Document of

THE WORLD BANK

Report No. 25971

PROJECT PERFORMANCE ASSESSMENT REPORT

BRAZIL

PUBLIC SECTOR MANAGEMENT PROJECT (Loan 2721-BR)

PRIVATE SECTOR FINANCE PROJECT (Loan 3268-BR)

RIO GRANDE DO SUL STATE REFORM LOAN (Loan 4139-BR)

RIO DE JANEIRO STATE REFORM PRIVATIZATION PROJECT (Loan 4211-BR)

MATO GROSSO STATE PRIVATIZATION PROJECT (Loan No. 4189-BR)

May 23, 2003

Operations Evaluation Department

Currency Equivalents (monthly averages for December)

Currency Unit = Brazilian Currency (R$) 1986 US$1 = 4.96E-09 1987 US$1 = 1.43E-08 1988 US$1 = 9.54E-08 1989 US$1 = 1.03E-06 1990 US$1 = 2.48E-05 1991 US$1 = 0.0001 1992 US$1 = 0.0016 1993 US$1 = 0.032 1994 US$1 = 0.638 1995 US$1 = 0.917 1996 US$1 = 1.005 1997 US$1 = 1.078 1998 US$1 = 1.205 1999 US$1 = 1.843 2000 US$1 = 1.963 2001 US$1 = 2.363

Fiscal Year

January 1 – December 31

Director-General, Operations Evaluation Mr. Gregory K. Ingram Acting Director, Operations Evaluations Department Mr. Nils Fostvedt Senior Manager, OEDCR Mr. R. Kyle Peters Task Manager Mr. John H. Johnson PPAR prepared by: Mr. William Tyler, Consultant

OED Mission: Enhancing development effectiveness through excellence and independence in evaluation.

About this Report

The Operations Evaluation Department assesses the programs and activities of the World Bank for two purposes: first, to ensure the integrity of the Bank’s self-evaluation process and to verify that the Bank’s work is producing the expected results, and second, to help develop improved directions, policies, and procedures through the dissemination of lessons drawn from experience. As part of this work, OED annually assesses about 25 percent of the Bank’s lending operations. In selecting operations for assessment, preference is given to those that are innovative, large, or complex; those that are relevant to upcoming studies or country evaluations; those for which Executive Directors or Bank management have requested assessments; and those that are likely to generate important lessons. The projects, topics, and analytical approaches selected for assessment support larger evaluation studies.

A Project Performance Assessment Report (PPAR) is based on a review of the Implementation Completion Report (a self-evaluation by the responsible Bank department) and fieldwork conducted by OED. To prepare PPARs, OED staff examine project files and other documents, interview operational staff, and in most cases visit the borrowing country for onsite discussions with project staff and beneficiaries. The PPAR thereby seeks to validate and augment the information provided in the ICR, as well as examine issues of special interest to broader OED studies.

Each PPAR is subject to a peer review process and OED management approval. Once cleared internally, the PPAR is reviewed by the responsible Bank department and amended as necessary. The completed PPAR is then sent to the borrower for review; the borrowers' comments are attached to the document that is sent to the Bank's Board of Executive Directors. After an assessment report has been sent to the Board, it is disclosed to the public.

About the OED Rating System

The time-tested evaluation methods used by OED are suited to the broad range of the World Bank’s work. The methods offer both rigor and a necessary level of flexibility to adapt to lending instrument, project design, or sectoral approach. OED evaluators all apply the same basic method to arrive at their project ratings. Following is the definition and rating scale used for each evaluation criterion (more information is available on the OED website: http://worldbank.org/oed/eta-mainpage.html).

Relevance of Objectives: The extent to which the project’s objectives are consistent with the country’s current development priorities and with current Bank country and sectoral assistance strategies and corporate goals (expressed in Poverty Reduction Strategy Papers, Country Assistance Strategies, Sector Strategy Papers, Operational Policies). Possible ratings: High, Substantial, Modest, Negligible.

Efficacy: The extent to which the project’s objectives were achieved, or expected to be achieved, taking into account their relative importance. Possible ratings: High, Substantial, Modest, Negligible.

Efficiency: The extent to which the project achieved, or is expected to achieve, a return higher than the opportunity cost of capital and benefits at least cost compared to alternatives. Possible ratings: High, Substantial, Modest, Negligible. This rating is not generally applied to adjustment operations.

Sustainability: The resilience to risk of net benefits flow s over time. Possible ratings: Highly Likely, Likely, Unlikely, Highly Unlikely, Not Evaluable.

Institutional Development Impact: The extent to which a project improves the ability of a country or region to make more efficient, equitable and sustainable use of its human, financial, and natural resources through: (a) better definition, stability, transparency, enforceability, and predictability of institutional arrangements and/or (b) better alignment of the mission and capacity of an organization with its mandate, which derives from these institutional arrangements. Institutional Development Impact includes both intended and unintended effects of a project. Possible ratings: High, Substantial, Modest, Negligible.

Outcome: The extent to which the project’s major relevant objectives were achieved, or are expected to be achieved, efficiently. Possible ratings: Highly Satisfactory, Satisfactory, Moderately Satisfactory, Moderately Unsatisfactory, Unsatisfactory, Highly Unsatisfactory.

Bank Performance: The extent to which services provided by the Bank ensured quality at entry and supported implementation through appropriate supervision (including ensuring adequate transition arrangements for regular operation of the project). Possible ratings: Highly Satisfactory, Satisfactory, Unsatisfactory, Highly Unsatisfactory.

Borrower Performance: The extent to which the borrower assumed ownership and responsibility to ensure quality of preparation and implementation, and complied with covenants and agreements, towards the achievement of development objectives and sustainability. Possible ratings: Highly Satisfactory, Satisfactory, Unsatisfactory, Highly Unsatisfactory.

Abbreviations and Acronyms

AGER-MT Agência Estadual de Regulação dos Serviços Públicos de Mato Grossol (Regulatory Agency for Public Services for the State of Mato Grosso)

AGERGS Agência Estadual de Regulação dos Serviços Públicos Delegados do Rio Grande do Sul (Regulatory Agency for Public Services for the State of Rio Grande do Sul)

ASEP-RJ Agência Reguladora de Serviços Públicos Concedidos (Regulatory Agency for Public Services for the State of Rio de Janeiro)

BANERJ Banco do Estado do Rio de Janeiro (Bank of the State of Rio de Janeiro) BANRISUL Banco do Estado do Rio Grande do Sul (Bank of the State of Rio Grande do Sul) BEMAT Banco do Estado de Mato Grosso (Bank of the State of Mato Grosso) BEMGE Banco do Estado de Minas Gerais (Bank of the State of Minas Gerais) BCB Banco Central do Brasil (Central Bank of Brazil) BNDES Banco Nacional de Desenvolimento Econômico e Social (National Development Bank) CEDAE Companhia do Estado de Aguas e Esgotos (State Company for Water and Sewerage for Riode Janeiro) CEMAT Centrais Elétricas Matogrossenses (Mato Grosso Electricity Company) CEMIG Centrais Elétricas do Estado de Minas Gerais (Minas Gerais Electricity Company) CENDEC Economic Development Training Center CRT Companhia Riograndense das Telecomunicações (Rio Grande Telecommunications

Company) ESW Economic and Sector Work FARL Fiscal and Administrative Reform Special Sector Adjustment Loan FGV Fundação Getúlio Vargas (Getúlio Vargas Foundation) FSAL Financial Sector Adjustment Loans GDP Gross Domestic Product IBGE Instituto Brasileiro de Geografia e Estatística (Brazilian Institute for Statistics) IBRD International Bank for Reconstruction and Development ICMS Imposto de Circulação de Mercadorias e Serviços (state value added tax) ICR Implementation Completion Report IDB Inter-American Development Bank IFC International Finance Corporation IMF International Monetary Fund INPES Instituto de Pesquisa (IPEA’s National Research Institute) IPEA Instituto de Pesquisa Econômica Aplicada (Institute of Applied Economic Research) IPLAN Instituto de Planejamento (IPEA’s National Planning Institute) MF Ministry of Finance MG State of Minas Gerais MT State of Mato Grosso OED Operations Evaluation Department OED ES OED Evaluation Summary PCR Project Completion Report PFR-SAL Programmatic Fiscal Reform Structural Loan PSBR Public Sector Borrowing Requirements PSFL Private Sector Finance Loan PSML Public Sector Management Loan RJ State of Rio de Janeiro RS State of Rio Grande do Sul SAR Staff Appraisal Report SEFAZ Secretaria da Fazenda (Secretariat of Finance) SEPLAN Secretaria de Planejamento (Ministry of Planning, at federal level) SEPRO Serviço Federal de Processamento de Dados (Federal Data Processing Service) SEST Secretariat for State-Owned Enterprises (federal level) SIAFI Integrated Government Financial Accounting and Information System SME Small and Medium Enterprises SNAL Sub-national Government Adjustment Loan SOE State-Owned Enterprise SRF Secretaria da Receita Federal (Federal Revenue Secretariat) SRL State Reform Loan STN Secretaria do Tesouro Nacional (National Treasury Secretariat) TA Technical Assistance

Contents Ratings and Responsibilities.............................................................................................. i Preface ............................................................................................................................... iii Summary ............................................................................................................................ v 1. Introduction .................................................................................................................. 1

Background and Context ......................................................................................... 1 2. Objectives and Design.................................................................................................. 3

World Bank Assistance Strategy ........................................................................... 3 Loan Objectives and Design .................................................................................. 4

Public Sector Management Loan....................................................................... 4 Private Sector Finance Loan ............................................................................. 4 State Reform and Privatization Loans ............................................................... 6

3. Implementation Experience....................................................................................... 10

Public Sector Management Loan........................................................................... 10 Private Sector Finance Loan ................................................................................. 11 State Reform and Privatization Loans ................................................................... 12

4. Outcome and Assessment........................................................................................... 14

Public Sector Management Loan........................................................................... 14 Private Sector Finance Loan ................................................................................. 16 State Reform and Privatization Loans ................................................................... 18

5. Lessons Learned ......................................................................................................... 22 Box in text 2.1: Relevant Principles of the Levy Report ...................................................................... 5 Tables in text 1.1: Macroeconomic Indicators, 1970-2001 (%)................................................................ 1 1.2: Composition of Fiscal Primary Surplus, 1995-2001 (% of GDP)............................... 3 2.1: SRL Objectives and Content, for SRL States ............................................................. 8 3.1: BNDES Lending to the Public Sector and through Public Sector Financial

Intermediaries, Selected Years (% of BNDES Lending) ...................................... 12 4.1: Size and Composition of the Brazilian Banking System, 1989 and 2000................. 17 4.2: BNDES Disbursements and Employment, 1989, 1990 and 2000 ............................. 17

This report was prepared by William Tyler (Consultant), with John Johnson as Task Manager. Betty Casely-Hayford and Tirsit Dinka provided administrative support.

Contents (cont.)

Annexes A. List of Persons Interviewed ......................................................................................... 23 B. Statistical Annex: Selected Tables .............................................................................. 25 B1.1: Money Aggregates and Monetary Indicators, 1980-2001........................... 25 B1.2: Fiscal Performance and Public Sector Borrowing Requirements............... 25

B1.3: PSML Components Disbursements: Planned vs. Actual (US$000) .......... 26 B1.4: Disaggregated Composition of Fiscal Primary Surplus, 1998-2001 .......... 27

B1.5: State Fiscal Indicators in 1999: Projections versus Actuals ...................... 27 C. Brazilian State Fiscal Adjustment and Reform............................................................ 28

C.1: Fiscal Performance Indicators in Selected (SRL) States, 1996-2000........... 29 D. Basic Data Sheets ........................................................................................................ 31 Attachments A. Comments from BNDES ............................................................................................. 45 B. Comments from BNDES (trans lation of Portuguese letter) ........................................ 52

i

Ratings and Responsibilities Public Sector Management Loan (PSML)

LAC PCR OED PCR Review OED PPAR Outcome

n.r.

Unsatisfactory

Moderately Satisfactory

Sustainability n.r. Uncertain Likely Institutional Development n.r. Modest Modest Bank Performance n.r. Satisfactory Unsatisfactory Borrower Performance n.r. Unsatisfactory Unsatisfactory

Private Sector Finance Loan (PSFL)

LAC PCR OED PCR Review OED PPAR Outcome

n.r.

Moderately Unsatisfactory

Moderately Satisfactory

Sustainability n.r. Uncertain Likely Institutional Development n.r. Modest Modest Bank Performance n.r. Satisfactory Unsatisfactory Borrower Performance n.r. Unsatisfactory Satisfactory

Rio Grande do Sul State Reform Loan (RS-SRL)

LCR ICR OED ES OED PPAR Outcome

Satisfactory

Marginally Satisfactory

Moderately Satisfactory

Sustainability Uncertain Uncertain Likely Institutional Development Modest Modest Modest Bank Performance Satisfactory Satisfactory Satisfactory Borrower Performance Unsatisfactory Unsatisfactory Unsatisfactory

Rio de Janeiro State Reform Privatization Loan (RJ-SRL)

LCR ICR OED ES OED PPAR Outcome Satisfactory Satisfactory Satisfactory Sustainability Likely Likely Like ly Institutional Development Partial Substantial Modest Bank Performance Satisfactory Highly Satisfactory Highly Satisfactory Borrower Performance Satisfactory Satisfactory Satisfactory

Mato Grosso State Privatization Loan (MT-SRL)

LCR ICR OED ES OED PPAR Outcome Satisfactory Satisfactory Satisfactory Sustainability Likely Likely Likely Institutional Development Substantial Substantial Substantial Bank Performance Satisfactory Satisfactory Satisfactory Borrower Performance Satisfactory Satisfactory Satisfactory

Note: n.r. signifies not rated.

ii

Key Project Responsibilities Project Staff Appraisal Completion PSML Task Manager Graeme Thompson Isabel Serrão Emerson Division Chief Roberto Gonzalez-Cofino Paul Meo Director/Country Director Bertrand van der Meer Rainer Steckhan PSFL Task Manager Roberto Mosse Roberto Mosse Division Chief Demetrios Papageorgiou Demetrios Papageorgiou Country Director Armeane Choksi Rainer Steckhan RS-SRL Task Manager Mauricio Carrizosa Mauricio Carrizosa Division Chief Paul Meo Country Director Gobind Nankani Gobind Nankani RJ-SRL Task Manager Danielle Berthelot Danielle Berthelot Division Chief Paul Meo Country Director Gobind Nankani Gobind Nankani MT-SRL Task Manager David Vetter William Dillinger Division Chief/Manager Paul Meo Country Director Gobind Nankani Gobind Nankani

iii

Preface This is the Project Performance Assessment Report (PPAR) for five loans to Brazil, covering the period 1986-2001. The loans are: the Public Sector Management Project (Loan 2721-BR); the Private Sector Finance Project (Loan 3268-BR); the Rio Grande do Sul State Reform Loan (Loan 4139-BR); the Rio de Janeiro State Reform Privatization Project (Loan 4211-BR); and the Mato Grosso State Privatization Project (Loan No. 4189-BR). A fourth in the state reform loan series (SRLs) was approved for the state of Minas Gerais (Minas Gerais State Privatization Project – Loan 4318-BR), but never became effective. The Public Sector Management Loan (PSML), totaling US$29 million, was approved on May 29, 1986. The project closed three years behind schedule in December 1993, after formal amendment on three separate occasions. At closing, an undisbursed balance of US$5 million was cancelled.

The Private Sector Finance Loan (PSFL) was approved on August 31, 1990 in the amount of US$300 million. The loan closed on the originally-scheduled date of December 31, 1993. The remaining balance of US$116 million was cancelled. The Rio Grande do Sul State Reform Loan (RS-SRL), in the amount US$125 million, was approved on March 4, 1997, and became effective June 31, 1997. It closed on schedule on December 31, 1998. A final disbursement took place on December 9, 1998, when a balance of US$20 million was cancelled. The Rio de Janeiro State Reform Privatization Project (RJ-SRL) was approved July 17, 1997 for the amount US$250 million. It closed on the originally-scheduled date of December 30, 1998, when a balance of US$50 million was cancelled. The Mato Grosso State Privatization Project (MT-SRL), totaling US$45 million, was approved June 12, 1997, but did not become effective until April 20, 1999. It closed on September 30, 2001, nearly three years later than originally envisaged. The Minas Gerais State Privatization Project (MG-SRL) was approved on April 28, 1998 in the amount US$170 million. The loan was never signed, and lapsed on October 19, 1999, eighteen months after Board approval. Justification for the PPAR. The five loans addressed central problems of economic management with different approaches and instrumentalities. The Public Sector Management Loan provided technical assistance to strengthen the federal government’s analytical and institutional capacity, and build support for comprehensive reform. The Private Sector Finance Loan promoted financial sector reform via a credit line to Brazil’s most important national development bank – BNDES. In both cases, the Brazilian experience serves to confirm lessons learned elsewhere from similar operations. Equally important, the passage of time has altered significantly the assessment of their development impact, which was obscured at the time of first evaluation by a protracted period of economic instability.

iv

The four state reform loans (SRLs) cannot yet benefit from the same long-term retrospective, but benefit from being analyzed in a cluster, which reveals facets of their performance which might, otherwise, have been obscured, had they been examined only individually. The SRLs were innovative, because, for the first time, they involved the Bank in direct lending to sub-national governments. Hence, their assessment furnishes some first-time lessons. Sources. The PPAR is based on Bank project files, reports, and documents; data produced by the federal and state Brazilian governments; International Monetary Fund documents; academic studies; discussions with Bank staff and ex-staff involved in the projects; and interviews with Brazilian federal and state officials, academics, and private sector representatives. Key Bank documents included project identification and preparation reports, back-to-office reports, concept and issues papers, Staff Appraisal Reports, President’s Reports, loan agreements, supervision reports, Project and Implementation Completion Reports, correspondence, and other project files. Economic and sector reports from 1984 to 2001 (including Country Assistance Strategy documents) have also been consulted. A mission visited Brazil during August-September 2001. PPAR Finding. Differences between PPAR and ICR/PCR ratings arise for two main reasons: First, because the passage of time may clarify the impact of intangibles which lead to altered judgments about the project’s long-run achievement of objectives; and, secondly, because clustering project evaluations frequently yields insights that could not have been readily divined through assessment of any single one of them. The draft PPAR was sent to officials in the federal and state governments, related agencies and BNDES. Comments were received from BNDES on March 27, 2003. The comments in the original Portuguese, and an English translation, have been included in Attachment A and Attachment B. Upon review of these comments, the text of the PPAR was amended to report additional details on BNDES efforts to restore compliance with the PSFL-covenanted ceiling on lending to public intermediaries. No further change in the outcome rating was deemed necessary, since the points made in BNDES’ submission had already been taken into account in the draft PPAR, which upgraded the rating of outcome from moderately unsatisfactory in the PCR review to moderately satisfactory. However, on the basis of these comments, a decision was made to upgrade the rating of Borrower performance from unsatisfactory to satisfactory. In the end, BNDES’ argument that a temporary breach of the covenanted ceiling on lending through public financial intermediaries was outweighed by long-term policy actions ensuring over- fulfillment of that and other covenanted ceilings proved persuasive.

v

Summary 1. Attached is the Project Performance Assessment Report (PPAR) for the above loans to Brazil, approved and operative from 1986 to 2001. A fourth loan in the state reform loan (SRL) series, approved by the Board for the State of Minas Gerais (Minas Gerais State Privatization Project – Loan 4318-BR), never became effective. Although not formally assessed, its experience is briefly recounted.

2. The Public Sector Management Loan (PSML) supported the strengthening of Brazil’s public sector planning and management capabilities at the federal level in the areas of information, research, planning, budgeting, program implementation and operational control, including the supervision of state enterprises. The loan was designed under a wide umbrella as a multi- faceted technical assistance project administered jointly by the ministries of planning and finance. Shifts in governmental priorities over the lengthy implementation posed major difficulties.

3. The Private Sector Finance Loan (PSFL), one of a number of credit line loans to Brazil’s National Development Bank (BNDES), supported the reorientation of this public sector bank toward the private sector, including the banking system, through its direct lending and lending through financial intermediaries.

4. The four State Reform Loans (SRLs) promoted state fiscal adjustment and structural reforms, especially privatization of state-owned public enterprises.

5. The results of the Public Sector Management Loan were mixed. However, the payoffs from several components, including the SIAFI system, public enterprise reforms instrumental to subsequent privatizations, and strengthened national income accounting, have proven to be substantial, justifying an upgrading of the outcome rating from unsatisfactory to moderately satisfactory. Moreover, the sustainability of these improvements, reinforced by complementary reforms implemented by subsequent governments, justifies upgrading this rating from uncertain to likely. Institutional development impact is rated modest, while Bank performance – owing to careless accounting for project expenditures – is downgraded to unsatisfactory.

6. Like the PSML, the Private Sector Finance Loan (PSFL) was prepared in the late 1980s. As with the PSML, some ratings were upgraded, relative to the PCR review. Despite serious flaws in the loan design, the outcome of the PSFL was rated moderately satisfactory, rather than moderately unsatisfactory. Noncompliance with a covenant requiring staged reductions in BNDES lending through public financial intermediaries turned out, in the end, to be only a minor, and temporary, departure from a longer-term trend of declining BNDES lending, directly and indirectly, to the public sector. Given that this was the major stated objective of the loan, an improvement in the outcome rating was in order. Since the shift toward directing a larger proportion of BNDES lending to the private sector appears to be irreversible, sustainability is now considered likely, rather than uncertain, as in the PCR review. Institutional development was rated modest, unchanged from the PCR review, reflecting that, although the PSFL influenced a long-term shift in BNDES policy on lending to the public sector, it had little impact on the internal workings of that bank. Finally, due to the flawed loan design, the rating of Bank performance was lowered from satisfactory to unsatisfactory.

vi

7. The SRLs were similar in design and results. The outcome of the Rio Grande do Sul SRL is rated moderately satisfactory, as it was in the ES. The loan’s many accomplishments were partially offset by shortcomings in the design of the privatization strategy, in the use of privatization proceeds, from an unraveling of state fiscal discipline in 1998, and in the establishment of the state regulatory agency. Sustainability is rated likely, up from uncertain, since the privatizations are not reversible, and, more recently, because substantial follow-up fiscal adjustment has taken place. Institutional development impact is rated modest overall, although it was substantial in some areas. Bank performance is rated satisfactory.

8. The outcome of the Rio de Janeiro SRL is rated satisfactory, unchanged from the ES. Given the irreversibility of the privatization actions, sustainability is rated likely. Had the state regulatory agency not gotten off to such a poor start, institutional development impact would have been rated substantial, as in the ES, but, because of this problem, and its longer-term ramifications, institutional development impact was downgraded to modest. Bank performance is rated highly satisfactory, with special acknowledgment of the high quality of the technical assistance provided.

9. Of the three SRLs taken to effectiveness, the Mato Grosso SRL appears to have been the most successful. The outcome of the Mato Grosso SRL is rated satisfactory, with likely sustainability. Despite a slow and uncertain start to the state regulatory agency, institutional development impact was substantial, while Bank performance was satisfactory.

10. Despite certain drawbacks, in the end, the SRLs provided effective support to Brazil’s development priorities. When the currency crisis of 1997-98 offered the opportunity for action, the Bank proved itself adroit in diagnosing the underlying state problems and preparing suitable interventions, which ultimately provided important underpinnings for the parallel fiscal adjustment of the federal government.

11. Major lessons of general applicability from the five loans assessed include: • Continuity of Bank interventions is important for promoting lasting institutional change.

Sub-national programmatic loans offer advantages, in this respect, over time-bound SRLs.

• The principles of the Levy Report remain relevant for designing financial sector lending operations.

• Credit lines (financial intermediary loans) are unlikely to be appropriate instruments for supporting financial sector adjustment.

• Reconciling project expenditures fully and correctly at closing is a core Bank responsibility.

• An oversight agency operating within an appropriate regulatory framework is an important prerequisite to successful privatization of public services.

• As investment loans, the SRLs proved to be cumbersome instruments for supporting structural change

Gregory K. Ingram Director-General

Operations Evaluation

1

1. Introduction Background and Context

1.1 During the late 1960s and 1970s, Brazil enjoyed a period of vigorous economic expansion, with real GDP growth averaging nearly 9 percent annually. Exports grew rapidly, and Brazil became an important industrial exporter of shoes, food products, and other products. High rates of domestic investment were financed, in part, by high levels of external borrowing, and the current account deficit grew to unsustainable proportions (Table 1.1). Inflation burgeoned, as monetary and fiscal policies became increasingly lax, reinforced by a process of creeping indexation of domestic prices, and the impact of two international petroleum shocks in 1973 and 1979.

Table 1.1: Macroeconomic Indicators, 1970-2001 (%)

Annual Average Growth (%) Current Public

Year

GDP

GDP Implicit Deflator

Exports of Goods a

Gross Domestic

Investment b

Account c Bal/GDP

(%)

Sector d Bal/GDP

(%)

1970-80 8.6 39.7 22.1 8.6 - 4.4 n.a. 1980-90 1.6 330.8 4.5 - 1.3 - 1.6 n.a.

1990-2000 2.7 205.7 5.8 2.7 - 2.3 n.a.

1993 4.9 1996.2 7.7 6.3 - 0.1 - 58.8 1994 5.9 2240.2 12.9 14.3 - 0.9 - 45.4 1995 4.2 77.6 6.8 7.3 - 2.8 - 7.2 1996 2.7 17.4 2.7 1.2 - 4.4 - 5.9 1997 3.3 8.3 11.0 9.3 - 4.4 - 6.1 1998 0.2 4.9 - 3.5 - 0.3 - 4.3 - 8.1 1999 0.8 4.6 - 6.1 - 7.2 - 3.1 - 10.0 2000 4.5 8.0 14.7 4.5 - 4.1 - 3.6

2001e 1.5 8.5 5.7 1.5 - 4.6 - 3.6

Notes: a. Expressed in nominal US$. b. Computed from an IPEA investment series, expressed in 1980 prices. c. The current account balance in the balance of payments is expressed as a percentage, with a minus sign indicating a deficit. d. The public sector fiscal deficit is depicted by the total public sector borrowing requirements (PSBR) for the

consolidated public sector. A minus sign indicates a deficit. e. Preliminary estimates or forecasts.

Sources: Central Bank of Brazil, IBGE, IPEA, and World Bank, World Development Indicators, CD-ROM version.

1.2 By the early 1980s, external debt had multiplied ten-fold from a decade previously, leading to a severe debt crisis. Unable to rollover existing debts, nor obtain new foreign loans, the Government was compelled to redress the external and internal imbalances which had accumulated. The externally-financeable current account deficit was quickly reduced, but so was output growth, which slowed to a trickle. Such was not the case with domestic policies,

2

which, if anything, became even more accommodative immediately after the onset of the debt crisis than they had been just before.1

1.3 The acceleration of inflation during the 1980s and early 1990s prompted numerous ineffectual efforts to stabilize. Price controls, price and wage freezes, delays in adjusting public sector prices, alterations of the price indices on which indexation was based, half-hearted attempts to scale back indexation, debt moratoria, and even partial confiscation of the government’s domestic debt in the hands of the public were tried, all without success.

1.4 A major ingredient missing from the policy mix was concerted fiscal discipline. Federal, state and municipal governments had become over-dimensioned, while state-owned enterprises had proliferated. Fiscal imbalances imposed large borrowing requirements on the public sector, crowding out the private sector. Banking spreads remained high, and numerous government- imposed restrictions impeded the functioning of financial markets. Public banks channeled subsidized credit to preferred users, and served, in effect, as fiscal agents for state governments pursuing undisciplined fiscal policies.

1.5 In an increasingly open and democratic political environment, these economic problems prompted a re-examination of the foundations of Brazil’s development strategy which persists to this day. 2 Only in the early 1990s did this search begin to yield fruits. The Collor administration began redimensioning the public sector - closing down federal agencies, dismantling heavy-handed regulation, privatizing the first public enterprises, lifting price controls, reducing trade restrictions, and reforming the financial sector.

1.6 But only in 1994 were serious efforts to introduce macro-economic stabilization policies begun, with the Plano Real. Using the exchange rate as a nominal anchor, it led to a systematically dismantling of price indexation in labor, product, and financial markets. The plan was an immediate success, yielding a sharp and lasting decline in both inflation and poverty. 3 Added to this were orthodox monetary and fiscal policies, the effects of which can be viewed in Table 1.2, and the supporting Annex B Tables B1.1 and B1.2.

1 The degree of monetary - and to a certain extent, fiscal – expansion during this period is reflected in the growth of the monetary aggregates, presented in Statistical Appendix Table B1.1. 2 These problems were extensively analyzed in the Bank’s ESW of the 1980s and 1990s, yielding many policy suggestions later adopted by federal and state governments. 3 Sonia Rocha, “Pobreza no Brasil: Principais Tendências da Espacialização,” IPEA/Dipes, Rio de Janeiro,1998 and Sonia Rocha, “Pauvreté au Brésil:L´Épuisement des Effets Distributifs de la Stabilisation Monétaire,” IPEA, Rio de Janeiro, Abril 1999.

3

Table 1.2: Composition of Fiscal Primary Surplus, 1995-2001 (% of GDP)

Government Category/Level

1995

1996

1997

1998

1999

2000

2001

Federal Government & Central Bank 0.58 0.38 - 0.32 1.35 2.41 1.91 1.92 State and Municipal Governments - 0.17 - 0.55 - 0.72 - 0.41 0.23 0.57 0.92 Public Enterprises - 0.05 0.08 0.07 - 0.07 0.65 1.06 0.94

Total Primary Surplus 0.36 - 0.09 - 0.97 0.01 3.29 3.54 3.76

Memo Item: Net Public Sector Debt/GDP 30.8 33.2 34.3 41.7 49.4 49.3 53.4

Source: Banco Central do Brasil and BNDES. 1.7 Despite this dramatic improvement, the fiscal deficits of the state and municipal governments continued to worsen. The Constitution of 1988 had made it virtually impossible to fire state employees, whose wages constituted a high proportion of total expenditures. When rates of inflation were high, control of the wage bill could be achieved by delays and partial adjustments. But, once price stability returned, these options no longer worked. Matters worsened when the nominal interest rates the states were paying on their debt failed to decline as fast as inflation, raising the real burden of debt service.4 If the state fiscal deficits could not be contained, the Plano Real was effectively doomed. It was against this background of events that the three state reform loans (SRLs) were put together.

2. Objectives and Design World Bank Assistance Strategy 2.1 At the time the SRLs were conceived (1995), the relevant CAS specified several broad objectives, including: (a) macroeconomic stabilization and modernization; (b) poverty alleviation and human resource development; (c) infrastructure and urban development; and (d) environmental protection. Intermediate goals included assisting with the stabilization plan, and advising on fiscal, financial, social, monetary, tax, and privatization reforms. The instruments specified to achieve these objectives included, inter alia, ESW on state finances and fiscal management, loans to support state fiscal reform, the privatization of state banks, and technical assistance to the states. More recent CASs have reiterated these objectives.

4 This problem was perceptively identified in November 1995 by a Bank report (Brazil – State Debt: Crisis and Reform, No. 14842-BR) which served as the point of departure for the subsequent SRLs.

4

Loan Objectives and Design

Public Sector Management Loan

2.2 At its origin in 1986, the Public Sector Management Loan (PSML) was comprised of fourteen components, and a plethora of subcomponents. They covered five major areas: (a) the development of budgeting, evaluation, research and training in the Ministry of Planning (SEPLAN); (b) integrated systems for managing budgetary execution, finances, and debt through the recently established National Treasury Secretariat (STN) in the Ministry of Finance; (c) the imposition of procedures to evaluate state-owned enterprise (SOE) performance and institute SOE rehabilitation; (d) improved information systems, including national and regional statistics, and (e) research on future reforms. Jointly administered by SEPLAN and the Ministry of Finance, the loan contained no blueprint of measurable, anticipated results, which led to confusion during implementation.

2.3 By 1991, Brazil’s system of public administration remained in dire need of modernization. Both the Bank and the incoming Government decided to transform the loan into a vehicle to build support for recasting the role of the government in the economy. The ensuing redesign stressed flexibility, recognizing that project priorities would need to evolve rapidly to keep pace with sweeping public administration modernization efforts.

Private Sector Finance Loan

2.4 The Private Sector Finance Loan (PSFL) emerged from discussions between the Bank and the Government about a possible financial sector loan to develop the private banking system and increase the supply of long-term private credit. However, the deteriorating macroeconomic situation in1989-90 precluded a financial sector adjustment loan. In its place, the PSFL provided a line of credit intermediated by the Brazilian National Development Bank (BNDES). At the time of its preparation, an internal Bank report, informally known as the Levy report, questioned the rationale for line-of-credit operations in Bank operations, and proposed a number of guidelines restricting the use of such instruments. Box 2.1 summarizes certain relevant principles which the PSFL largely ignored.

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2.5 BNDES was an easy choice as intermediary for the Bank, since three credit- line projects had already been implemented with BNDES. Despite some past disagreements, relations between the two institutions remained close and cooperative. And, from BNDES’ standpoint, a new credit- line project made sense, since lending had stagnated, and a new administration was bent on modernizing and refocusing BNDES on the private sector.

2.6 A key concern was the weakness of the private commercial banking sector, which, at the end of 1989, held only 40 percent of total banking assets (see Table 4.1 on page 17). So, the objectives of the loan were to: (a) reorient BNDES’ direct lending and second tier lending toward the private sector, including the banking system; (b) reduce credit segmentation; and (c) strengthen credit policies and procedures. Quantifiable criteria on BNDES lending were complemented by measures to reorganize BNDES so as to reduce directed credit lines and strengthen BNDES’ credit, planning and audit departments. The loan sought to finance only technically sound, financially viable, and economically justifiable private sector investments, without regard to sector, region or company size.5 As such, the loan was not a directed credit line, as had been the case with previous Bank loans to BNDES.

2.7 Were these the right objectives? Increasing long-term financing to the private sector was a relevant objective, as was the aim of increasing BNDES’ lending to the private sector, at least as a short-term palliative. BNDES has been – and still is – the only financial intermediary in Brazil effectively providing long term financing to the private sector. It has no real competition. BNDES’ dominance stems from its privileged access to payroll tax proceeds as a source of funding, which enables BNDES to lend at long-term rates, which (while positive in real terms) are significantly lower than short-term market rates. However, if the project goal was to strengthen long-term credit markets and private sector competition in those markets, then the failure to include components to strengthen the capacity and involvement of privately-owned banks represented a significant oversight.

5 A controversial question not addressed in the loan was the issue of capital ownership for borrowers. At the time of the loan, there was a BNDES restriction against extending credit to foreign-owned firms. This restriction has been subsequently relaxed.

Box 2.1: Relevant Principles of the Levy Report The Levy report deals with the preconditions for successful financial sector operations, including credit lines. Among the principles articulated are:

a. Financial sector reform and macroeconomic stability are intimately interrelated. High inflation

breeds uncertainty regarding prices, real interest rates and exchange rates, thus inhibiting savings and investment. Proposed financial sector operations, therefore, should be preceded by a determination that the macroeconomic environment is conducive to realizing their objectives.

b. The market determination of interest rates is an essential element of financial market competition

and of the efficient mobilization and allocation of financial resources…Administered interest rates and credit lines usually lack the flexibility to adjust to changing economic conditions, [and] tend to lag behind inflationary and exchange rate expectations.

Source: IBRD, internal document.

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2.8 Should the Bank have made the loan? The Bank has long identified development of private long-term financial markets as a priority development goal. Yet the PSFL credit line operated at cross-purposes with that objective. Strengthening BNDES’ privileged role may well have retarded the emergence of such markets in Brazil.6 This drawback was not considered so important at the time, because macroeconomic instability was also undermining the development of such markets, and because the Bank still provided direct long-term credit lines through public banks, a practice strongly criticized in the Levy Report. 7 Under conditions of macroeconomic stability, such a course of action would certainly have been ill-advised.

2.9 Yet, even under conditions of macroeconomic instability, such as prevailed at the time the PSFL was being appraised, proceeding with the operation can be viewed in retrospect as of dubious justification. Increasing instability had actually depressed the demand for BNDES investment finance, while rising inflation had distorted computation and interpretation of key parameters used in the project analysis.

State Reform and Privatization Loans

2.10 By 1995, it became clear that emerging fiscal problems in the states placed the consolidation and continuation of the country’s macroeconomic stabilization at risk. This was the point of departure for development of the SRLs, which aimed to support fiscal adjustment in the states, a policy objective shared by the federal government.

2.11 A first question concerned selection of the states. The state of São Paulo, whose fiscal problems and debt overhang were particularly large and daunting, was eliminated from consideration, on the grounds it was too large, too politically-sensitive, and too weak in its performance on past Bank loans to the state to permit effective Bank involvement. The second tier of states heavily weighted in the aggregate of state deficits and debt included Minas Gerais, Rio de Janeiro and Rio Grande do Sul. On the basis of discussions with the political leadership, Bank staff concluded that the will to deal with these problems was strong in these three states – a key selection criterion – justifying their inclusion in the first round of SRLs. After exploratory discussions with other states, Mato Grosso was added later.

2.12 Another selection criterion was the willingness to privatize or liquidate the state-owned banks, all of which constituted heavy fiscal drains. In the case Rio Grande do Sul, an exception was granted, since the Government was unwilling to privatize its state bank but chose, instead, the state telecommunications company. This substitution was acceptable, because privatization of the Rio Grande telecommunications company provided a good test case for later privatization of the much larger federal telecom network. Indeed, subsequent privatization of the state-owned company (CRT) garnered a good price for the state.

2.13 Originally, the SRLs had two primary objectives: (a) fiscal adjustment and (b) longer-term structural reform, including privatization. Debt management and debt workouts were to form an integral part of the fiscal adjustment process. However, during loan preparation, it 6 In reality there are many explanations for the non-emergence of long-term financial markets, including regulatory considerations and financial contract enforcement. 7 It can be noted that at the time of loan preparation for the PSFL (1990-91) the Levy Report was still being rather contentiously discussed within the Bank.

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became clear that a nationwide approach under the aegis of the National Treasury (STN) to refinance or write down state debts made better sense, ruling out a workout for just a few states. On the other hand, until the impact of the nationwide workout on individual state finances was known, it became impractical to stipulate specific fiscal targets. In the end, the Ministry of Finance decided to refinance the state debts, rather than pursue debt write-downs. These politically-charged negotiations were not translated into individual state agreements until early 1998. To qualify for subsidized debt refinancing, states were compelled to adopt fiscal adjustment programs, including quantified fiscal performance targets. With this delay, the Bank faced a dilemma: (a) delay the SRLs until the debt refinancing agreements were concluded, so as to ensure strong up-front fiscal conditionality; or (b) de-emphasize the fiscal, and stress the non-fiscal structural reforms. Unwilling to allow this window of opportunity to close, the Bank opted for the latter option.

2.14 Accordingly, non-fiscal reforms emerged as the focus of the SRLs. Hopes that significant state government labor force reductions could be achieved were dispelled, once it became clear that the requisite constitutional amendment would not be passed. Thereafter, divestiture and the concessioning of state enterprise services (including the creation of regulatory agencies to oversee the newly-concessioned services) became the foremost aims. The objectives and key components of the SRLs are summarized in Table 2.1.

2.15 . Assessment of the SRL Objectives. The shift toward concessioning and privatization proved to be a sensible response to altered circumstances. It usefully supported the CAS objectives of macroeconomic stability, public sector modernization, and increased private sector participation in the provision of infrastructure. 2.16 How well designed were the instruments? The design of these loans stressed front-loading of most Borrower actions, which were completed before Board presentation. With the possible exception of Minas Gerais (whose incoming administration in January 1999 was philosophically opposed), participating state governments exhibited strong ownership of the loan objectives and design.

2.17 Although the SRLs supported reform measures more akin to adjustment than investment loans, the Bank lacked procedures at the time that would have permitted providing adjustment lending to the states. So disbursement and procurement had to be handled as if the SRLs were standard investment loans. This meant that it was impossible to synchronize exactly loan disbursements with the timing of reform actions. Nevertheless, Bank staff devoted considerable time – and resources – to working out disbursement arrangements consistent with both the intent of the loans and prevailing Bank practice.

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Table 2.1: SRL Objectives and Content, for SRL States

Objectives and Content

Rio Grande do Sul

Rio de Janeiro

Mato

Grosso

Minas Gerais

1. Support Fiscal Adjustment X X X Fiscal Adjustment Targets X X X Public Sector Investment/Expenditure Review X X X X 2. Support Privatization/Liquidation/Concessioning of State SOEs X X X X State Bank(s) X X X X Electricity Distribution Company(ies) 1 X 2 X X 3 Water and Sewerage Company 1 X X X State Gas Company X X State-Owned Telecommunications Company X Highway Concessions X X X Port Concessions X X Suburban Trains Company X Metro X Bus Company X Ferry Boat Company X Others X X X 3. Establish a State Regulatory Agency for the Privatized or Concessioned Public Services X X X X Loan Amount (US$ million) 125.0 250.0 45.0 170.0 Date of Board Approval Mar 97 July 97 June 97 April 98

Notes: 1. The electricity distribution and water privatization/concessioning components were dropped in the Minas Gerais during

the course of loan preparation. 2. The RS state electricity SOE was subdivided into three distribution companies, two of which were privatized. 3. The MT state SOE (CEMAT) privatized also included electricity generation and transmission activities. Source: Loan SARs or MOPs. 2.17 An important design feature involved establishment of state regulatory agencies for those public services being privatized or concessioned. The experience with privatization amply demonstrates the need to have a regulatory framework in place at the time of privatization. While some argue that separate regulatory agencies for each concessioned or privatized public service is preferable (e.g., urban transportation, water, gas distribution, etc.), the SRLs established a single regulatory agency in each state covering all these services.8 The justification for adopting this approach centered on: (a) resource constraints; (b) presumed startup difficulties in establishing several regulatory agencies; (c) possible benign externalities from regulating multiple activities; and (d) a reduced likelihood of regulatory capture. Should

8 For some privatized activities in Brazil, a dedicated federal regulatory agency exists, e.g., for banking, electric energy, and telecommunications.

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subsequent experience demonstrate that separate regulatory agencies were necessary, it was reasoned that a single regulatory agency could easily be divided, as needed.

2.18 Timing the approval and implementation of the SRLs posed another difficult challenge. The plan was to time these loans so that they conformed to the electoral cycle, closing them prior to the assumption of office by incoming state governments on January 1, 1999. This greatly compressed the time available for developing and implementing coherent economic reform programs, all the more so since roughly half of a four-year political cycle must be set aside to undertake organization of the new administration and, later, in preparing for a new election. Terminating the loans before a new administration took office reduced the risk that parts of the reform program might not be implemented, due to a lack of interest or commitment by an incoming government. But, it also greatly increased the risk of running out of time before complicated measures could be completed. Of course, whenever a state governor was re-elected, closure of the SRL was readily extended. This was the case in Mato Grosso, enabling that Government valuable additional time to complete a complex process of concessioning water services and devolving them to the municipalities.

2.20 An added degree of complexity pertained to the privatization and concessioning of water and sewerage services, whose functional assignments were greatly affected by the Constitution of 1988. This Constitution transferred responsibility for providing these services to the municipal governments. An exception was supposed to be made whenever water and sewerage facilities were being shared by multiple municipal governments, as is often the case in large metropolitan regions. Here, it was believed that the Constitution allowed the functional responsibility to remain with the corresponding state, although this was not entirely clear, and is currently the subject of pending, clarifying legislation. Moreover, the Brazilian federation is unlike the US and German systems, in that Brazilian municipalities have considerable autonomy from state governments. This fact has greatly complicated the process of reaching new agreements between the two. Particularly nettlesome were the problems of establishing municipal companies and concessions, and reimbursing state authorities for the physical facilities and assets transferred. Finally, the absence of any federal regulatory framework meant that project task managers could expect little guidance from that direction.

2.21 In view of these uncertainties, some Bank staff advised against inclusion of the state water companies in the SRLs. However, in the end, it was decided to support privatization of the state water programs because of: (a) the strong interest and will of the state governments to proceed; (b) the difficulties experienced nationwide in financing and delivering adequate water and sanitation services; and (c) the potential for improving the quality of these services through privatization. To mitigate the risk that privatization or concessioning might fail, “floating” tranches were designed for the water components of the SRLs.

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3. Implementation Experience

Public Sector Management Loan (PSML)

3.1 The PSML became effective in December 1986, six months after Board approval. After a slow start, the loan was redesigned in 1991, resulting in cancellation of $5 million of the original $29 million. Thereafter, the project gained momentum, closing three years late in December 1993, after three amendments and four extensions.

3.2 The slowness in launching the project had several causes. First, the Bank and the Government underestimated the administrative difficulties involved in contracting third-party services and consultants, especially international consultants, for the various components. Contracting was constrained by restrictive features in Brazilian law and procurement regulations. Only after the UNDP became involved in the project in 1991 was this constraint overcome.

3.3 Second, the complexity of the project was daunting. The original project included fourteen components, engaging the same number of government agencies. Two economic ministries – SEPLAN and the Ministry of Finance – managed these components. A single executing agency would have helped accelerate implementation of the loan, a step which was not taken until five years after loan approval, when this responsibility was invested in IPEA. A Project Management Unit was also established, and functioned reasonably well over the remaining life of the loan. Lastly, competition for funds led to squabbling and jealousies among Governmental agencies, tensions which could not be easily resolved. However, once overall responsibility for project management was unified, this difficulty was attenuated.

3.4 Design and flexibility issues frequently arise in connection with technical assistance loans. One approach is to introduce a great deal of flexibility, sufficient to adapt to changes in circumstances and/or governments. However, this may deprive the loan of adequate focus, resulting in meager results at termination. There is also the risk that such a loan could become a sort of “slush fund”, financing activities far from the original goals of the technical assistance. The alternative is to have a fixed blueprint, with clearly defined objectives and measurable results. The downside of this approach is that it may become so rigid, as to preclude desirable modifications due to changing circumstances or government priorities. In the end, some balance between these two approaches is called for. Unfortunately, the PSML may have erred on the side of excessive flexibility, which led to amorphous interventions.

3.5 The goals of the project were defined broadly enough to accommodate a wide set of modifications. Over the course of three presidential administrations, Governmental priorities changed frequently, forcing changes in loan content which were, at times, disruptive and even wasteful. Examples of components added after considerable discussion, then little utilized, included components for creating a trade promotion and market information system in the Ministry of Foreign Relations and a tax administration and training facility in the National Revenue Service.

3.6 The PSML was implemented during a period of major instability (1986-1993). Repeated stabilization attempts failed to harness high, and accelerating, inflation. Political

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uncertainty was heightened, not only by frequent changes in policy direction, but also by a presidential impeachment, the enactment of a new Constitution, and successive administrative reforms. To some extent, these obstacles to implementation blunted the loan’s ultimate usefulness.

3.7 Bank supervision of the project was intensive and expensive. Staff responded flexibly to changing Government priorities and administrative mechanisms, modifying project content and modalities appropriately. However, this required seventeen supervision missions over the life of the loan, which consumed over 200 staff weeks. Moreover, supervision failed to pick up inconsistencies in project accounting which left US$2.6 million unaccounted for (see Annex B Table B1.3)

Private Sector Finance Loan (PSFL)

3.8 The PSFL, in the amount of US$300 million, became effective on schedule in March 1991. Following a dispute with the borrower, BNDES, over one of the loan covenants (described below), the loan was closed on its originally scheduled date in December 1993, with an undisbursed balance of US$116 million.

3.9 To meet a major project objective, increasing the provision of direct and indirect BNDES lending to the private sector, quantitative performance indicators were designed into the loan covenants. These indicators are summarized in Table 3.1. BNDES’ direct lending to the public sector was scheduled to decline from 27 percent of the total in 1989, to 19 percent in 1993, while indirect lending through public sector financial intermediaries was set to decline from 50 percent in 1989 to 40 percent in 1993. As can be observed, although the direct lending target was met and exceeded, lending through public sector financial intermediaries failed to decline to covenanted levels, exceeding the limit in both 1992 and 1993. This was the only loan covenant which the Borrower failed to meet.

3.10 In 1992, BNDES’ senior management changed, and the new president was less supportive of the project objectives than his predecessor. The new management stressed that, as a public institution, BNDES followed Government directives, and that these directives placed a priority on lending to agriculture (where the public sector Banco do Brasil was dominant). At the end of that year, BNDES advised the Bank that, because of a Banco do Brasil- financed agricultural credit program (FINAME) undergoing rapid expansion, the covenanted ceiling on lending to public intermediaries would be temporarily breached, promising to restore compliance by late 1993.9 For purposes of measuring compliance with the end-1992 ceiling, BNDES proposed excluding its exposure to the Banco do Brasil accounted for by the FINAME program. This was not acceptable to the Bank. In April 1993, BNDES wrote a second letter, indicating that it hoped to restore compliance by the end of the second quarter of 1994 through new policy measures, including reductions in BNDES lending to the Banco do Brasil for non-agricultural purposes and promotion of a larger role for privately-owned banks in the FINAME program. Concerned that this meant a second consecutive year in which compliance with a covenanted target had been missed, the Bank counter proposed that disbursements be suspended, and loan closing extended by one year until 9 Ultimately, the ceilings for both 1992 and 1993 were missed.

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compliance could be reestablished, but this proposal was not acceptable to the Borrower.10 So, the PSFL was closed on its originally-scheduled date of December 1993, leaving 39 percent of its committed funds undisbursed.

Table 3.1: BNDES Lending to the Public Sector and through Public Sector Financial Intermediaries, Selected Years (in % of Total or Indirect BNDES Lending)

Lending to Public Sector Lending through Public Sector Financial Intermediaries

Year PSFL Agreed Actual PSFL Agreed Actual

1989 27 % 27 % 50 % 50 % 1990 23 15 45 44 1991 19 12 40 40 1992 19 16 40 48 * 1993 19 12 40 52 * 1994 15 40 1995 9 35 1996 23 34 1997 22 40 1998 9 25 1999 3 14 2000 2 16

Note: * indicates that compliance with Loan Agreement conditions was not met. It is interesting to note that more recent data, not available to Bank missions at the time, now put the percentages for the actuals in 1992 and 1993 at 41 and 44 percent, still out of compliance, but less so. Source: BNDES and Bank’s Project Completion Report (for Loan 3268-BR).

State Reform and Privatization Loans (SRLs) 3.11 The four SRLs were prepared nearly simultaneously. Project identification began in 1995, followed by appraisals in 1996-97. The first approved by the Board was for Rio Grande do Sul, followed shortly thereafter by Rio de Janeiro and Mato Grosso. Loan effectiveness was reached in June 1997, April 1998, and April 1999, respectively for Rio Grande do Sul, Rio de Janeiro and Mato Grosso. Although the Minas Gerais SRL was to first to undergo intensive preparation, it was the last to be approved, and never became effective. Had the Governor of Mato Grosso not been re-elected in 1998, a similar fate might have befallen the Mato Grosso SRL. The Rio Grande do Sul and Rio de Janeiro SRLs closed on schedule in December 1998, but an extension was granted for the Mato Grosso loan, which closed in September 2001 – nearly three years after the originally-envisaged date.

3.12 Front-Loaded Conditionality. Loan implementation was facilitated by front-loading conditionality. Although this increased preparation costs, it minimized implementation problems, averting after-the-fact misunderstandings. Altered circumstances led to ensuing changes of conditionality during preparation, avoiding frictions further on down the road. Consequently, supervision was able to focus on verification that a few previously-agreed actions left for the implementation stage had actually been completed on time.

10 Had the Bank’s counterproposal been accepted, it is likely the loan would have been fully disbursed before the end of 1994, since, true to its promise of April 1993, BNDES did subsequently reduce its other operations with the Banco do Brasil sufficiently to restore compliance before the end of 1994 (Table 3.1).

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3.13 Disbursement Mechanisms. Considerable time and energy had to be invested during preparation in making what were, in reality, policy-based adjustment operations conform to Bank disbursement procedures for investment loans. Time slices of the states’ public sector investment programs were in effect financed, with the specification and agreement on projects conceivably suitable for Bank financing. Considerable, time-consuming efforts had to be devoted to the identification of eligible expenditures and subsequent follow-up verification during implementation. The issue of qualifying reimbursable expenditures became particularly problematic in Mato Grosso, leading to considerable misunderstanding and a major delay in getting the loan signed. The political opposition in the state legislature capitalized on the lack of clarity in the disbursement mechanism by criticizing the treatment of certain categories of reimbursable expense and overall by questioning the loan’s suitability for Mato Grosso’s needs.

3.14 Time Constraints for Completing Actions. The deadline imposed by the political calendar – December 1998 – left state governments with little time to carry out the agreed reforms, many of which were complex. The states were also constrained by a lack of staff with relevant experience, and by the press of competing duties. Hence, for some of these reforms, time ran out before they could be completed.

3.15 Water and Wastewater Services. Time limitations were especially acute in the area of water and wastewater services. Critical legal problems had to be resolved, including the issue of how to interpret and apply the relevant provisions of the new Constitution of 1988 with regard to devolution to the municipalities. Secondly, politically-powerful opposition from the state water companies, which, in the case of Rio de Janeiro, employed 15,000 people, had to be overcome during an election year. And deficiencies in management and information systems had to be rectified in short order, so that the desired transfer of assets could take place. For example, in Rio de Janeiro, the water company (CEDAE) had no inventory of its physical assets or their whereabouts – much less any reliable information on their commercial value.

3.16 Because of such difficulties, the privatization and concessioning of water services envisaged in their SRLs could not be completed in Rio Grande do Sul and for Rio de Janeiro. Only in one state, Mato Grosso, was the concessioning of water successful, and that only because re-election of a committed Governor justified granting an extension of loan closing so that the process could be completed.11

3.17 The question arises whether the Bank should have done likewise for the Rio de Janeiro and Rio Grande do Sul SRLs, in order to initiate a dialogue with the incoming governments on fulfilling the covenants on water privatization. In the case of Rio de Janeiro, the new Governor asked the Bank to extend the loan closing for additional time to conclude an agreement with the state water authority, CEDAE. The Bank decision to not extend the loan may well have been the correct course, as staff doubts about the state’s commitment to the actions required for tranche release were reinforced by subsequent political developments. In the case of Rio Grande do Sul, the strong anti-private sector orientation of the new Government – at least

11 In the end the state government of Mato Grosso, tired of waiting for the federal government to enact regulatory legislation, decided to submit its own, very comparable legislation to the state assembly. Working through the complex issues involved was assisted by Bank supervision of the loan.

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during its first year in office – reduced the likely benefits of keeping the loan open for a longer period of time.

3.18 State Regulatory Agencies. The agencies and regulatory frameworks were not in place at the time the major privatizations took place. Moreover, in Rio Grande do Sul and Rio de Janeiro, the regulatory commissioners were appointed by the outgoing Governors, producing immediate tensions with the incoming administrations. The result was that these were hobbled from the beginning.12 The absence of staggered terms proved to be another design flaw, since it meant that all commissioners in Rio Grande do Sul had to be replaced at once, raising doubts about the continuity and future direction of the AGERGS.

4. Outcome and Assessment

Public Sector Management Loan

4.1 The objectives of the Public Sector Management Loan supported the Bank’s country assistance strategy. The success of individual components was mixed, but, on balance, the overall outcome is rated moderately satisfactory.

4.2 The most successful components entailed support for: (a) the national statistical system; (b) integration of the federal accounting and monitoring system (SIAFI) in the National Treasury; and (c) reform of the state-owned enterprises and the system that controlled them. Major improvements to the national statistical system were particularly notable for the national income accounts. Prior to the PSML, the national accounts were housed in the Getúlio Vargas Foundation, and estimated in precarious and incomplete fashion. The PSML facilitated the transfer of these accounts to the IBGE (Brazilian Statistical Institute), realignment of the estimating methodology with international practice, enhanced reliability, and improved timeliness.

4.3 The establishment of the SIAFI system of integrated public financial accounting enabled the federal government to monitor expenditures and budget execution transparently; receive information on a timely basis; and increase expenditure control, all of which were key to ensuring greater fiscal discipline. Without such a system, the major fiscal adjustment achieved during the late 1990s might not have been possible. Subsequently, SIAFI’s scope was extended, although not with Bank financing, to the state and municipal governments – the so-called SIAFI-EM. More recently, the Bank has supported further improvements in the SIAFI system via an FY01 technical assistance operation.

4.4 The program for evaluation and, if necessary, rehabilitation of the SOEs under control of the Secretariat for State Enterprises (SEST) had, as a sub-text, the privatization of the most problematic enterprises, although this was not an explicit objective. First-time operational audits produced recommendations for improving performance, which then routinely became 12 In the case of Rio de Janeiro, the incoming Governor immediately fired all the staff of the regulatory agency, leaving the newly appointed Commissioners with little professional support but with considerable encouragement for their own resignations. All of the originally appointed Commissioners were eventually replaced. This early setback delayed making the operationalization of the agency effective.

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SEST requirements. Thanks to the extensive privatization which ensued, the need for SEST oversight gradually diminished, to the point where the Secretariat was phased out of existence.

4.5 While public asset administration and training were greatly improved, there were also some notable failures. For example, progress was scant toward strengthening the budgetary process, which resided in the Planning Secretariat (SEPLAN). Institutional rivalries developed between SEPLAN and the Ministry of Finance (which houses the National Treasury). The SIAFI system was perceived by SEPLAN as a threat to its budgetary authority, so integration of the two systems – budgetary and financial monitoring – never took place. Attempts under the aegis of the loan to modernize the auditing system also encountered institutional resistance, and were, consequently, frustrated.

4.6 On balance, the impact of successful components outweighed the failures. Moreover, the intangible accomplishments, such as building a consensus for reform through research and analysis of public sector modernization options, were considerable. Many Brazilians involved in the project emerged later as reform-minded policy-makers. And, in a period of limited budgetary resources, the PSML provided vital support to the Institute of Applied Economic Research (IPEA), which served as an incubator for policy-makers and reform proposals. All of these seeds nourished by the PSML were to bear fruit in the policy reforms of the late 1990s.

4.7 The changing content of the PSML can be seen by comparing originally-budgeted amounts for different components to the amounts actually spent (Annex B, Table B1.3). Given that the expenditure categories are broadly defined, the comparison actually understates the change in loan substance. The budgeted amounts did not predict accurately how the resources would be applied, or whether they would be successful. The SIAFI component – arguably the loan’s most striking, visible and enduring success – absorbed slightly more than had been originally budgeted. But other successful components, such as modernizing national income accounting and rehabilitating state enterprises, actually wound up costing less than had been originally planned. For example, the PSML failed to disburse for all the privatization activities envisaged (and was, therefore, considered a failure at the time of its initial evaluation). But the privatization work which did proceed under the loan eventually proved to be pivotal.

4.8 Managerially and administratively, the PSML was too complex. Its components were far too numerous to be pursued effectively. In effect, it was a huge, and risky, gamble. The fact that the gamble paid off in a few specific instances, with significant benefits for Brazil, should not be seen as an endorsement of this kind of approach to providing technical assistance.

4.9 From this longer perspective, substantial payoffs from several components – the SIAFI system, public enterprise reform, and the strengthened system of national income accounting – loom larger than they did at the time OED reviewed the project completion report (PCR). Therefore, the PPAR upgrades the outcome rating from unsatisfactory to moderately satisfactory. The sustainability of these improvements is considered likely, compared to uncertain in the PCR review.

4.10 The institutional development impact is judged to be modest, reflecting the substantial impact of a few components, mixed in with a larger number having no impact. Borrower performance – reflecting the many shifts in priority and behavior which disrupted

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implementation of the project – is rated unsatisfactory. These latter two ratings reconfirm the ratings originally provided by OED’s original PCR review. On the other hand, Bank performance has been downgraded and is now rated as unsatisfactory. Inconsistencies in project accounting and supervision have come to light, as revealed in a more exacting examination of the PCR. OED was unable to fully reconcile project expenditures from the PCR, the numerous supervision reports or the project files (see Annex B Table B1.3). These inconsistencies marred an otherwise satisfactory Bank performance.

Private Sector Finance Loan

4.11 The PCR evaluation of the Private Sector Finance Loan (PSFL) was heavily influenced by the failure of BNDES to comply with a single covenant, namely that it channel no more than 40 percent of its lending through public sector financial intermediaries during 1992-93. Non-compliance led to a disagreement about remedies, ultimately leading to the suspension, and eventual termination, of the loan, leaving a large undisbursed balance.

4.12 Lending to the Private Sector and the Private Banking System. Examination of Table 3.1 above reveals that the period of non-compliance was relatively brief, representing only a temporary departure from the long-term trend showing a marked contraction in BNDES lending through public sector financial intermediaries. By 1999 and 2000, BNDES had fallen to less than half the covenanted ceiling of 40 percent.13 Meanwhile, BNDES lending to the public sector, which had been declining since the late 1950s, continued to fall, from 12 percent in 1993 (already substantially below than the covenanted ceiling of 19 percent) to 2 percent in 2000. 14 With both of the covenanted PSFL targets now surpassed, the goal of inducing BNDES to increase activities supporting the private sector and reduce lending to the public sector can be considered fully met.

4.13 The general objective, to stimulate growth in the private banking system, was integral to the Bank’s country assistance strategy. The growth of private sector banking, in absolute terms and relative to the public banks, is shown in Table 4.1. By the end of 2000, private banks accounted for 55 percent of total banking sector assets and 66 percent of total equity, up from 40 and 35 percent, respectively, in 1989.

13 To be sure, this reduction coincided with the privatization or closing of a number of public sector banks, as pursued under the Government’s fiscal adjustment program, including the state reform programs. 14 The percentages for 1957, 1967, 1977 and 1987 were 79, 66, 56 and 36 percent, respectively. The reversals in 1996 and 1997 to the generally downward trend reflect financing used to facilitate SOE privatization.

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Table 4.1: Size and Composition of the Brazilian Banking System, 1989 and 2000 As of December 31, 1989 As of December 31, 2000 1 Total Total Total Total Assets2 % Equity 2 % Assets2 % Equity 2 %

Public Banks 145 60 16 65 208 45 14 34 Federally-Owned 116 48 13 55 193 42 12 32 Federally-Owned, exc. BNDES

87 36 7 30 141 30 6 16

BNDES 29 12 6 25 52 11 6 15 State-Owned 29 12 3 10 16 3 1 3

Private Banks 99 40 8 35 254 55 26 66

TOTAL1 244 100 24 100 462 100 39 100

Notes: 1. Data for 2000 represent only the largest 50 banks, which account for 96.2% of total banking sector assets. 2. Values are expressed in current US$ billions.

Source: For 1989, IBRD, Brazil: Private Sector Finance Project, Staff Appraisal Report, Report No. 8793-BR, August 31, 1990. For 2000, Banco Central do Brasil, 50 Maiores Bancos por Ativos Totais , March 23, 2001.

4.14 Financial Performance. BNDES has continued to improve its financial performance. Non-performing loans fell from a three-year average of 9.6 percent of the portfolio in 1990-92 to 2.7 percent in 1998-2000.15 Return on equity capital averaged 7.6 percent during the 1995-2000 period.

4.15 Efficiency and Cost Effectiveness. Efficiency in a development bank is hard to conceptualize or measure. One measure, albeit flawed, is the ratio of disbursements per employee over time. It is flawed because the denominator includes employees engaged in non-lending services, such as risk analysis and resource acquisitions through capital markets. Nevertheless, the fact that the ratio for BNDES increased considerably between 1989 and 2000 (Table 4.2) suggests a large improvement in operating efficiency. Part of this improvement stems from an internal reorganization in 1990. As can be seen, this led to a significant reduction in the number of employees.

Table 4.2: BNDES Disbursements and Employment, 1989, 1990 and 2000 BNDES 1989 1990 2000

Total Disbursements (current US$ billons) 3.4 3.3 12.6 Total Employment 2,317 1,877 1,641 Disbursements/Employee (US$ 000) 1,476 1,731 7,672

Source: BNDES. 4.16 There is little question BNDES has emerged as a stronger development institution. It now places much greater emphasis on lending for social development and human resources, and even lends to foreign firms, which was prohibited until its internal procedures were changed during the 1990s. It also became an effective executor of Brazil’s national 15 Because of improvements in the BNDES loan classification system, the numbers may not be strictly comparable, but the trend seems undeniable.

18

privatization program. Bank technical assistance associated with the PSFL, although not formally a part of it, may have helped in this regard.16

4.17 PPAR Assessment. The PPAR upgrades the outcome of the Private Sector Finance Loan from the moderately unsatisfactory rating of the PCR review to moderately satisfactory. Covenant noncompliance was a temporary departure from the longer-term trend toward reduced BNDES lending to the public sector and through public sector banks. Since there is little likelihood such a vast transformation will be reversed, sustainability is rated likely (as compared to uncertain in the PCR review). As in the PCR review, ins titutional development is rated modest, reflecting the fact that the PSFL had limited impact on the internal workings of the BNDES.

4.18 Bank performance is downgraded to unsatisfactory, in view of the flawed and ill- timed, approach to promotion of a market for long-term credit, which largely ignored the lessons of experience highlighted in the Levy Report issued several months before appraisal and widely discussed within the Region. However, the Borrower’s performance has been upgraded to satisfactory, considering that, despite temporary non-compliance with the financial intermediary covenant, BNDES subsequently took measures which more than compensated for that lapse. For all its deficiencies, the PSFL had a lasting impact on later BNDES decisions which favored expansion of private long-term credit markets.

State Reform and Privatization Loans

4.19 Role of the SRLs in Supporting State Fiscal Adjustment. The SRLs provided important support to the fiscal adjustment process in the states, a fuller discussion of which can be found in Annex C. The very fact of Bank involvement strengthened STN’s hand, providing additional inducements for good fiscal behavior by the states. SRL preparation entailed a high degree of de facto technical assistance to these states, while privatization helped rid them of a huge fiscal burden. For example, in Rio de Janeiro, the four state SOEs eventually privatized had absorbed transfers equivalent to about one month of the state’s net current revenues.

4.20 Privatization Strategies. The SRLs contained no explicit strategy for privatization, but two elements were evident. First, privatization of state-owned banks was given high priority, and became a criterion for state participation. Secondly, the maximization of sales returns was considered more important than the maximization of economic efficiency. Two examples will suffice to illustrate this. First, none of the state regulatory agencies or associated regulatory regimes were in place by the time the major privatizations were completed. Secondly, the company acquiring the state-owned telecommunications company in Rio Grande do Sul was granted a two-year monopoly over fixed line services, which likely increased the sale price. Only in 2001 was a new entrant admitted, which, by common account, had a marked impact on the quality of consumer service.

4.21 Effects of Privatization. With one or two exceptions,17 the SRL-supported privatizations appear to have had significantly positive effects.18 The fiscal drain on state

16 Among other things, the Bank organized a workshop in BNDES featuring the experience in New Zealand, with the participation of the former New Zealand prime minister.

19

revenues was stanched, and the companies became net payers of taxes. Investments increased, as did financial and operating efficiency, and the quality and quantity of service improved. Even in states where the SRL privatizations were not politically popular, such as in Rio Grande do Sul and Rio de Janeiro, state officials now concede that, although flawed, the privatizations have since yielded significant fiscal and consumer benefits.

4.22 Use of Privatization Proceeds. Given the fungibility of resources, the use of privatization proceeds must be set in a broader context. The Bank followed the lead of STN, which, during SRL preparation, had not yet evolved a set of rules for how any sales proceeds should be applied. With the exception of Minas Gerais, Bank staff encouraged, but did not require, the states to use the proceeds for reducing their sizeable debts. However, with the advent in 1998 of elections, pressures to permit the states to spend the proceeds on politically popular programs proved irresistible. Since there were no applicable loan covenants in the two Rio SRLs or in the Mato Grosso SRL, the Bank had little choice but to acquiesce. It could be argued that the Bank should have anticipated an accommodation of this sort, but this would be expecting clairvoyance as well as prudence. Less understandable is why neither the Bank nor STN insisted on binding expenditure ceilings for the fiscal years during and immediately following the privatizations being supported.19

4.23 In Rio de Janeiro, privatization proceeds were insignificant, because the state was selling a bank (BANERJ) with a large negative net worth. What little there was did become a down payment to refinance the state debt. In Rio Grande do Sul, privatization proceeds of R$3.8 billion (approximately US$3.6 billion at the time) funded a substantial increase in road construction and other public investments (Table 4.3).20 In Mato Grosso, use of the substantial proceeds generated by the 1997 privatization of the power company (CEMAT) did not figure in negotiations with either the Bank or STN. Given the fungibility of resources, it is still unclear how they were applied. In Minas Gerais, the SRL – which was the last to go to the Board (in April 1998) – did include a condition that the proceeds from the sale of two state banks be applied to the reduction of the state’s debt with the federal government, a condition that was rendered inoperative when the loan failed to become effective.

17 One exception may be the suburban commuter train system (FLUMITRENS) in Rio de Janeiro. After initial improvement during 1998 and 1999 in various indicators, such as ridership, the number and condition of coaches, the regularity and frequency of trains, investment, and passenger revenues, a temporary deterioration of service and financial performance occurred. Although performance remains less satisfactory than originally projected, it is still better than that prior to the concessioning. More recently, there are signs that the originally planned improvements in rolling stock are now being implemented, and that demand is recovering. The state regulatory agency has, so far, not taken an active role in resolving disputes between the state and the concessionaire over financial commitments, which clearly falls within its responsibility. By contrast, the concessioning of the Rio Metro proceeded without major difficulties. 18 This conclusion is based in large part upon information contained in the implementation completion reports (ICRs), and is consistent with more general analyses of privatization in Brazil. For a well-founded representative analysis, see Armando Castelar Pinheiro, “Impactos Microecononômicos de Privatização,” Pesquisa e Planejamento Econômico , Vol. 26, No. 3 (December 1996), pp. 357-398. 19 State debt contracts with the STN were negotiated around this time, but never linked to the SRLs. The state contracts eventually did contain binding annual fiscal targets which have been successfully implemented since. 20 A state-owned thermoelectric generating facility (CGTEE) transferred to the federal government generated R$508 million, which became a down payment toward an STN debt refinancing agreement.

20

4.24 Establishment of Regulatory Agencies and Frameworks. Appropriately, the SRLs contained provisions for state regulatory agencies to oversee the services privatized or concessioned to private operators. Significant difficulties were involved in the establishment of these regulatory agencies, and, in some cases, had to be bypassed so as not to slow the momentum of privatization. This decision, to privatize even though the regulatory framework was not fully in place, made sense, given the need to complete the process before the end of the electoral cycle in all four states. Still, it was unfortunate that Bank technical assistance, which had been vital to the creation of these regulatory agencies, ceased at loan closing, while they were still in their infancy. In all cases, the regulatory start-up has been delayed and flawed. All of these agencies have experienced significant “teething” problems, blunting their impact on the newly-privatized companies and leaving uncertain what their ultimate effectiveness will be.

4.25 Should the SRLs have included the state water companies for privatization or concessioning? It was understood from the beginning that attempting to privatize or concession water services posed high risks. Even so, the legal, administrative and political difficulties were underestimated. Only in Mato Grosso did the gamble pay off, to the considerable credit of the state and federal governments and the Bank. In Rio de Janeiro, a last-minute court ruling at the end of the Alencar administration made the privatization of CEDAE unviable. But, there, as in Rio Grande do Sul, SRL-sponsored studies and discussions have planted useful seeds which may yet bear fruit.

4.26 Cost of SRL Preparation. Bank costs for processing the SRLs in Rio Grande do Sul (US$727 thousand) and Rio de Janeiro (US$955 thousand) were high relative to those in Mato Grosso (US$294 thousand). Clearly, there has been considerable learning by doing, since the Mato Grosso SRL was, if anything, more ambitious in design than its predecessors. Considerable time and effort were expended in trying to fit disbursement and procurement procedures intended for investment lending into what were essentially adjustment loans. The recently-developed Sub-national Adjustment Loan (SNAL) is an instrument which should avoid much of this unnecessary effort, cutting Bank processing costs, and allowing the attention of Bank and Borrower to be focused where it belongs – on policy issues, not disbursement minutiae.

4.27 Context of PPAR Assessment. Distinguishing the benefits of a specific loan – or series of loans – from the concurrent benefits of other Bank activities is difficult. Economic and sector studies, formal and informal technical assistance, and the incidental benefits of daily contact between Bank and Government staff have all helped foster fiscal reform and adjustment in the Brazilian states.21 That being said, it may be worthwhile citing one former state planning secretary, who, having dealt with a number of development loans, argued that the SRL was by far the most beneficial, mainly because it triggered profound changes in the way the state’s political leadership thought about the role of government in promoting development, and the need for greater efficiency in the delivery of public services.

4.28 PPAR Ratings. The ratings table on p. v displays the individual project ratings rendered in this, and in previous evaluations of the SRLs, which are elaborated below.

21 The interaction of these interventions is discussed more fully in Annex C.

21

4.29 Rio Grande do Sul. Like the OED ES, the PPAR rates the overall outcome of the Rio Grande do Sul SRL as moderately satisfactory. The loan’s many accomplishments were diminished by shortcomings in the design of the privatization strategy, sub-optimal allocation of the proceeds, an unraveling of state fiscal discipline during loan implementation, and a flawed approach to establishing a regulatory agency. Unlike the previous state government, the present administration accepts that privatized services have brought improved quality and widespread social benefits. Hence, political support for the reforms has increased, and their sustainability is now considered likely, rather than uncertain. All other ratings remain unchanged from the ICR review. Institutional development impact is rated modest, although its impact was substantial in some areas. Bank performance is rated satisfactory, but Borrower performance unsatisfactory, given how the privatization proceeds were spent, and the relaxation of state fiscal discipline during loan implementation, a trend which was, fortunately, reversed, but only after the SRL had closed.

4.30 Rio de Janeiro. Because of the poor start-up of the state regulatory agency, a fact which was not evident at the time the ES was prepared, institutional development impact was downgraded from substantial to modest. All other ratings remain unchanged. The outcome of the Rio de Janeiro SRL is rated satisfactory, and sustainability likely. Bank performance is rated highly satisfactory, notably in recognition of the high quality of technical assistance provided. Borrower performance is rated satisfactory.

4.31 Mato Grosso. The PPAR re-affirms all the ES ratings. Indeed, the Mato Grosso loan appears in retrospect the most successful of the three SRLs actually implemented. Outcome is rated satisfactory, with likely sustainability. The institutional development impact of the loan is rated as substantial, despite a slow and uncertain start-up for the state regulatory agency. Both Bank and Borrower performance are rated satisfactory.

4.32 Minas Gerais. Although the first to be prepared, the Minas Gerais SRL was the last to go to the Board (April 1998), and never became effective. After many disagreements about the content of the state’s fiscal adjustment and privatization program, agreement was reached on a set of ambitious measures, which left aside the difficult fiscal problem. 22 That program – the basis for the loan – consisted of four major, largely up-front, components: (i) the sale of the two state-owned commercial banks; (ii) the concessioning of highway maintenance on a toll-financed basis; (iii) the sale of the state gas company; and (iv) the creation of a new regulatory framework for private providers of public services. Only the sale of the banks was ever completed. A change of administration in January 1999 brought an incoming Governor who displayed little zeal for reform. As a consequence, after reaching an advanced stage of processing, the other objectives were never achieved, and the Bank appropriately allowed the undisbursed SRL to lapse.

22 The 1996 primary deficit was enormous – amounting to 17 percent of current net revenues . Although unwilling to include performance targets in the SRL, the state’s new political leadership soon realized fiscal adjustment was inescapable. This was because a performance contract previously reached with the federal government to refinance the state’s staggering debt would have triggered a cut-off of federal transfers. and higher interest rates in the event of non-compliance. Over the next two years, Minas Gerais converted a primary deficit of 13.9 percent of current net revenues in 1998 to a primary surplus of 0.5% percent in 2000 (Annex C Table C.1), a remarkable accomplishment which occurred entirely outside the auspices of the SRL.

22

5. Lessons Learned 5.1 The lessons learned are not particularly new, especially for those deriving from the technical assistance and credit line loans. Indeed, they have been reiterated in many OED reports and PPARs. Major lessons of general applicability from the five loans assessed include: • Technical assistance which lacks a clear blueprint is hard to manage, and provides too

many temptations to apply unallocated funds to low-priority activities. • Macroeconomic instability and the absence of market-determined interest rates greatly

increase the risk of failure for financial sector loans, confirming the findings of the Levy Report.

• Credit lines (financial intermediary loans) are unlikely to be appropriate instruments for

supporting financial sector reform.

• Full and complete accounting for project expenditures is a core Bank responsibility.

• Lending to sub-national governments can be a powerful instrument for advancing specific country strategies.

• Continuity of Bank interventions across state administrations promotes lasting

institutional change in Brazilian state governments. Sub-national programmatic loans may prove to be better instruments than time-bound SRLs. A prime example is the regulatory agencies, which have suffered because, once the SRLs closed, the Bank effectively abandoned the agencies while they were still in their infancy.

• A functioning regulatory agency with an established regulatory environment is vital to

optimal privatization of public services.

• The benefits of dialogue during loan preparation and supervision can outweigh the importance of the funding, when complex issues of privatization and regulation are being addressed. Officials in all three SRL states cited the Bank’s informal technical assistance as the most important benefit they derived from these loans.

• The SRLs were cumbersome instruments because of their investment loan

characteristics. Sub-national adjustment loans (SNALs) should be a major improvement, allowing the Bank and Borrower to focus on what is important – policy reforms – rather than the minutiae of disbursement and procurement.

23

Annex A

List of Persons Interviewed

World Bank Group Mr. Gobind Nankani, former Country Director, LCC5C Mr. Antonio Magalhaes, LCC5C Mr. Dennis Mahar, former Resident Representative Mr. Paul Meo, former Operations Division Chief Mr. Homi Kharas, former Operations Division Chief Mr. Mauricio Carrizosa, Lead Economist and Task Manager, Rio Grande do Sul SRL Mr. David Vetter, former Task Manager for the Mato Grosso and Minas Gerais SRLs Mr. William Dillinger, Task Manager for the Mato Grosso SRL Ms. Danielle Berthelot, Task Manager for the Rio de Janeiro SRL Mr. Armando Araujo, former Procurement Advisor, LCR Mr. Roberto Mosse, Task Manager for the Private Sector Finance Project Ms. Maria Helena Cordeiro, former Task Manager, Public Sector Management Loan Brazilian Government Mr. Fábio Barbosa, Secretary of the National Treasury (STN) Mr. Renato Villela, Deputy Secretary of the National Treasury

Mr. João do Carmo Oliveira, former Deputy Secretary of the National Treasury Mr. Jorge Khalil, National Treasury Mr. Francisco Gros, President, BNDES Mr. Isac Zagury, Director and Chief Financial Officer, BNDES Ms. Stella Almeida, former Director for Privatization, BNDES Ms. Angela Carvalho, Manager, International Finance, BNDES Mr. Claudio Andrade, Engineer, Industrial Operations Area 3, BNDES Mr. Nilson Holanda, former President of IPEA Mr. José Brakarz, former IPEA official and Coordinator for PSML

Mr. Raul Reis Velloso, former IPEA and Ministry of Finance official Ms. Maria Conceição da Silva, former IPEA official

Mr. Ernani Hickmann, former Ministry of Finance official, currently Professor of Economics, Getúlio Vargas Foundation, Porto Alegre

Mr. José Carlos Brum Torres, former Secretary of Planning, State of Rio Grande do Sul Mr. Luiz Correa Noronha, former Director of Special Projects, Secretary of Planning Mr. Antonio Lima, Director of Special Projects, Secretary of Planning, RS Mr. Claudio Perrone, Advisor, Secretary of Planning, State of Rio Grande do Sul Mr. Felipe Rodrigues da Silva, Tecnical Director, Secretary of Finance, RS Mr. Henrique Peixoto, Economist, Secretary of Finance, State of Rio Grande do Sul Ms. Ida Silveira, Economist, Secretary of Finance, State of Rio Grande do Sul

Mr. Dagoberto Lima Godoy, Commissioner and President, Regulatory Agency for Rio

24

Grande to Sul (AGERGS) Mr. Gilberto Capeletto, Commissioner, Regulatory Agency for Rio Grande to Sul Mr. Vlamir Ramos, Chief Financial Officer, Rio Grande Energia (RGE)

Ms. Túlia Brugalli, Financial Manager, Rio Grande Energia (RGE) Mr. Damián Obligio, President, AES Sul Distribuidora Gaúcha de Energia Mr. Luis Carlos de Castro, Director and Superintendent, Superintendency of Ports and Waterways, Sate of Rio Grande do Sul

Mr. Tito Ryff, Secretary of Planning, Economic Development and Tourism for the State of Rio de Janeiro

Ms. Iracema B. Passoa, Under-Secretary of Planning, Economic Development and Tourism for the State of Rio de Janeiro

Mr. Paulo Cesar Silva Costa, Deputy Under-Secretary of Planning, Economic Development and Tourism for the State of Rio de Janeiro

Mr. Jorge Fernandes da Cunha Filho, Deputy Under-Secretary of Planning, Economic Development and Tourism for the State of Rio de Janeiro

Mr. Henrique Dittmar, former Director of Privatization and Commissioner, Regulatory Agency for Public Services (APEC), State of Rio de Janeiro. Also former Superintendent, BNDES Audit Department

Mr. Renan Saad, former official in Alencar Administration and Commissioner, Regulatory Agency for Public Services (APEC), State of Rio de Janeiro

Ms. Cristina Lucia Vianna, Executive Director, Regulatory Agency for Public Services (APEC), State of Rio de Janeiro

Mr. Ronaldo Sadock, Advisor, Regulatory Agency for Public Services (APEC), State of Rio de Janeiro

Mr. João Ricardo Ripper Nogueira, Manager, Sanitation Bureau, Regulatory Agency for Public Services (APEC), State of Rio de Janeiro

Mr. Edison Garcia, former Secretary of Planning, State of Mato Grosso Mr. Guilherme Frederico Müller, Secretary of Planning, State of Mato Grosso, former

Director of Privatization Mr. Tony Bicudo, Advisor, Secretariat of Finance, State of Mato Grosso Mr. Gaspar Jacobina Turíbio, Manager, Project Implementation Unit for SRL, Secretary

of Planning, State of Mato Grosso Mr. Aldair da Silva Leite, President and Executive Director, State Regulatory Agency

(AGER), State of Mato Grosso Ms. Márcia Vandona, Executive Director, State Regulatory Agency (AGER), State of

Mato Grosso Mr. Clodomiro Mingoranse, Executive Director, State Regulatory Agency (AGER),

State of Mato Grosso Mr. Valdir Jonas Wolf, Financial Director, REDE-CEMAT (Centrais Elétricas

Matogrossenses) Mr. Paulo R. Haddad, former Economic Advisor to Governor’s Office, State of Minas

Gerais, 1995-98, also former Minister of Planning Mr. Sebastião Vital, former Director of Privatization, State Government of Minas

Gerais, 1995-98 Mr. Walter Ness, currently Professor of Finance, Catholic University of Rio de Janeiro

Annex B

25

Statistical Annex

Table B1.1: Mone y Aggregates and Monetary Indicators, a 1980-2001 (%) Annual Rate of Change Rate of

Year

Base Money

M1 b

M2 c Inflation d (%)

1980-90 364.3 323.1 566.6 427.6

1990 2,304.2 2,335.7 313.3 1,476.6 1991 291.2 330.7 472.4 480.2 1992 991.3 896.5 2,052.9 1,158.0 1993 1,953.2 2,117.5 3,005.4 2,708.6 1994 3,322.5 2,556.7 1,242.3 1,093.8 1995 22.6 23.4 47.7 14.8 1996 -8.7 4.6 55.6 9.3 1997 60.8 60.1 21.7 7.5 1998 23.1 5.9 24.4 1.7 1999 15.6 20.5 7.8 20.0 2000 2.0 19.2 3.0 9.8 2001 14.1 12.1 11.4 10.4

Notes: a. All rates of change, including that of the price index, are calculated as end-of-year estimates, i.e., December to December. Because of definitional dissimilarities and since the implicit GDP deflator is calculated as an average for the year, some differences exist between the two measures of annual inflation.

b. Base Money plus demand deposits. c. M1 plus federal, state and municipal government securities held by the public.

d. As measured by IBGE’s General Price Index for Domestic Availability (IGP-DI). Sources: Central Bank of Brazil, IBGE, IPEA, FGV and World Bank, World Development Indicators, CD-ROM version.

Table B1.2: Fiscal Performance and Public Sector Borrowing Requirements, 1995-2001 (% of GDP)

Year

Primary Balance a

Interest b

Nominal Deficit c

1995 0.4 7.6 7.2 1996 - 0.1 5.8 5.9 1997 - 0.9 5.2 6.1 1998 0.0 8.1 8.1 1999 3.2 13.2 10.0 2000 3.5 7.2 3.6 2001 3.8 7.3 3.6

Notes: a. A primary deficit is indicated by a minus. b. Interest on external debt and the real portion of domestic debt interest. c. Equals total public sector borrowing requirements (PSBR). Source: IPEA, Boletim de Finanças Públicas, Dezembro 2000, and BCB, Nota para Imprensa: Política Fiscal,

25 February, 2002.

Annex B

26

Table B1.3: PSML Components Disbursements: Planned vs. Actual (US$ thousand) Component Original Final a Strengthening the Ministries of Economy, Finance & Planning b 7,647 9,520 SEPLAN 4,147 4,996 SOF-Budget Office 897 n.a. IPLAN 1,750 n.a. INPES 1,500 n.a. Ministry of Finance/Economy 3,500 4,524 Integrated Financial Information and Control System 1,500 1,850 Comptroller General Auditors Training 1,500 1,371 Government Assets Administration 500 1,303 State Enterprise Evaluation, Audits and Rehabilitation 6,420 551 Support for Administrative Reform 1,116 508 Training 957 2,212 CENDEC 957 1,552 Central Bank n.i. 106 Attorney General’s Office n.i. 553 Strengthening the Statistical System 8,190 4,963 Tax Administration and Training n.i. 1,748 Modernization of Data Processing System (SEPRO) n.i. 1,050 Ministry of Foreign Relations Trade Information System n.i. 300 Refunding of Project Preparation Advance n.i. 551

Total Base Cost w/o Management and/or Contingencies 24,330 21,403

Project Management and Contingencies 4,670 n.a. Project Management (including UNDP fees) 300 n.a. c Physical Contingencies 2,217 -- Price Contingencies 2,153 --

Total Project Cost 29,000 23,995

minus Cancellation in the third amendment (March 15, 1991) 5,005 --

Net Project Cost 23,995 23,995

Notes: a. Final disbursements as reconstructed from the loan’s incomplete PCR. It should be noted that there is inconsistency in

the totals, which can not be accounted for by management costs alone. In other words, there seem to be missing component expenditure items. An examination of the supervision files did not clear up the mystery of the unaccounted for US$2.6 million. Part of the explanation lies with the improper accounting and non-inclusion of project management fees, which included at least US$121 thousand. In addition, the Region notes that “The project implementation period (1987-1993) was a highly turbulent time for Brazil’s economy, with double and triple digit monthly inflation rates toward the end of the period. It is not inconceivable that …the apparently “missing” project components could be due to the effect of rapid devaluation of local currency vis a vis the US$ during that time period. The staff preparing the PCR and SPN reports (and conceivably even the PIU information systems) could well have used different exchange rates to convert local currency-denominated expenditures into US dollar values than the exchange rates used by LOA to disburse.” More generally, the final presentation of the project disbursements in the PCR appears haphazard and incomplete, as can be observed from the incomplete components disbursements table on p. 31 of the PCR. On the other hand, disbursements by expenditure category (e.g., consultant services, goods, etc.) do in fact add up to the disbursement total of US$23,995 thousand (p. 30 of the PCR).

b. The Ministry of Finance component was originally separate but was included in the overall component for the strengthening of institutional capacity for economic policy-making in the Third Amendment of the Loan.

c. A project administration cost disbursement of US$121 million is reported in the PCR (p. 30) but disbursements for the larger category of project administration, including the UNDP fees, are left unrecorded in the PCR.

n.a. not available. n.i. not included in the original plan for the project. Sources: President’s Report, supervision reports and the PCR for the loan.

Annex B

27

Table B1.4: Disaggregated Composition of Fiscal Primary Surplus, 1998-2001(% of GDP)

Government Category/Level 1998 2000 2001

Central Government: Federal Government & Central Bank 1.35 2.87 2.99 INSS (Social Security) - 0.79 - 0.93 - 1.07 Federal Public Enterprises - 0.25 0.94 0.63 Subtotal 0.31 2.84 1.92 Regional Governments: State Governments - 0.41 0.42 0.62 Municipal Governments 0.22 0.13 0.28 State Public Enterprises - 0.07 0.14 0.30 Municipal Public Enterprises - 0.04 0.00 0.01 Subtotal - 0.30 0.70 0.90 Total Primary Surplus 0.01 3.54 3.76

Source: Banco Central do Brasil and BNDES. Table B1.5: State Fiscal Indicators in 1999: Projections versus Actuals

State and Indicator Variables

Projections in SAD

Actuals

Rio Grande do Sul Primary Fiscal Balance/Current Net Revenues (%) 10 -11.3 Debt/Real Current Revenues 1,2 (%) 193 324 Personnel Expenditures/Current Net Revenues (%) 70 81 Rio de Janeiro Primary Fiscal Balance/Current Net Revenues (%) 4 -4.4 Debt/Real Current Revenues 1,2 (%) 304 348 Personnel Expenditures/Current Net Revenues (%) 79 70 Mato Grosso Primary Fiscal Balance/Current Net Revenues (%) 3 12.4 Debt/Real Current Revenues 1,2 (%) 350 298 Personnel Expenditures/Current Net Revenues (%) 63 51 Minas Gerais Primary Fiscal Balance/Current Net Revenues (%) -18 5.4 Debt/Real Current Revenues 1,2 (%) 444 330 Personnel Expenditures/Current Net Revenues (%) 90 73

Notes: 1. Debt acknowledged by the state in terms of its responsibility to service, as well as by the STN. Some of the

growth during 1997-2000 is due to inclusion of previously unrecognized debt. 2. Real current revenues are defined slightly differently from Current Net Revenues but are used in the Law 9496,

which gives the STN the authority to undertake debt refinancing with the states. Source: Staff Appraisal Documents (SAD) for the individual loans. Actuals based upon STN data.

Annex C

28

Brazilian State Fiscal Adjustment and Reform

12. The SRLs were consistent with emphasis of the Country Assistance Strategy on macroeconomic stabilization and modernization of the public sector. The Plano Real, promulgated in 1994, was correctly perceived by the Bank as the linchpin for re-establishing a climate conducive to growth, development, and poverty alleviation. By 1995, it was clear that the requisite fiscal discipline was still not in place, jeopardizing the entire program. Central to this issue were the fiscal imbalances of the states, which the SRLs were invented to address.

13. State Fiscal Adjustment and Reform. Shortly after the initiation of the Plano Real, the federal government sought to rein in the free-spending states by restricting their ability to borrow, linking access to some fiscal transfers to their fiscal performance, promoting administrative reforms, and empowering the federal government to impose harder budgetary constraints on the states through the Law of Fiscal Responsibility.

14. Thanks to these measures, the combined state and municipal government primary balance moved from a deficit equivalent to 0.55 percent of Brazilian GDP in 1996, to a primary surplus of 0.57 percent in 2000, reversing a longstanding deterioration in state fiscal performance. Disaggregation of state from the municipal accounts, as displayed in Annex Table B1.4, shows that the aggregate state primary balance improved from a deficit of 0.41 percent of GDP in 1998 to a surplus of 0.42 percent in 2000.23

15. In preparing the SRLs, the Bank staff accurately diagnosed the states’ fiscal problems, despite reliance on projections which did not prove to be particularly accurate (Annex Table B1.5). The fiscal performance of the four states in which SRLs were initiated is presented in Annex Table C.1. All four achieved a substantial adjustment, and reduced the share of current net revenues going toward personnel costs. By 2000, only Rio Grande do Sul, burdened with a high percentage of employee pensioners, still had a primary deficit, which was subsequently turned into a surplus.24 Nonetheless, all four remain burdened by heavy indebtedness, impeding their return to creditworthiness, and placing the sustainability of their fiscal adjustment efforts under a cloud of doubt.

23 A similar improvement occurred in the state public sector enterprises, whose aggregate primary deficit of 0.07 percent of GDP in 1998 was transformed into a primary surplus of 0.14 percent in 2000. Combining state governments with their SOEs, the total adjustment amounted to slightly more than one percent of GDP over a two-year period. 24 The state governments show a small deficit in 2001, followed by a small surplus in 2002.

Annex C

29

Annex Table C.1: Fiscal Performance Indicators in Selected (SRL) States, 1996-2000 State and Fiscal Indicator Variables 1996 1997 1998 1999 2000

Rio Grande do Sul Primary Fiscal Balance/Current Net Revenues (%) -13.8 -18.9 -29.5 -11.3 -6.4 Primary Fiscal Balance/State GDP (%) -1.0 -1.3 -2.2 -0.8 -0.5 Debt/Real Current Revenues 1,2 (%) 206 228 270 324 310 Personnel Expenditures/Current Net Revenues (%) 88 85 78 81 72 Investment/Current Net Revenues (%) 3.1 4.3 15.6 5.5 6.4 Rio de Janeiro Primary Fiscal Balance/Current Net Revenues (%) -5.7 -13.9 -14.9 -4.4 9.1 Primary Fiscal Balance/State GDP (%) -0.3 -0.8 -1.1 -0.2 0.5 Debt/Real Current Revenues 1,2 (%) 164 226 342 348 336 Personnel Expenditures/Current Net Revenues (%) 87 83 75 70 50 Investment/Current Net Revenues (%) 2.8 12.4 11.3 8.0 11.5

Mato Grosso Primary Fiscal Balance/Current Net Revenues (%) 9.2 16.7 -6.4 12.4 15.2 Primary Fiscal Balance/State GDP (%) 1.1 2.3 -0.8 1.9 2.2 Debt/Real Current Revenues 1,2 (%) 263 300 295 298 317 Personnel Expenditures/Current Net Revenues (%) 74 57 60 51 53 Investment/Current Net Revenues (%) 5.4 5.7 13.9 5.7 7.0 Minas Gerais Primary Fiscal Balance/Current Net Revenues (%) -17.2 -15.0 -13.9 5.4 0.5 Primary Fiscal Balance/State GDP (%) -1.3 -1.1 -1.1 0.5 0.0 Debt/Real Current Revenues 1,2 (%) 219 238 287 330 318 Personnel Expenditures/Current Net Revenues (%) 79 80 79 73 75 Investment/Current Net Revenues (%) 6.7 8.1 9.7 2.6 2.9

Notes: 1. Debt acknowledged by the state in terms of its responsibility to service, as well as by the STN. Some of the growth

during 1997-2000 is due to inclusion of previously unrecognized debt. 2. Real current revenues are defined slightly differently from Current Net Revenues but are used in the Law 9496, which

gives the STN the authority to undertake debt refinancing with the states.

Source: Calculations based upon STN data. 16. Thanks to a new law governing the refinancing of state debt, the National Treasury (STN) became the lead federal agency charged with imposing fiscal discipline on the states. Debt refinancing contracts are now routinely negotiated by STN with all Brazilian states, except Tocantins, which has virtually no debt. The inducements for entering into these contracts include more favorable terms of service on the refinanced debt, interest capitalization, and extended repayment periods.

17. Putting this system in place was conceptually, administratively, and politically complicated. The contracts contain quantifiable fiscal performance targets for primary balances, debt ratios, personnel and investment expenditure ratios, etc. In this sense, they

Annex C

30

resemble fiscal adjustment programs of the type the IMF typically negotiates with sovereign governments. Debt default or noncompliance can result in withheld federal transfers and higher interest rates on the refinanced debt.

18. Role of the Bank. The Bank provided important assistance of various sorts toward establishing the fiscal framework and control mechanisms. The PSML helped the STN develop an integrated financial accounting and information system covering all governmental levels (the SIAFI). Second, Bank ESW helped the federal government recognize early on that there was an emerging state debt crisis, and aided in the identification of possible solutions. Day-to-day strategic advice further illuminated the policy options, even though a number of them – such as a proposed constitutional amendment to facilitate laying off state employees, and a Brady-style initiative for dealing with the overhang of state debt – had to be discarded on grounds of political infeasibility.

19. Third, technical cooperation and informal technical assistance to the STN were provided through the SRLs, including not only discussions with Bank staff on appropriate fiscal targets for the refinancing contracts, but also grant- financed training. One seminar for state secretaries of finance to Australia and New Zealand proved particularly effective. One participant later noted that what he learned on this tour proved critical in convincing his Governor that the state needed to adopt a stringent fiscal adjustment program and privatize the state’s public enterprises.

20. A fourth form of support were personnel exchanges. One of the main architects of the fiscal adjustment framework for the states was a Bank staff member on external assignment, who had also served two years at the IMF.

21. Fifth, technical assistance provided as part of follow-on lending operations has further strengthened federal institutions.25 A Fiscal and Administrative Reform Special Sector Adjustment Loan (the FARL), which became effective in June 2000, supports: (i) adherence to the Fiscal Stability Program; (ii) implementation of state debt refinancing contracts; (iii) enforcement of ceilings on state borrowing: (iv) preparation of the Law of Fiscal Responsibility; and (v) administrative reforms. The First Programmatic Fiscal Reform Structural Adjustment Loan (PFR-SAL), approved in January 2001, had similar goals.

25 The most prominent examples are the Fiscal and Administrative Reform Loan, the First Programmatic Fiscal Reform Structural Adjustment Loan, and the Fiscal and Financial Management Technical Assistance Project.

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31

BASIC DATA SHEETS

BRAZIL– PUBLIC SECTOR MANAGEMENT LOAN (Loan 2721-BR)

Key Project Data (amounts in US$ million)

Appraisal Estimate Actual or Current Estimate

Actual as % of Appraisal Estimate

Total Project Costs 58.5 n.a. n.a. IBRD Loan Amount 29.0 24.0 83 Federal Government of Brazil 29.5 n.a. n.a. Cumulative Estimated and Actual Disbursements (US$ million) FY87 FY88 FY89 FY90 FY91 FY92 FY93 FY94 President’s Report Estimate1 6.00 17.00 24.00 29.00 24.00 24.00 24.00 24.00 Actual 3.47 4.49 5.44 8.12 13.01 17.71 22.75 23.99 Actual as % of Appraisal 58 26 23 28 54 74 95 100 Date of final disbursement: March 31, 1994 1. US$ 5.0 million was cancelled in 1991, reducing the loan amount to US$24.0. Project Dates

Lending Cycle Original Actual Reconnaissance Mission 06/11/84 Preparation Mission 11/05/84 Preappraisal Mission 12/03/84 05/01/85 GOB Requests Loan to Proceed 1 06/85 Bank Resumes Loan Processing 07/85 Initial Project Brief 08/14/85 Decision Memorandum 12/18/85 Appraisal/SEPLAN Components 03/18/85 10/07-25/85 Appraisal/Min. Finance Components 02/16/86 Post-Appraisal 02/23/86 Yellow Draft 05/85 04/03/86 Green Cover 08/85 05/16/86 President’s Report 10/85 05/29/86 Negotiations 05/05-13/86 Board Approval 06/19/86 Signing Date 07/15/86 Effectiveness 12/16/86 Loan Closing 12/31/90 12/31/91(1st extension) 12/31/92 (2nd extension) 06/30/93 (3rd extension) 12/31/93 (4th extension) PCR Completion 06/30/94

1 During the November 1984 mission, the Bank and the Government of Brazil agreed that decisions on whether to

proceed with loan preparation should be left to the new administration. Subsequent delays in the transition between Governments due to illness and subsequent death of Dr. Tancredo Neves, who was elected President in January but unable to take office, further delayed consideration of loan proposals by new ministers and officials. In June, 1985, the Minister of Planning agreed, in principle, to proceed, and specific planning for the loan began in July.

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32

Staff Inputs (staff weeks) Stage of Project Cycle Actual

Preparation 30.4 Appraisal 43.2 Negotiations 9.0 Supervision 212.0

SUBTOTAL 294.6

Completion (PCR) 13.6 Project Total 308.2

Bank Resources: Missions

Stage of Project Cycle

FY1

No. of persons Days in Field

Total Days

Preparation/Reconnaissance2 1984 2 5 10 Preappraisal 1985 Appraisal/SEPLAN Components 1984 6 21 126 Appraisal/Min. Components 1986 Post-Appraisal 1986 2 11 22 Project Launch Seminar 1987 3 9 27 Supervision 1989 3 10 30 Supervision 1989 1 14 14 Supervision 1989 2 5 10 Supervision 1989 1 23 23 Supervision 1989 2 17 34 Supervision 1990 1 7 7 Supervision 1990 1 11 11 Supervision 1990 1 9 9 Supervision 1990 1 8 8 Supervision 1991 1 10 10 Supervision 1991 1 4 4 Supervision 1991 1 12 12 Supervision 1991 1 3 3 Supervision 1991 1 21 21 Supervision 1992 1 7 7 Supervision 1992 1 18 18 Supervision 1992 2 6 12 Supervision 1993 2 12 24 PCR 1994 2 12 24 Total 39 255 466

1. From 1986 to 1989 time allocated for missions was not recorded in the Bank’s Management Information System (MIS). Mission information concerning these years was compiled based on the Back-to-Office reports available in the project files.

2. The President’s Report indicates the project took six months to prepare.

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33

Other Project Data Project/Loan No. Purpose Fiscal Year of Approval Status Electric Power Sector Loan (US$500 million) 2720-BR

The loan aimed at deepening, at the sectoral level, the overall strategy of structural adjustment of the Public Sector.

1986 Completed

The Credit and Marketing Reform Loan (US$500 million) 2727-BR

The loan supported the structural adjustment program by introducing major steps towards deregulation of the economy, and towards a fully market-oriented agricultural policy.

1986 Completed

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34

BASIC DATA SHEET BRAZIL–PRIVATE SECTOR FINANCE LOAN (Loan 3268-BR) Key Project Data (amounts in US$ million)

Appraisal Estimate Actual or Current

Estimate Actual as % of

Appraisal Estimate Total Project Costs 1,198.5 612.6 51 IBRD Loan Amount 300.0 184.0 61 BNDES 299.5 184.0 61 Private Investors 599.0 244.5 41 Cumulative Estimated and Actual Disbursements (US$ million)

FY91 FY92 FY93 FY94 Appraisal estimate 75 150 250 300 Actual 81 n.a. n.a. 184 Actual as % of Appraisal 108% 61% Date of final disbursement: March 3, 1994

Project Dates

Lending Cycle Original Date Revised Actual Identification/Preparation 6/89 6/89 Executive Project Summary 6/89 9/89 3/90 Pre-appraisal 11/89 11/89 Appraisal 4/90 4/90 Negotiations 8/90 8/90 Board Approval 10/90 11/90 11/90 Loan Signature 1/91 1/91 Loan Effectiveness 3/91 3/91 Loan Closing 12/93 12/93 Loan Completion 4/94 3/94 Staff Inputs (staff weeks) Stage of Project Cycle FY89 FY90 FY91 FY92 FY93 FY94 FY95 Preparation to Appraisal

4.3 6.1

Appraisal through Board Approval

56.0 8.7

Supervision 3.0 5.7 11.9 12.3 Completion 10.5 10.0

Total 4.3 62.3 11.7 5.7 11.9 22.8 10.0

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35

Other Project Data Loan /Title & Amount

Purpose

Year of Approval

Status

Comments

First Development Banking (US$ 85 million) 1206-BR

Finance small and medium scale enterprise

1976 Cancelled Lending rates to small and medium enterprises from 1976-1980 were negative in real terms .

Second Development Banking (US$220 million) 2225-BR

Finance small and medium scale enterprises through financial intermediaries.

1982 Closed Intermediaries were trained in project appraisal methodology.

Third Development Banking Loan (US$300 million) 2488-BR

Finance small and medium scale enterprises and develop economic analysis capability of BNDES and financial intermediaries.

1985 Closed US$1.3 million cancelled.

Bank Resources: Missions Performance Rating

Stage of ProjectCcycle

Month/ Year

No. of persons

Days in Field

Special.*

Implem. Status

Develop. Objectives

Types of Problems

Through Appraisal Identification Mission Pre -Appraisal Mission

June 1989 Nov. 1989

2 2

17

11

FPSs

FPSs

Appraisal through Board April 1990 2 14 FPSs Supervision April 1991 1 13 FPSs 1 1 None Nov. 1991 1 7 1 1 None March

1992 (Mid Term Review)

1 13 FPSs 1 1 None

Nov. 1992 2 3 FPSs 2 1 BNDES unable to meet loan target for landing through public financial intermediaries

April 1993 2 8 FPS 2 1 Same as above

Nov. 1993 2 8 FPSs 2 2 Same as above

March 1994

1 10 FPSs 2 2 Same as above

Completion Sept. 1994 1 0 2 2 Same as above

*Specialization: Financial Project Specialists = FPSs

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36

BASIC DATA SHEET

BRAZIL–RIO GRANDE DO SUL STATE REFORM LOAN (Loan 4139-BR)

Key Project Data (amounts in US$ million)

Appraisal Estimate Actual or Current

Estimate Actual as % of

Appraisal Estimate Total Project Costs 461.0 1,574.0 341 IBRD Loan Amount 125.0 105.0 84 Cofinancing – IDB (Tax Project) 19.0 0.0 0 State of Rio Grande do Sul 217.0 1,335.0 615 Caixa Econômica Federal 100.0 134.0 134 Cumulative Estimated and Actual Disbursements (US$ million)

FY97 FY98 FY99 Appraisal estimate 50 105 125 Actual 0 74.98 104.98 Actual as % of Appraisal 0% 71% 84% Date of Final Disbursement: December 9, 1998 Date of Cancellation: US$20 million – December 31, 1998 Project Dates

Lending Cycle Original Actual Identification 3/27/96 Preparation Appraisal 07/15/96 Negotiations 12/16/96 Letter of Development Policy 12/12/96 Board Presentation February, 1997 03/04/97 Signing 06/10/97 Effectiveness 06/30/97 First Time-Slice Release Jan.–June 1997 06/30/97 First Program Review Jun.–Sept. 1997 11/20/97 Second Time-Slice Release July–Dec. 1997 02/17/98 Second Program Review March–June 1998 06/22/98 Third Time -Slice Release March–June 1998 12/09/98 Cancellation 12/31/98 12/31/98 Loan Closing 12/31/98 12/31/98

Staff Inputs (staff weeks and US$ equivalents)1

Stage of Project Cycle Actual Staff Weeks US$ (000) Through Appraisal 77.8 312.1 Appraisal-Board 30.1 149.2 Board-Effectiveness 11.4 35.5 Supervision 43.2 189.5 Completion 7.5 40.9

Total 170.0 727.2 1. Includes Bank-financed and trust fund consultants. Dollars are direct costs only.

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37

Bank Resources: Missions Performance Rating

Stage of Project

Cycle

Month/

Year

No. of persons

Days in

Field

Specialized staff

skills

Implem. Status

Develop.

Objectives

Types of

Problems Through appraisal September 1995 9 15 A,B,C,G,J,K,L November 1995 6 10 A,F,G,H,I,M December 1995 3 4 G,H,I January 1996 10 5 B,C,D,G,H,I,J,L February 1996 4 5 G,N,O,Q May 1996 8 12 C,D,G,H,J,P,R July 1996 2 3 G,Q Board approval through effectiveness

Supervision July 1997 5 4 A, B,C,D,E S S No difficulty in complying with fiscal and investment targets. Risk that state will not comply with target for personnel.

September 1997 3 4 A,C,F S S Project on track. Ahead of 2nd time-slice disbursements implementation conditionality.

November 1997 3 2 A,C,E S S Project on track for first review and 2nd time-slice disbursement.

February 1998 3 1 A,B,C S S Number of obstacles to reform water sector and privatize water company.

June 1998 2 2 A,B S S Last time-slice disbursement (US$20m) dependent on partial privatization of the state water and sanitation company.

Completion March 1999 4 5 A,F,H,K Key to Specialization: A. Task Manager H. Telecommunications O. Pensions

B. Public Finance I. Ports P. Adm. Reform C. Water J. Power Q. Division Chief D. Disbursement/Auditing K. Roads R. Private Sec.Dev. E. Regulation L. Education F. Financial Sector M. Budget Reform G. Sr. Economist N. Health

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38

Other Project Data

Loan

Purpose Amount

(US$ million) Year of

Approval

Status Roughly Simultaneous and Related Operations Loan 4189-BR Mato Grosso State Privatization 45.0 1997 Closed Loan 4211-BR Rio de Janeiro State Reform and

Privatization 250.0 1997 Closed

Loan 4318-BR Minas Gerais State Privatization 170.0 1998 Never Signed

Annex D

39

BASIC DATA SHEET

BRAZIL–RIO DE JANEIRO STATE REFORM PRIVATIZATION LOAN (Loan 4211-BR) Key Project Data (amounts in US$ million) Appraisal Estimate Actual or Current

Estimate Actual as % of

Appraisal Estimate Total Project Costs 5,900.0 6,304.1 107 IBRD Loan Amount 250.0 199.6 80 State of Rio de Janeiro 5,650.0 6,104.6 108

Cumulative Estimated and Actual Disbursements (US$ million)

FY98 FY99 Appraisal Estimate 200 250.0 Actual 125 199.6 Actual as % of Appraisal 63% 80% Date of final disbursement: March 31, 1998 Project Dates

Lending Cycle Original Actual Identification October 1995 Preparation Oct. 1995-Dec. 1995 Pre-appraisal March 1996 March 5-15, 1996 Appraisal May 1996 May 20-31, 1996 Negotiations July 1996 February 24-27, 1997 Board Presentation August 1996 July 17, 1997 Signing March 27, 1998 Effectiveness October 1996 April 9, 1998 Project Program Review No later than June 30, 1998 June 24-26, 1998 Project Completion September 30, 1998 December 31, 1998 Loan Closing December 31, 1998 December 31, 1998

Staff Inputs (staff week and US$ equivalent)

Stage of Project Cycle Actual Staff Weeks US$ (000) Preparation to Appraisal 121.1 498.3 Appraisal 34.8 96.5 Negotiations through Board Approval 50.6 161.9 Supervision 46.6 178.6 Completion 7.2 20.0

Total 253.1 955.3

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40

Bank Resources: Missions Performance Rating Stage of Project

Cycle Month/

Year No. of

persons Days in Field

Special.*

Implem. Status

Develop. Objectives

Types of Problems

Identification October 2-11, 1995 9 10 PSD, EE, E HE, TS, HR, WS

Preparation 1 December 11-15, 1995

8 5 PSD ID, E, D, P, SS

Preparation 2 January 29-February 2, 1996

20 5 PSD, E, D, SS, HR, ID, FS, TS, WS, EE.

Pre-appraisal March 5-15, 1996 15 10 PSD, E, ID, L, FS, SS, D, WS, TS, En, R, EE

Appraisal May 20-31, 1996 11 11 PSD, L, ID, D, R, TS, WS, En

Follow-up 1 November 24-29, 1996

6 6 PSD, L, ID, E, R TS, WS En

Follow-up 2 January 12-17, 1997

5 6 PSD, TS, TC, E

Negotiations through Board Approval Follow-up April 13-18, 1997 7 5 PSD, E, WC,

TS, R, TC

Follow-up June 1-6, 1997 7 6 PSD, E, WC, R, TC, WS

Follow-up July 6-10, 1997 6 4 PSD, E, R, WC, E

Supervision 1.

September 15-30, 1997

3

16

PSD, TC, WC

S

S

Slow preparation of FLUMITRENS concession documents; need to ensure adhesion of key municipalities to proposed privatization of CEDAE to ensure its success

2. November 1-21, 1997

6 13 PSD, En, E, WC, TC, R

S S Delays in signing debt agreement with federal government; slow preparation of FLUMITRENS concessions; need to convince municipalities of benefits of CEDAE privatization.

3. November 3-6, 1997 (Partial mission)

1 4 EE Delayed appointment of regulatory commission members.

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41

Performance Rating Stage of Project

Cycle Month/

Year No. of

persons Days in Field

Special.*

Implem. Status

Develop. Objectives

Types of Problems

4. February 10-20, 1998

3 9 PSD WC, TC S S Delays in provision of legal opinions necessary for loan signing; poor performance of electricity concessionaire, concern regarding support by municipalities.

5 March 18-April 4, 1998

2 18 PSD, WC S S State conceding authority for water challenged by municipalities: Federal Supreme Court to decide.

6. May 1998 2 6 PSD, WC S S Bidders for FLUMITRENS may require more time to prepare bids pending Senate approval of Bank-financed FLUMITRENS modernization project, uncertainty in legal context for water concessions still unresolved.

7. June 24-26, 1998 2 3 PSD, E S S Formal Project Review-all conditions met, except for auction of FLUMITRENS and sale of CODERTE, delaying disbursement of second tranche.

8. November 7-18, 19982

4 12 PSD, WC, E IE

S U State Assembly votes against privatization of CEDAE, making concessioning impossible despite agreement with municipalities. Federal Supreme Court decision still pending; discussions of state completion report/ICR preparation.

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42

Performance Rating Stage of Project

Cycle Month/

Year No. of

persons Days in Field

Special.*

Implem. Status

Develop. Objectives

Types of Problems

9.

January 18-25, 1999

5 9 PSD, WC, WE, E IE

S U New administration challenges regulatory framework for private provision of public services established under the project; review of request for extension of closing date; discussion with new government of requirements for ICR preparation.

* Key: PSD Private Sector Development W Water/Sanitation Sector FS Financial Sector EE Energy Engineer ID Institutional Development L Legal

E Economist D Disbursements En Environment TS Transport Sector P Procurement R Regulation HR Human Resources SS Social Security T C Transport Concession WC Water Concession IE Industrial Engineer 2.

Also completion mission

Other Project Data Loan No.

Loan/Title & Amount

Loan Amount (US$ millions)

Year of Approval

Status

34420-BR Water Sector Modernization 250 1992 Closed 36330-BR Federative Republic of Brazil – Rio de Janeiro

Metropolitan Transport Decentralization 128 1993 Closed

40460-BR Federative Republic of Brazil Railway Restructuring

350 1996 Active

4139-BR Rio Grande do Sul-State Reform 125 1997 Closed 42910-BR State of Rio-Rio de Janeiro Mass Transit 200 1998 Active 4318-BR Minas Gerais -State Reform 170 1998 Never Signed 4189-BR Mato Grosso-State Privatization 45 1997 Closed

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43

BASIC DATA SHEET

BRAZIL–MATO GROSSO STATE PRIVATIZATION LOAN (Loan 4189-BR) Key Project Data (amounts in US$ million)

Appraisal Estimate Actual or Current

Estimate Actual as % of

Appraisal Estimate Total Project Costs 281.0 430.8 153 IBRD Loan Amount 45.0 45.0 100 Cofinancing – IDB (Fiscal Admin) 20.0 20.0 100 State of Mato Grosso 216.0 365.8 169 Cumulative Estimated and Actual Disbursements (US$ million) FY98 FY99 FY00 FY01 FY02 Appraisal Estimate 25.0 45.0 45.0 45.0 45.0 Actual 0 15.0 33.1 39.1 Actual as % of Appraisal Date of final disbursement: 9/30/01

Project Dates

Lending Cycle Original Actual Preparation Appraisal March 17, 1997 Negotiation - - Letter of Development/Sector Policy May 23, 1997 Board Presentation June 12, 1997 Signing March 30, 1999 Effectiveness September 21, 1997 April 20, 1999 First Tranche Release April 20, 1999 Mid-Term Review June 21-25, 1999 Loan Closing December 31, 1998 September 30, 2001

Staff Inputs (staff weeks and US$ equivalent)

Stage of Project Cycle Actual Staff Weeks US$ (000) Preparation to Appraisal 54.8 234.4 Appraisal/Negotiation 15.8 59.9 Board Approval - - Supervision 50.1 253.0 FY98 20.0 81.4 FY99 13.8 70.7 FY00 11.4 78.3 FY01 n.a. n.a. FY02 n.a. n.a. ICR 4.0 16.7

Total n.a. n.a.

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44

Bank Resources: Missions Performance Rating

Stage of Project Cycle

Month/ Year

No. of persons

Specialization

Implem. Status

Develop. Objectives

Identification/Preparation 1. June 96 5 DC, TM, EE, PFS, WSS 2. July 96 1 PE 3. Dec 96 3 TM, FA, PFS 4. Jan 97 2 TM, ES Appraisal/Negotiations Mar 97 7 TM, PFS, EE, WSS, ES, E, SA Supervision 1. Feb 98 4 TM, FMS, WSS, CD 2. June 98 1 FMS 3. Feb 99 2 TM, FMS 4. June 99 3 TM, WSS, FMS 5. Sep 99 2 TM, WSS, 6. Nov 99 1 FMS 7. Dec 99 1 TM 8. Apr 00 2 TM, FMS ICR 1. April 00 2 E, IE 2. Dec 01 2 E, IE Note: Specialization abbreviations are:

CD = Country Director DC = Division Chief E = Economist EE = Energy Economist EE = Energy Specialist ES = Environmental Specialist

FA = Financial Analyst FMS = Financial Management Specialist E = Industrial Engineer

PE = Power Engineer PFS = Public Finance Specialist SA = Staff Assistant TM = Task M anager WSS = Water Sector Specialist

Other Project Data Loan No.

Loan/Title & Amount

Loan Amount (US$ millions)

Year of Approval Status

34420-BR Water Sector Modernization 250 1992 Closed 4139-BR Rio Grande do Sul-State Reform 125 1997 Closed 4211-BR Rio de Janeiro State Reform Privatization 250 1997 Closed 4318-BR Minas Gerais -State Reform 170 1998 Never Signed

45