Nicaragua SecondRuralMunicipalitiesDevelopmentProject (Credit No. 3480-NI) ProposedAmendment to the DevelopmentCredit Agreement Summary 1. This proposal seeks the ExecutiveDirectors' approval to amend the Credit Agreement for the Nicaragua SecondRuralMunicipal Development Project (Credit 3480-NI) inthe amount o f SDR 22.0 million equivalent to US$28.7 million on standard IDAterms. The Republic ofNicaraguahasrequestedthis amendment bemadeto reflect the enactment ofLaw 466 ofMunicipal Budgetary Transfers, inAugust 2003. This new Law created an environment more conducive to the accomplishment o f the project development objectives and the proposed modifications will allow the Project to go beyondthe original objectives to assist the Government o fNicaragua (GoN) implement a comprehensive decentralization legal and institutional framework This proposal includes a request for an extension o f the original closing date o f the Project for eighteen additionalmonths to allow the government sufficient time to implementthe new activities. 2. The purpose o fthis Memorandumis to recommend changesto the 3840-NI Project and approval o fthe corresponding amendment to the Development Credit Agreement (DCA). This Credit restructuring proposal responds to the Borrower's request presentedinthe letter from the Minister o f Finance and Public Credit dated October 26,2004, attached hereto. Background 3. An IDA Credit (Credit 3480-NI) inthe amount o f SDR 22.0 millionthe equivalent o f US$28.7 million on standard IDA terms supporting the Second Rural Municipal Development Project for a total amount 0840.7 millionwas approved by the Board o f Directors on March 27,2001 and became effective on September 30,2001. The Closing date i s December 30,2004. 4. The project development objective (PDO) is to buildthe capacity of rural municipalities inthree major areas inwhich they can make a critical contribution to sustainable rural development: (i)provision o f localpublic infrastructure and the delivery of municipal services; (ii) protectiono f the environment and the sustainable the management o fnaturalresources, and (iii) the promotion of local economic development. 5. The Bank's mid-term evaluation mission (28 April-9 May, 2003) concluded that the project was not achieving the expected results within the original timeframe except for subcomponent 1.A o f Decentralized Financing. At the same time, the passage in August 2003 of a national law that would increase significantly the amount o f fiscal transfers form the Central to the Municipal govemments suggested that the strategy o fthe project to achieve its development objective had to be revised inthe context o f the new legal framework. Four project missions visited Nicaragua inthe period between June 2003 and October 2004 to strengthenkey institutional areas o f INIFOM (Nicaraguan Institute for Municipal Development) and MARENA (Ministry o f Environment and Natural Resources) delaying Project implementation, as well as to assist the G o N inthe preparation o f the proposals for restructuring o f the Project. The Decentralization Forum for cooperation and coordination on decentralizationpolicies endorsed these proposals. 6. Duringthe CPPRon June 7-8,2004' the Bankrecognized some notable improvements inINIFOM's intemal management as well as inthe implementation o f its corporate Municipal Strengthening Program. Inaddition, the GoN and the Bank agreed to postpone the restructuring o f the project untilthe findings o f a decentralization study being preparedby the IMF and the Bank would hadbeenpresented and discussed by government counterparts. After a workshop that was held on August 13,2004 to discuss and endorse the findings o f the above study, the G o N requested the Credit agreement be amended to inter alia, provide technical assistance to address key deficiencies inthe current decentralization legal and institutional framework, prompted by events not envisioned inthe original Project design. Justification 7. The Enactment o f Law 466 o f Municipal Transfers, inAugust 2003, provides evidence that the Project achieved one o f its principal objectives to develop a system o f intergovernmental transfers, which could serve as a model for a national revenue sharing mechanism. Eventhough such revenue sharing mechanism i s a central element o f decentralizationreform, it has creatednew challenges and opportunities including the need for a comprehensive decentralization legal and institutional framework. 8. The GoN has requested this Amendment be made to reflect changes inthe country's legal framework and to align the credit activities with the new Government's more proactive comprehensive decentralization strategy. Specifically, it has requested that the Credit be amended and funds remaining inthe project's FONDEM (Municipal Development Fund) component reallocated inorder to strengthen the decentralization process. This would be achieved by the (i) extension o f Project coverage from 43 to 151 municipalities (all with the exception o f the municipality o f Managua); (ii) involvement o f additional institutions inProject implementation; and (iii) a first extension o f the Project's closing date for eighteen additional months to allow the government sufficient time to implement the new activities. 9. The extension o fproject coverage is warranted inorder to buildon acquired experience and capacity o f INIFOMto extend institutional building assistance to more municipalities than envisaged at project appraisal. The involvement o f the Ministryo f - 3 - Finance and Public Credit (MHCP), and the General Controller o f the Republic (CGR) office would enable both institutions to comply with their new duties detailed inthe Municipal Transfers Law. Finally, an extension o f the closing date i s required to ensure completion o f Project implementation, and strengthen on-going institutional building. 10. Inparticular, the proposedrestructuringwill ensure: (i) INIFOMprovides that critical municipal strengthening to implement local investment plans, especially for small municipalities inremote areas; (ii) that the Budget Office o f the M H C P takes over the management o f the intergovernmental transfers system with the support o f the Municipal Transfers Commission; (iii) that the capacity o f the Office o f Fiscal and Economic Affairs (OAFE) to introduce and implement a fiscal dimension to decentralization reform i s strengthened; and (iv) that the General Controller's Office (CGR) i s staffed and equipped to ensure adequate auditing o f the municipalities' use o f funds. Finally, it i s crucial that INIFOMhave the financial and technical resources necessary to support decision making o f the Municipal Transfers Commission since the Commission discharges its decision-making responsibilities inits Technical Secretariat coordinated by INIFOM. ProposedAmendments 11. Inorder to reflect the necessary changes inthe project activities requestedbythe borrower, the following amendments to the DCA would be needed: 12. Part A.4 (d) will be added to include support to the Municipal Transfers Commission created by Law 466 to oversee the implementation o f the intergovernmental transfers system and inparticular, advise on the application and further development o f the revenue distribution formula, including (i) a base line study o f fiscal potential -by August 2005, for the full application o f the revenue co-sharing formula; and, (ii) the proposed revision o f the formula after two years o f enactment o f the law; 13. Part C will be added to include support to MHCP as described inPart C.1and to the CGR as described inPart C. 2. In Part C.1, technical assistance, limited equipment and incremental costs will be financed to strengthen the Ministry o f Finance and Public Credit to improve management o f decentralized finances. Activities have been grouped under the following sub components: Part C.l Subcomponent (a) Strengthening MHCP's capacity to: (i)develop methodologies for costing o f expenditures and appropriate transfer o f resources to municipalities; (ii) streamline internal procedures for management o f intergovernmental transfers; (iii)up-grade technological facilities for better management o f municipal data; (iv) carry out fiscal decentralization; (v)manage aggregate municipal finance and apply international best practice in decentralization and in public sector management; and (vi) to improve public sector management analysis. - 4 - Part C.1 Subcomponent (b) Enhancement o f the Intergovemmental Transfers System to: (i) outofassessmentsofthere-distributiveimpactoftransfers;(ii) proposals carry make for an improved distribution formula; (iii) make proposals for improved information flow for calculation o f transfers; (iv) carry out analysis o f the conditions under which revenue- sharing can be automated; (v) advise the Sectoral Commission on Decentralizationon the introduction o f a matching-grant systems as conditioned transfers; and (vi) periodically monitor and evaluate the fiscal impact o f revenue-sharing and the extent to which reforms insupport o f fiscal neutrality are implemented. Part C.1Subcomponent (c) Improvements to Sub-national Debt Regulations that: provide technical assistance to assess magnitude and forms o f sub-national debt in a sample o f municipalities; propose reforms for improved registration and reporting o f sub-national debt; and for improvedinformation flow regarding private bank lendingto municipalities. Part C.1 Subcomponent (d) Design and Implementation o f Expenditures Transfers for Fiscal Neutrality through the Provision o f technical assistance to: (i) conduct costing exercises for fiscal neutrality; (ii)advise on the use o f transfer formulas for each responsibility to be transferred in order to provide incentives for efficient service delivery; (iii)advise on appropriate human resources management at sub-national levels including the assessment o f labor debt and severance payments (iv) monitor transferred expenditures; and (v) introduce legal reforms that facilitate transfer o f expenditures. Part C.l Subcomponent (e) Development o f Information Systems for Improved Information Flow Among Levels o f Govemment including design of: (i) an interface for S I I M and SIGFA' that allows on-time access on municipal data; and (ii) web page for a publication o fmunicipal financial data and transfers. Part C.l Subcomponent (f) Dissemination, Participation and Training aimed at: (i) provision o f technical assistance to produce informationmaterial for decentralization; and (ii)carryingout oftrainingfor MHCP officials ondecentralization models andbest practice. 14. Part C.2 - The principal objective o f component C.2 to be executed by the CGR (through DAF) is to improve the efficiency and effectiveness o f oversight o f municipal administrations by strengthening CGR capacity to improve the control environment o f municipal administrations as well as monitor local public expenditures and financial administrations through ex ante controls as well as ex post auditing. The component will staff the Municipal Audit Office o f the CGR, and provide technical assistance, training, and limited equipment as well as finance incremental operation costs o f the CGR to carry out the following activities grouped under three sub-components: - 5 - Part C.2 Subcomponent (a) Strengthening CGR' capacity through: (i)creation o f a specialized unit within its Audit Directorate to manage municipal oversight activities; (ii) to develop key procurement capacity to support pilot outsourcing of extemal audits to private firms; (iii) through the continuous update o f key audit staff skills; and (iv) and through the provision o f support for in-country travel expenditures associated with supervision functions. Part C.2 Subcomponent (b) External Auditing o f a Sample o f Municipalities through the provision o f technical assistance to: (i)carry out extemal audits o f a sample o f municipalities, to be outsourced to private audit firms (Firmas de Contadores Publicos Independientes (FCPIs); and (ii) carry out municipal audits by four de-concentrated delegations o f the CGR in: (A) the northern region o f Nueva Segovia, (B) Chontales, (C) the Autonomous Region o f the Northern Atlantic (RAAN), and (D) the Autonomous Regiono f the Southern Atlantic (RASS), all within the Borrower's territory. Part C.2 Subcomponent (c) Strengthening o f Municipal Internal Controls, through inter alia: (i)carrying out of workshops, seminars, and dissemination media events o f an awareness campaign to promote the establishment of internal audit units integral to municipal administrations; (ii)carrying out o f a training-of-trainers program; (iii) carrying out o f training workshops for selected municipal internal auditors; (iv) carrying out o f on-the-job training to help trainees put newly learned skills to use; (v) the implementation o f a program to provide incentives to municipalities interested in establishing internal audit units; (vi) the provision o f technical assistance to consolidate and analyze audit findings and recommendations for a policy and regulatory framework update; (vii) publication and wide dissemination o f consolidated audit findings; and (viii) the design of an information system to monitor internal auditing and recommendations ofmunicipal governments' internal administrations. 15. Resources to finance the new activities will be reallocated from the Part A.1 (FONDEM component) as well as through reallocation of loan proceeds between expenditure categories, as shown inthe following table: - 6 - Nicaragua SecondRuralMunicipalitiesDevelopmentProject (Credit 3480-NI) ResourceReallocation(SDR thousands) Component and sub Components Original Proposed Part A. Municipal Development / Evaluation 14,310 13,400 and Policy Development A.1FONDEMsubprojects 8,440 5,300 A.2, A.3 and A.4 executed by INIFOM 5,870 8,100 Part C. Support to decentralization reform C.1Strengthening o f MHCP 0.0 750 C.2 Strengthening o f CGR 0.0 510 Sub total Part A andPart C n/a 14,660 Part.B Municipal Environmental 5,600 6,240 Management 1,150 392 PPF refinance 940 708 Unallocated TotalProjectCosts 22,000 22,000 ImplementationArrangements 16. Inview of INIFOM'Snotable improvements in its internal management through the implementation o f new financial and procurement systems as well as the incorporation o f staff with the required qualifications to manage those systems, the INIFOM component will continue to be managed by the institute's financial and administrative directorate. 17. For the implementationo f the new Part C. Component, the borrower and the Bank analyzed alternatives administration arrangements, recognizing the lack o f bank experience with the CGR, the pilot nature o f the program, the small size o f the loan amount and the short implementationperiod. After an analysis of the different options, the government decided and the Bank endorsed the proposal that the sub component be administered by the Ministry o f Finance through its Direccion Administrativa Financiera (DAF,. DAFis being strengthened to manage other Bank financed programs co financed by the European Union and the IDB.The DAF will manage both the MHCP and CGR components. - 7 - Conditionfor PresentationofAmendment to the Board 18. Conditions for presentation o f the amendment to the Boardhave been met by the Borrower, including: (i) execution o f an inter-institutional agreement between the Borrower (throughDAF) and the General Controllers's Office with respect to Part C.2 o f the project; (ii) revision o f the INIFOMOperations Manual and the DAF's Manual to manage Part C o f the project, to the satisfaction o f the Association, including implementation arrangements and responsibilities, time bound action plans, targets to measureprogress towards results, procurement plans and estimated costs o f new activities through the end o f the Project. Evidence that the government has secured the required counterpart funds to inter alia, pay for INIFOM's employees severance payments liabilities stemming from the restructuring o f the institute, will be a condition for disbursement. The World Bank 1818 H Street N.W. (202) 477-1234 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Washington, D.C. 20433 Cable Address: INTBAFRAD INTERNATIONAL DEVELOPMENT ASSOCIATION U.S.A. Cable Address: INDEVAS DRAFT 2211112004 ,2004 HisExcellency EduardoMontiel Minister of Finance andPublic Credit Ministryof FinanceandPublic Credit Frente a1Edificio de la Asamblea Nacional Managua, Nicaragua Re: NICARAGUA-Credit No. 3480-NI (Second Rural Municipal DevelopmentProject) Amendment to the DevelopmentCredit Ameement Your Excellency: Please refer to the Development Credit Agreement between the International Development Association (the Association) and the Republic of Nicaragua (the Borrower) dated April 3, 2001 (the Development Credit Agreement), with regard to the referenced Project. We are pleased to inform you that, pursuantto your letter dated October 26, 2004 requesting an amendment to the Development Credit Agreement, the Bank hereby agrees to: (a) create a new component in order to support decentralization reform; (b) expand Project coverage to larger number of Municipalities under the Project; (c) extend the Closing Date to allow the Borrower sufficient time to, inter alia, implement the activities under such new component; and (d) create new disbursement categories and reallocate the proceeds of the Credit to assist in the financing of the management of the revenue sharingmechanism and oversight of municipal administrations. Therefore the DCA i s hereby amended as follows: Section 1.01: This Section is amended inits entirety as reflectedinAnnex A hereto. Section 1.03 i s deleted. Section 2.02 A new sub-section (b) is added to read: "(b) The Borrower shall, for the purposes of each of Parts A, B and C of the Project open and maintain in US dollars in its Central Bank three separate special deposit accounts, namely the INIFOM Special Account, the MARENA Special Account and the DAF Special Account, on terms and conditions satisfactory to the Bank. Deposits into, -2- and payments out of each Special Account shall be made in accordance with the provisions of Schedule 5 to this Agreement." Section 2.03 i s amended to read: "The Closing Date shall be June 30, 2006 or such later date as the Association shall establish. The Association shall promptly notify the Borrower of such later date." Article I11-Execution of the Proiect This Article is amendedinits entirety as reflectedinAnnex B hereto. Article IV -Financial Covenants This Article is amended inits entirety as reflectedinAnnex C hereto. Article V Section 5.01i s amended to read: "Pursuant to Section 6.02 (1) of the General Conditions, the following additional events are specified: (a) that INIFOM shall have failed to performany of its obIigations under the INIFOM Subsidiary Agreement; (b) that CGR shall have failed to perform any of its obligations under the CGR Inter-Institutional Agreement; and (c) that as a result of events which have occurred after the date of this Agreement, a situation shall have arisen which shall make it improbable that INIFOM will be able to performits obligations under the INIFOMSubsidiary Agreement.'' Schedule 1 This Schedule is amendedinits entirety as reflected inAnnex Dhereto. Schedule 2 (a) a new subparagraph (d) i s added under Part A.4 to read as follows: " support the MunicipalTransfers Commission created by Law 466/03 to oversee the implementation of the intergovernmentaltransfers system and provide advise on the application and further development of the revenue distribution formula, including: (i) a base line study of fiscal potential by August 2005, for the full application of the revenue co-sharing formula; and (ii) the proposedrevision of the formula within 24 months from the enactment of said Law." (b) A new component C is hereby created to readas reflectedinAnnex Ehereto. -3- Schedule 3 The paragraphs listed here below are hereby amended to read: Section I, Part C, paragraph 1i s amended to read as follows: "Goods estimated to cost less than $150,000 equivalent per contract, up to an aggregate amount not to exceed $600,000 equivalent, may be procuredunder contracts awarded in accordance with the provisions of paragraphs 3.3 of the Guidelines." Section I, Part C, paragraph2 i s amended to read as follows: "Goods estimated to cost less than $25,000 equivalent per contract, up to an aggregate amount not to exceed $600,000 equivalent, may be procuredunder contracts awarded on the basis of international or national shopping procedures in accordance with the provisions of paragraphs 3.5 and 3.6 of the Guidelines." Section I, Part C, a new paragraph i s added to read as follows: 1. Selection Basedon Consultants' Qualifications Consultant services estimated to cost less than $ 100,000 equivalent per contract may be procuredunder contracts awarded in accordance with the provisions of paragraphs 3.1 and 3.7 of the Consultant Guidelines. Section 11,Part C: former paragraph 1i s being re-numberedto read 2. Schedule 4 A new Schedule "Special Accounts'' is incorporated as reflected inAnnex Fhereto. Please confirm your agreement to the foregoing amendments by signingand dating this letter inthe spaces provided below. This Amendment Letter will be executed in two counterparts, each of which shall be an original. Upon your confirmation, please return one fully executed original to us. The provisions of this Amendment Letter will become effective as of the date of this letter upon receipt by the Bank of one fully executed original of this Amendment Letter. Very truly yours, INTERNATIONALDEVELOPMENT ASSOCIATION BY Jane Armitage Director Central America Country Management Unit Latin America andthe Caribbean Region -4- AGREED: REPUBLICOF NICARAGUA By: Authorized Representative Date: