the authority of AGERGS is the dispute mechanism included in the concession contract. In the event that DAER and the concessionaire cannot agree on an issue, they can bring the dispute to an independent expert panel created specifically for the issue in question. The concession contract implies, but does not clearly state, that the decision of the panel is binding on both parties. This type of expert panel dispute resolution is common in cases where there is no formal regulator. But in the current case, AGERGS has the mandate to regulate the road concession obviating the need for an expert panel. This is another example of the conflict between the contract and AGERGS's legal mandate which can have a negative impact on the future operation of the road concessions. 14. It appears that political interference in the implementation of the concession contract will continue to plague the concessions in the immediate future. The conflict in tariff setting authority between the government and AGERGS can threaten the viability of the concessions. The current protest by the trucking industry claiming excessive tariffs is an example of how the legal issued discussed above may have a negative effect on the future sustainability of the concessions. 15. The trucking industry has demanded a reduction in the tariffs paid by commercial vehicles. They feel that the Base Tariff is excessive and have organized protests and demonstrations against the concession program. AGERGS has intervened and suggested to all parties to institute a moratorium on tariff increases for three months to study the issue as to whether commercial vehicle tolls are to high. This is consistent with its mediating role expressed in the concession contract, but it is unclear as to whether AGERGS will impose a new tariff on the concessionaire after the study is completed. The major issue for the tariff study is to determine whether any new Base Tariff disrupts the financial-economic equilibrium. If the Base Tariff is lowered it will decrease the concessionaire's rate or return which the concessionaires will surely claim, changes the financial-economic equilibrium. How the proposed AGERGS study unfolds and the role of AGERGS as a mediator or arbitrator of the road concession contract will have a major impact on the viability of the road concession program. D. Other Impacts Associated with the Road Sector Reform Program 16. Two other impacts to consider in the Road Sector Reform Program is the fiscal impact on RGS's fiscal position and the broader economic impact of the road concession program. DAER has undertaken a restructuring program to reduce the number of employees which will reduce the State's current operating expenditures. DAER has decreased its active employee payroll from 4,200 in 1995 to 2649 in 1998, a 37 percent. The road concession program should help support the State's overall economic development as road rehabilitation and maintenance improvements will reduce auto and commercial vehicle operating costs through less wear and tear on the vehicles. The road concession program will also have positive fiscal impacts for the state treasury as it will not have to provide maintenance expenditures to DAER for the roads included in the toll 68 Annex D: Roads Concessions road program. As indicated above, this amounts to a savings of up to Rs$2 billion over 1 5 years. E. Key Lessons Learned 17. Conflicts between the Regulator, AGERGS and RGS: Perhaps the most important lesson learned in the concession pole program are the potential conflicts created by the concession contract between the regulator AGERGS and the control of the concession by DAER. The concession contract was written from the historical perspective of government control of toll roads. DAER plays the major role in monitoring concessionaire performance and setting tariffs. In the event of disputes, the contract provides for DAER and the concessionaire to create an expert panel that has the final decision on the dispute. The contract considers AGERGS as a mediating party in the revision of the Base Tariff, but the parties can still bring a tariff dispute to the expert panel. In other words AGERGS is more of a bystander mediating a conflict. 18. In future road concession programs where single or multi-sector independent regulators are created by law, the Bank should, to the extent possible, review proposed concession contracts to insure that they are consistent with the role of the proposed regulator. This is a difficult task in that the timing of preparing the regulatory legislation and the writing of the concession contract may not coincide. Nevertheless, it is critical for Bank clients to carefully consider the future impact the concession contract language will have on the credibility of the future regulator. 19. Vague Concession Contracts: Related to the regulator and concession contract issue is the lack of clarity and vague definitions in concession contracts for critical items such as the financial-economic equilibrium, termination events, and other clauses. Lack of clarity will lead to disputes and subjective interpretations of these clauses threatening the viability of the concession program. 20. Appropriate Resource Allocation: A third lesson to consider is the appropriate allocation of resources in concession program preparation. DAER spent a significant amount of resources on the technical aspects of the road concessions. Perhaps resource allocation could have been shifted from engineering studies to developing a more detailed and consistent concession contract. However, the lack of clarity in concession contracts is probably due to the style of writing these contracts with an emphasis on flexibility, rather than any lack in resources. 21. Viability of the Concession Pole Concept: The concession pole concept appears to be a good approach for maintenance concessions which Bank staff may consider in other countries. When using a pole strategy, however, it is important to ensure a consistent level of maintenance along the entire road network connecting the different poles. In the case of RGS, some intermediate highway segments connecting different poles have not been concessioned. Moreover, the state is exploring the possibility to return these non-concessioned sections to the federal government, which would lead to 69 Annex D: Roads Concessions the uneven quality of the network. Table 1 Road Concessions Concession Pole Awarded Min. Km. Con. Proposal Concession Concessionaire Maint. Edital Km. Maintained In Operation Investment (1) Pelotas Yes 539.00 551.50 No 279,790.00 Metropolitano Yes 510.00 536.00 Yes 377,425.00 Caxias Do Sol Yes 165.85 173.75 Yes 322,846.00 Vacaria Yes 121.16 132.66 Yes 140,922.00 Gramado Yes 110.37 131.97 Yes 71,601.00 Carazhinho Yes 209.38 250.40 Yes 253,455.00 Santa Maria Yes 249.21 256.21 Yes 209,973.00 Santa Cruz do Sul Yes 154.49 196.82 Yes 204,771.00 Lajeado Yes 282.31 318.80 Yes 340,142.00 Total All Concessions 2,341.77 2,548.11 2,200,925.00 Total Operating Concessions 1,553.56 1,740.40 1,711,162.00 Total Paved Km. In Network 8,600.00 % Total Paved Awarded to Concessionaires 29.63% % Total Paved in Operating Concessions 20.24% (I) Includes 455,639.00 concessionaire tax payment * Source: DAER "Programa Estadual de Concessao Rodoviaria, Resumo Informativo 70 Annex E Mission's Aide Memoire Annex E: Mission's Aide Memoire RIO GRANDE DO SUL STATE REFORM LOAN Loan 4139-BR Project Completion Mission (March 15-19 de 1998) Aide Memoire A Bank mission composed by Mauricio Carrizosa (Task Manager), Phil Gray, Ben Darche and Cecilia Zanetta visited Porto Alegre with the objective of conducting the implementation completion review of the Rio Grande do Sul State Reform Loan. Meetings were held with Mr. Arno Augustin Filho, Secretary of Finance, Arq. Clovis Ilgenfritz da Silva, Secretary of State Planning, and other government officials. The mission would like to thank the Government of Rio Grande do Sul for the valuable assistance received during the mission. The mission conducted a detailed review of the implementation of the project, which closed on December 31, 1998. The objective of the Rio Grande do Sul State Reform Project was to support the implementation of a series of reforms aimed at improving the state's fiscal situation and its infrastructure and services. The focus of the mission was on assessing the achievement of the project's objectives, the impact of each of the project's activities, the major factors affecting implementation, and the prospects for its sustainability in the medium and long term. To develop a more comprehensive perspective in terms of the impact of the privatizations, meetings were held with several of the stakeholders in each sector, including the corresponding regulatory agencies, the concessionaires, and consumers groups. The findings of the mission indicate that the project has been highly successful in terms of the privatization of the power and telecommunication state-owned enterprises, the concessioning of roads and port terninals, as well as the establishment of an adequate regulatory framework that allows the state to monitor the quality of privately provided services. The privatization of the water company was not implemented, thus the US$20 million amount corresponding to that activity was canceled. The performance was less satisfactory in terms of the project's overall fiscal objectives, as the state's public finances have not shown any significant improvement. These findings will be developed further in the Implementation Completion Report (ICR). The mission's specific findings are as described below. Privatization of State-Owned Companies: The most important part of the state of RGS Government's reform program has been the privatization of state-owned companies (Table 1). In the area of public services, two major privatizations were undertaken-the state-owned telecommunications company, CRT, and two electricity distribution companies, representing approximately two-thirds of the territory of the 71 Annex E Mission's Aide Memoire state. A further component of the electricity company, its thermal generation assets, representing 490 MW of capacity, were transferred to the Federal Government as part of a debt-swap agreement. An additional component of these reforms was the establishment of a cross-sectoral regulatory agency, known as AGERGS, which was to be responsible for regulating the public services in the State. The failed privatization of CORSAN was the least successful part of the program. AGERGS has been slow to receive delegated powers (it only recently received an agreement to regulate certain aspects of electricity supply in the state from the Federal regulatory authority, ANEEL) and is now embroiled in a dispute with the Government about whether certain commissioners should be removed prior to the end of their appointments. Table 1 Privatization Proceeds Sector Company Date Proceeds (Rs$ million) Telecommunications CRT 1st Tranche (35%) 12/96 681 CRT 2nd Tranche (50.12%) 6/98 1,176 Electricity RGE 10/97 895 AES-Sul 10/97 1,635 CGTEE 12/98 508* Total 4,895 * Reduction in state debt via 'Federalization' of company Unlike the other states, where telephone service was until recently provided by federally-owned subsidiaries of the Telebras system, RGS owned 85.4 percent of its local telephone company, the Companhia Riograndense das Telecomunicaqoes (CRT). The main objective of its privatization was to meet the considerable unmet demand (estimated in January 1997, in the MOP to be around 700,000 fixed lines and 300,000 cellular connections), as well as a strong interest in more sophisticated services such as data transmission, video conferencing and internet access. The privatization of CRT was undertaken in two tranches, 35 percent being sold in December 1996 to a consortium headed by Telef6nica de Espana. The group paid Rs$681 million for the stake. The remainder of the government's shares were later sold to the same consortium in June 1998 for Rs$1.176 million. The result has been a considerable increase in the number of cellular and fixed connections and public phones, the rates of increase having been 261 percent, 67 percent, and 125 percent respectively. Quality of service does not seem to have suffered unduly, unlike the systems in Sao Paolo and Rio de Janeiro where quality of service declined notably as a result of the increase in the number of new connections. The privatization of two of the distribution entities that were sold when CEEE was restructured was also successful, generating significant revenues for the state, happening as it did fortunately before the crisis greatly decreased the dollar value of assets in Brazil, and reduced access to the international capital market. Although there 72 Annex E Mission's Aide Memoire has been some move to increase the number of connections, the numbers are not large in comparison with the increase in connections in telecommunications. Quality of service and productivity have also improved marginally, although this may have suffered recently as a result of the national blackouts. In terms of regulatory and other issues, the companies seem concerned with what they regard as 'unfair' competition with the rural cooperatives which have been expanding into urban areas. CEEE has also suffered because of the fact that it still maintains excess liabilities (the distribution companies were sold largely free of debt), and the previous government took some of the capital it had otherwise promised to reduce these liabilities, and used it for other purposes. The company is now suffering financially as a result. The failed attempt to partially privatize CORSAN was the least successful of the reform efforts of the government. Despite extensive discussions and a review of possible reform options, the government's final decision to sell 49 percent of the government's stake was shelved as the election approached. Consequently, there are currently no plans to significantly reform CORSAN, and hence it is likely to remain inefficient and starved of funds with which to invest in sewerage. These difficulties are likely to be exacerbated by possible moves of certain municipalities to opt out of CORSAN's service provision. The former Government's privatization strategy seems to have been predominantly oriented towards maximizing the sales value of the companies sold. In maximizing sale value, the governments actions were very successful, in part because the sales were undertaken prior to the devaluation of the Real and the full impact of the Asian crisis. Indeed, the privatization of the distributors, as measured relative to the minimum reserve price and size of the companies, were one of the most successful in the country. Road Concessions: DAER successfully awarded 9 "concession poles" to the private sector in its innovative road concession program. Concessionaires will invest approximately Rs$2.2 billion for the rehabilitation and maintenance of about 2,500 km. of State roads (approximately 30 percent of its paved network) over the 15 year term concession contract term. However, there are two concessions that have been awarded, but not implemented because of unanticipated events. If these concessions do not proceed, the State will still have fiscal savings of up to Rs$1.7 billion for 20 percent of its paved network over the term of the concession contract. The concession program should also provide broader benefits to the State's economic development through improved road conditions and lower vehicle operating costs (less wear and tear on autos and trucks). The concession projects appear to be sustainable in the future, although conflicts have already arisen between the State Government and concessionaires regarding tariff adjustments and the interpretation of the financial-economic equilibrium clause in the concession contract. How these conflicts are managed will depend on another potential problem between the authority of AGERGS to set tariffs and the tariff adjustment and dispute mechanisms provided in the concession contract. The concession contract gives DAER a major role in these activities. The primary lesson learned is the need to develop more detailed, unambiguous, and transparent concession contracts that provide better definitions of critical clauses, such as the 73 Annex E Mission's Aide Memoire financial-economic equilibrium and that are more consistent with the law that established AGERGS. Port Concessions: The Superintendencia do Porto do Rio Grande (SUPRG) successfully awarded concessions to most of its remaining publicly operated terminals and facilities by the end of 1997. It entered into concession agreements39 for the Petroleum and Container Piers and the Wheat and Soy Terminal which comprise over 76 percent of the port cargo movements. SUPRG was not able to find sufficient interest in the Refrigeration, Liquid Bulk and Storage Warehouse which remain under public operation. The latter facilities only provide a small amount of the ports total cargo movements. With the completion of the above concessions, the port is over 90 percent operated by\private parties with almost 100 percent of its cargo movements provided by private operators. In the aftermath of privatization, the National Association of Industries considered Porto Rio Grande (PRG) as one the three best performers of the 13 largest Brazilian ports. Private operations will keep Porto Rio Grande (PRG) competitive with other large regional ports (Buenos Aires, Montevideo, Santos and Paranagua). Private operators can keep the port competitive through better use of port resources, management of the flexible work rules created under the 1993 port reform law, and access to capital for investment in port facilities, as contemplated in the leasing contracts. The ability of the private operators to invest in new facilities will allow PRG to continue to expand its facilities to accommodate the increasing growth in general cargo and containers. The PRG experienced an average annual growth rate of 7 percent per year in general merchandise and over 26 percent growth rate in containers between 1995 and 1998, the years when the major terminal facilities were transferred to private operators. Regulatory Agency: As part of the privatization process, the Government established a regulatory agency AGERGS, whose council is a 'representative' one where four members were appointed by the Government (although one of the nominations of which was rejected by the Legislative Assembly during the nomination process), two members were nominated by consumer groups, and one by the concessionaires. The process of establishment of the agency was a gradual one because many of its powers were to be delegated to it by other authorities, such as the Federal regulatory authorities. The agency has started to monitor the quality of infrastructure services, resolve disputes and conduct other regulatory activities regarding the services over which it has responsibility. Its activities are, however, presently overshadowed by a larger political dispute about the question of whether fixed terms are appropriate for commissioners of a regulatory commission, or whether their mandate should be determined by political decisions. The politicization of the debate seems to have been caused in part by the political background of a number of the appointed commissioners. The consequence of the political debate about the regulatory agency is a court case where the current Government is seeking to annul the appointment of the government appointed 39 The concession agreements are called "Rental Contracts", that have an initial term of 15 years renewable for another 15 years. They are long term leases that allow the contractor to expand the facilities based on its business growth. 74 Annex E Mission's Aide Memoire commissioners and appoint its own. Fiscal Situation: The Reform Letter presented by the State describing its reform program specified five fiscal targets, as shown on Table 2. In 1997, the state did not meet three of these targets: growth in revenues, reductions in personnel expenditures and declines in debt:revenue ratio. By 1998, the targets with regard to reductions in personnel expenditures and declines in the debt:revenues ratio had not yet been met. However, the growth in net current revenues surpassed the corresponding target by 7 percent, mainly due to a growth in transfers and a rebound in ICMS during the second semester. As a result of a comprehensive debt agreement with the National Government, the stock of bonds was reduced significantly, although the total stock of debt has increased with respect to 1996 despite the proceeds from the privatizations and a Rs$1.645 billion debt forgiveness by the National Government. The increase in debt has been mainly the result of three factors: a) excessive primary deficits (i.e., 20.3 percent and 23.2 percent of net current revenues in 1997 and 1998 respectively); b) an increase in borrowing from PROES to assist in the restructuring of the state financial institutions; and c) the due- interest burden on the high levels of accumulated debt. Personnel expenditures as a proportion of net current revenues have decreased from 85 percent to 81 percent, but mainly as a result in increase in revenues due to transfers. The remaining two targets -- amount of investment financed by debt and the type of investment spending -- were both met in 1997 and 1998. Table 2 Summary of Reform Letter Targets Indicators Target 12/31/97 12/31/98 Growth in Net Current Revenues 4% -1% 11% Personnel as % of Net Current Revenues 75% 85% 81% Debt/Revenue Ratio (1) 1:1 (2) 2.39 2.54 Amount of Investment Financed from Debt 225 56 101 Investment Spending Highways Rs$281 million Rs$550 million Education Rs$53 million Rs$74 million Health and Sanitation Rs$ 11 I million Rs$118 million Municipal Investments Rs$46 million Rs$23 million Others Loan to GM Loan to Ford and GM (Rs$253.2 million) (Rs$306.7 million) (1) It includes Rs$2,379 million for PROES. The debt / revenue ratio decreases to 2.28 if net of Caixa Stadual portfolio. (2) The target is to be achieved by the year 2008 Mission Agreements: The following agreements were reached with the Government during the mission. Disbursement and Auditing: The loan was designed to help finance expenditures related to the Government's reform project. The costs of the project comprised expenditures in four areas: a) goods, works, consultant services and training; b) 75 Annex E Mission's Aide Memoire severance payments; c) grants; and d) incremental recurrent cost of reforms on a declining basis. The loan disbursed chiefly against expenditures on severance payments and grants during 1997 and 1998. These project expenditures still need to be audited. The bidding documents for the audit have already been finalized and the Government is ready to invite bids from five auditing firms. The Government expects to complete the audits with regards to 1997 and 1998 expenditures by the contractual deadline date for the 1998 expenditures (June 30, 1999). ICR Timetable: The Government and the mission have agreed on the following timetable (Table 3) with regard to the preparation of the Implementation Completion Report. Table 3 Agreed Timetable for ICR Action Agreed Date Borrower's contribution sent to the Bank April 30, 1999 ICR Draft sent to Borrower May 7, 1999 Borrower's comments on ICR draft sent to the Bank May 14, 1999 Expected date of final report May 30, 1999 Mauricio Carrizosa Task Manager The World Bank 76 Annex F: Borrower's Contribution Annex F: Borrower's Contribution40 PROJETO DE REFORMA DO ESTADO EMPRESTIMO BIRD N 0 4139 - BR RELATORIO DE CONCLUSAO DA IMPLEMENTA§AO RELATORIO SINTETICO AvaliaVao Da Implementafio Do Projeto 1. Objetivos Do Projeto 1.1 Objetivo Geral: De acordo com o Anexo 2 do contrato de emprestimo - Descri,cao do Projeto: "O objetivo do Projeto 6 dar suporte a consecucao dos objetivos do Programa [ de Reforma do Estado ] no que se refere ao aumento da eficiencia do Tomador na prestacao de servicos puiblicos e melhoria de suas condi,oes financeiras." 1.2 Objetivos Especificos: Os objetivos especificos do Projeto de Reforma do Estado estao expressos nos Anexos 6 e 7 do contrato de emprestimo. 2. Reafizasao Dos Objetivos Do Projeto A maioria dos objetivos especificos do Projeto de Reforma do Estado, constantes do empr6stimo com o Banco Mundial, foram realizados, especialmente, os relativos aos itens b, c, d, e, e f do anexo 6 e os itens b, c e d do anexo 7. Salientamos que o Governo anterior deixou de cumprir a parte mais relevante que havia se proposto, explicitado no item a do anexo 6. A politica de despesas publicas nao se pautou na busca do equilibrio fiscal, enquanto a proposta de melhoria na administracao fazendaria foi severamente prejudicada pela pratica exagerada da renuincia fiscal e o incentivo a ampliacao da guerra fiscal entre as unidades da Federacao, mediante a transferencia de recursos puiblicos para grandes grupos econ6micos mundiais (GM e Ford). A seguir, explicitamos os resultados da implementacao dos objetivos especificos: a) Politicas do Tomador referentes a despesas pzublicas, etc.: Para cumprimento desse objetivo especifico, o Estado assumiu perante o Banco Mundial, atrav6s de carta de intencoes datada de 12 de dezembro de 1.996, o compromisso de buscar o equilibrio fiscal e financeiro do setor puiblico com a,coes, como: Ajuste fiscal, Reforma patrimonial, Modemizacao e Racionaliza9ao da Administracao Publica e Investimentos do Estado no 40 The Borrower has prepared a comprehensive report discussing its views on the project's performance. For reasons of space, only the Executive Summary is included as part of the ICR. A copy of the complete report is in the Project's files and can be made available upon request. 77 Annex F: Borrower's Contribution bienio 97/98. A administra9ao anterior nao logrou exito na implementa,cao de suas politicas de ajuste, conforme exposto a seguir: a.1) Politica de despesas publicas: 0 PDV foi realizado sem criterios objetivos quanto a necessidade, para a Administra,ao Puiblica, do funcionario demissionario, nem tampouco quanto aos custos decorrentes. Como consequencia, houve uma desqualifica,ao da presta,ao dos servi,os puiblicos, em razao da saida desses servidores treinados e pela ausencia de pessoal em areas prioritarias, como seguran,a puiblica, saiude e educa,ao. a.2) Melhoria na Administra9do Fazendaria: 0 prop6sito de busca do equilibrio fiscal, via incremento da arrecada,ao estadual, nao foi atendido, ficando reduzido ao Programa de Modemiza,ao e Racionalizacao do Aparelho Arrecadador, incipientemente implementado. b) Aliena,do de 35 % das a,ces ordinarias da CRT: A aliena,ao de 35 % das a,6es da CRT, ocorreu em dezembro de 1.996, a um " investidor estrategico "- um cons6rcio liderado pela Telefonica de Espanha, por Rs$ 681 milhoes. Convem salientar que, ap6s essa venda, por decisao do Govemo da epoca, a administra,ao da empresa passou para o controle do novo s6cio, mesmo possuindo esse a minoria do capital votante. Ainda, por iniciativa do Governo anterior, sem fazer parte dos objetivos contratados com o BIRD, foi alienada a parcela restante da participa,co do Estado no capital da empresa, 50,12 % do controle acionario por Rs$ 1.176 milhoes; sendo vencedora a mesma empresa que havia adquirido o primeiro lote de a,coes. c) Concessoes de Terminais de Conteineres e do Terminal de Trigo e Soja: Foram concedidos, em fins de 1.997, os terminais de conteineres, o terminal de trigo e soja e pier petroleiro. As demais concess6es do Porto de Rio Grande nao se realizaram. Segundo a Superintendencia do Porto de Rio Grande, atualmente a grande maioria das opera,ces esta sendo realizada por 6 operadoras, de um total de 60, aproximadamente. d) Concessoes de Sete P6los Rodoviarios: A sugestao inicial do Banco Mundial ( conforme comentado em reuniao de fechamento da ajuda mem6ria da uiltima missao ) era colocar em operacao um p6lo piloto, para, a partir desse referencial, estabelecer a sequncia de novas concess6es a iniciativa privada. Essa proposta foi totalmente cumprida. Cabe revelar que foram concebidos nove p6los, equivalentes a 30 % da rede pavimentada. Desses, sete estao em operacao, por concessionarias privadas e os terminais de Pelotas e Santa Maria estAo fora de opera,ao. e) Estudos sobre o Setor de Agua e Saneamento: 0 estudo sobre o setor de agua e saneamento foi entregue, ao governo, em abril de 1.998, dando-se como cumprido esse prop6sito. f) Cria,do de um 6rgdo regulador dos servi,os pzublicos: Atraves da Lei Estadual 10.931, de 09 de janeiro de 1.997, criou-se a Agergs - Agencia Estadual de Regula,ao de Servi,os Puiblicos Delegados do RS. 78 Annex F: Borrower's Contribution g) Privatizaqdo da CEEE. 0 processo de privatiza,ao da Cia Estadual de Energia Eletrica - CEEE, foi precedido de um estudo que resultou na proposta de transforma9ao da empresa em cinco unidades, sendo uma de transmissao, tres de distribui9,co e um complexo termoeletrico ( Candiota). 0 objetivo proposto ao Banco de alienar o controle acionario de duas distribuidoras foi integralmente realizado, tendo sido feito em duas oportunidades: Data Distribuidora Alienada Valor (Rs$ milh6es) Empresa Atual Out/97 Cia. Distribuidora 895,00 RGE - Rio Grande Nordeste Distribuidora Dez/98 Cia. Distribuidora entro 1635,00 AES Sul Oeste A CEEE ficou reduzida a uma unidade de transmissao, A distribuidora nao vendida e As usinas de gera,Ao de energia hidreletrica. 3. Fatores Que Afetaram A Implementa,Ao Do Projeto Pr6ximo do momento de iniciar os estudos e modelagens necessarios para as privatiza,ces e concessoes, houve aumentos significativos nas tarifas, donde se destaca telecomunica,6es. Somando-se a isso, o alinhamento politico do Governo do Estado com o Governo Federal serviu como fiador para implementa,cao do projeto de reforma do Estado, financiado pelo BIRD. 0 Governo Federal elaborou varios dispositivos legais, com repercussao direta nas finan,as estaduais. 0 Programa Nacional de Desestatizacao serviu como paliativo para o duplo deficit nacional, o deficit fiscal e o do Balan,o de Paganento. No estado, a adesAo ao programa foi a verdadeira ancora para o financiamento do hiato entre os fluxos fiscais de receita e despesa. Outro fator preponderante para implementa,co do projeto foram os investimentos puiblicos realizados na vespera das privatiza,6es em empresas ou areas objeto de concessao, tornado-as muito mais atrativas aos futuros controladores. Nessa situacao enquadram-se os investimentos feitos na CRT antes de sua privatiza,cao e em algumas rodovias antes de sua concessao. Um dos fatores que contribuiram para que o projeto tivesse andamento acelerado foi o fato de que a maioria da Assembleia Legislativa fazia parte do Governo de coalizao instalado anteriormente. 4. Sustentabilidade Do Projeto A sustentabilidade do Projeto de Reforma do Estado, executado pelo Governo anterior, esta alicer,ado na legisla,ao reguladora aprovada pelo Congresso Nacional e Assembleias Legislativas, estabelecendo regras para manuten,io e amplia,ao dos servi,cos concedidos, padroes de atendimento e remunera,ao minima dos capitais investidos. 0 Estado criou a Agencia Estadual de Regula,co dos Servi,os Puiblicos Delegados - 79 Annex F: Borrower's Contribution Agergs, com o objetivo de: * Assegurar a prestacao de servicos adequados, assim entendidos aqueles que satisfacam as condigces de regularidade, continuidade, eficiencia, seguranca, atualidade, generalidade, cortesia na sua prestacao e modicidade nas suas tarifas; * garantir a harmonia entre os interesses dos usuarios, concessionarios, permissionarios e autorizatarios de servicos publicos; * zelar pelo equilibrio econ8mico-financeiro dos servicos pudblicos delegados. Passamos a analisar, a seguir, a sustentabilidade do projeto em cada um dos setores privatizados ou concedidos, alem do pr6prio Setor puiblico: a) Finanqas Publicas: Analisando-se o desempenho recente e a estrutura atual das contas publicas do Estado do Rio Grande do Sul, ficam evidentes alguns aspectos do processo de debilitamento das financas estaduais, assim resumidos: (a) a politica de financiamento do Setor Puiblico, implementada nos ultimos anos, voltada para a obtencao de recursos via alienacAo de patrim8nio, deixou de lado medidas capazes de estabelecer as condicoes estruturais de sustentacao do gasto puiblico no longo prazo; (b) a sistematica necessidade de utilizacao desses recursos na estrutura de gastos primarios do Estado compromete as execucoes futuras; (c) o fraco desempenho das Receitas Pr6prias no periodo recente, em especial a defasagem na arrecadacao do ICMS, em relacao aos demais Estados e a evolucao da pr6pria economia gauicha; (d) a defasagem nas transferancias de receitas da Uniao decorrentes, principalmente, da criacao do Fundo de Estabilizacao Fiscal; (e) o crescimento das despesas deu-se em patamares superiores A taxa de crescimento das Receitas Correntes, notadamente os altos valores realizados na conta de manutencAo, conforme destaque feito adiante; (f) o aurnento significativo do comprometimento fixo das Receitas com o pagamento efetivo do Servico da Divida Puiblica. Os recursos oriundos das privatizac6es e concessoes ocorridas nao diminuiram o estoque da divida, nao constituiram Fundo de Previdencia do Servidor, nem tampouco solucionaram o problema dos "deficits" primario e operacional, conforme pode ser observado na tabela abaixo: Evolu4ao do Resultado Fiscal (Rs$ milhao) Descricio 1.995 1.996 1.997 1.998 Resultado Primario (405) (618 ) (767) (1.032) Resultado Operacional ( 205 ) ( 782 ) (1.243) (1.127) Total arrecadado com as privatizac6es: Rs$ 5 bilhoes Fonte: Plano Plurianual 2000-2003 Apesar da proposta de melhor controle dos gastos puiblicos, as despesas com a manutencao da maquina puiblica estadual atingiram 17 % da Receita Corrente Liquida, em 1.998, enquanto que, em 1.995, representavam 13 %. Com relacao ao endividamento do Setor Publico Estadual, observa-se que , de um 80 Annex F: Borrower's Contribution montante de Rs$ 4,4 bilhoes, em dezembro de 1.994, o estoque da divida passou para Rs$ 13,4 bilhoes, em dezembro de 1.998., ou seja mais de 200 %; enquanto que o IGP-DI, do mesmo periodo foi de 37 %. Isso representa um crescimento real de mais de 100 % da divida pAblica. Evolucao da Divida Publica Estadual (exceto estatais) (Rs$ milhao) Descricao 1.994 1.995 1.996 1.997 1.998 Divida Fundada Interna 4.154 6.834 8.715 10.761 13.008 Dfvida Fundada Externa 245 167 158 252 408 Divida Total 4.399 7.001 8.873 11.013 13.416 Fonte: Plano Plurianual 2000-2003 b) Area de TelecomunicaqJes: Na area de telecomunica96es a Agencia Nacional de Telecomunicag6es - Anatel, reguladora desses servigos, estabeleceu indicadores de universalizagao e qualidade dos servigos bastante ousados para referenciais anteriores ao aumento tarifario. No entanto, com as tarifas atuais, a CRT passou a apresentar uma capacidade de investir superior as exigidas pela agencia, resultado dos aumentos tarifarios verificados antes da sua privatiza9ao, conforme quadro. No tocante ao capital social da empresa, ap6s a sua privatizagao, nao houve mais aportes, apenas a incorporagao de reservas, conforme tabela. Somente em 2.003 sera aberto o mercado para outros concorrentes. Conseqiuentemente, no ambito da telefonia fixa, foi trocado um monop6lio estatal por um monop6lio privado, com todas as conseqiitncias que se espera face ao poder de exploravao do mercado que esses novos proprietdrios da CRT venham desempenhar. Com relacao A telefonia celular, em margo desse ano, foi iniciada a comercializagao dos terminais da Banda B, que serao operados pela Telet. Dados de UniversalizaqAo, Qualidade e Tarifirios da CRT Terminais\ano 1.995 1.996 1.997 1.998 Terminais fixos 777.056 781.799 1.031.493 1.402.255 Terminais celulares 79.249 168.479 350.756 542.695 Fonte: DADE/SCP - RS Conta mensal media telefonia bisica (USs$ 1,00) DescriVAo\Ano 1.994 1.995 1.996 (10 semestre) Conta mensal 55,48 61,4 84,21 Fonte: DADE/SCP - RS 81 Annex F: Borrower's Contribution Capital Social da CRT Capital da CRT 11.06.96 10.06.97 08.12.98 (em Rs$) 662.963.026,32 706.994.378,43 732.176.239,79 Fonte: Junta Comercial do RS c) Concessdo de Terminais do Porto de Rio Grande: A concessao dos terminais de conteineres e do terminal de trigo e soja representou a transferencia de um monop6lio piiblico para um monop6lio privado. 0 Porto de Rio Grande e o mais importante do Estado e seu movimento garante a sua sustentabilidade. 0 quadro, a seguir, demonstra o movimento realizado nos iltimos exercicios: A preocupa,co do atual Governo refere-se as tarifas, pelo fato de que os operadores e os concessionarios de terminais, por monopolizarem as opera,ces, possam praticar tarifas exorbitantes. d) Concessdo de P6los Rodoviarios: No momento, a associa,ao de concessionarias esta pleiteando um reajuste contratual de 18,6 %, onde alega a necessidade de cumprimento de clausula contratual. No entanto, quatorze pracas de pedagio de tres p6los - Metropolitano, Caxias do sul e Lajeado, estao com diminui,ao de tarifas, 20 % para veiculos de passeio e 28 % para veiculos comerciais, determinada pelo Govemo do Estado ap6s auditoria realizada pela Contadoria e Auditoria Geral do Estado, em razao da constatacao de irregularidades contratuais. Em razao disso, o atual Govemo do Estado procedeu a uma alteracao unilateral de contrato com tres p6los, estando outros quatro p6los sendo alvo de estudos identicos. Dessa forma, a sustentabilidade desse projeto esta vinculada a adapta,co das atuais operadoras a pratica de tarifas m6dicas sob a otica do usuario e, que ao mesmo tempo proporcionem o equilibrio econ6mico-financeiro das concessionarias. e) Setor de Agua e Saneamento: A disposicao do Governo e manter a Corsan sob o controle Estatal. Os servi,os prestados pela empresa sao acoes fundamentais na area de sauide preventiva. A Associacao Brasileira de Engenharia Sanitaria e Ambiental - Abes, afirna que para cada um real investido em saneamento basico no Brasil, tres deixam de ser gastos em baixas hospitalares. 0 segmento de esgotamentamento sanitario apresenta altos investimentos e baixas tarifas, caracterizando-se como uma area de servicos subsidiados. 0 governo acredita que a soluc ao desses problemas encontra ressonancia em uma politica de subsidios cruzados de agua e esgoto complementarmente a uma pratica tributaria e de outorga de usos da agua. f) Criaqdo da Agergs: Em dezembro passado foi sancionada uma lei estadual, definindo mandato de quatro anos para os conselheiros da Agergs, o que impede o Govemo de indicar os pr6prios representantes. Somente ao final do segundo ano de mandato do Governo estadual, poderao ser indicados os seus legitimos representantes. Esta sob apreciacao do Supremo Tribunal Federal uma acao direta de inconstitucionalidade da lei estadual, impetrada pelo Governo Estadual. Essa acao visa 82 Annex F: Borrower's Contribution garantir ao Govemo a imediata indicacao dos seus representantes. g) Privatizaqdo da CEEE: A CEEE resultante do processo da privatiza,co das duas companhias distribuidoras, ficou com todo o 6nus do Programa de Demissoes Voluntarias - PDV, que incentivou a aposentadoria de 3.640 empregados a um custo de Rs$ 444.650 milhoes, e toda a divida remanescente dos investimentos realizados pela CEEE antes das privatiza6oes. Numeros de Funcionarios e Custos do PDV Orgao N0 Funcionarios Custos(R$ mil) Adm. Direta 9.791 75.511 Autarquias e Fundacoes Puiblicas 2.313 43.600 Banrisul 1.079 34.895 CRT 1.450 77.593 Ceee 3.924 456.537 CORSAN 1.643 12.679 Total 20.200 700.815 Fonte: Secretaria da Administracao e Recursos Humanos e DADE-SCP A empresa herdou, tamb6m, uma pratica de baixa eficiencia em rela,co a cobran,a de haveres, al6m de nao obter autoriza,cao, junto a Anatel, de reajuste tarifario, o qual ja foi concedido as outras duas distribuidoras privatizadas. Para sua consolida,cao, a CEEE devera ter aprovado, pela Anel, o reajuste de suas tarifas de forma equivalente aos montantes concedidos as distribuidoras privatizadas. Endividamento da CEEE - em R$ mil Divida 1.995 1.998 (30/11/98) Interna 794.825 822.179 Externa 679.631 161.670 Total 1.474.456 983.849 Fonte: CEEE Superintendencia financeira 5. Desempenho Do Banco O Banco Mundial realizou os desembolsos a conta do Tesouro Estadual de acordo com as clausulas contratuais. As visitas de acompanhamento realizaram-se dentro do previsto e de acordo com as necessidades de acompanhamento da implementacao do Projeto. 6. Desempenho Do Estado O que se observa no Brasil e, com maior enfase aqui no Rio Grande do Sul, 6 a velocidade com que os processos de privatiza,oes e concessoes ocorreram. 0 pr6prio Banco Mundial, como ja mencionado, recomendou maior cautela nos processos de concessao de p6los rodoviarios, no entanto, o Govemo anterior, no afa de se antecipar ao Govemo Federal, mostrando-se mais rapido, ao inv6s de seguir a orientacao do Banco, de 83 Annex F: Borrower's Contribution construir urn p6lo piloto, ja de imediato, procedeu nas concessoes dos nove p6los. No Rio Grande do Sul, os objetivos de eficacia sobrepuseram-se aos de efetividade, o que gerou os problemas ja mencionados e o comprometimento das finan,as publicas para os pr6ximos anos. Ha de se envidar um esfor,o enorme de ajustarnento das contas para que se possa cumprir os objetivos maiores do Governo. 7. 0 Desenvolvimento Futuro E Sustentabilidade: Diretrizes Da Nova Administrasao 0 Governo que se estabeleceu no Estado do Rio Grande do Sul parte da premissa que o Estado deve ter transparencia suficiente em suas a,oes para que possa haver o controle efetivo da sociedade. Esse Govemo, para garantir-se da sustentabilidade de suas a,ces, utiliza-se dos principios de equilibrio nas contas piiblicas - comprometer-se com gastos ate o limite de seus recursos, fim dos subsidios aos grande empresarios e combate A sonega,ao; probidade administrativa - estabelecer mecanismos de controle para reprimir todo e qualquer ato passivel de questionamento legal ou moral; austeridade - gastar de forma m6dica, de acordo com as suas possibilidades; participasao popular - as decis6es de alocacao de recursos acontecem sob a iniciativa do controle popular e se dAo atraves do Or,amento Participativo. Considerando-se que, nesse ano de 1.999, R$ 850 milhoes estavam previstos como receitas de alienacao de bens, diga-se privatizacoes e concess6es, a Administra,cao reavaliou o conjunto de despesas fixadas e ira realizar o que foi entendido como prioritario pelo Conselho de Govemo. 7.1. Desenvolvimento De Verdade 7.1.1. Contexto Geral: As dificuldades atualmente enfrentadas pelos setores produtivos existentes no Estado, antes de representarem o esgotamento definitivo desses setores refletem, principalmente, uma crise decorrente da politica econ6mica federal. Nao se pode desconsiderar a estrutura produtiva do Rio Grande do Sul apostando exclusivamente num possivel desenvolvimento vindo de fora do Estado, pois e possivel incentivar a retomada do crescimento da economia gauicha a partir dos setores ja instalados e do fortalecimento das cadeias produtivas existentes. 7.1.2. A Estrategia de AVao: 0 Estado proposto pela nova Administra,ao desenvolverA acoes de inducao e regulacao das atividades econ6micas prioritarias, com o objetivo de implementar uma estrategia de desenvolvimento sustentavel que incentive o crescimento do emprego e da renda, e a sua justa distribuicao ao conjunto da sociedade. A estrategia geral de atuacao do nosso Estado, no campo do desenvolvimento, sera pautada pela priorizacAo nas ac6es de apoio As cadeias produtivas da economia gauicha, no fortalecimento dos micro, pequenos e medios empreendimentos economicos e no estimulo As atividades produtivas nas regioes menos desenvolvidas. Paralelamente buscaremos a partir das potencialidades econ6micas locais, fomentar um desenvolvimento no qual as atividades nao s6 estejam integradas a dinamica da regiao, mas tambem que permitam integrar A sociedade os cidadaos e as localidades hoje 84 Annex F: Borrower's Contribution excluidas do desenvolvimento. Ou seja, um desenvolvimento integrado-integrador. O Sistema Financeiro Puiblico Estadual deve multiplicar suas funq6es de fomento as atividades economicas com vistas a geracao de emprego e renda para os trabalhadores, produtores rurais e empreendedores urbanos. Em especial para que o Estado possa, nao s6 contribuir para a instala,cao e o crescimento de grandes empreendimentos, como tambem viabilizar a instalacao de micro, pequenos e medios empreendedores. 7.2. Afirmar Direitos E Garantir A InclusAo Social As politicas sociais no Brasil, presididas por uma no,ao de Estado-Minimo, v8m sofrendo um reves, que pode ser resumido nos seguintes fatores: (a) tentativa de se eliminar importantes direitos sociais consignados na Constituicao Brasileira de 1988, no que inclusive ja ha 8xito parcial atraves das reformas previdenciaria e administrativa; (b) introdu,ao de mecanismos privatizantes para a condu,ao das politicas sociais,; (c) progressiva quebra do principio de universalidade da acao estatal nas areas sociais, que cede lugar a focalizacao e a selecao de "clientelas"; e (d) desfinanciamento e desinvestimento em areas essenciais, em decorrencia da drastica reducao dos or,amentos das areas sociais. O Rio Grande do Sul, como foi visto no diagn6stico explicitado anteriormente, nao escapou dessa dinarmica. 0 desemprego elevado e ascendente, e o nivel reduzido de renda, determinam a emergencia de um novo e complexo universo de demandas sociais ao Poder Puiblico. Assim, o Estado passa a ser um instrumento fundamental capaz de assegurar meios reais de sobreviv8ncia para as pessoas e as familias, mediante o provisionamento de condic6es minimas de subsist8ncia. 7.3. Gestao Democratica Do Estado - Participa,ao Popular A participacao popular constitui o principio norteador da mudanca que perpassa toda a concep9ao da nova Administra,ao sobre Estado e Sociedade Trata-se de um movimento que pretende conferir niveis crescentes de participacao social, para a criacao de uma nova ordem democratica comprometida com a universalizacao dos direitos de cidadania. Pretende reverter a tend8ncia hist6rica de enfraquecimento da sociedade civil frente ao Estado, pela via fecunda do fortalecimento das formas democraticas de relacao entre essas duas esferas. O Orcamento Participativo e um processo de democracia direta voluntaria, no qual a populacao pode discutir, decidir e controlar o orcamento publico, a gestao do Estado e as politicas de desenvolvimento. A iniciativa do Governo esta alicer,ada em quatro principios basicos: discussao da totalidade do orcamento, universalidade, auto- regulamenta,Ao e controle social. O direcionamento dos recursos do Estado para o atendimento das reais necessidades da maioria da populacao - inversao de prioridades - e a recuperacao da qualidade dos servicos puiblicos passam pela construcao de um Estado democratico, no qual a participacao popular e dos servidores publicos, juntamente com o Governo, sao os elementos construtores do aumento da efici8ncia e da eficacia das ag6es puiblicas. 85 Annex F: Borrower's Contribution 8. As LiV6es Do Projeto A execucao do Projeto de Reforma do Estado foi desenvolvida pelo Governo do Estado da administracao anterior, com estreita colaboracao e acompanhamento do Banco Mundial, em razao de ser um projeto pioneiro destinado a patrocinar a reforma patrimonial e implementar o ajuste fiscal na busca do equilibrio das contas puiblicas do Estado do Rio Grande do Sul. Ao longo da execucao do projeto foram realizadas emendas ao objeto original, adaptando as propostas as acoes efetivamente implementadas pelo Estado, habilitando o tomador ao saque dos recursos disponibilizados pelo Banco. Ao final da sua execuJco constata-se que o projeto limitou-se a alienacao total da CRT, parcial da CEEE, a concessao de p6los rodoviarios e terminais portuarios e, nao solucionou o seu objetivo central que era a busca do equilibrio das finan,as puiblicas estaduais. A implementa9ao do Plano de Demissoes Voluntarias agravou a prestacao dos servi,os puiblicos essenciais, alem de nao impactar positivamente sobre o custo de pessoal do Estado. A conducao do processo deixou licoes que permanecem para avaliacao, sendo perceptivel que, nas privatiza,oes ocorridas, o interesse privado prevaleceu sobre o interesse piublico e a funcao social a ser executada pelo Estado ficou submissa ao atendimento do interesse econ6mico dos grupos habilitados a assumir a concessao dos servi,os ofertados. Deve ser ressaltada, ainda, a pouca transparencia com que foram realizadas todas as acoes implementadas e a ausencia de consulta a opiniao publica para manifestar-se sobre a aliena,ao do patrimonio puiblico. Finalmente, cabe destacar ac6es que foram implementadas e cujo resultado foi negativo em rela,ao aos objetivos tra,ados, como: a) A renuincia de gestao da CRT feita pelo Govemo anterior a favor do cons6rcio que adquiriu 35 % das suas a,oes ordinarias diante do fato de que o Estado ainda mantinha o controle acionario da empresa; b) alienacao de mais 50,12 % do capital votante da empresa, nao previsto nos objetivos do Projeto, realizada enquanto a CRT estava sob a gestao do cons6rcio liderado pela Telefonica de Espanha, casual vencedora, tambem desse leilao; c) a transferencia as duas distribuidoras de energia elktrica apenas dos ativos rentaveis, sem transferir a parcela de divida correspondente; d) o Govemo anterior arrecadou RS$ 2,2 bilhoes com a aliena,co das duas distribuidoras. No entanto, isso nao oportunizou o saneamento financeiro da CEEE, resumindo-se a transferencia dos ativos rentaveis e mercado as novas empresas; al&m de pernanecer com a empresa estatal resultante todo o encargo decorrente do quadro de pessoal aposentado; e) o Programa de Demissoes Voluntarias nao correspondeu a real necessidade de austeridade nos gastos puiblicos. Houve uma evasao de funcionArios altarnente capacitados e, hoje a administracao estadual carece de seus servicos. f) Na concessao dos p6los rodoviarios, na forma apressada com que foram implantadas demonstraram a real necessidade de estabelecer contratos de concessao mais detalhados, sem ambiguidades e transparentes, que suprissem de melhores definicoes a respeito das clausulas criticas, como as que se referem ao equilibrio econ6mico-financeiro e a qualidade da rodovia. 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