DOCUMENT OF THE VVORLD BANK GROUP FOR OFFICIAL USE ONLY REPORT NO. 24235 GU MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ONA COUNTRY ASSISTANCE STRATEGY PROGRESS REPORT FOR THE REPUBLIC OF GUATEMALA May31, 2002 Central America Country Management Unit ]Latin America and the Caribbean Regional Office L This document has a restricted distribution and may be used by recipients only in the performance of their | official duties. Its contents may not be otherwise disclosed without World Bank authorization. Government Fiscal Year January l-December 31 Currency and Equivalents Currency Unit = Quetzal (QZ) US$1.00 = 7.8 1QZ (May, 2002) WEIGHTS AND MEASURES METRIC SYSTEM Acronyms and Abbreviations BANGUAT - Central Bank of Guatemala CABEI - Central American Bank for Economic Integration CAS - Country Assistance Strategy CDF - Comprehensive Development Framework CG - Consultative Group CSIR - Country Strategy and Implementation Review EU - European Union FIS - Social Investment Fund (Fondo de Inversiones Sociales) FONAPAZ - National Peace Fund (Fondo Nacional de la Paz) FRG - Guatemalan Republican Front (Frente Republicano Guatemalteco) FSAP - Financial Sector Assessment Paper GEG - Global Environment Fund IBRD - International Bank for Reconstruction and Development EDB - Inter-American Development Bank IDF - Institutional Development Fund IFC - International Finance Corporation IFML - Integrated Financial Management Loan HG - Invest in Guatemala ILO - International Labor Organization IMF - International Monetary Fund LIL - Learning and Innovation Loan LSMS - Learning Standards Measurement Survey MDG - Millennium Development Goals MIGA - Multilateral Investment Guarantee Agency MINUGUA - UN Special Mission to Guatemala NGO - Non-Governmental Organization OED - Operations Evaluation Department PAN - National Advancement Party (Partido de Avanzada Nacional) PER - Public Expenditure Review PRONACOM - National Program of Competitiveness PRONADE - National Program of Education PRSP - Poverty Reduction Strategy Paper TA - Technical Assistance UNDP - United Nations Development Programme Vice President: David de Ferranti Country Director: Donna Dowsett-Coirolo Task Manager: Eduardo Somensatto/Suzana Abbott FOR OFFICIAL USE ONLY GUATEMALA COUNTRY ASSISTANCE STRATEGY PROGRESS REPORT Iable of Contents Executive Summary I. Background and Recent Developments ....................................I * Social and Economic Background ................................... 1 * The Peace Process .....................................3 * Political Developments ....................................4 * Economic Developments .....................................4 II. The Government's Poverty Reduction Strategy .................................... 8 * Growth with Equity ....................................9 * Investment in Human and Physical Capital ................................... 10 III. Prospects, Financing Requirements and Risks . ............................... 12 * Medium Term Outlook ................................... 12 * Financing Requirements ................................... 14 * Risks ................................... 15 IV. The Bank Group's Country Assistance Strategy . .............................. 16 * Evaluation of FY99-01 Assistance .................................... 16 * Portfolio Perfonnance .................................... 19 * Lending during the Previous CAS Period .................................... 19 * IFC and MIGA Experience ................................... 20 * Bank Group Assistance Strategy .................................... 21 * Lending ................................... 27 * Exposure .................................... 27 * Analytical Work .................................... 27 * Role of Other Donors ................................... 28 * Monitoring and Evaluation ................................... 29 IV. CAS Risks ................................... 30 This docume,nt 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. Tables and Boxes Table 1: Key Social Indicators ..............................1 Table 2: Key Economic Indicators ..............................5 Table 3: Medium Economic Indicators ............................. 13 Table 4: Financing Requirements and Sources ............................. 15 Figure 1: Poverty and Inequality Trends ..............................2 Box 1: Progress on Anti-Money Laundering ..............................8 Box 2: Millennium Development Goals ..............................11 Box 3: OED's Country Assistance Evaluation ............................. 17 Box 4: Governance Issues ............................. 26 ANNEXES ANNEX I: The Government's Poverty Reduction Program ANNEX AI: Key Economic and Program Indicators ANNEX A2: Guatemala at a Glance ANNEX B1: CAS Program Matrix FY02-03 ANNEX B2: Selected Indicators of Bank Portfolio Performance and Management ANNEX B3: IBRD Program Summary ANNEX B4: Summary of Non-Lending Services ANNEX B6: Key Economic Indicators ANNEX B7: Key Exposure Indicators ANNEX B8: Status of Bank Group Operations REPUBLIC OF GUATEMALA COUNTRY ASSISTANCE STRATEGY PROGRESS REPORT FY02 EXECUTIVE SUMMARY 1. The Government of Guatemala has recently undertaken important legislative reforms in the financial sector, and has requested assistance from the World Bank and the Inter-American Development Bank (IDB) to support implementation of those reforms. A proposed Financial Sector Adjustment Loan (FSAL) and companion Technical Assistance Loan (FTAL) are being submitted for consideration together with this Progress Report. This Progress Report is being presented at this time to provide an update on the World Bank Group's Country Assistance Strategy (CAS) that takes into account these important reforms, and Guatemala'.s macroeconomic program that is being supported by an IMF Standby. A full CAS for FY03-05 is under preparation and will be presented for consideration by the Executive Directors in FY03. Accelerating preparation of the full CAS to accompany the FSAL/FTAL would not have been advisable, given the importance of consultations underway on the Government's PRSP effort and the related Bank Poverty Assessment. 2. The Peace Accords signed on December 29, 1996, marked not only the end of a long internal armed conflict but also established a broad development agenda aimed at building a more inclusive society. The Accords identified the reduction of poverty, particularly among rural and indigenous people, as essential for lasting peace. The Peace program included a number of policy actions and outcome targets, covering areas such as economic, social, and human development, public sector reforms, justice and human rights, security and reconciliation, in a broad and challenging agenda. 3. Implementation of the Peace Accords has been uneven. Despite successes in some areas, compliance in other areas will require more time, and consequently, targets have been rescheduled. Nonetheless, there is widespread agreement in Guatemala that the Accords renmain the basis the country's medium term development. Perhaps the most important observable trend is the fact that differences within and between the Government and other stakeeholders are now being addressed in the political arena, rather than through any return to insurgent activity. Since the time of the Peace Accords, tuatemala has made signifcant progress in structural reforms, particularly by promoting private participation in infrastructure, eliminating restrictions to trade, improving public financial management, and more recently, increasing revenues and strengthening revenue administration through tax reforms. The fincncial sector reforms supported by the FSAL/FTAL provide an important complement to previous progress. 4. Although not an IDA-eligible country, the Government of Guatemala has elected to prepare a PRSP and presented the results to date of its work to a Consultative Group Meeting chaired by the IDB in mid-February 2002. It is now working on consultations with civil society, and hopes to use the PRSP as an instrument for the preparation of regional and local development programs. The PRSP is not intended to replace the Peace Accords, but rather to complement them and address key policy and institutional issues that are essential to the long- term sustainability of the Accords. 5. The World Bank Group worked closely with the Government and the international community in the design and implementation of the peace program, as described in the last CAS (Report No. 18036 dated June 19, 1998), discussed by the Board of Directors on July 14, 1998. The CAS was designed to support programs aimed at ending the exclusion that has long characterized Guatemala's dualistic society and economy within a CDF-type framework that provided coordination with other donors and civil society. Within this broad theme, the CAS highlighted four areas as the focus of the World Bank Group's program: 1) Building social cohesion and strengthening participatory decision processes; 2) Reducing poverty; 3) Improving economic management to maintain stability and foster growth; and 4) Modernizing the public sector to make it more effective at essential tasks. 6. Bank assistance to Guatemala intensified considerably'during the CAS implementation period. Ten new projects were approvedfrom FY98 to FY01, and the portfolio today contains 13 projects for a total net commitment of US$435.9 million. Assistance expanded considerably in the areas of policy analysis, civil society engagements, decentralization, and special focus on gender and indigenous issues. 7. This Progress Report provides a stocktaking of the achievements and challenges faced in implementing the last CAS, updates information on economic developments and prospects, and sets forth Bank assistance plans during the interim period until the next CAS is ready. Important inputs to the design of the CAS are underway, inc'luding major analytical and consultative work on poverty, which continues to be the main thrust of the Government's development priorities and the focus of the World Bank Group's assistance. The Bank is finalizing a highly participatory Poverty Assessment that builds upon quantitative information from a 2001 Living Standards Measurement Study (LSMS). The analytical work has been completed, and has provided an important input for preparation of the aforementioned PRSP. 8. The Bank's country assistance strategy objectives for FY02-03 remain consistent with those presented in the FY98 CAS. On a broad level, they continue to focus on poverty reduction by assisting Guatemala to secure implementation of the Peace Accords. The four interlinked development priorities outlined in the previous CAS (para. 5) continue to be relevant. Areas currently receiving increased attention include the financial sector and governance, and it is likely that the next CAS will also emphasize health and malnutrition issues more than in the past, reflecting thefindings of the Poverty Assessment and the Government's PRSP work MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND D)EVELOPMENT TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY PROGRESS REPORT FOR THE REPUBLIC OF GUATEMALA I. BACKGROUND AND RECENT DEVELOPMENTS Social and Economic Background 1. Poverty and Social Indicators. Guatemala is the largest country in Central America, wiiih a population close to 12 million inhabitants. Approximately half of the population is indigenous, including 23 ethno-linguistic groups. It has one of the highest poverty rates in Latin America, and some of its weakest social indicators. According to a 2001 Living Standards Measurement Survey (LSMS), about 56 percent of the population is poor and 16 percent lives in extreme poverty. Evidence suggests that poverty in Guatemala is higher than in other Central American countries, despite its middle income country status (per capita income of $1,670 in 201)1). 2. Poverty is higher amongst the indigenous population (76 percent), as compared with the non-indigenous population (41 percent), and is almost three times as high in rural as in urban areas. Over 81 percent of the poor and 93 percent of the extreme poor live in the countryside. Guatemala has the second most skewed income distribution pattern in Latin America. The top quintile of the population accounts for 54 percent of total consumption, while the large incligenous population accounts for less than one quarter of total income and consumption (See Figure 1). Table 1 - Guatemala Key Social Indicators 3. Poverty is clearly associated with Incidenc of Poverty lower levels of education, access to physical %of Headcountindex (%oof pop.) assets (including basic utility services, land, National HeconIne(%opp. Poplationa All Poor Extmme Poor and housing), the productivity of labor, and weak social capital. Geographic location and Total Guaterala 100.0 56.2 15.7 household size are also found to be important By Geographic Area correlates of poverty. Disparities in assets Urban 38.6 27.1 2.8 Rural 61.4 74.5 23.8 accumulabon also constitute the mam By Ethnicity sources of inequality, with education (or Non-Indigenous 57.6 41.4 7.7 human capital) accounting for over half of all Indigenous 42.6 76.1 26.5 inequality in Guatemala. Source: Living Conditions Measurement Survey. Instituto Nacional de Estatisticas 2001. 2 Guatemala: Countrv Assistance StrateEv Progress Revort Figure 1: Guatemala CAS: Poverty and Inequality Trends Inequality: % of total consumption Tentative Trends in Poverty over Time received by each quintile (1989-2000) 60% 540ml 100% A 40% - 80% 62%5% 40% - ~~~~~~~~~60%-56o 30% -2 e40% 20% - 10%- 0 ~44 01 Q2 03 04 0 1989 2000 SOUrce. Guatermaa Poverty Assessment, 2002. 4. Guatemala has some of poorest health indicators in LAC, ranking among the lowest for life expectancy (65 years), and highest in maternal (190 per 100,000) and infant mortality (45 per 1000 live births.) Only about 60 percent of the population have access to basic health services. A Poverty Assessment under preparation by the Bank reports that close to half of all children and over two thirds of indigenous children suffer from malnutrition. These poor health and nutrition outcomes are due in great part to the lack of potable water, proper disposal and treatment of sewage and lack of hygiene, especially in handling food. 5. Although Guatemala's performance in education still lags other countries, there has been significant progress lately. Net enrollment in primary education increased from 72 percent in 1997 to more than 82 percent in 2001. Still, with an illiteracy rate of 31 percent, only Nicaragua and Haiti rank worse than Guatemala in LAC. Illiteracy is particularly high among indigenous women (62 percent). Likewise, educational attainment is extremely low (4.3 years on average). While primary enrollment has improved in the last few years, 21 percent of primary school-aged children are still not enrolled in school. 6. Progress is also evident for basic utility services, although some gaps and disparities remain. Overall, about 70 percent of Guatemalan households have piped water and electricity. Almost 90 percent have some kind of basic sanitation, though fewer than half have sewerage. Expansions in coverage have accelerated since the signing of the Peace Accords, but inequalities remain, with significant coverage gaps for the poor. A deficient network of roads, especially in rural areas, effectively limits access of the poor to basic services and constrains the distribution of agricultural crops. 7. The poor are highly dependent on agricultural income (which accounts for about half of the total income of the poorest quintile compared with just three percent for the top quintile). Poorer households are fairly homogeneous in their occupations, dividing their labor primarily between agriculture, self-employment and blue collar jobs, mainly in the informal sector. Women and the indigenous population face both constrained opportunities and discrimination in the labor market, and are limited mostly to lower return jobs in agriculture and the informal sector. Land ownership in Guatemala is among the most highly unequal in the world; the poor Guatemala: Country Assistance Stratezv Proeress Report 3 are less likely to use land markets or possess title to their land than the non-poor, which presents an obstacle to obtaining credit in rural areas. The Peace Process S. Recent developments in Guatemala have been shaped in great part by the signing of the Peace Accords in December 1996. The Accords redefined the country's economic and social development agenda, with the vision to build a more prosperous, inclusive and egalitarian society. The Accords focused mainly on: a) resettlement, re-incorporation and reconciliation issues; b) an integral human development program; c) goals for productive and sustainable development; and d) a program for the modernization of the State. A Peace Commission, which includes representatives of former combatants, Government and civil society, was established to oversee the implementation of the Accords. 9. The Peace Accords contained specific targets and deadlines for achieving the goals of many programs. They included the adoption of policies and expected outcomes in areas such as education, health, the judiciary, the military and police, security, human rights protection, rural development, access to land and land reform, modernization of the public administration, civil service reforms, decentralization, and community participation, among others. 10. The targets were very ambitious, but since signing the Peace Accords, successive governments have made considerable progress in a number of areas, especially in terms of increasing public spending in line with the social and economic targets, reversing decades of under-investment in basic infrastructure and social services, modernizing public sector management, and improving the coverage and equity of education and basic services. 11. Results on other outcome indicators, however, have not been as positive. After proposed constitutional reforms linked to the peace process were defeated in a 1999 referendum, the CGovernment realized it faced considerable challenges in implementing some elements of the Peace Accords. Thus, after the initial strong progress, the reforms lost some momentum, particularly in the areas of security, military reforms, human rights protection and rural development. 12. The implementation of the Peace Accords was also affected by the political cycle. The tiansition to a new Government in early 2000 led to a slow down in the introduction of policies during the campaign, and then to a re-evaluation of the program by the new Government. As a result, the Commission Accompanying the Peace Agreements, in consultation with the new Government, rescheduled many of the targets in late 2000, postponing their deadlines until the year 2004. One of the main factors that have delayed the progress in meeting the Peace Accord targets has been the Government's inability to reach the projected tax revenue target ratio of 12 percent of GDP-a key target for channeling increased resources to tackle poverty. 13. The Peace Accords unleashed expectations of major changes, which in turn brought irncreased intemational support for Guatemala's efforts within a CDF context. At the first Consultative Group (CG) Meeting for Guatemala in January 1997, the international donor community extended offers of aid in excess of $2.0 billion for the 1997-2000 period in support of the peace process. The international community re-affirmed this support at a subsequent 4 Guatemala: Country Assistance Strate-av Proeress Report meeting, where the pre-eminent issue was the need for Guatemala to increase its own efforts to secure additional resources, primarily by achieving the Peace Accord tax revenue target of 12 percent of GDP. The latest CG Meeting for Guatemala was held on February 11-12, 2002. In that forum, the Government presented its macroeconomic program, for which it has since secured IMF support, as well as its plans for financial sector reform and an anti-corruption campaign. The Government also reemphasized its commitment to the re-programmed Peace Accords. Political Developments 14. President Alfonso Portillo took office in January 2000. He was elected by a large majority (68 percent) of the popular vote, with broad support coming from the poorer, rural communities. His administration includes a diverse cabinet, with representatives from different ideological groups and of indigenous peoples. 15. President Portillo was elected under the banner of the Frente Republicano Guatemalteco (FRG), a party that was co-founded by the current President of Congress, General Efrain Rios- Mont and by the current Vice-President, Francisco Lopez. Both men share in the political decision making process within the Administration. The FRG also controls Congress since it secured 61 of the 113 seats during the last elections. 16. Upon assuming office, President Portillo outlined the main policy goals of his administration, including: a) in the economic area, continued liberalization of the economy and the trade regime, increased investments in infrastructure and human capital, reform of the financial sector and of the tax system and efforts to improve tax administration, and strengthened property rights; and b) in the political area, greater transparency in the management of public affairs, reform of the military, strengthened protection of human rights, and more importantly, a continued commitment to the agenda of the Peace Accords. 17. President Portillo is in the third year of his four year term. His administration has confronted many difficulties due in part to a deteriorating economy, growing allegations of corruption and a perceived confrontational attitude towards the elite and the business community. The Government has also been affected by constant changes in cabinet members, and the differing interests of the Executive and the Legislative branches of Government. Constitutional restrictions prevent the President from being re-elected. Recently, the Congress has assumed a growing role in policy deliberation and initiative, and an agreement among several parties has led to the passage of important legislation, including the financial sector laws and laws on transparency and corruption. Economic Developments 18. Economic Background. Guatemala has maintained a respectable track record of growth and stability over the past decade. Since 1990, real GDP growth has averaged 4.0 percent (compared to an average increase in the population growth of 2.7 percent). After reaching a high of 42 percent in 1990, inflation has declined to less than 8 percent in 2001. Guatemala: Country Assistance Stratewjy Prog-ress Report 5 External debt management has been prudent, and today Guatemala has one of the lowest levels of external indebtedness (17 percent of GDP) among countries at similar stages of development. '19. Economic growth on per capita basis, however, has not been sufficiently fast to reduce the country's high poverty rates. The poverty rate has declined from approximately 62 percent in :1989 to 56 percent in 2000 (Figure 1), a reduction of less than 10 percent during a period when income per capita grew by approximately 15 percent. Economic growth has had a low impact on poverty since the traditional agricultural sector--where most of the rural poor are either employed or depend-grew at only around 3 percent per year, or one percentage point lower than the wvhole economy, during the same period. Table 2: Guatemala - Key Economic Indicators * (as % of GDP, unless otherwise indicated) Actual Estimate 1997 1998 1999 2000 2001 National Accounts and Prices RealGDP (%change) 4.4 5.0 3.8 3.6 2.1 Consumer price index (% change, average) 9.2 6.6 5.2 6.0 7.3 Real exchange rate, % change, (Us/Qz) 13.0 2.4 -8.9 1.6 5.5 Gross Domestic Investment (as % of GDP) 13.7 17.4 17.4 18.1 16.2 Gross National Savings (as%ofGDP) 9.8 12.1 11.8 13.6 10.9 Central Government finance Total revenues 9.4 9.7 10.5 10.5 11.0 Total expenditures 10.1 11.9 13.3 12.4 13.8 of which, Social expenditure 4.3 5.8 5.3 5.0 5.5 Deficit (-) Surplus (+) -0.4 -2.2 -3.3 -2.2 -2.8 of which, Net Foreign financing 2.0 1.5 2.4 0.9 0.9 Balance of Payments Exports of GNFS 17.8 17.8 18.8 19.9 18.4 Imports of GNFS 23.5 25.9 27.2 27.8 27.7 Current account balance -3.9 -5.4 -5.6 -5.5 -5.3 Reserves as months of imports of GNFS 2.8 2.9 2.6 3.9 4.8 Public and Publicly Guarantee Debt Total Debt 20.2 20.1 23.7 23.1 22.3 Domestic Debt 5.4 5.0 5.8 5.8 5.4 External Debt 14.7 15.0 18.0 17.2 16.9 External Debt Service / Exports of GNFS 16.5 14.5 14.1 20.2 22.5 Memorandum items Gross domestic product (US$ million) 17,768 19,306 18,225 19,070 20,573 Source: Bank of GuateTnala, IMF and World Bank Staff estimnates. GNFS = goods and nonfactor services *See Annex B6 for a complete list of economic indicators. 6 Guatemala: Country Assistance Stratenv Progress Report 20. The last decade also witnessed important structural reforms, particularly in the areas of communications, infrastructure and trade. The liberalization of the power and telecommunications sectors in the mid-nineties has led to a significant increase in the coverage of these services. The economy has also gained from the dynamism of increased trade and integration; today Guatemala's economy is fairly open and with low levels of protection. Exports account for more than 18 percent of GDP, and are increasingly more diversified, both geographically and by product. 21. Despite some fluctuations, fiscal policy has also been relatively stable, with central government budget deficits averaging about 1.5 percent of GDP over the last ten years. The perennial shortcoming of fiscal policy, however, has been the very low levels of taxation, which have inhibited public investment in much needed infrastructure and social programs. Guatemala's main challenge has been to raise tax revenues, which were around 8 percent of GDP in 1995 and have been gradually raised to an estimated 9.7 percent of GDP in 2001. 22. The Peace Accords called for an important increase in government spending on social services. As a result, in recent years budget deficits increased as tax revenues did not keep pace with increases in spending: the Central Government budget deficit rose from 0.6 percent of GDP in 1996 to 2.8 percent in 2001. During the same period, expenditures as a share of GDP rose from less than 10 percent to 13.8 percent of GDP, with the bulk of the expenditures in the social sectors and for investment. 23. Economic policies have also been subject to fluctuations during the political cycle. In the run-up to the 2000 Presidential election, the Government pursued expansionary monetary and fiscal policies resulting in a widening of the current account deficit, a depreciation of the currency and the loss of foreign exchange reserves. Macroeconomic conditions were aggravated by adverse terms of trade movements, particularly due to depressed coffee prices, and unprecedented weather related conditions, including the impact of Hurricane Mitch in late 1998. 24. Recent Developments. The first two years of the Portillo Administration were marked by some important accomplishments. Faced with a deteriorating macroeconomic situation upon assuming office, the Government assigned high priority to stabilizing the economy. It pursued initially a policy of restraining expenditures and liquidity through aggressive open market operations. As a result, the Central Government deficit was lowered to 2.2 percent of GDP in 2000, interest rates on bank loans declined sharply from an average of 27 percent in late 1999 to less than 20 percent a year later. Capital began to flow back to the country and international reserves increased sharply to $1.8 billion at the end of 2001 (close to 5 months of imports). 25. A relaxation of fiscal policy at the beginning of 2001 led not only to a higher budget deficit for the year (2.8 percent of GDP) but prompted increased domestic and foreign borrowing. The Government in November 2001 successfully issued Eurobonds, after receiving a BB risk rating from two of the major rating agencies. Inflation also rose slightly during 2001 reaching 9 percent (e.o.p.), in part because of the price effects of an increase in the value added tax rate, as described below. 26. Despite improvements in macroeconomic management, the growth rate has been declining over the last two years (Table 2). The economy has been affected adversely by a series of shocks, particularly from external sources, and by an uncertain investment climate. The sharp Guatemala: Country Assistance Strateev Progress Renort 7 decline in international coffee prices, of close to 50 percent over the last two years, has had a devastating impact on the coffee sector. Coffee has been the country's main export for many years, accounting for 18 percent of total exports and generating $549 million in revenues in 2000. In 2001, the value of coffee exports declined to $304 million, a loss in revenues equivalent to 1.2 percent of GDP. As a result, the value of Guatemala's total exports declined by 11 percent in 2001 and the trade balance widened to $2,290 million (11 percent of GDP). Coffee exports and production are expected to decline further in the near term, posing a major constraint on economic recovery. 27. The slow down in global economic activity has also contributed to the decline in growth. In the short run, Guatemala's overall economic performance is correlated closely to the performance of its main trading partners, particularly the United States. Estimates show that a decline of one percentage point in quarterly GDP growth in the US leads to a similar reduction in the index of economic activity in Guatemala. Finally, investment was also lower in 2001 (Table 2), in part due to economic conditions but also due to the business climate. Uncertainty regarding the Government's position on tax policy-clarified with the adoption of the tax package described below--and public campaigns by business associations questioning Government policies fueled doubts regarding business conditions and led to a postponement of investments. 28. In the midst of these difficult conditions, the Government introduced some important structural reforms. Perhaps the most significant has been in the area of tax revenues. Since taking office, the Government has taken measures to raise revenues by increasing the income tax rate from 25 to 31 percent, by widening the coverage of the Value Added Taxes, and by eliminating some exemptions. It subsequently took additional measures by increasing the Value Added Tax (from 10 to 12 percent), and introduced important reforms to the tax and penal codes, enhancing the powers of the tax administration by allowing closure of establishments in arrears, remnoving banking secrecy on tax related information and allowing electronic tax payments. In addition, with Bank support the Government introduced joint inspections of customs and tax inlbrmation, increased the number of audits, and improved the number and operations of the Large Tax Payers Unit. These measures are expected to raise tax revenues from 9.7 percent of GI)P in 2001 to an estimated 10.6 percent of GDP in 2002. 29. The Government has also taken important action to start address weaknesses in the banking sector. Guatemala's financial sector grew considerably in the last two decades, but has been under some stress in the last few years due to a deteriorating portfolio. Some small banks have confronted liquidity and solvency problems and remained in operation in part with support from emergency loans from the Central Bank (Banco Central del Guatemala - BANGUAT) and dqposits from the public sector, including the social security institute. In recognition of the long term costs of such strategy and the inability to sustain it, the Government intervened, paid off fully the depositors, and is in the process of closing three small banks. The initial cost of these interventions (close to $200 million) was absorbed by the Central Bank in 2001. 30. Congress recently approved four important laws that modernize financial sector legislation (some of the laws dated back to the 1940s). These laws establish a new legal framework for the operation of banks and financial groups, as well as conduct of monetary policy and the operation of the Central Bank. The Bank and Financial Groups Law introduces modem rules for the formation, operation and the closure of banks, new methods for 8 Guatemala: Country Assistance Strategv Pro-aress Report consolidating the balance sheets of financial groups (including off-shore operations), a new limited deposit insurance mechanism, and risk-based capital requirements. The new Central Bank Law enhances the autonomy of BANGUAT, clears its balance sheet, makes its operations more transparent and establishes price stability as the main objective of monetary policy. The new Banking Supervision Law gives stronger powers to a more independent and professional Supervisory Board and establishes the concept of consolidated supervision. The new Monetary Law eliminates restrictions on capital flows and certifies the concept of convertibility. Together with legislation approved last year to control money laundering, these laws constitute a comprehensive and far reaching set of sectoral reforms. Box 1 - PROGRESS ON ANTI-MONEY LAUNDERING As part of its financial sector reforms, the Government of Guatemala approved a new Anti-Money Laundering Law in December 2001. This new legislation aims to prevent, control, supervise and sanction those transactions deemed to be carried out with illicit funds. The new law has gone into effect, and already the Banking Supervisory Agency has obtained several reports of suspect transactions, which it is investigating. The Govermnent has requested technical support from the World Bank and other international agencies to implement the reforms under this new law. The Bank's assistance is included in the Financial Sector Technical Assistance Loan that is being presented to the Board with this Progress Report. As a result of this progress, the Government is hopeful that Guatemala will be removed from the list of non-cooperative countries and territories when the Financial Action Task Force on Money Laundering next meets to review the list. 31. The Govermnent has also pursued other structural reforms. Under the auspices of the ILO, important changes aimed at reinforcing worker's rights were introduced to the labor code. These reforms strengthened the collective bargaining process, the role of minimum wages in the agricultural sector and the right to strike. The Government also continues to pursue free trade policies, including negotiations of trade agreements with Mexico and other Central American countries. The Government is now negotiating a Free Trade Agreement with Canada and the United States, jointly with other Central American countries. In preparation for negotiations, the Government has begun to harmonize trade policies and improve product certification and health inspections. II. THE GOVERNMENT'S POVERTY REDUCTION STRATEGY 32. President Portillo plans to pursue several initiatives during the remainder of his administration to further the process begun with the Peace Accords. The Government's program is anchored in its Poverty Reduction Strategy and macroeconomic program which is aimed at maintaining macroeconomic stability and improving social expenditures. The Government recognizes that Guatemala's key long-term challenge is to sustain the peace process by ending the exclusion that led to the conflict and by reducing the levels of poverty, especially extreme Gu atemala: Country Assistance Strateev Progress Revort 9 poverty. As a result, poverty reduction has been placed at the center stage of the Govermment's policy agenda. 33. Recently, the Government completed a comprehensive Poverty Reduction Strategy (PRSP), Estrategia de Reducci6n de la Pobreza, to make operational its commitments under the Peace Accords. The Government views the PRSP, which was presented at the CG Meeting in February 2002, as a blueprint to improve the social conditions of the poor. The PRSP was developed to provide a framework that could focus the Government's and country's efforts and associated support from the international community. The PRSP establishes clear targets to be achieved in many areas between 2002 and 2005. Details of the Government's program and the policy content of the PRSP are presented in Annex I; a brief summary of the main points is provided below. 34. The PRSP and the Government's economic program are built on three main pillars: * economic growth with equity; * investment in human capital; and * investment in physical capital. Growth with Equity 35. Guatemala must raise its level of economic growth if it is to make significant progress in re(lucing poverty. Recent growth performance has been disappointing, particularly in the those sectors that employ the poor, such as agriculture. The PRSP establishes clear social indicators for the next few years that can only be met if there is a strong economic recovery and growth reaches at least 4 percent per annum. The Government plans to achieve stronger economic growth in the near and medium term by: a) maintaining macroeconomic stability; b) reforming and strengthening the financial sector; c) reorienting public expenditures to the social sectors and inirastructure; and d) promoting agricultural and rural development. 36. Macroeconomic stability is expected to be achieved by reducing the public sector deficit to 1.5 percent of GDP in 2002, by pursuing monetary policy consistent with a rate of inflation in the 4 to 6 percent range for the year, and by maintaining a competitive and flexible exchange ral:e. Macroeconomic stability will be key to growth prospects since sharp policy fluctuations in the past, particularly prior to elections, led to a boom and bust cycle of credit and investment that were detrimental to long run economic growth. 37. The financial sector reforms (para. 30) should strengthen commercial banks' ability to expand credit to new sectors and customers, particularly to smaller and medium enterprises that heretofore have not been widely served. The reforms should make the sector more competitive and better poised to confront the challenges of global and regional integration. More importantly, they should improve capital and financial positions, prevent a deterioration in the banks' portfolios, and thus help to fend off a possible crisis that could have detrimental effects on growth. 10 Guatemala: Country Assistance Strategv Progress Report 38. The Government plans to increase and improve investment in power and transport infrastructure by offering concessions to the private sector. These investments would include among others hydroelectric plants, roads, maritime port services, and airports, and the concessions are to be complemented with new laws governing some of the sectors, especially in transport. The other component is the National Competitiveness Program that is being launched with Bank support, and is designed to improve product promotion and help develop new markets. 39. Finally, the Government is attempting to address the plight of the agricultural sector, which has been affected adversely by several shocks recently. In order to give coffee producers, particularly the small and medium farmers, time to confront the crisis in the sector, the Government has created a $100 million fund designed to help with diversification and debt rescheduling. For subsistence farmers, who are mostly indigenous and rely on small family plots, the Government is providing subsidized seeds and fertilizers to ensure food security. 40. The Government has already moved ahead by announcing a complementary program of economic reactivation policies including plans to: accelerate the process of infrastructure concessions to the private sector, adopt new laws to liberalize transport, promote standards and market development, and deal with problems in the agricultural sector. 41. Investment in Human and Physical Capital. While recognizing that macroeconomic stability and economic growth are important prerequisites for tackling poverty, the PRSP also notes that growth must be accompanied by deliberate efforts to accelerate social development. Thus, the PRSP's second pillar relates to increasing public investment devoted to human capital, especially targeted at the poor. The Goveriunent's strategy proposes that these investments should concentrate in food security, education, especially preschool and primary, and in health, emphasizing preventative primary health care. To ensure that public resources are directed at the neediest, the poverty map-prepared using information from the 2000 LSMS carried out with support of an IDF grant--will be used as the basis of targeting of expenditures. 42. A major contribution of the PRSP is to identify the resources required to reach target goals for expanding the coverage in education and health. The Government estimates that to reach the goals for education, including the expansion of coverage, 200,000 new scholarships for girls and improvements in feeding programs and literacy, it will require increasing annual allocations that reach approximately $160 million per annum by 2005. Similarly, the expansion of health services in rural areas, along with broader preventive services to reach the goals established in the PRSP, would require increasing annual allocations that reach an estimated $110 million per annum by 2005. 43. The PRSP's third pillar is investment in physical infrastructure, particularly in the poorest and most remote areas of the country. Actions to extend coverage of basic infrastructure will be focused on water supply, basic sanitation, roads and energy. Most of the investments are to be carried out by social funds, and priority will be given to areas with limited or inefficient services. The social funds in Guatemala currently invest close to $200 million annually. The needs identified in the PRSP to improve water and sanitation alone would amount to approximately $60 million per year. Guatemala: Country Assistance Stratea'v ProRress Report 11 44. The Government's strategy to improve service delivery and empower communities relies on decentralization as an objective and a mechanism for implementation. Three new laws rec,ently approved by Congress (a new Municipal Code, the Law on Regional and Local Councils, and a Decentralization Law) have established a new institutional framework for decentralization. The Government intends use these laws to begin transferring gradually greater responsibility for local services to the municipalities. The main objective is to improve service delivery and make the operations more responsive to community needs. The Government is also considering a reform of its social funds to complement the decentralization process and make the operations of the funds more community demand driven. 45. The PRSP also incorporates four general implementation principles. First, it assigns preferential attention to the rural areas, using the poverty map to prioritize investments in poorer areas. Second, it emphasizes the need to modernize further public administration, in order to increase the effectiveness of public expenditures and to strengthen tax collection capabilities. Third, it identifies decentralization as the primary vehicle for coverage expansion and for improvement in supervision and monitoring of public social expenditures. Finally, it highlights the role of consultations with affected groups as the means to gauge better the needs of the population and to obtain suggestions in the design of priority investments. The PRSP also identifies three cross-cutting themes for the design of specific actions: multi-culture and inter- culture, gender equality, and the reduction of vulnerability to natural disasters. Box 2: THE MILLENNIUM DEVELOPMENT GOALS The Poverty Reduction Strategy Paper establishes clear goals for the next few years for the most inportant Millennium Development target indicators. The PRSP identifies the irmprovements in 5 of the 8 indicators expected to be achieved by 2005. This is an important development since it helps to focus public policy towards achieving the MDGs. While Guatemala had been making some progress towards achieving the MDGs, the progress had not been fast enough and had not been part of a concerted effort by the Government. Now the PRSP targets will provide the basis to measure the success of the Government's program with respect to achieving the MDGs. Poverty reduction in Guatemala has been slow. Although comparable numbers are not available, estimates reveal that since 1990 the poverty rate has been reduced from 62 to 56 percent of the population. The PRSP identifies a target for reducing extreme poverty from 16 percent of the population at present to 13 percent by 2005. The second most important goal is to expand net primary school enrollment from 82 to 88 percent by 2005. This will require an increase in public spending of $180 million. The Bank is supporting this goal with an ongoing operation of $62 million. The goals of the program also call for improving the attendance of girls tirough a scholarship program for 200,000 primary school-aged girls. The PRSP also identifies programs and fmancing requirements to reduce child mortality from the current 45 to 35 per thousand by 2005, and maternal mortality from the current 190 to 100 per 100,000 live births by 2005. Achieving both of these targets might require an increase in health expenditures for the next four years of $134 million. To complement the health goals and improve environmental sustainability, the PRSP also proposes to increase access to potable water and sewage to 60 percent of the rural households (from the current 44 percent). The PRSP identifies goals that are specific to Guatemala's needs but not explicitly included in the MDGs, such as expanding the rural electrification coverage to 90 percent of the rural households (from today's 70 percent), and expanding the network of rural roads. Finally, it also sets targets for expanding the transfer of Lund to grouvs of landless Door farmers 12 Guatemala: Countrv Assistance Strateyv ProEress Report 46. The Government sees further development of the Poverty Reduction Strategy as a participatory process, where not only key sectors of society will be asked to provide additional inputs, but will also be called to develop similar regional and local development strategies consistent with the goals and approach of the PRSP. The Government is now proposing to use the PRSP consultations and discussion also as a tool to assist regional and local councils in preparing their own plans. 47. Finally, the Government has used the PRSP to raise public awareness about the Millennium Development Goals (Box 2), as there had been until very recently little discussion of and attention to these goals in Guatemala. With the PRSP, there is a greater focus on the actions that might be needed to reach those goals. As noted in the Box 2, the PRSP has established the framework necessary to achieve the MDGs, but unless growth is accelerated on a consistent basis Guatemala will also have difficulties in reaching them. HI. PROSPECTS, FINANCING REQUIREMENTS, AND RISKS Medium Term Outlook 48. With the successful implementation of the PRSP and the Government's economic program, Guatemala's economic outlook should improve. The macroeconomic program signals the Government's commitment to maintain macroeconomic stability and to ensure a stable and smooth economic transition to a new Government in 2004. It also identifies policies that could contribute to growth, such as the financial sector reforms, improvements in public investment, support for a rural development strategy, and movement towards free trade arrangements and places the country in a position to benefit in the near term from the expected recovery in world growth and trade. Thus, in the next two years, GDP growth is projected to return to the average rate of the last decade, around 4 percent per annum. Still, this projected growth is rather modest and not sufficient to reduce sharply the country's high poverty rates, and there are several constraints, such as the crisis in the coffee sector, limited increases in Government spending, and a possible reductions in bank credit growth that may likely restrict Guatemala's growth performance. 49. Implementation will be key to the program's success. Continued compliance with the commitments and continued support from the IFIs should help enhance the credibility of the Government's program and improve the investment climate. Investors should be encouraged by the prospect of a stable transition and the reduction of policy fluctuations that have been prominent in previous political cycles. Thus, the resurgence of investment from the current level of around 16 percent of GDP to more than 17 percent of GDP by 2004 is expected to be one of the principal contributors to the projected increase in economic growth. 50. The expected recovery of the global economy should also improve Guatemala's prospects. Exports are projected to increase by approximately 2 percent in 2002 and then resume a growth pattern more consistent with projected world trade flows. The Government is committed to preserving a market based exchange rate system, which should contribute to export competitiveness. Non-traditional exports are likely to benefit the most from the economic Guatemala: Country Assistance Strateev Progress Reyort 13 recovery of Guatemala's main trading partners. With imports rising along with domestic demand, the current account balance should decline sligfitly over the next few years. In 2002, the current account deficit will still be close to 5 percent of GDP, with most of the financing expected to be provided by private flows. The high current account deficit, however, remains a source of concern and makes the economy vulnerable to shifts in capital flows. Finally, in the short run, plans to provide financial support to poor farmers through subsidized seeds and fertilizers should ameliorate temporarily their situation and ensure the maintenance of the subsistence fanning. TABLE 3: MEDIUM TERM MACROECONOMIC SCENARIO* (as % of GDP, unless otherwise indicated) Estimate Projected 2001 2002 2003 2004 National Accounts and Prices Real GDP (% change) 2.1 2.3 3.3 4.0 Consumer price index (% change, average) 7.3 6.5 7.3 6.6 Real exchange rate, % change, (Us/Qz) 5.5 1.1 1.3 0.6 Gross Domestic Investment (as % of GDP) 16.2 16.2 16.6 17.1 GrossNational Savings (as %ofGDP) 10.9 11.3 11.8 12.7 Central Government finance Total revenues 11.0 11.5 12.0 12.3 Total expenditures 13.8 13.0 14.0 13.8 of which, Social expenditure 5.5 5.2 5.6 6.4 Deficit (-) Surplus (+) -2.8 -1.5 -2.0 -1.5 of which, Net Foreign financing 0.9 1.0 1.2 0.7 Balance of Payments Exports of GNFS 18.4 17.9 17.8 17.8 Imports of GNFS 27.7 26.7 26.3 26.0 Current account balance -5.3 -4.9 -4.7 4.4 Reserves as months of imports of GNFS 4.8 4.2 4.1 4.1 Public and Publicly Guarantee Debt Total Debt 22.3 22.2 22.6 22.6 Domestic Debt 5.4 5.0 5.0 5.1 External Debt 16.9 17.2 17.6 17.5 External Debt Service / Exports of GNFS 22.5 19.9 20.7 20.8 Memorandum items Gross domestic product (US$ million) 20,573 21,751 23,294 24,928 Source: Bank of Guatemala, IMF and World Bank Staff estimates. GNFS = goods and nonfactor services *See Annex B6 for a complete list of economic indicators. 51. In the medium term, growth could benefit from the Government's recently announced reactivation program and the implementation a comprehensive program to improve productivity and develop new markets through the National Competitiveness Program (PRONACOM). This 14 Guatemala: Countrv Assistance Strateev ProEress Report joint partnership between the public and private sector is designed to help attract new investment and promote non-traditional exports, and should help improve the business climate and opportunities. The reactivation plan to open infrastructure for concessions and to increase investments in infrastructure will at best yield results in a few years, and it is not expected to have a large impact during the projection period. 52. The Government intends to redirect spending towards the social sectors to ensure that economic growth benefits the poor during a period of fiscal restraint. Under the program, total social spending is expected to rise from 5.2 percent of GDP in 2002 to 6.4 percent of GDP over the next two years. The efficiency of these expenditures should improve marginally as the Government proceeds with its intended program of social investment reforms in the social investment areas. The Government is also committed to introduce tax policies that will raise tax revenues over the next two years closer to the Peace Accords target of 12 percent of GDP. Financing Requirements 53. The program's success depends in great part on the Government's ability to secure the required financing. Guatemala's 2002-2003 financing gap is approximately $225 million. These requirements arise from an expected current account deficit of close to $1.06 billion per year, a small budget deficit of the consolidated government (which includes the losses of the Central Bank), the amortization of some $1.14 billion of loans, and also the contingent financing needed to support the financial sector modernization process (including the initial contribution by the Government to the Deposit Insurance Fund). As shown in Table 4, Guatemala is expected to attract considerable financing from the private sector. Besides the expected capital flows and, in particular, remittances from Guatemalan expatriates (currently the country's largest source of foreign exchange earnings), Guatemala anticipates receiving as much as $175 million of foreign investment per annum. Even with these expected inflows, the Government will need to use approximately $200 million of foreign exchange reserves and will need to rely on the support of the IFIs in order meet its financing needs. 54. More broadly, Guatemala is looking forward to continued support from its bilateral donors and other multilateral agencies for a successful implementation of the PRSP. The Government has estimated that more than $2.9 billion will be required over the next three years to finance additional programs and the expansion of existing programs identified in the PRSP. More than half of these expenditures will be covered by internal financing. The rest would have to be complemented by foreign financing. At the CG Meeting last February, the Government was able to secure commitments from the international community amounting to $1.4 billion for the next three years. Thus, if the Government is able to fulfill the commitments made at the Consultative Group Meeting, it should be able to raise sufficient funds to finance its program. Guatemala: Country Assistance StrateRv Proeress Report 15 Table 4: Guatemala - Financing Requirements and Sources (in mnillions of US$) 2000 2001 2002 2003 Combined Public Sector and Banking System Financing Requirements -375.7 -856.5 -474.0 -584.1 Central Govermment Deficit -413.8 -566.3 -327.8 -459.8 RestoftheNFPS 114.4 123.4 108.8 116.5 Central Bank Deficit -76.3 -164.6 -130.5 -139.8 Banking Sector Requirements ... -249.1 -124.5 -101.0 Financing Sources 375.7 856.5 349.5 483.1 Net External Borrowing 171.7 190.8 217.9 288.0 NetInternalBorrowing 74.5 304.4 74.7 195.1 Privatization Proceeds 129.5 361.3 56.9 0.0 Financing Gap 0.0 0.0 -124.5 -101.0 Memorandum items Annual average exchange rate (Qz /US$) 7.77 7.88 8.12 8.40 Source: Bank of Guatemnala, IMF and World Bank Staff estirmates. Rtisks 55. The program faces several external and internal risks. A possible delay in the recovery of the global economy could postpone the resumption of faster economic growth in Guatemala. UJnder such conditions, the burden on the financial sector could grow as both enterprises and households continue to have difficulties servicing their loans. Under this scenario, tax revenues would also be lower than expected and the Government might be faced with the need to reduce expenditures further or to increase taxes during a period of a slow growth. 56. One possible risk is the reduction in credit growth that could take place as a result of the capitalization needs of the banking sector. Under the new financial sector laws, commercial banks will have to increase their capital, particularly as their operations are consolidated with the inclusion of the off-shore facilities. Total capital requirements are still unknown and could restrict the availability of bank credit to the private sector, thus reducing expected growth rates. 57. Another risk is that political pressures for higher public spending may emerge as elections approach next year. This risk is heightened by ongoing difficulties in the rural sector caused by depressed coffee prices. A continued deteriorating trend in the rural sector precipitated by a further decline in coffee prices would not only constrain the Government's poverty reduction efforts but also put additional pressures on the Government's budget, especially during a pre-electoral period. Already in 2002, the budget approved by Congress is coming under significant pressure, since planned expenditures for some programs are not sufficient to cover their needs. The program will test the Government's ability to maintain its fiscal position. Failure to adhere to the budget deficit targets for the next two years would place upward pressures on interest rates, the exchange rate, and inevitably on inflation. Guatemala has wiritnessed the consequences of lax fiscal and monetary policies in the run-up to presidential elections, and any sign that the Government is loosening its stance could lead quickly to capital flight. The Government could attempt to contain the impact of such development by using the 16 Guatemala: Countrv Assistance Strateev Proeress Reort foreign exchange reserves accumulated through the sale of public sector assets (such as the telecommunications and power companies). Such response, however, would place the country in a more vulnerable position. Guatemala is susceptible to natural disasters, such as earthquakes and hurricanes, and thus needs to preserve sufficient foreign exchange reserves in order to cope with the unexpected costs of a possible natural disaster. IV. THE BANK GROUP'S COUNTRY ASSISTANCE STRATEGY 58. This Progress Report presents the Bank's FY02-03 assistance program for Guatemala, while the new Country Assistance Strategy is being prepared. The assistance program is aligned with the priorities that have been established in the Government's program as outlined in the PRSP, and consistent with the analytical input provided in the draft Poverty Assessment. 59. The Government recently accelerated the implementation of important reforms in the financial sector, and has requested Bank assistance for these reforms and its program. The Government also reached an agreement with the IMF on a Stand-by program. Bank support will be provided by the Financial Sector Adjustment Loan and the Technical Assistance Loan that are being submitted for consideration together with this Progress Report. The schedule of the CAS was not advanced to ensure adequate consultations on the Government's PRSP and the Bank's Poverty Assessment that are considered critical inputs for the design and the development of a fuller and more participatory World Bank assistance program. This Progress Report will provide an additional input for discussions with civil society and donors that will be held in parallel with consultations on the Poverty Assessment and the Government's consultations on the PRSP. Evaluation of FY99-01 Assistance 60. Bank assistance to Guatemala expanded considerably over the period of the last CAS. The signing of Peace Accords in 1996 paved the way for increased lending and non-lending assistance by the Bank, as well as by Guatemala's other external donors. With increased lending, coordination efforts intensified. The IDB has taken the lead in organizing CG meetings at regular intervals. The Bank's participation in this process has been guided by the last CAS, where the Bank Group committed to work with many partners-the Government, the Peace Commission, civil society, international lenders and donors-to solidify the peace process. Bank assistance supported programs designed ultimately to reduce the exclusion that has long characterized Guatemala's dualistic society and economy, and its focus was on: building social cohesion and strengthening participatory decision processes; reducing poverty; improving economic management to maintain stability and foster growth; and modernizing the public sector to make it more effective at essential tasks. G'uatemala: Country Assistance Strateev Proe'ress Report 17 Box 3: Operations Evaluation Department's Country Assistance Evaluation The Operations Evaluation Department has recently carried out a Country Assistance Evaluation (CAE), which reviews the Bank's assistance to Guatemala over the last fifteen years. The CAE highlights the significant increase in the efficacy of Bank assistance during the period. It notes that assistance was satisfactory during the 1990s as a result of Government ownership of the program and its sharper focus in supporting the Peace Accord objectives of eliminating poverty, inequality, and social exclusion and in assisting people in rural areas-mainly indigenous-gain access to education, land, rural and urban markets, and access to the legal system. Adjustment lending and support for the improvements in the Government's system of public financial management were also important aspects of Bank assistance. The report also highlights the improvements in the Bank's analytical capacity and country dialogue in recent years. The CAE rates the outcome of the Bank's assistance as unsatisfactory for the 1985-90 period and satisfactory for the 1991-2000 period. Institutional development impact is rated as modest and the sustainability of the Bank's assistance program is rated as likely. The Recommendations of the CAE will be taken into account in the preparation of the FY93-95 CAS. In fact, most of the recommendations are consistent with the thrust of the ongoing and future assistance program, as presented in this Progress Report. The reconmmendations include: * Growth with stability: The Bank should focus on strengthening the financial system by improving the regulation and supervision of financial institutions. * Reduction in poverty and exclusion: The Bank should support programs for primary education, rural roads, and basic infrastructure for rural communities, titling of land to the poor, and strengthening of the judiciary. The design of Bank-supported programs should ensure that the benefits also reach indigenous people. * The Bank should support redirecting Government expenditure in education, health, electricity, water supply, and sanitation towards the poor. * The Bank should support the Social Investment Fund (FIS) if: (i) FIS is made more accountable and transparent; (ii) the communities have more power to select and manage projects; and (iii) the Government streamlines the various social funds currently in operation. 61. The last CAS had identified three criteria for judging the success of the Bank's assistance. They were: achievement of the broad socioeconomic targets established in the Peace Accords; sector specific indicators in the context of project implementation; and the effects on living standards in San Marcos, a region where three innovative projects were being irnplemented and where the Bank was to open a domestic regional office. 62. What worked well. Bank assistance provided direct support in many areas established wader the Peace Accords, and had its greatest impact on education for poor indigenous communities, public sector modernization, and the delivery of basic services to the poor. In education, the Bank supported the creation and has financed PRONADE - a community based p]rimary education program, which has been responsible for a sharp increase in primary school coverage. The program now covers 10 percent of primary education (all in rural areas not served by the regular programs of the Ministry of Education). The schools are run by parent committees, and greater community participation has led to better student attendance and performance. Financing for PRONADE has focused on teachers' training, scholarship for girls, and development of teaching materials in Mayan language. 63. In the area of public sector modernization, Bank assistance has been key to improving the public sector financial management, tax administration and the judicial sector. The Bank has supported through a series of operations the introduction and development of the Integrated 18 Guatemala: Country Assistance Strateev Progress Report Financial Management System, which introduced new budgeting, accounting and cash management systems in the Central Government. The financial management system has been recognized for its contribution to increasing efficiency and improving transparency. The Bank has also helped improve tax collections through the modernization of the now autonomous tax administration agency, and has supported Judicial Sector reforms aimed at modernizing many of the processes in the court system, at improving efficiency and general access to justice. 64. Bank support for the delivery of basic services to poorer communities has been channeled primarily through social funds and the rural roads programs. The social funds (FIS and FONAPAZ) have financed a large number of small scale infrastructure projects that contributed greatly to the expansion of coverage in poor rural areas. But experience has shown that the basic operations of these funds need improvement, particularly in fostering a more decentralized and community demand driven approach. A pilot road program has used this decentralized approach and demonstrated the merits of community involvement in project design. The Rural Roads Project helped create an unique and effective regional association of mayors who contributed to the financing and maintenance of the roads in consultations with their communities that has become model for other municipalities, and is now being replicated country wide. 65. Bank assistance also benefited from concentrating support in one region of the country and opening a small satellite office in San Marcos. This northern region is one of the poorest in the country, and the synergy created by a multi project approach located in one place has shown impressive results. The office today houses the executing units for one of the social funds (FONAPAZ), the staff of the Rural Roads Project, the Institute of Municipal Development, the regional association of Mayors, and CARE, which has an important presence in the area. The presence of multiple groups involved with community development in a single place has created a thriving regional center for development where clients can present projects, enquire about sources of financing, and obtain support and advice. The office has also provided on the ground project implementation support. 66. Some Lessons Learned. The Bank's experience has also yielded some lessons on dealing with changing priorities. The only project currently rated as unsatisfactory, Private Participation in Infrastructure Project (Loan No.4149-GT), has shown that when Government priorities change to the point where there is no longer strong commitment to project objectives, implementation will suffer, even though the Bank may be willing to restructure the loan to meet the Borrower's revised objectives. 67. The Bank's experience with the social funds has also revealed areas for further work. Many of the projects should now take fuller advantage of the growing participation and interest by civil society and local communities in the preparation and execution of projects. While the activities supported by the more conventional social fund supported by the FIS have implemented quickly in expanding basic services, the evolution towards a more community driven development mechanism has taken longer than expected because of the additional time needed to build capacity at the local level and the limited availability of counterpart resources. The current process of decentralization and self determination highlight the need to design projects that are community demand driven and more responsive and tailored to local needs. The Bank is currently working with the Government to develop a more community demand driven approach for future assistance, including possibly direct support to municipalities and communities through greater decentralization to the local level. Guatemala: Country Assistance Strateev Proeress ReDort 19 68. The FY98 CAS noted weaknesses in project implementation capacity, especially the slow pace of project execution caused in part by effectiveness delays. While project execution has been generally good, implementation continues to be affected by approval to effectiveness delays, counterpart funding constraints, and staff turnover. The Bank has worked closely with the Executive to streamline the authorization process for Bank loans, but delays in the submission of loans to Congress to control the timing of their consideration and of Congressional consideration and debate of loans continue to cause delays in signing and effectiveness. To sorne extent this is an issue that affects most countries that require Congressional approval of external financing-and more so in countries reestablishing democratic institutions where Congress provides a live forum for the discussion and debate of national priorities. Recognizing that this process of debate is healthy and desirable, the Bank is trying to work with the Government to facilitate this process by promoting discussions with key actors earlier in the project preparation process. Tight fiscal constraints have affected occasionally the assignment of counterpart resources to Bank-financed projects. While funds are assigned eventually to permit continuity in project implementation, the budget allocation process is often lengthy and the Bank has tried to assist by working with the various Government agencies. Finally, several projects were affected by staff turnover shortly after the change in Presidential Administration in early 2000. This, in some cases, affected the pace of execution. Portfolio Performance 69. The Guatemala portfolio, which had only nine projects under implementation at the time of the CAS, grew rapidly since then as ten new projects were approved from FY98 to FY01. As of March 31, 2002, the portfolio contained 13 projects for a total net commitment of $435.9 million, of which $258.7 million remained undisbursed. The undisbursed balance reflects the age profile of the portfolio and the increase in lending following the Peace Accords. The Guatemala portfolio is relatively new, with an average implementation period of only 3.3 years. Despite sporadic implementation issues-which have mostly been project-specific-- irnplementation has been quite good. Only one of the projects in the portfolio (Private Palrticipation in Infrastructure) is now rated U for Implementation Progress. Lending During the Previous CAS Period 71). The FY98 CAS proposed base-case lending of $310 million over three years (FY99-01). This amount represented a slight increase over the high case proposed in the previous CAS, and was justified on the basis of the signing of the Peace Accords and the introduction of a comprehensive program to address long-standing development needs. The distribution of the proposed $310 million was considered indicative, given the need to retain flexibility, to be able tco complement other donors, and to respond to Government priorities, especially if they reflected greater progress in achieving, certain targets of the Peace Accords. 7L. Actual lending over the CAS period totaled $249.5 million, marginally below the proposed base case scenario. The shortfall was the result mostly of adapting the Bank's lending to areas of assistance that were eventually supported by other donors (Low Income Barrios-an urban project was financed by the IDB), or a slower phasing of the program to reflect longer than expected transition following the change in Government in January 2000. There were also some 20 Guatemala: Country Assistance Strateia Progress Report delays in project preparation, primarily because of their broad participatory approach. As expected, Bank lending was heavily front-loaded-five loans totaling $167 million were approved in FY99. Mirroring the political transition, no new loans were approved in FYOO-and a proposed follow-up Rural Roads Project was delayed until FY03 to reflect actual needs given implementation of an ongoing project. Lending in FY01 was generally in line with CAS expectations. IFC and MIGA Experience 72. Since the last CAS, IFC has approved three projects for Guatemala: a $7 million investment in a banana producer; a $1 million risk management facility to an independent power producer; and, most recently, an $8 million investment (including $2 million in syndications) in a sustainable forestry company. IFC also approved several regional investments that can benefit Guatemala, including a $10 million investment in a private equity fund targeted at medium-sized companies that, in particular, have regionally focused strategies; a $8.3 million equity investment in a regional provider of high speed data and internet services, a $15.0 million investment in a regional power development company that will invest in small to medium sized renewable and co-generation projects; and an $8 million in a Salvadoran bank with a regional focus. 73. IFC has also provided support to the private sector through regional technical assistance projects. One, financed by Italian and IFC Trust Funds, sought to provide assistance to small and medium enterprises in Central America in the areas of (a) project development, (b) training, technical assistance and skill development, and (c) identifying sources of funding for projects. IFC also held training courses in banking and leasing aimed at the management of banks and leasing companies throughout Central America. 74. Following priorities under the last CAS, IFC's strategy is expected to continue to focus on supporting (i) industries and services, infrastructure and the financial sector in Guatemala; and (ii) the development of regional financial and physical infrastructure in Central America. Given the importance of a stable financial sector for private sector development in Guatemala, IFC is currently supporting the government efforts in financial sector reform. In tandem with the Bank's assistance to the sector, IFC is supporting a bank with a proposed investment of $10 million; IFC's first investment in the Guatemalan financial sector that, after a long period, is faced with an opportunity for significant reform and much needed consolidation. The project will strengthen the capital base of the bank and help it play an important role in supporting the consolidation process. The investment will also help prepare the institution to meet the stricter requirements of recently passed financial sector legislation, the implementation of which will be supported by the Bank's FSAL. This investment should also provide a strong signal to the market that well managed Guatemalan financial institutions can attract long term external resources. Going forward, IFC is also looking at a $37 million (including $22 million in syndications) in an independent power producer and a $5 million investment in a private university. 75. In April 2001 MIGA began a comprehensive 24 month technical assistance program to assist the Ministry of Economy in developing institutional and promotional capacity to attract foreign direct investment through the establishment and development of a new investment promotion agency: Invest In Guatemala ( IIG). Working closely with the executing agency of Guatemala: Country Assistance Stratery Pro_are.ss Report 21 the World Bank-financed National Competitiveness Program (PRONACOM), IIG was established in May, 2001 and is already operational. MIGA's assistance has focused on the design of HG, its internal structure and functions, as well as the determination its of budgetary reqluirements. MIGA has provided assistance in the development of program objectives and targets, as well as critical local and international networking. Bank Group Assistance Strategy 76. The Bank's country assistance strategy objectives for FY02-03 remain consistent with those presented in the FY98 CAS. On a broader level, they continue to focus on assisting Guatemala to reduce poverty and accelerate the implementation of the Peace Accords. The four interlinked development priorities outlined in the previous CAS continue to be the fundamental objectives of Guatemala's economic and social development. These are to: a) reduce poverty and. promote inclusion; b) maintain macroeconomic stability and raise economic growth; c) strengthen participatory decision making; and d) improve governance. The Country Assistance Matrix (Annex BI) follows the priorities in the PRSP and indicates how the Bank's program is addressing these strategic priorities, and complementing the work of other donors. The Bank will continue to function as one of many partners within a CDF-like framework-with Government, donors and civil society-in support of the peace program and the implementation of the Government's PRSP. 77. Reduce Poverty and Promote Inclusion. Reducing poverty and promoting inclusion have been the central objectives of the Bank's assistance strategy. Sustained progress in this area will. require a broad-based approach that should include: economic growth and income generating opportunities, particularly in the rural areas; an increase in spending on social programs; more effective delivery of social services that are targeted to the poorest; rapid improvements of infrastructure; and better functioning markets and rural financial systems. 78. As identified in the previous CAS, the largest share of ongoing Bank assistance has been devoted to poverty alleviation projects that address efforts to: (i) expand delivery of basic services, with emphasis on education; (ii) target the social safety net to the poor; and (iii) improve access to sustainable productive opportunities. 79. Bank assistance for the expansion of basic services delivery continues to focus heavily on education. - Following on the success of the recently-completed Basic Education Reform Project (Loan No. 3003-GT), the recently-approved Universalization of Basic Education Project (Loan No. 7052-GT) will provide continued support for expansion of the community based PRONADE program, by bringing schooling to an additional 40,000 rural and mostly indigenous students, and by introducing of a non-formal pre-primary education program attached to PRONADE schools. It will also contribute to the Government's education reform initiative through the development of a new curriculum and the adoption of new text books. 80. Bank assistance for financing of schools, health and small rural infrastructure is also being provided through social funds operations--Social Investment Fund Project (Loan No. 35341-GT) and Reconstruction and Local Development Project--PDL (Loan No. 4379-GT). PDI, is a community demand driven project focused in an area with one of the highest poverty inci(lences and some of the highest concentrations of indigenous population. The approach used 22 Guatemala: Countrv Assistance Strategv PfoLress Report in PDL is serving as basis for discussions on how to make the social funds more responsive to the community needs and to promote decentralization'. 81. The ongoing Rural Roads Project (Loan No. 4260-GT) is supporting continued expansion of Guatemala's rural road network to ensure that physical barriers to transport do not constrain access of the rural poor to markets and basic social services such as education and health. The Bank is now finalizing the preparation of a proposed follow-on project, Rural Roads II (FY03, $90 million), which will extend the pilot program (where communities and municipalities actively participate in the construction and maintenance of the roads) in the region of San Marcos to the entire country. 82. Transforming the traditionally skewed land distribution pattern and clarifying land tenure rights are necessary preconditions for improving access to sustainable productive opportunities for the poor. Two ongoing Bank-financed projects are supporting the Government in its efforts in this area. The Land Administration Project (Loan No. 4415-GT) is supporting regularization of land tenure and conflict resolution mechanisms in the northern province of Peten, and the Land Fund Project (Loan No. 4432-GT) is supporting the operation of a Land Fund that was established to finance land purchases (financed by the Government). Bank financing complements the purchases by supporting investments to improve land productivity, and by providing legal and technical assistance for the beneficiaries. 83. Raising Economic Growth and Maintaining Stability. Sustained poverty reduction in Guatemala cannot be achieved without a period of consistent economic growth. To generate higher economic growth, the Government will need to act decisively to attract foreign and domestic investment, diversify its agricultural production, further the potential for non-farm income, develop access to new markets, and continue to integrate its economy to both regional and global associations. 84. World Bank Group assistance to promote employment and income generating growth is focusing in three areas: a) maintaining a stable macroeconomic environment; b) creating the conditions to attract foreign and local investment; and c) designing targeted programs to increase the participation of the rural poor in economic growth. Unquestionably, this remains one of the most challenging areas for the Bank Group, and the forthcoming CAS consultations will be of The Bank and other donors are engaged in a dialogue with the Authorities on possible reforms of the social funds. The objective is to modernize their operations and make them an instrument for community driven development. The Bank is considering the possibility of supporting this process with a follow on Social Investment Fund Project. A decision would depend on the reform efforts and the establishment of such priority during the forthcoming CAS consultations. Preliminary thoughts are that the project could help transform the funds into an engine for local development by empowering poor communities, strengthening their self-reliance, and improving coordination at the local level. Given the continued high need for basic social infrastructure and services in the country, and especially in rural areas, the project could fund community-based subprojects (including infrastructure and services) for which prioritization, execution, operation and routine maintenance would be carried out by communities in accordance with the principles of decentralization and community-driven development. The project might also pilot a financing mechanism to foster private-public partnership in the delivery of social assistance for vulnerable groups (e.g., migrant workers and their families, exploited children, displaced people) and/or against specific social risks (e.g., domestic violence, HIV/AIDS). ,uatemala: Country Assistance Stratefev Profress Report 23 great value for determining how the Bank can best support these efforts to achieve higher economic growth, especially in the rural areas. 85. In the interim, support for efforts to maintain macroeconomic stability is being provided through several assistance vehicles, including lending, both adjustment and technical assistance, supervision, economic and sector work and other non-lending services. The Bank is carrying out a. high-level policy dialogue and has developed a program of analytical work, in close coordination with the IMF and other donors, to monitor and provide advice on the economic program, especially in the pre-electoral period. Already key inputs in this area, such as the Flublic Expenditure Review and the FSAP, have proven to be of value to the Government. An update of the Public Expenditure Review is planned for FY03. Its primary aim will be to improve the efficiency and focus of social public spending (in line with the recently completed poverty map). Macroeconomic stability will also require continued efforts to increase government revenues, in part through the strengthening of revenue collection and administration. The Bank is supporting these efforts through the ongoing Tax Administration Project (Loan No. 4225-GT), which is providing technical and analytical support to the Tax Administration Secretariat. 86. The financial sector is an area of high vulnerability for the Guatemalan economy. Following joint IMF-Bank technical assistance for the design of the reforms and relevant legislation under the FSAP, the Government has requested the Bank and the IDB to support its financial sector reforms through both a proposed Financial Sector Adjustment Loan (FY02, $150 million) and a proposed Financial Sector Technical Assistance Loan (FY02, $5 million) that accompany this Progress Report 8'7. The proposed Financial Sector Adjustment Loan would support the creation of a modem, stronger and better functioning banking sector, able to improve and expand its intermediating functions and to withstand shocks. The technical assistance loan would help the Bank of Guatemala and the Banks' Supervisory Agency to prepare the regulations needed to implement key legislation, and strengthen and adapt these institutions to carry out their new mandates. Bank assistance would also support efforts to implement the recently approved M oney Laundering Law and its relevant regulations. 88. The Government will need financial assistance to carry out it financial sector reforms because recent legislation has now limited the Central Bank's ability to continue providing funds to distressed banks (either to re-capitalize or restructure them). The financial burden of dealing with troubled banks will now be partially transferred to the Deposit Insurance Fund program, wlhich the Government will have to finance initially. Over time, the banks in the system will contribute to the fund, but at the outset the Government will have to provide sufficient contingent resources. Bank financing will also assist with the mergers and acquisitions required to strengthen the banking system. 89. The reforms of the financial sector are also important for raising the level of investment and economic growth in the medium tern. The structural changes contemplated under the legal reforms will allow the banks and financial intermediaries to expand lending to the private sector and will also open access to groups and enterprises that today are largely excluded frorn commercial financing (micro, rural and small and medium enterprises). The limitations on 24 Guatemala: Country Assistance Strategv Progress Renort connected lending will now create conditions for banks to explore lending to new costumers and to new areas of the economy. 90. The FSAL also has important linkages to the Government's PRSP and to poverty reduction. Experience in other countries show that banking crisis have a significant impact on the poor and often require public resources that could have been used to fund poverty reduction programs. The proposed operation will help the Government strengthen the banking sector and reduce the chances of a possible banking crisis that would divert funds from the Govemment's poverty reduction agenda. The single greatest threat to the peace process would be to not address the issues of the financial sector, since a crisis would have a damaging impact on macroeconomic prospects and would preclude the Government from following its poverty agenda. 91. In the area of private sector development, the Bank's assistance is being provided through the ongoing Competitiveness Project (Loan No. 7044-GT), now in its initial stages of implementation. This project supports the Government's National Program for Competitiveness, a partnership between the public and private sector to improve the productive capacity. of the country, expand its exports, promote the development of small and medium enterprises, create a system of clusters, extend financial and technical assistance support to small producers of non- traditional producers, and establish a system of market and product development information. 92. The promotion of income generation and economic growth in the rural areas are critical to Guatemala's development. The ongoing Land Administration Project (Loan No. 4415-GT) and the Land Fund Project (Loan No. 4432-GT) are supporting agricultural productive initiatives through financing of investments designed to increase the productivity of land beneficiaries. The Bank intends to deepen its efforts in the rural areas with the proposed Rural Roads II Project (FY03, $90 million), which will improve road transport access in the poorer areas of the country, and will provide better access to markets and to social and other public services. Lack of infrastructure is still a major impediment to the growth in rural areas, and rural roads in particular are considered necessary to stimulate economic activity and improve commercialization of non-traditional agricultural products. The project would also generate rural employment through an intensive roads rehabilitation program and will promote the creation of micro-enterprises that could participate in the contracts for rural roads construction. 93. Complementing these initiatives, a proposed Integrated Management of Natural Resources Project (FY03, $35 million), currently under preparation, would provide targeted support for the development of sustainable productive investments in rural areas, including activities to promote small-scale productive activities and natural resource management by using a decentralized approach in which the identification of specific activities and their implementation are carried out by community groups. The project would also strengthen natural resource management to address the high level of environmental degradation taking place in the highlands. The sustainability of growth in rural areas requires an appropriate and balanced use of natural resources. Several ongoing local and regional projects, some financed by the Global Environmental Fund, are dealing directly with the issues of sustainable use and conservation of natural resources., including the Laguna del Tigre (GEF $750,000), Bio-Itza (GEF, $1.47 million), Mesoamerican Biological Corridor (Regional), and the Mesoamerican Barrier Reef (Regional) projects. Guatemala: Country Assistance Strateev Progress Report 25 '4. Non-lending channels are also being used to further policy discussions and dialogue in the area of growth and economic stability. The use of the newly-established Global Distance Learning Network, in association with University Rafael Landivar, provides local access to seminars and courses on macroeconomic topics. Additionally, the Country Development Gateway, under development with the a local NGO and the Chamber of Commerce, will provide better information on attractiveness of the country for foreign investment. 95. Strengthen Participatory Decision Making. Guatemala will not be successful in reducing poverty without the participation of rural and indigenous communities who have been so far marginalized and have not benefited from the country's economic and social development. This requires, among other things, better targeting government spending and programs to poorer communities, and empowering the communities to take greater control of their own development needs. 96. The Bank is promoting efforts to build and strengthen community participation through projects and programs that: (i) foster decentralized decision-making and implementation; (ii) support reforms to make the social funds more demand driven; (iii) strengthen communities and local levels of Government; (iv) improve coverage and responsiveness of the judicial sector in the rural areas; and (iii) expand the Bank's outreach program, including social communications strategies. 97. Ongoing Bank assistance for strengthening communities and expanding beneficiary participation focuses primarily in the rural areas. Many of the projects place rural communities at the center of the decision making. The Universalization of Basic Education (Loan No. 7052-GT), Reconstruction and Local Development (Loan No. 4379-GT), and the Rural Roads (Loan No. 4260-GT) respond essentially to community demands. Support for this approach would expand with the proposed Rural Roads II (FY03 $90 million), which will help create municipal associations that will be responsible for the identification, construction, and maintenance of the roads. Preliminary work is underway to prepare a possible operation that would support the modernization and operations of the social funds. The Government is interested in making the funds more responsive to community needs, and be an instrument to promote the process of decentralization. 98. Improving Governance and Public Sector Management. In recent years, Bank assistance has provided broad support for public sector modernization in all three branches of Government. At the center of this modernization process is the Government's integrated financial management system, which was developed with Bank assistance through a series of Integrated Financial Management Loans (IFML). The system is widely recognized as a case of best practice, and has been instrumental in introducing greater transparency and efficiency in public sector finances. The ongoing Tax Administration Project (Loan No. 4225-GT) has also assisted in the creation of the Superintendencia de Administraci6n Tributaria, an autonomous tax agency, and has helped to improve the professional capacity of its personnel and operational assistance. The ongoing Judicial Reform Project (Loan No. 4401-GT) is supporting efforts to improve the functions, and services of the judicial system, expand the access to justice, strengthen the administrative management, improve the professional capacity ol'judges, and combat corruption. 26 Guatemala: Country Assistance Strategv Progress Renort 99. The recently approved IFML III Project (Loan No. 7104-GT) will provide continued assistance for the Government's efforts to modernize its financial management sub-systems. The focus will be on: (i) expanding the financial management reform effort to decentralized agencies and the 330 municipalities; (ii) extending the management information systems to lower levels of the ministries and agencies; and iii) reforming the central Government's human resources function. The project will also strengthen the role of the Comptroller General's Office, will update the system of public audits, will modernize the public contracting rules and procedures, and will begin introducing E-Government applications to many contracts and other activities that could benefit from the available new technology. 100. Recently, the Government has requested Bank assistance for the development and implementation of its National Program to Combat Corruption (Box 4). The World Bank Institute is assisting the Government with the design and implementation of the analytical work necessary to identify the sources and causes of corruption, as well as to help the Government put in place an effective institutional arrangement to review the required changes in policies to combat corruption. This effort will complement several operations and initiatives of the Bank Group that already address the issues of corruption. The IFML operations have improved transparency and the Judicial Reform Project (Loan No. 4401-GT) has a specific anti- corruption component that include assistance for development of an ethics code for judges, training on ethics, transparency in judicial procedures. The WBI is also sponsoring long distance learning program on justice reform and the combat of corruption. Box 4 - GOVERNANCE ISSUES Issues of governance and corruption have become a major source of concern and public debate in Guatemala over the last few years. Despite improvements in public sector financial management and transparency, there have been several highly publicized cases of misuse of public funds. There have been also an array of reports of influence peddling, mismanagement in banks that have been intervened, and failures to prosecute suspects of corrupt activities. This has reduced public confidence in some institutions and diminished the credibility of some public officials. The public clamor for improvements in governance has led to many new initiatives and policy changes. President Portillo announced in February 2002 the launching of a National Anti-Corruption Plan and asked for World Bank assistance to implement the plan. The World Bank Institute has already begun to provide support, and a high level Anti-Corruption Commission is being formed. The Congress has approved several new laws to deal with corruption and transparency, and is considering further legislative measures. An important new law giving greater powers to the Comptroller General was enacted in May 2002. A law reforming Public Sector Procurement is expected to be approved in June, along with a new code of ethics for public employees under a new Probity Law. Finally, a proposed law on transparency has been presented and is likely to be approved by Congress in its next session in August. Civil society groups have also organized and have prepared proposals to deal with corruption and to inprove governance. These are being widely debated and have become important inputs to the development of the Government's plans. The International Donor Community has also re-affirmed its intention to provide greater support for programs to eradicate corruption, and during the most recent Consultative Group Meeting in February 2002, highlighted the importance of progress on this front for their continued assistance to Guatemala. Guatemala: Country Assistance Stratefv Prostress Report 27 ]Lending [01. Bank lending is expected to amount to up to $310 million for the FY02-03 period. Adjustment lending would account for $150 million (the proposed Financial Sector Adjustment Loan, being presented with the Progress Report). Approximately $35 million is in support of two technical assistance operations (Integrated Financial Management III, already approved by the Board and the Financial Sector TA, being presented with this Progress Report). Planned lending for investment operations in FY03 would include the Rural Roads Project ($90 million), end the Integrated Natural Resource Management Project, ($35 million). Besides the proposed operations, the Bank is discussing with the Governnent possible support for increasing the efficiency, effectiveness, and responsiveness of the social funds, as well as for improving health services, which were identified as priorities in the Poverty Assessment. If during the CGS consultation process these priorities are confirmed, these possible operations could be included im the Bank assistance program for FY03-05. 102. Lending in FY02-03 is predicated on: a satisfactory macroeconomic framework, as evidenced by compliance with the IMF Stand-by program; progress towards strengthening revenue administration; implementation of the four financial sector laws recently approved by Congress; the execution of the poverty reduction program identified in the PRSP; and satisfactory progress with the implementation of the projects in the Bank portfolio. Exposure 103. Guatemala has a relatively low level of external debt compared to countries in similar stage of development. As shown in Annex B7, even with the projected increase of indebtedness resulting from the proposed sector adjustment loans from the Bank and the IDB over the next two years, total debt will remain below 18 percent of GDP. Total debt service is expected to be around 20 percent of exports of goods and services, primarily because of scheduled amortizations. Interest payments account for approximately one quarter of total debt service. 104. The structure of Guatemala's external debt is tilted heavily towards preferred creditors. They account for slightly over 50 percent of the country's total debt. This structure is the result olf the surge in official international financial support that took place following the signing of the Peace Accords, and also to Guatemala's historical low access to financial markets. Guatemala only recently began to tap the international financial markets. Last year it successfully floated $325 million of Eurobonds after receiving a BB rating from Standard & Poor's. Debt service to preferred creditors is approximately 25 percent of total service, reflecting the maturity of structure of official debt and also its lower average interest rates. While the exposure indicators to preferred creditors may be a concern, they should be measured against the country's low level of extemal indebtedness and the changing structure of its debt. Amalytical Work 1(15. The Bank's non-lending assistance has been extensive and has taken many forms, including economic and sector worlc (ESW), project preparation support, institutional development under IDF grants, knowledge management and a program of seminars, and a program of civil society outreach. 28 Guatemala: Country Assistance Strategy Progress Report 106. Although constrained in recent years, the Bank's economic and sector work (ESW) has focused on important areas in the Government's agenda. The two main pieces of formal economic and sector work carried out during the CAS period were a Public Expenditure Review (PER) (FY01) and a joint IMF/World Bank Financial Sector Assessment Program (FSAP) (FY01). The PER assessed the costs and effectiveness of programs needed to reach the Peace Accord targets, thereby providing important inputs to the debate about the levels of tax revenues needed to fund those programs. The solid dialogue established in the process of carrying out the joint FSAP, has led to the preparation of financial sector legislation and a request for support of the FSAP's key recommendations under the proposed adjustment and technical assistance operations. IDF support has been useful in providing institutional development assistance to provide the Guatemalan Congress with increased access to legal information and data bases. ESMAP is currently completing an extensive analysis of the health impact of indoor air pollution and the need to promote the use of improved stoves and alternative sources of fuel to wood. 107. Analytical and advisory services, both formal reports, informal policy notes, and just-in- time advisory services continue to be an important component of the Bank's assistance program. Building upon updated information provided through IDF support for a Living Standards Measurement Survey, a highly participatory Poverty Assessment (FY02) is being completed, which has already provided valuable inputs into the formulation of the Government's PRSP, and into the design of Bank assistance. The Country Financial Accountability Assessment (FY02) analyzes and builds upon the assistance provided under the Integrated Financial Management Projects. The report has just been reviewed by the Government and is being updated with the official comments. The CFAA complements the Country Procurement Assessment Report (FY99) that has already provided inputs to the preparation of a Procurement Law, now under consideration in Congress, and related institutional components that are being supported under the Integrated Financial Management Projects. In other studies, the Bank completed an important report on violence titled Violent Conflict and the Transformation of Social Capital (FY01). 108. A number of regional Central America studies under preparation are addressing issues in Guatemala, including those on the coffee crisis and its social impact, growth, trade, e- Government and education. Work on a Central America Gender Review (FY02) is nearing completion, and other studies are to be completed during the FY03 period. There are three studies contemplated for Guatemala in the near future. The Social Expenditure Review (FY03) will build on the findings of the Poverty Assessment Report. An Education Sector Strategy (FY03) will provide an overview of the effectiveness of sector resource allocation, will carry out an assessment of student achievement and will identify interventions to improve quality. A planned Country Economic Memorandum (FY04) will analyze the challenges that remain for economic policy, the reform agenda, and the promotion of growth. These studies will serve as important inputs into a possible set of policy notes for the incoming government in January 2004 and to respond to requests for "just-in-time" advisory support by the Government. Role of other Donors 109. Donor activity in Guatemala increased considerably following the signing of the Peace Accords. The UN has played an important role in coordinating and overseeing implementation Guwitemala: Country Assistance Strateav Proeoress Report 29 of the Accords, and the Bank has worked closely with UN agencies in several areas. The most recent activities involve working with the UN Resident Coordinator in identifying those activities and responsibilities currently being carried out by the Special UN Mission foir Guatemala (MINUGUA) that should be transferred to the agencies once Minugua's term expires in 2003. 110. The Inter-American Development Bank (IDB) is the largest multi-lateral lender to Guatemala, followed by the IBRD and Central American Bank for Economic Integration (CABEI) both with programs of approximately equal size in recent years. The IDB's strategy is veiy similar to that of the Bank, focusing on poverty alleviation, public sector modernization., and infrastructure development and improvement. The IDB has taken the lead in health care, disaster mitigation, large-scale urban infrastructure and housing and development of thc: productive sectors, but coordinates closely with the Bank in the areas of the FIS, roads, education and, now, financial sector. CABEI's assistance has focused on decentralization, rural development and environmental management, along with the construction, improvement and expansion of roads and highways. 11.. The bilateral donors and the European Union combined provide the largest annual fin.mcial support to Guatemala. The United States and Japan are the two single largest donors, with disbursements of around $60 million annually, but combined the countries that comprise the European Union and the EU itself provide a higher volume of assistance. Bilateral assistance not only supports public sector programs, but increasingly are directed at NGOs and civil society organization, including the areas of humani rights. 112. Finally, the Bank is an active participant in the Dialogue Group, which was formed among the major donor countries and international organizations to coordinate assistance and establish a more unified dialogue with both the Government and Civil Society. This provides an excellent forum for close consultations with bilateral donors, and also serves as basis for cocrdinated work to follow up on the agreements reached at the most recent Consultative Group Meetings. Monitoring and Evaluation 113. The Peace Accords have provided the overall framework that has been used for moaitoring compliance with key output and outcome targets in the Government's program. The PRSP now has built on the Peace Accord targets and has further refined the indicators that will be 'used to monitor its progress. The PRSP, as noted in Box 2, has established clear linkages wit]l the Millennium Development Goals. Thus, the progress in assistance efforts will be measured by progress in meeting the targets set in the Government's PRSP. 114. The Bank has provided assistance to develop Guatemala's monitoring and evaluation systems, particularly through advisory services provided during the preparation of the PRSP. This involved continuous cooperation, technical assistance and training with three main counterpart agencies: INE, the Planning Secretariat (SEGEPLAN), and the University of Rafael Landivar (URL). The process has already generated several outputs, including the ENCOVI and its dlatabase, which will serve as a baseline for monitoring the progress in poverty reduction and other MDGs. This effort is being complemented by the monitoring and evaluation system being 30 Guatemala: Country Assistance Strateev Progress Report created under the Integrated Financial Management 111 Project, which includes assistance for analysis of the incidence of government expenditures and investment programs on the MDG targets, and systems to follow physical implementation of government projects. V. CAS RISKS 115. The short term risks to the Bank's country assistance strategy stem mostly from the Government's possible inability to carry out its macroeconomic program because of internal or external factors. To be successful, the program requires strict fiscal and monetary policies, particularly during the transition to a new Administration. Guatemala's experience, however, suggests the possibility of pressures to ease the fiscal stance before elections. Failure to maintain macroeconomic stability would place the objectives of many Bank operations in jeopardy, particularly thosz in the financial sector. 116. There are other internal and external risks that could affect the compliance with the economic program. One source of concern is a delay in economic recovery or less than robust economic growth, particularly as a result of the global economic environment. The country's near term prospects are highly dependent on the recovery of the global economy. A shortfall in global growth by one percentage point could generate a similar reduction in Guatemala's economic growth. A failure by the major trading partners to boost their demand for Guatemalan exports would not only increase the country's financing needs, but could also lead to a shortfall in domestic revenues making it more difficult for the Government to assign the necessary funds for the poverty reduction programs. 117. Perhaps the most immediate threat to the success of the economic program would be any further decline in the price of coffee and the continued difficulties in the rural sector. Revenues from coffee exports declined by more than $250 million (1.2 percent of GDP) in 2001 due to a 50 percent fall in prices, and projections are that these revenues will fall further in 2002. This has had a dramatic impact on the rural economy in Guatemala. Prices are not expected to recover and close to 40 percent of the area in production may have to be diverted to other uses. There are indications of another El Nino, a climatic occurrence that sharply reduces precipitation in Guatemala. Under these deteriorating conditions in the rural sector there could be pressures on migration to the cities and other countries, on the environment and on the Government's budget. The goals of reducing rural poverty could be difficult to achieve if recovery in the rural sector is not forthcoming. 118. Besides economic developments, the strategy could also be placed at risk if there are set backs in the Peace Process, a deterioration in governance and corruption, and growing concerns about public safety. The Bank's assistance could suffer if the Government fails to make progress in complying with important commitments under the Peace Accords, particularly those related to human rights, violence, and security in general. While reported urban violence is on the rise, this must be weighed against the level of violence prevailing before the Peace Accords. Overall, the Peace process is holding in Guatemala, and the society is now more open to debate, freedom of expression and the press, and protests. The sense of growing lawlessness stems in part from greater media scrutiny and reporting of human rights cases and crime. Still, the Government will have to redouble its efforts to stem violence, which is one of the Peace Accords' main objectives. Guatemala: Country Assistance Stratee-v Proeress Renort 31 119. Another source of risk 4to the strategy would be delays in enacting the policies necessary to improve govemance and combat corruption. Credibility is key to the success of the overall program. Ongoing reports of mismanagement of public funds are eroding public confidence, damaging the Government's credibility and making the task of increasing revenues increasingly dii:'ficult. Without the proper policies to improve governance, confidence will not be restored, the expected increases in investment and growth might not materialize, and support for further revenue increases-which is never easy-will disappear. 120. There are several measures being taken to reduce some of these potential risks. The involvement of key donors and the clear understanding at the highest level,of the need to preserve stability and address financial sector issues, provides some assurances that commitment to a comprehensive program is strong. The Government has recognized the importance of initiating a broad-based national program to combat corruption, and has requested the World Bank for support in this effort. The Government's commitments were announced to the donor community at the recent CG'Meeting, and the Government agreed to have the international community monitor the implementation of its programs. James D. Wolfensohn President By: Shiengman Zhang Washington, D.C. May 31, 2002 Guatemala: Country Assistance Strateev Proeress Report ANNEX I Page I of 11 THE GOVERNMENT'S POVERTY REDUCTION PROGRAM 1. This Annex provides a summary of the Government's economic and poverty reduction program. As noted in the text, the program is based on three main pillars: economic growth with equity; investment in human capital; and investment in physical capital. Economic Growth with Equity 2. The PRSP highlights that Guatemala must raise its level of economic growth if it is to make significant progress in reducing poverty. Despite the country's historically reasonable growth rates and macroeconomic stability, recent growth performance has not been sufficiently fast to benefit greatly the poor. Growth has slowed overall and has been almost non-existent in those sectors that primarily employ the poor (such as agriculture). Unless growth is accelerated, Guatemala will have difficulties reaching the Millennium Development Goals (MDGs). A strong economic recovery will be needed for Guatemala to meet the 2005 targets for social indicators established by the PRSP, which presumes economic growth of no less than 4 percent per annum. 3. The Government's plans to achieve stronger economic growth include actions to: a.) maintain macroeconomic stability (supported by an IMF Standby agreement); b) reform and strengthen the financial sector; c) reorient public expenditures to the social sectors and infrastructure; and c) promote agricultural and rural development. 4. Macroeconomic Stability. During the initial years of the current administration, the Government has focused on reestablishing a stable macroeconomic environment. The Government aims to ensure macroeconomic stability, supported by an IMF Standby for 2002- 20,03. 5. The Government's economic program supports policies aimed at generating a stronger fiscal position and redirecting an ever increasing share of public expenditures towards the social sectors. The program aims to reduce inflation to a rate of 4 to 6 percent in 2002 (from 8.7 percent in 2001), to narrow the external current account deficit to 4.6 percent of GDP (from 5.5 percent in 2001), and to maintain the level of international reserves at close to 4 months of imports. Guatemala is confronting a difficult external environment this year and the Authorities believe that by consolidating recent macroeconomic gains with the support of the international organizations, the climate for trade and investment will improve. Its policies will also enjoy greater credibility and will prepare the domestic economy to benefit from the expected recovery of the international economy. With the adoption of its economic program, the Government expects the Guatemalan economy to grow by more than 2.0 percent in 2002, and 3.0 percent in 2003. 6. Fiscal policy will be the main instrument used by the authorities to maintain macroeconomic stability. The 2002 budget--already approved by Congress--is austere and will require concerted efforts by the Government. It has established as the cornerstone of the program a halt in the nominal growth of expenditures which had increased by more than 22 percent in 2001. With tax revenues projected to increase by 1 percentage point of GDP (to 10.7 Guatemala: Country Assistance Stratee'v Proeress Report ANNEX I Page 2 of 11 percent of GDP), the public sector deficit is expected to be reduced to 1.5 percent (after having reached 2.8 percent in 2001). The improvement in tax revenues reflects the full effects of the tax rate increases approved in July 2001 and continued improvements in tax administration. The Peace Accord target for tax revenues of 12 percent of GDP by 2002 is now expected to be fulfilled by 2004. Annex Table 1: Medium Term Macroeconomic Scenario* (as % of GDP, unless otherwise indicated) Estimate Projected 2001 2002 2003 2004 National Accounts and Prices Real GDP (% change) 2.1 2.3 3.3 4.0 Consumer price index (% change, av.) 7.3 6.5 7.3 6.6 Real exchange rate, % change, (Us/Qz) 5.5 1.1 1.3 0.6 Gross Domestic Investment (as % of GDP) 16.2 16.2 16.6 17.1 Gross National Savings (as % of GDP) 10.9 11.3 11.8 12.7 Central Government finance Total revenues 11.0 11.5 12.0 12.3 Total expenditures 13.8 13.0 14.0 13.8 of which, Social expenditure 5.5 5.2 5.6 6.4 Deficit (-) Surplus (+) -2.8 -1.5 -2.0 -1.5 of which, Net Foreign financing 0.9 1.0 1.2 0.7 Balance of Payments Exportsof GNFS 18.4 17.9 17.8 17.8 Imports of GNFS 27.7 26.7 26.3 26.0 Current account balance -5.3 4.9 -4.7 -4.4 Reserves as months of irnports of GNFS 4.8 4.2 4.1 4.1 Public and Publicly Guarantee Debt Total Public Debt 22.3 22.2 22.6 22.6 Domestic Debt 5.4 5.0 5.0 5.1 External Debt 16.9 17.2 17.6 17.5 External Debt Service / Exports of GNFS 22.5 19.9 20.7 20.8 Memorandum items Gross domestic product (US$ million) 20,573 21,751 23,294 24,928 Source: Bank of Guatemala, IMF and World Bank Staff estimates. GNFS = goods and nonfactor services *See Annex B6 for a complete list of economic indicators. 7. The Government has adopted complementary measures to reinforce its fiscal policy position. It has restricted possible increases in budgetary appropriations to priority expenditures that have identified external financing, has frozen public sector salaries for 2002, and has committed to expand public sector employment only in priority areas, such as health and education. The Government also adopted strict budgetary norms that will govern the actions of ministries and other public sector agencies. All public sector investments will be evaluated and monitored by the Ministries of Finance and Planning. The Integrated Financial Management System established with Bank assistance under a series of technical assistance operations will be 4Guatemala: Country Assistance Strate2v Progress Report ANNEX I Page 3 of 11 extended to a greater number of executing agencies (including the social funds) and to key municipalities. Also, stricter controls will be placed on advances payments and commitments to contractors. 8. The fundamental objective of monetary policy will be to maintain low and stable inflation rates and an adequate level of foreign exchange reserves. An improved fiscal position, along with measures to strengthen the banking sector (through implementation of the financial sector laws now in Congress) should allow the Central Bank to pursue a firm stance on monetary policy without the need for domestic financing. The important change in the management of rnonetary policy is that the program does not contemplate the need for the Central Bank to issue high levels of internal domestic debt, which were required in the last two years in order to sterilize the effects of several sources of liquidity. While the program envisions a continued inflow of foreign capital and remittances, the exchange rate is expected to depreciate slightly in real terms. The policies identified in the Government's program should provide the basis for continued stability and help the country solidify its position during what could be a difficult year, especially on the external front. The program would help ensure that latent problems (such as t:hose present in the banking sector) do not emerge as possible crises. More importantly, it reveals the commitment by the Government to maintain a path of prudent economic management during a difficult pre-electoral and political transition period next year. 9. Financial Sector. The Government's PRSP acknowledges that a healthy, solid and efficient financial system is prerequisite for achieving macroeconomic stability. Recognizing the past piecemeal financial sector reforms had not achieved the intended modernization of the financial sector, the Government decided to address the issues in a comprehensive basis, and requested IMEF and Bank diagnostic support under a Financial Sector Assessment Program (FYO1). With subsequent analytical support from the IMF, the Bank and the IDB, the Government has designed a financial sector reform program that addresses: (i) reform of the monetary policy legal framework for the conduct of monetary and financial policy, including the capitalization of the Central Bank; (ii) reform of the financial sector legal framework aimed at: strengthening the regulation of financial groups and create an orderly market exit mechanism, enhance credit risk management, and increase access to financing; (iii) reform of bank supervision legal framework aimed at strengthening the autonomy of the SB and its legal and institutional capacity to supervise financial groups, and rise banking sector regulation towards international standards; (iv) enactment of legislation to prevent money laundering thereby reducing illegal activities and complying with international norms; and (v) consolidation of the banking system through the restructuring or closure of insolvent banks, and through mergers and acquisitions. Congress recently approved four laws to improve regulation, supervision and foreclosure procedures in the financial sector. These include the: Central Bank Law, Law of E,anks and Financial Groups, Monetary Law, and Supervision Law. 10. Public Investment. Sustained and high growth will require increased investment, both public and private. The Government aims to continue to create the conditions for attracting private sector investment that can generate employment opportunities. At the same time, the Crovernment aims to increase public investment in basic infrastructure in order to reduce operational costs, to increase efficiency and to attract private investment. The PRSP proposes that priority be given to infrastructure investment in rural areas, especially water supply, sanitation, rural roads and electricity. Guatemala: Country Assistance Stratewv Progress Report ANNEX I Page 4 of 11 11. Private Investment. A sustained annual growth of four percent will require private investment, and the Government intends to continue its efforts to attract foreign investment and to open the economy to increased competition. Trade policy will play a fundamental role through: a) consolidation of customs tariffs with low levels of protection and little dispersion; and b) creation of a new integral export and foreign investment system, adapted to international trade regulations, security and incentives for exporters. The Government is committed to fulfill its obligations to the Central American Common Market and the other bilateral free trade agreements recently concluded. The commitment also includes maintaining an exchange rate system free of restriction (which is being further codified in the new Monetary Law). At the same time, the PRSP acknowledges that improving safety conditions, increasing the clarity and stability of investment policies and modernizing the judicial system will all be important to attract increased investment. 12. Agriculture and rural development. Agricultural and rural development will be critical for sustained growth and poverty reduction in Guatemala. Agriculture accounts for a quarter of GDP and 60 percent of the country's exports. It is the source of employment for six out every ten poor. More than 70 percent of the population lives in the rural areas, with heavy concentration in the highlands, where most subsistence farming takes place. 13. Improving the agricultural and rural economy will be particularly challenging. Recent growth in agriculture production has been lower than growth in other sectors of the economy. Factor productivity has been low, and investment in agriculture has lagged, accounting for only 10 percent of total investment. The four traditional export crops--coffee, sugar, bananas and cardamom---account for 35 percent of agricultural production. The recent fall in coffee prices, which has had far-reaching effects on the rural economy (where coffee is the source of employment for more than 500,000 workers) clearly indicates the need for diversification. Given the patterns of land use, however, there limited scope for expanding existing areas of production. Also, soil erosion and environmental degradation (through deforestation, and inefficient use of natural resources), specially in the mountainous highlands, preclude the consideration of more intense farming in the region. 14. In the PRSP, the Government has identified a set of policy priorities for the agricultural sector. The main objectives of the program are to intensify efforts to increase food security, through actions that will strengthen the productive capacity of small farners. This is to be accomplished with programs of technical assistance, fertilizer and seeds distribution, as well as crop diversification. Efforts to promote private investment, together with infrastructure investment in rural areas are also important to stimulate agricultural development. Together, these are expected to increase agricultural productivity, reduce input costs, and increase the prices of agricultural products at the local level. 15. Also, in response to the deteriorating conditions in the rural areas resulting from depressed coffee prices, the Government has complemented its poverty reduction strategy with a more focused emergency program to deal with food shortages and malnutrition in 102 municipalities (one third of the total). The program has three basic phases: the first, involves distribution of basic food with the support of the World Food Program; the second, is geared towards ensuring the planting and harvest of basic food grains for next year; and the third is a longer term process of agricultural restructuring away from subsistence crops and those Guatemala: Countrv Assistance Stratewv Progress Report ANNEX I Page 5 of 11 adversely affected by international conditions to those with greater potential of exports. I'he Government plans to continue food assistance through school breakfast and lunch programs, and other similar programs that target the needy. L6. There are sub-sectors with future potential in agriculture. During the last 10 years, the non-traditional agricultural sector has grown rapidly, multiplying by four in value terms, mostly (due to crops from temperate highland valleys and tropical coastal plains. Not only does this emerging sector generate significant foreign exchange earnings, accounting for more than 15 percent of exports, it also provides income and employment for over 105,000 small-scale, often indigenous producers. Estimates suggest that non-traditional agricultural exports could be (loubled and employment increased 50 percent over the next decade or less. There are other lypes of rural development activities with the potential for high returns, employment generation, or incentives for wise use and conservation of natural resources (e.g., eco-tourism, small and medium enterprises, improved management of local and national protected areas for provision of water and other environmental services). iL7. Finally, government efforts to improve rural infrastructure, access to services, titling, land purchases and rural credit will encourage the expansion of non-traditional agriculture and rural development more broadly. The Peace Accords commit the Government to promote agricultural development through the delivery of land, and the delivery of inputs to small farmers. The Land Fund, created with Bank assistance, is promoting access to land with productive potential. Its goal is to deliver at least 35,700 hectares annually to benefits 6,300 families over the PRSP period. The Government also has parallel programs providing technical assistance to support Land Fund beneficiaries in agricultural technologies. 18. Because rural indigenous populations have strong cultural ties to the land and natural resource base, access to land and appropriate livelihood strategies are extremely important not only to subsistence and income generation, but also to quality of life and cultural identity and sustainability. However, the scope for increased incomes and productivity of subsistence farmers in the highlands will remain limited by their isolation and small fragmented land lholdings. Many of these farmers will continue to rely on seasonal migration to work on the larger commercial estates in the coastal plains. Also, with peace and a revitalized sense of cultural identity, the ex-conflict areas have potential for the development of ecologically and culturally sensitive tourism, which could be an important source ofjobs and markets. ][nvestment in Human Capital 19. The second pillar in the PRSP relates to increasing public investment devoted to humnan capital, targeted at the poor. The Government plans to concentrate investments in the areas of food security (discussed. above), education, especially preschool and primary, and in health, emphasizing preventative primary health care. To ensure that public resources are directed at the neediest, the poverty map--prepared using information from the 2000 LSMS carried out with support of an IDF grant--will be used as the basis of targeting of expenditures. 20. Education. Because of the close correlation between education and poverty, the PRSP ]'lighlights investment in education as one of its highest priorities. Improving education is central Guatemala: Country Assistance Straterv Prog ress Report ANNEX I Page 6 of 11 to both the Peace Agenda and the poverty agenda as it is a crucial determinant of poverty, inequality and earnings, and influences health outcomes, malnutrition and fertility rates. 21. There have already been significant improvements in education since the signing of the Peace Accords: (a) the sector has undergone important institutional and structural reforms (including some decentralization and deconcentration): (b) public spending on education has increased significantly since 1996, with the bulk going to the primary level; (c) literacy and educational attainment are increasing over time, with important reductions in disparities between gender, ethnicities, and the poor versus the non-poor; (d) coverage has accelerated at all levels since the Peace Accords, particularly at the primary level, and the expansion has been well- targeted to the poor (largely through the Bank-supported PRONADE program); and (e) official statistics on internal efficiency suggest improvements. 22. Nonetheless, significant coverage gaps and disparities remain, particularly for the poor, girls, rural and indigenous children. Very few poor make it to the secondary level, where the highest potential for increased earnings due to education are, attained. Despite progress, indicators of internal efficiency suggest serious structural deficiencies in the educational system. Moreover, low returns to primary school suggest shortcomings in the quality of schooling. Demand-side factors, particularly the direct costs of attending school, are the main constraints to increased coverage at the primary level. Secondary enrollment is constrained by both supply- and demand-side constraints, particularly the direct costs of attending school and opportunity costs (work and domestic duties). The targeting of public spending on education is neutral at best, and highly regressive at the secondary and university levels. PRONADE is the exception, since it is essentially targeted to the poor. Other programs (e.g., school feeding and school supply program) are slightly better targeted, but mainly benefit the middle quintiles of the population. The Government plans to use the school feeding programs to achieve some of its food security goals mentioned above. 23. The PRSP includes three goals related to education: to increase the net enrollment rate in preschool and primary schooling to 40 percent and 88 percent, respectively, and to reduce the illiteracy rate to 20 percent. To extend coverage while improving the quality of preschool and primary education, the Government aims to provide school lunches, textbooks and supplies, a program of scholarships for children in rural areas, and promote further community participation as well as rehabilitation and expansion of school infrastructure. Several of these measures are seen as necessary for guaranteeing student attendance by reducing the opportunity costs of attending school. Efforts to improve quality will focus on programs of teacher training, greater availability of textbooks, and strengthening and expanding bilingual education. 24. Health. While Guatemala has made progress in the health, significant challenges remain, especially in trying to improve health outcomes. Progress has taken place primarily in policy reforms and new delivery methods (e.g., particularly through decentralization and use of non-govemment providers). In spite of these, key health outcomes--malnutrition, infant mortality, matemal mortality, and morbidity--have not improved as much as desired, and Guatemala remains among the worst performers in LAC. As expected, health outcomes are worse among the poor, the indigenous, and rural residents, suggesting a need for better targeted interventions since a significant share of the population lacks access to affordable health services, particularly the poor and rural and indigenous residents. Gwatemala: Country Assistance Strateey Progress Report ANNEX I Page 7 of 11 2:5. A combination of supply and demand-side factors appears to be blocking improved health access. On the supply side, services are fragmented; insurance coverage is minimal; waste in public funding is generated by use of highly-subsidized public facilities by the few who are inisured (virtually exclusively the non-poor); and even when facilities are available, they often lack medicines, doctors, or staff. Public spending on health has not increased sufficiently and public spending is not well targeted to the poor. On the demand side, economic barriers (direct costs of health care) present the main constraint to improved access. Although public health care is highly subsidized, patients still have to incur certain costs, particularly for medicine. Private health care is relatively expensive. As such, in situations in which only private services are available, disadvantaged groups lack access due to economic constraints. Cultural barriers fLrther constrain access of the indigenous population to health care. 26. The PRSP proposes extending coverage of basic health services, strengthening health promotion and disease prevention services, with an emphasis on prenatal and neonatal care, nourishment education and vaccination programs. A key element in extending coverage of the basic health system will be promoting further decentralization and de-concentration of health services at different levels, incorporating where necessary traditional indigenous medicine. Municipal and community participation is to be promoted. liivesting in Physical Capital 27. Investment in physical infrastructure in the poorest and most remote areas of the country is the PRSP's third pillar. Actions to extend coverage of basic infrastructure will be focused on water supply, basic sanitation, roads and energy. Most of this investment will be carried out by social funds, and priority will be given to areas with limited or inefficient services based on the poverty map. 283. Infrastructure. There has been significant progress in expanding the equitable provision oi basic utility services since the signing of the Peace Accords: (a) sectoral reforms have inmproved competition and efficiency; (b) the volume of resources channeled towards the expansion of rural service provision has increased substantially through a variety of new and existing institutional mechanisms; (c) overall coverage of basic services has accelerated considerably since 1996; and (d) this expansion has been well targeted, with new connections going disproportionately to traditionally disadvantaged groups. Despite improvements, however, significant coverage gaps and disparities in access remain. A significant share of those without access to basic services live in communities where the services are present but do not connect due to demand-side barriers, such as the direct costs of connecting to and using services. Furthermore, Guatemala needs to extend. the road network and public transport to the poor, particularly in rural areas. Rural residents and the poor are relatively more isolated in terms of rcad and transport access, which significantly constrains their access to health services, opportunities and institutions, further exacerbating their isolation. 29. The PRSP aims to increase access to safe water and basic sanitation to 60 percent of rnral homes by the year 2005 (coverage was 48 percent in 2001). Within the context of the Government's decentralization process, it is expected that municipalities will be responsible for managing and maintaininig water and sanitation services. Guatemala: Countrt Assistance Strategv Progress Reyort ANNEX I Page 8 of 11 30. The PRSP acknowledges that a good system of rural roads is a necessary precondition for agricultural development, both by reducing transport costs for raw materials and agricultural products and by increasing the access to basic services such as education and health. As an initial step, the Government has carried out an inventory of over 12,000 kilometers of rural roads to facilitate the development of a maintenance strategy based on municipal and community participation. The PRSP aims to build 100 kilometers of new rural roads and pave 60 kilometers of dirt roads each year. 31. Less than half of the poor in Guatemala have access to electricity, impacting not only poverty levels, but also leading to adverse environmental consequences by promoting deforestation to obtain needed firewood. The Govermnent has designed a Rural Electrification Program that aims to extend coverage of electricity in rural areas to 280,000 new users in 2,600 communities over the 2000-2004 period, benefiting an expected 1.5 million inhabitants. Public Sector Modernization 32. One of the areas where Guatemala has made the most significant improvements since the Peace Accords has been in modernizing some of the institutions in the public sector. With Bank assistance, the Government has introduced a integrated financial management system in all of the ministries, thus improving budgetary management and increasing transparency. It has also established an autonomous tax administration agency, with new systems and more professionally qualified personnel. Finally, it is in the midst of a major reform of the administration of the judicial system, aimed at improving access to the courts, accelerating the process of cases, improving transparency, and reducing corruption. 33. Despite recent efforts, Guatemala still scores poorly on most governance indicators, particularly those for corruption, the rule of law and the justice system, and political instability, all of which damage the climate for growth and investment. The PRSP acknowledges that it is necessary to promote new systems of public administration that incorporate criteria of solidarity, efficiency and effectiveness of public expenditures and strengthen further the tax collection capability to respond more dynamically to changes in social conditions. It also proposes that mechanisms that promote transparency at all levels of Government will be necessary to avoid corruption and mismanagement in the use of public funds. Finally, transparency and efficiency in public expenditures are necessary to support the Government's plans to increase further the tax burden, since mismanagement and the need for seeking greater efficiency in the use of existing revenues has often been cited as a justification for not increasing taxes. 34. - Governance. The aim of public sector modernization has been to enhance its public service delivery capacity, with a focus on alleviating poverty and improving social conditions. The Government realized early on that its efforts to modernize the public sector needed to start by improving the way the public sector manages its own finances. Thus, at the core of the Government's modernization effort is the adoption of an integrated financial management system, not only to increase the efficiency of financial management but also to improve accountability. The Integrated Financial Management System has made an outstanding start but it requires continued effort to ensure it becomes sustainable, especially in terms of extending its coverage, and strengthening its underlying legal and institutional framework. Over the medium term, efforts need to focus on: expanding horizontally to integrate all ministries, social funds Guratemala: Country Assistance Strate-'v Progress Report ANNEX I Page 9 of 11 and most municipalities, which remain outside the budgetary and the Comptroller's auditing process. 35. Civil service reform is a key priority in the Peace Accords, and is critical to sustain economic modernization and expenditure reform in the medium-term. Although the Government has not been able to carry out a comprehensive reform in this area, it has begun addressing some key issues that are already contributing to improved efficiency and flexibility in the public sector. As in other countries, salaries to public employees are the largest Government operating expenditure, but in Guatemala there is presently no system to handle properly such payments, or maintain in an integrated manner the most basic information on the Government's human resources. Moreover, in view of the lack of personnel information the Government has only limited ability to carry out rationally staff reorganizations, to evaluate the impact of alternative salary policies, or to even evaluate staff (in terms of skills, previous experience, education, etc.) to carry out specific activities. This affects the Government's capability to manage the public sector human resources. And consequently, to achieve its goals in terms of improved service delivery in an efficient, cost effective, and transparent manner. Development of a public sector human resource system will be a key component of the Integrated Financial Management Loan Ir:, recently approved by the Bank. 36. The Government's program includes actions to combat corruption and improve transparency. The expansion of the Integrated Financial Management System to all levels of Government will help, but is not enough. Realizing that decisive action is needed, the Government has created a Transparency/Anti Corruption Commission that will be charged with investigations and establishment of norms, and has requested World Bank support to assist with the design and implementation of the National Plan to Combat Corruption. The World Bank Institute is already engaged and has started providing technical support for the design of a anti- corruption strategy. The Government has already sent several draft laws to Congress, including those on probity, on oversight and controls, and public procurement. 37. Decentralization and Participation. The PRSP establishes that decentralization will be the key process for expanding coverage, improving targeting and reducing the expenditure bias toward large urban areas. It will also serve to empower communities that until now have been disenfranchised. It will allow communities and affected groups to take ownership in the design ol their programs and it will strengthen the oversight of expenditure management. 313. The Government's decentralization strategy is based on the reforms of the system of councils (Regional, Departmental, Municipal and local), a new Code for Municipalities, a new law establishing the basis for the decentralization of service delivery, and the reforms of the social funds to create more community based development. Several of these laws, recently approved by Congress, would transfer greater powers to the local communities and would also ensure greater participation by local associations, the church, the private sector, and non- government organizations. 319. Guatemala is a unitary state with essentially two levels of government -central and municipal. The 330 municipal governments are locally elected and of increasing importance in the delivery, operation and maintenance of basic services. The Government has made progress irn its decentralization effort, through some de-concentration of functions and especially in Guatemala: Country Assistance Strate2v ProgLress Report ANNEX I Page 10 of 11 increasing the transfers and financial autonomy of municipalities. Since 1988, the Central Government has transferred an automatic 10 percent of general revenues to municipalities based on population and other considerations. While this program has led to a major and practical decentralization of political power and responsibilities, the full benefit of this effort in terms of greater response to basic needs has been undermined by the weak institutional capacity of most municipal governments. The deconcentration effort has focused on pilots in a few ministries, transfer of investment execution to the social funds, decentralized programs in education (PRONADE), and health, and pilot programs to transfer responsibility for rural road maintenance to selected municipalities. 40. Now the Government intends to build on the existing structure, particularly by strengthening the system of councils. The system was established in the 1986 Constitution but has not be operating effectively, especially since the Constitutional court determined that the local councils were unconstitutional. The new approach, embedded in a new law approved in February 2002, recreates the community councils within the municipal structures and broadens the participation of civil society. The council structure will be used for the consultation and dissemination of the Poverty Reduction Strategy Paper. The new system of councils, along with the reforms of the social funds, could be the most fundamental set of reforms undertaken by the current government. Cross-cutting Themes 41.- Culture. Because of Guatemala's cultural and linguistic diversity, the PRSP incorporates the concept of culture throughout. Community participation will be promoted in the process of designing, executing, monitoring and evaluating investments proposed in the PRSP to ensure that cultural and linguistic issues are addressed. Bilingual education will be strengthened and traditional indigenous medicine will be taken into account in designing health programs. These actions are seen as fundamental towards reducing cultural exclusion. 42. iGender. There are important gender inequalities in Guatemala. These have a strong impact on poverty by limiting family incomes and by providing fewer opportunities for women to participate in decisions regarding household spending. Women participate less in the labor market (35.2 percent) than men (66.8 percent), and when they do, their salary is 53 percent lower than that of their male counterpart. Recognizing the magnitude of the problem and the need for a concerted mechanism to address it, the Government created the Presidential Women's Secretariat charged with coordinating the formulation of public policies that allow the integral development of women. The Government's policies with respect to gender have the following objectives: a) to assign priority to actions for the female population of every age group in the different ethnical groups and areas of the country; b) to adapt policies, legislation, plans, programs and projects to incorporate women's needs; c) to increase participation of women at the different levels of public administration; and d) to adapt the legal base, institutional budgets and mechanisms to ensure the institutionalization of women's issues. 43. Vulnerability. Because of its geographic and topographic characteristics, Guatemala has been prone to natural disasters. The poor are more subjected to the impact of natural disasters than their non-poor counterparts. The lack of adequate assets makes the poor especially vulnerable to shocks, including not only natural disasters, but economic shocks, as well. The key Guetemala: Country Assistance Strate-iv Proeress Report ANNEX I Page 11 of 11 sources of vulnerability include: (a) worsening terms-of-trade and job loss associated with the crisis in the coffee sector; (b) lost remittances from the global economic slowdown; and (c) natural disasters. Certain sub-groups of the population are inherently or structurally vulnerable to shocks, especially young children, school-aged children, the working poor, particularly those in agriculture, seasonal migrants and poor, rural households living in disaster prone areas. The poor are less equipped than the non-poor to fight shocks, and are more likely to reduce consumption or use existing assets. Indeed, existing social protection programs are poorly targeted and inefficient. Social assistance programs are scattered across many agencies, with. many gaps and duplications in coverage, and are generally regressive. 44. The PRSP recognizes that actions must be taken both to mitigate the impact of natural disasters and to increase the effectiveness of programs aimed at protecting vulnerable groups when natural or economic shocks occur. Guatemala signed the "Strategic Setting for the Reduction of Vulnerabilities and Disasters in Central America" with other Central American Govermments in 1999. It contains policies and measures for the prevention and mitigation of damages, as well as policies and actions for the administration of emergencies and preparation to face them. An essential part of that strategy is the development of a prevention and mitigation culture that allows the population to organize and be prepared to face all types of contingencies at ihe local and national levels. This will require full participation of society in the tasks to reduce vulnerability and risk management and implies that special attention will be given to the most vulnerable population groups and sectors, and that gender aspects will be incorporated. The strategy also contemplates that sector development plans and programs will incorporate prevention and mitigation measures reduce the vulnerability of the social and productive sectors, infi-astructure and the environment, at local, national and regional levels. Annex Al Guatemala CAS Key Economic & Program Indicators - Change from Last CAS Forecast in Last CAS Actual Outcome Current CAS Forecast Economy (CY) 1998 1999 2000 2001 1998 1999 2000 2001 a 2002 2003 2004 Growth rates (%) GDP 5.0 5.0 5.0 5.5 5.0 3.8 3.6 2.1 2.3 3.3 4.0 Exports of#GNFS,b- 12.7 18.1 18.1 18.0 8.9 -0.6 13.3 -2.6 2.9 6.3 6.7 Imports of GNFS b 10.4 16.3 14.5 14.5 20.1 -0.9 12.1 2.0 2.0 5.3 5.8 Inflation, average (-%) 8.5 8.1 8.1 8.0 6.6 5.2 6.0 7.3 6.5 7.3 6.6 National accounts (% GDP) Current account balance -4.0 -3.8 -3.5 -3.4 -5.4 -5.6 -5.5 -5.3 -4.9 4.7 -4.4 Gross domestic investment 14.8 15.2 15.8 16.3 17.4 17.4 18.1 16.2 16.2 16.6 17.1 Public finance (% GDP) Tax Revenues 9.5 9.7 10.2 10.5 8.7 9.3 9.5 9.7 10.6 11.0 11.3 NFPS Fiscal balance -0.7 -0.8 -0.6 -0.4 -1.5 -2.8 -1.9 .. Net Foreign financing 1.1 0.4 0.2 0.3 1.5 2.4 0.9 0.9 1.0 1.2 0.7 Intemational reserves 2.8 2.8 2.8 2.8 2.9 2.6 3.9 4.8 4.2 4.1 4.1 (months of imports of GNFS) Program (Bank's FY FY99 FY00 FY01 FY99 FY00 FY01 FY028 FY03 Total FY02-FY03 Millions of US$ Lending .. 160.0 65.0 85.0 167.0 0.0 82.5 185.0 125.0 310.0 Gross disbursements .. 66.3 66.0 70.8 40.3 61.7 54.6 53.8 163.3 217.1 a. Estimated year b. GNFS = Goods and Nonfactor Services. 5/29/2002 Annex A2 Guatemala at a glance 5/30102 Latin Lower- POVERTY and SOCIAL America middle- Guatemala & Carib. Income Development dlamond 2001 Population, mid-year (millions) 11.7 516 2,046 LIfe expectancy GNI per capita (Atlas method, USS) 1,700 3,680 1,140 GNI (Atlas method, US$ bilions) 19.9 1,895 2,327 Average annual growth, 199541 Population (%) 2.6 1.6 1.0 GNI Gr Labor force (%) 3.4 2.3 1.3 per Grimar per ~~~~~priMary Most recent estimate (latest year available, 1995-OI capita enrollment Poverty (% of population below national poverty line) 58 c e Urban populatlon (% of total population) 39 75 42 Life expectancy at birth (years) 65 70 69 Infant mortality (per 1,000 live births) 45 30 32 Child malnutrtlion (6 of children under 5) 44 9 11 Access to improved water source Access to an Improved water source (96 of population) 92 85 80 Illiteracy (96 of population age 15+) 31 12 15 Gross primary enrollment (% of school-ago population) 88 113 114 Guatemala Male 93 116 Lower-middle-income group Female 83 114 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1981 1991 2000 2001 Economic ratlos GDP (US$ billions) 8.6 9.4 19.1 20.6 Gross domestic Investment/GDP 17.0 14.3 18.1 16.2 Exports of goods and serviceslGDP 17.1 18.0 19.9 18.4 Trade Gross domestic savings/GDP 10.5 10.7 10.3 7.0 Gross national savIngslGDP 10.6 11.9 13.6 10.9 Current account balancelGDP -6.7 -2.7 -5.5 -5.3 Domestic Interest payments/GDP 0.7 1.2 0.8 0.9 savlngs Investment Total debt/GDP 14.9 32.9 17.2 16.9 Total debt service/exports 8.7 15.3 17.0 18.2 Present value of debtGDP Present value of debtexports Indebtedness 1981-91 199141 2000 2001 200145 (average annual growth) GDP 1.4 4.1 3.6 2.1 3.4 Guatemala GDP per capita -1.1 1.3 0.9 -0.6 0.7 Lower-middle-lncome group Exports of goods and services 0.1 6.2 3.9 -2.6 5.9 STRUCTURE of the ECONOMY 1981 1991 2000 2001 Growth of Investment and GDP (%) (96 of GOP) 6 Agriculture 25.0 25.7 22.8 22.8 60 Industry 21.7 19.6 19.8 19.7 o Manufacturing 16.0 14.9 13.2 131 20 Services 53.3 54.7 57.4 57.7 5 Private consumption 81.6 83.9 83.4 87.8 -20 97 Oa 99 00 01 General govemment consumption 7.9 5.4 6.3 5.2 GDI e GDP Imports of goods and services 23.6 21.6 27.8 27.7 7 (average annyal growth) 1981-91 199141 2000 2001 Growth of exports and Imports (%) Agrkcufture 1.7 2.7 2.6 1.1 30 Industry 0.7 4.1 1.5 1.6 20 Manufacturing 0.7 2.7 1.9 1.6 _0 Services 1.6 4.6 4.6 2.7 Private consumption 1.7 4.1 2.9 3.6 - 97 Oa 90 o General govemment consumption 2.6 5.5 14.5 10.2 -10 Gross domestic Investment 0.1 4.9 4.2 -6.3 -Exports * tInpoft Imports of goods and services 0.8 8.5 6.1 2.0 Note: 2001 data are preliminary estimates. The dlamonds show four key Indicators in the country (in bold) compared with ts income-group average. If data are missing, the diamond will be Incomplete. Source for Social Indicators: Guatemala Poverty Assessment, 2002. Annex A2 Guatemala PRICES and GOVERNMENT FINANCE Domestic prices 1981 1991 2000 2001 Inflation (%) (% change) 12 T Consumerprirs 11.4 33.1 6.0 7.3 Implicit GDP deflator 8.5 33.0 5.7 7.2 6 . Central Govemment flnance (% of GDP, includes current grants) o Current revenue 9.0 10.5 11.0 ss 97 98 99 0o 01 Current budget balance 1.5 1.8 1.4 -G DP deflator oCPI Overafl surplus/deficit -0.5 -2.2 -2.8 TRADE _ 1981 1991 2000 2001 Export and Import levels (USS mill.) (US$ millions) Total exports (fob) . 1,298 3.082 2,980 E,OOO Coffee 281 569 335 Sugar 141 180 212 .000. Manufactures 692 1,907 1.805 Total imports (cif) 1,851 5,171 5.272 3,00 I *i I Food .. 284 1,085 1,182 Fuel and energy 311 540 561 a oo_ Capital goods 430 1.417 1.404 e Exportpriceindex(1995=100) 11 71 139 144 95 as e7 9e OD o Import price index (1995=100) 13 76 128 137 *Exports *Imports Terms of trade (1995=100) 85 93 108 105 BALANCE of PAYMENTS (USS millions) 1981 1991 2000 2001 Current account balance to GOP (%) Exports of goods and services 1,446 1,727 3,893 3,791 0 Imports of goods and services 2,024 2,030 5,585 5.698 -1 Resource balance -578 -302 -1.692 -1.907 -2 Net Income -86 -174 -225 -166 Net current transfers 90 220 868 981 -3 Current account balance -574 -256 -1,049 -1.093 4 Financing items (net) 273 812 1.784 1.535 4 Changes in not reserves 301 -556 -735 -442 40 Memo: Reserves induding gold (USS millions) 172 419 1,818 2.260 Conversion rate (DEC, locaW'US$) 1.0 5.0 7.8 7.9 EXTERNAL DEBT and RESOURCE FLOWS 1981 1991 2000 2001 (USS millions) ComposMton of 2001 etobt (USS mill.) Total debt outstanding and disbursed 1.278 3,092 3,285 3,476 IBRD 171 279 296 330 IDA 0 0 0 0 G:471 A: 330 Total debt service 136 290 786 855 \ IBRD 16 31 34 34 IDA 0 0 0 O 0 Composition of net resource flows F: 719 Official grants 12 72 87 88 Official creditors 169 46 94 84 D 1,342 Private creditors 110 -7 33 106 Foreign direct investment 127 91 230 470 Portfolio equity 0 0 0 0 E: 614 Wodd Bank program Signed Commitments 0 0 54 46 A - IBRD E - Bilateral Disbursements 35 4 51 46 B - IDA D- Other mulUlateral F - Private Principal repayments 7 21 13 12 C-IMF G-Short-term Netflows 28 -17 38 35 Interest payments 9 9 21 22 Net transfers 18 -26 17 12 Development Economics 5/30/02 Annex B I Guatemala: CAS Program Matrix, FY02-03 DEvELopmENT GovERNETnsz's PovERTY REDucrIoN PRSP'sEcrn BjE vE DLDcN STRATEGY (PRSP) PROGRESS BENciMmUe PARTNRS Proposed: Integrated Mgmt of UN, CABEI, Natural Resources (FY03) UNDP, EU To reduce extreme 16% of the population living Increase the share of public expenditure Reduce extrame poverty index by Ongoing: FIS H; Reconst and poverty. in extreme poverty in 2000. dedicated to poverty reduction. 3 percentage points by 2005. Local Development Non-lending: Poverty Bilateral Donors Assessment (FY02); Social _ ______________ Expenditure Review (FY04) Economic growth of 3.6% in Reduce fiscal deficit as a percentage of Economic growth of no less than Ongoing: Tax Administration IMF 2000. the GDP. 4% per annum, while maintaining TAL; Competitiveness macroeconomic stability. Enhancement Loan; Judicial Reform Project; IFML m To accelerate Accelerated annual growth of exports Non-lending: Public Expenditure economic growth and foreign investments. Update (FY03); Country Development Gateway UN Banking system under stress, Modernize and strengthen the financial Enacting of Financial Sector Proposd: Financial Sector TAL IDB and IMF outdated laws, weak sector. legislation. (FY02) supervision. Creation of a new Deposit Provo : Financial Sector Insurance Fund, to operate under a Reform Loan (FY02) more consolidated banking sector. In 1999, the net primary Increase share of public expenditure Increase rate of net primary school Oneoine: Basic Education IDB school enrollment rate was dedicated to primary and preschool enrollment to 88% and that of Reform; Universalization of 88%, while the net preschool education, as a percentage of total preschool enrollment to 40%/e by Basic Education To increase access to enrollment rate was 31.0o/o expenditure in education. 2005. preschool and Expand availability of bilingual schools primary education. and increase percentage of schools that Non-lendin : Public Expenditure have a school board. Review (FY03) KFW Literacy rate 40G/o in 1999 Increase share of expenditures devoted to Increase literacy rate to 80% by Non-lendin: Global Distance IDB literacy programs, as a percentage of the 2005. Learning Network KFW public expense infeducation. Average life expectancy of 64 Increase health expenditure as a Increase life expectancy to 67 Ongoink. FIS 11; Reconst. and CARE To improve access to years in 1996-2000. percentage of total public expenditure. years by 2005. Local Development UNDP health care. Increase preventive health expenditure as EU a percentage of total health expenditures. Page of 2|IDB Page I of 2 Annex B I Guatemala: CAS Program Matrix, FY02-03 DEvFLopmENT GovERNMENT's POVERTY REDUCnON PRSPs I B ExTERNAL OBJECTtVF ~sIsSTRATEGYNSTRMENSP)PoRs Ec RsPARNmERS Maternal mortality rate of Increase percentage of pregnant women Reduce maternal mortality rate to Ongoing: FIS H; Reconst. and CARE 190 per 100,000 live births in that have at least three prenatal 100 per 100,000 live births by Local Development 1998. consultations. 2005. EU Increase percentage of deliveries assisted IDB by health personnel. As of 2000, infant mortality Increase percentage of children under 5 Reduce, by end-2005, infant Ongoing: FIS II; Reconst and CARE rate was 40 per 1,000 live years with access to the basic health mortality rate to 35 per 1,000 live Local Development births and under 5 mortality service package. births and that of children under 5 To improve access to rate was 52 per 1,000 live . years of age to 48 per 1,000. IDB health care. births. Increase percentage of children under one year of age vaccinated against measles and polio. In 1998, only 44% of rural Raise expenditure in water services and Provide access to piped water and Ongoing: FIS II; Reconst. and IDB households had access to sanitation as a percentage of total public basic sanitation to 60% of the rural Local Development piped water and only 1.4% expenditure. households by 2005. had access to a sewage system. In 2000, 4,977 km of rural Increase expenditure in rural roads Expand the rural road network by Ongoing: Rural & Main Roads IDB roads were paved and 9,300 construction, as a percentage of total 500 km, of which 300 km will be Proposed Rural Roads 11 (FY03) km of dirt roads. expenditures in transportation paved. infrastructure. Proposed: Integrated Mgmt. of CABEI Natural Resources (FY03) To increase In 2000, more than 10,000 Raise share of public expenditure in rural Provide maintenance services to Ongoing: Rural & Main Roads IDB productivity in rural rural roads lacked adequate roads maintenance, as percentage of total 100% of rural roads. Prooosed: Rural Roads II (FY03) CABEI areas. maintenance. expenditure in transportation infrastructure. Currently, only 70% of rural Built new distribution and transmission Expand rural electrification Oneoine: Social Investment households has adequate lines. coverage to 90% of the rural Fund electric coverage. households by 2005. In 1994, 37% of rural Increase number of hectares delivered To benefit 6,300 new peasant Ongoing: Land Fund and Land households had no access to through the Land Fund. families annually through delivery Administration projects land. of land by 2005. 5/30/2002 Page 2 of 2 Annex B2 Guatemala CAS Selected Indicators* of Bank Portfolio Performance and Management As of March 31, 2002 Indlcator 1999 2000 2001 2002 Portfolio Assessment Number of Projects Under Implementation a 11 10 12 13 Average Implementation Period (years) b 2.1 2.3 2.8 3.3 Percent of Problem Projects by Number ac c 0.0 20.0 0.0 7.7 Percent of Problem Projects by Amount c. c 0.0 12.7 0.0 3.0 Percent of Projects at Risk by Number a, d 0.0 20.0 0.0 7.7 Percent of Projects at Risk by Amount a, d 0.0 12.7 0.0 3.0 Disbursement Ratio (%) e 23.8 20.8 23.3 14.2 Portfolio Management 'CPPR / CSIR during the year (yes/no) Yes Yes Yes No Supervision Resources (thousands of US$) 597.7 886.4 690.0 659.2 Average Supervision (thousands US$/project) 54.3 88.6 57.5 50.7 IMemorandum Item Since FY 80 Last Five FYs l'roj Eval by OED by Number 17 4 Proj Eval by OED by Amt (US$ millions) 514.8 73.0 YO of OED Projects Rated U or HU by Number 25.0 'YO of OED Projects Rated U or HU by Amt 31.9 a. As shown in the Annual Report on Portfolio Performance (except for current FY). b. Average age of projects in the Bank's country portfolio. c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: Investment projects only. All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year. 5/29/2002 Annex B3 Guatemala CAS IBRD Program Summary P osed IBRD Base-Case Lending Program Fi lyar mS$ (M) Strategic Rewards' Implementation Fiscal year Project Name Us$ (M) (HIMIL) Risks (HIMIL) 2002 Integrated Financial Management III 29.8 H M Financial Sector Adjustment Loan 150.0 H H Financial Sector TAL 5.0 M L 2003 Integrated Mgmt. of Natural Resources 35.0 M M Rural Roads III 90.0 H L Total Period FY02-FY03 309.8 a/ For each project, the table indicates whether the strategic rewards and implementation risks are expected to be High (H), Moderate (M) or Low (L). 5/30/2002 Annex B4 Guatemala: Summary of Non-lending Services Cost or Grant Product Completion FY Amounta Audience b Objective ECONOIIC SECTOR WORK Recent completions PIR- Investing for Peace FY98 168 G, D, B KG, PS Rural Financial Markets FY99 30 G, B, KG Country Procurement Assessment Report FY00 50 G, B KG, PS PER: Expenditure Reform in a Post Conflict FY00 69 G, D, B, PD KG, PD, PS Country Financial Sector Assessment Program FY01 188 G, B KG Underwav Country Financial Accountability Assessment FY02 66 G, B, KG, PS Central America Urban Review (Regional) FY02 189 G, D, B, PD KG, PD, PS Regional Coffee Study FY02 65 G, D, B, PD KG, PS Poverty Assessment FY02 589 G, D, B, PD KG, PD, PS Planned Public Expenditure Review FY03 226 G, D, B, PD KG, PD, PS Social Expenditure Review FY04 58 G, D, B, PD KG, PD, PS Policy Options Notes FY04 50 G, B, KG IDFANDPHND GRANT, Small-scale Rural Enterprise Support Services FY98 148 G, D, PD KG, PS Institutional Development of Congress FY98 239 G, D, PD KG, PS Development Household Survey System FY00 499 G, D, PD KG, PS Afro-Descendant Communities (Regipnal grant) FY03 500 G, D, PD KG, PS Basic Health for Vulnerable Groups PHRD FY03 1,000 G, D, PD KG, PS WRIACT!I TIES Economic Globalization and Sustainable FY97-98 .. G, D, PD PD Development Seminar (Regional) Municipal Govermments Workshops FY98-99 .. G, D, PD KG, PS Partnerships for Poverty Reduction FY98-00 .. G, D, PD KG, PS Bank Supervision and Fin. Markets (Regional) FY99 .. G, D, PD KG, PS OTHER Laguna del Tigure Mid-sized GEF FY99 750 G, D, B KG, PS FIAS Advisory Services FY99-00 .. G, B, PD PS RUTA Agricola Implementation Support FY99-01 .. G, D, B PS Central America Emergency Trust Fund FY99-02 1,400 G PS Itza Maya Community Management-GEF FY02 1,474 G, D, B KG, PS Westem Altiplano Natural Resources GEF FY03 8,000 G, D, B KG, PS a. Direct Cost Only. Expressed in thousands of US dollars. b. Government, donor, Bank, public dissemination. c. Knowledge generation, public debate, problem-solving. May 30, 2002 Annex B6 Page 1 of 2 Guatemala - Key Economic Indicators Estimate Projected Indicator 1997 1998 1999 2000 2001 2002 2003 2004 National accounts (as % of GDP) Gross domestic product' 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agriculture 23.7 23.4 23.0 22.8 22.6 22.4 22.2 22.0 Industry 20.0 20.0 20.2 19.8 19.7 19.6 19.5 19.4 Services 56.3 56.6 56.8 57.4 57.7 58.0 58.3 58.6 Total Consumption 92.0 90.7 91.1 89.7 93.0 92.6 91.9 91.1 Gross domestic investment 13.7 17.4 17.4 18.1 16.2 16.2 16.6 17.1 Govemment investment 3.1 4.3 5.5 4.2 4.2 4.0 4.5 4.2 Private investment 10.6 13.1 11.9 13.9 12.0 12.2 12.1 12.9 .Exports (GNFS)b 17.8 17.8 18.8 19.9 18.4 17.9 17.8 17.8 .[mports (GNFS) 23.5 25.9 27.2 27.8 27.7 26.7 26.3 26.0 Gross domestic savings 8.0 9.3 8.9 10.3 7.0 7.4 8.1 8.9 Gross national savings' 9.8 12.1 11.8 13.6 10.9 11.3 11.8 12.7 Memorandum items Gross domestic product (US$ million) 17,768 19,306 18,225 19,070 20,573 21,751 23,294 24,928 GDPpercapita(US$) 1,689 1,788 1,644 1,675 1,760 1,811 1,889 1,967 Real annual growth rates (%, calculated from 1958 prices) Gross Domestic Product 4.4 5.0 3.8 3.6 2.1 2.3 3.3 4.0 Gross Domestic Income 4.8 6.4 3.3 4.4 2.0 2.3 3.1 3.8 Real annual per capita growth rates (%, calculated from 1958 prices) Gross domestic product at market prices 1.7 2.3 1.2 0.9 -0.6 -0.4 0.6 1.3 Total consumption 1.8 2.2 1.1 1.4 1.6 -0.8 -0.2 0.4 Private consumption 1.1 2.1 1.5 0.2 0.9 0.0 -1.0 1.6 l3alance of Payments (US$ milllons) Exports (GNFS) b 3,175 3,456 3,435 3,893 3,791 3,900 4,148 4,426 Merchandise FOB 2,598 2,847 2,781 3,082 2,980 3,053 3,233 3,438 Imports (GNFS) b 4,188 5,028 4,984 5,585 5,698 5,812 6,120 6,474 Merchandise FOB 3,519 4,249 4,181 4,794 5,272 5,383 5,677 6,016 Resource balance -1,013 -1,572 -1,549 -1,692 -1,907 -1,911 -1,972 -2,049 Net income and current transfers 327 536 534 643 815 840 867 946 Current account balance -686 -1,036 -1,015 -1,049 -1,093 -1,072 -1,105 -1,103 Foreign direct investmentd 85 673 357 230 .470 150 180 200 Long-term loans (net) 222 234 294 116 191 268 366 264 Other capital (net inel. errors& ommissions) 612 372 238 1,438 874 446 591 750 Change in reserves - -232 -243 126 -735 -442 208 -31 -111 Memorandum items C(urrent Account balance (% of GDP) -3.9 -5.4 -5.6 -5.5 -5.3 -4.9 -4.7 -4.4 (Continued) 51291'2002 Annex 86 Page 2 of 2 Guatemala - Key Economic Indicators (Continued) Estimate Projected Indicator 1997 1998 1999 2000 2001 2002 2003 2004 Public finance (as % of GDP at market prices)' Total revenues 9.4 9.7 10.5 10.5 11.0 11.5 12.0 12.3 Tax revenue 8.8 8.7 9.3 9.5 9.7 10.6 11.0 11.3 Nontax revenue and transfers 0.5 0.9 1.1 0.9 1.3 0.9 1.0 1.0 Total expenditures 10.1 11.9 13.3 12.4 13.8 13.0 14.0 13.8 Current expenditure 6.2 7.3 8.1 8.6 9.6 9.0 9.8 9.4 Capital expenditure and net lending 3.9 4.6 5.2 3.7 4.2 4.0 4.2 4.4 Deficit (-) Surplus (+) -0.4 -2.2 -3.3 -2.2 -2.8 -1.5 -2.0 -1.5 Net Foreign financing 2.0 1.5 2.4 0.9 0.9 1.0 1.2 0.7 Net Domestic financing. -1.6 0.7 0.9 1.3 1.8 0.5 0.7 0.8 of which, privatization proceeds 0.0 3.1 0.6 0.7 1.8 0.3 0.0 0.0 Monetary indicators M2/GDP(%/.) 27.2 26.8 27.0 30.4 31.3 31.8 31.8 31.8 Growth of M2 (%) 15.5 13.4 9.8 23.3 12.5 10.9 10.8 10.8 Private sector credit growth (%) 19.9 27.5 14.4 10.0 34.7 17.8 12.2 10.7 Price indices( YR58 =100) Exports of GNFS price index 2362 2647 2906 3253 3380 3309 3497 3843 Imports ofGNFS price index 3831 3896 4429 4661 4989 5141 5320 5507 Terms oftrade index 61.6 67.9 65.6 69.8 67.8 64.4 65.7 69.8 Annual average exchange rate (Qz /US$) 6.07 6.42 7.42 7.77 7.88 8.12 8.40 8.70 Realexchangerateindex(US$/Qz)f 153.6 157.3 143.2 145.5 153.4 155.1 157.2 158.1 Consumer price index (% change, ave.) 9.2 6.6 5.2 6.0 7.3 6.5 7.3 6.6 GDP deflator (% change) .8.3 9.5 5.0 5.7 7.2 6.5 7.3 6.5 a. GDP at current market prices. b. "GNFS" denotes "goods and nonfactor services." c. Gross Domestic Savings plus net current transfers and net factor income. d. Includes privatization proceeds, if any. e. Includes only Central government operations. f. An increase in the index denotes appreciation. 5129/2002 Annex B7 Guatemala - External Debt Exposure Indicators Actual Estimate Projection 1997 1998 1999 2000 2001 2002 2003 2004 Total debt outstanding (US$m)a 2,619.7 2,900.5 3,274.0 3,285.1 3,475.9 3,743.8 4,109.3 4,372.9 (TDO) Net disbursements (US$m)a 252.1 264.2 391.2 127.2 190.8 267.9 365.5 263.6 Total debt service (US$m) 523.1 499.8 483.2 786.4 854.7 775.5 857.8 919.8 (TD:S) Debi and debt service indicators (%) TDO/ExportsofGNFSb 82.5% 83.9% 95.3% 84.4% 91.7% 96.0% 99.1% 98.8% TD'O/GDP 14.7% 15.0% 18.0% 17.2% 16.9% 17.2% 17.6% 17.5% TDS / Exports of GNFS 16.5% 14.5% 14.1% 20.2% 22.5% 19.9% 20.7% 20.8% Preferredcreditordebt/TDOC 39.0% 42.7% 45.6% 48.2% 48.1% 51.1% 51.5% 49.6% Pnrferred creditor DS/TDS (%)C 20.3% 22.7% 26.7% 17.3% 19.7% 24.6% 25.1% 26.0% IBRI) exposure indicators IBRD DS/ TDS 4.9% 5.3% 6.5% 4.3% 4.0% 4.5% 5.0% 6.3% IBRD DS/ Exports of GNFS 0.39% 0.41% 0.42% 0.34% 0.31% 0.34% 0.42% 0.65% IBIRD TDO (US$m) 187.6 202.9 258.4 295.7 330.4 422.3 581.1 623.3 Share of IBRD portfolio (%) 0.17% 0.17% 0.21% 0.24% 0.27% 0.34% 0.46% 0.50% IFC 4US$m, by Fiscal Year) Loans 0.0 19.0 0.0 19.2 ... ... ... ... Equity and quasi-equity d 0.0 0.0 0.0 1.2 ... ... ... ... MIGA (by Fiscal Year) MlGAguarantees(US$m)' 12.9 12.9 7.2 18.7 114.1 113.5 a. Irtcludes only public and publicly guaranteed debt. b. "GNFS" denotes exports of goods and non factor services services. c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the BIS. d. Includes equity and quasi-equity types of both loan and equity instruments. e. IDncludes present value of guarantees. 5/29/2002 4 t - N X ° ° ^ N N _ X N g 0 0000000 I. U0 -o e E C 0000000000000 S tfl: a~~~~~~~~~~~~~ nX~~~~~~i I 0 * j s X z 0 c iiE t I i 3 a - E Annex B8-2 CAS Annex B8 (IFC) for Guatemala Statement of IFC's Held and Disbursed Portfolio As of 4/30/2002 (In US Dollars Millions) Held Disbursed FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1993 Vigua 2.1 0.0 0.0 0.0 2.1 0.0 0.0 0.0 1994 Fabrigas 1.5 0.0 1.0 0.0 1.5 0.0 1.0 0.0 1996 Pantaleon 8.8 0.0 0.0 0.0 8.8 0.0 0.0 0.0 1998 La Fragua 17.9 0.0 0.0 0.0 17.9 0.0 0.0 0.0 2000 Frutera 7.0 0.0 0.0 0.0 7.0 0.0 0.0 0.0 2000 Orzunil 10.9 1.2 1.2 12.7 10.9 1.2 1.2 12.7 Total Portfolio: 48.1 1.2 2.2 12.7 48.1 1.2 2.2 12.7 Approvals Pending Commitment Loan Equity Quasi Partic 2002 Interforest 6.0 0.0 0.0 2.0 5/30/2002 IMAGING Report No.: 24235 GU Type: OAS