May 31, 2006

Document of the World BankR

eport No. 32797-PY

ParaguayPublic Expenditure R

eview

Report No. 32797-PY

ParaguayPublic Expenditure ReviewMain Report

Argentina, Chile, Paraguay & Uruguay Country Management UnitPoverty Reduction and Economic Management UnitLatin America and the Caribbean Region

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ABBREVIATIONS AND ACRONYMS

ANDE ACE ANNP ANTELCO

BANAVI

BCP BNF C A H CEDs CGR C N C N V CONATEL

COPACO

CORPOSANA

DGP DGT DIBEN DINAC DINATRAN DV ENREPD

ERSSAN ESSAP

FDC FG FONDEC GDP IBR IDB IGR IMAGRO IMF I N C INDI IPS ISC LAF

National Power Authority (Administracibn Nacional de Electricidad) School Cooperative Associations (Asociaciones de Cooperacibn Escolar) National Port Authority (Administracibn Nacional de Navegacibn y Puertos) (former) Telecommunications Company (Admini~tracibn Nacional de Telecornunicaciones) National Housing Bank (Banco Nacional de Ahorro y Prbstamo para la Vivienda) Central Bank o f Paraguay (Banco Central de Paraguay) National Development Bank (Banco Nacional de Fomento) Agricultural Credit Fund (Crbdito Agricola de Habilitacidn) Departmental Education Councils (Consejos Departamentales de Educacidn) Comptroller General o f the Republic (Contraloria General de la Republica) National Constitution (Constitucibn Nacional) National Securities Commission (Comisibn Nacional de Valores) National Telecommunications Commission (Comisibn Nacional de Telecomunicaciones) Paraguayan Telecommunications Company (CompaZa Paraguaya de Comunicaciones) (former) Urban Water and Sewerage Company (Corporacibn de Obras Sanitarias) General Budget Directorate (Direccibn General de Presupuesto) General Treasury Directorate (Direccibn General del Tesoro) National Charity Directorate (Direccidn Nacional de Beneficencia) National Aerospace Directorate (Direccidn Nacional de Aeronciutica Civil) National Transport Directorate (Direccibn Nacional de Transporte) Roads Authority (Direccibn de Vialidad) Poverty Reduction Strategy (Estrategia Nacional de Reduccibn de la Pobreza y la Desigualdad) Sanitation Regulator (Ente Regulador de Servicios Sanitarios) Urban Water Supply and Sewerage Company (Empresa de Sewicios Sanitarios del Paraguay) Rural Development Fund (Fondo de Desarrollo Campesino) Cattle Industry Fund (Fondo Ganadero) National Fund for Culture and A r t s (Fondo Nacional de la Cultura y las Artes) Gross Domestic Product Rural Welfare Institute (Instituto de Bienestar Rural) Inter American Development Bank Institutional and Governance Review Rural Land Tax (Impuesto a las Actividades Agropecuarias) International Monetary Fund National Cement Company (Industria Nacional del Cemento) Institute o f Indigenous Affairs (Instituto Nacional del Indigena) Social Security Institute (Instituto de Previsibn Social) Excise Tax (Irnpuesto Selectivo a1 Consumo) Financial Management Law (Ley de Administracibn Financiera)

MAG M E C M o F MSPyBS

OECD PAI PEM PETROPAR PFM PGN POA SAS SENACSA SENASA

SFP SIAF

SIC0 S I N A R H SIPP

SITE

S I W P A R SOEs SSEI

SSET

STP UAF U C P UNA UNDP UNE UNFPA UNI UNICEF VAT

Ministry o f Agriculture and Livestock (~ in is ter io de Agricultura y Ganaderia) Ministry o f Education and Culture (~ in is ter io de Educacibn y Cultura) Ministry of Finance Ministry of Health and Social Welfsue (~ in is ter io de Salud Ptiblica y Bienestar Social) Organization for Economic Cooperation and Development Annual Investment Programs (Programa Anual de Inversibn) Public Expenditure Management National Petroleum Company (Petrbleos Paraguayos) Public Financial Management National Budget (Presupuesto General de la Nacibn) Annual Operational Plan (Plan Operativo Anual) Social Action Secretary (Secretaria de Accibn Social) National Veterinary Authority (Servicio Nacional de Salud Animal) National Water and Sanitation Company (Rural) (Servicio Nacional de Saneamiento) Secretariat o f Public Administration (Secretaria de la Funcibn Ptiblica) Integrated Financial Management System (Sistema Integrado de Administracidn Financiera) Integrated Accounting System (Sistema Integrado de Contabilidad) Human Resources Payment System (Administracidn de Recursos Humanos) Integrated Budget Programming System (Sistema Integrado de Programacibn Presupuestaria) Treasury Module o f the Integrated Financial Management System (Sistema de Tesoreria) Road Maintenance Fund (Sistema Vial del Paraguay) State-Owned Enterprises Undersecretariat o f Finance and Integration (Sub-secretaria de Economia e Integracibn) Undersecretariat o f Tax Administration (Sub-secretaria de Estado de Tributacidn) Technical Planning Secretariat (Secretaria Ticnica de PlaniJicacidn) Financial Management Unit (Unidad de Administracibn Financiera) Public Investment Unit (Unidad Central de Inversibn Ptiblica) National University o f Asunci6n (Universidad Nacional de Asuncibn) United Nations Development Programme National University o f the East ( U n ~ v e r s ~ d a ~ ~ a c i o ~ a l del Este) United Nations Population Fund National University o f Itaplia (Universidad Nacionul de Itapzia) United Nations Children's Fund Value Added Tax

ACKNOWLEDGEMENTS

This report was prepared by a team led by Zeinab Partow (Task Manager) and composed o f Valerie Mercer-Blackman (Fiscal Analysis), Mauricio Cabrera (Debt Sustainability, IDB), Gerard0 Ui ia (Budget and Public Expenditure Management), Albert0 Arenas (Public Employment), Cristiiin Diaz (Public Employment), Ramon Figueroa (Public Employment), Gaston Blanco (Social Sectors), Cristina Flood (Social Sectors), Monica Rubio (Education, IDB), Carlos Grau (Education, IDB), Maria Elena Ruiz (Gender), Andrts Pizarro (Infrastructure), Daniel Pulido (Infrastructure), and Raul Auzmendi (Infrastructure). The report also benefited from the excellent assistance o f Mariela Alvarez in Buenos Aires, Gloria Durt in Asuncion and Patricia Chacon Holt in Washington. Mariela Alvarez, Patrick Temple y Rut Simcovich provided capable translation services.

The Public Expenditure Review greatly benefited from collaboration with the Inter American Development Bank on debt sustainability issues and on topics in the education sector.

The team would l ike to thank Government officials-too numerous to mention by name - for their cooperation and assistance during discussions and in obtaining information. The report draws upon discussions with a wide range o f individuals in Government, think tanks, consultants, and international organizations carried out during missions to Paraguay in December 2004 and February 2005.

Thanks are due to the peer reviewers Linn Hammergren (LCSPS), Anand Rajaram (PRMPS), and Gary Reid (ECSPE). Jesko Hentschel (LCSHD) and Juan Gaviria (LCSFP) provided valuable comments to various drafts, The PER was prepared under the guidance o f James Parks (Lead Economist, LCC7A) and Mawicio Carrizosa (Sector Manager, LCSPE).

TABLE OF CONTENTS

PREFACE .......................................................................................................................... 1 EXECUTIVE SUMMARY .............................................................................................. 2 OVERVIEW AND RECOMMENDATIONS .............................................................. 10 1 . INTRODUCTION ...................................................................................................... 10 2 . FISCAL CONDITIONS AND DEBT SUSTAINABILITY .................................................. 12 3. THE BUDGET PROCESS AND PUBLIC EXPENDITURE MANAGEMENT ....................... 21 4 . PUBLIC E~LOYMENT ............................................................................................ 30

6 . ENHANCING THE EFFECTIVENESS OF INFRASTRUCTURE SPENDING ......................... 54 7 . CONCLUSIONS ........................................................................................................ 63 8 . BIBLIOGRAPHY ...................................................................................................... 64 9 . STATISTICAL ANNEX .............................................................................................. 67

5 . SOCIAL EXPENDITURES AND OUTCOMES ............................................................... 41

LIST OF TABLES

........ TABLE 1 . BUDGETS AND BUDGET EXECUTION. BILLION GUARANTIES AND PERCENT TABLE 2 . LEGAL ~ T E R A T I O N S TO THE BUDGET LAW (2000-04) ..................................... 24 TABLE 3 . PARAGUAY AND SELECTED LCR COUNTRIES: ................................................... 42

TABLE 5 . PARAGUAY: ACCESS TO HEAL^ SERVICES BY INCOME, % (2000 ..................... 47

24

TABLE^. PARAGUAY: ENROLLMENTBY INCOME AND AGE GROUP,^^^^ ........................ 46

TABLE 6 . PARAGUAY: LEGISLATIVE DEBATE IMPACT DURING THE APPROVAL STAGE ON

TABLE 7 . SELECTED COUNTRIES: PERCEPTIONS OF DEGREE OF INFRASTRUCTURE

TABLE 8 . URBAN WATER AND SANITATION SUPPLY, SELECTED LATIN AMERICAN

2005 BUDGET LAW .......................................................................................... 53

DEVELOPMENT, 2003 ....................................................................................... 54

COUNTRIES ...................................................................................................... 55 TABLE 9 . BUDGET EXECUTION, 2002-04 ........................................................................... 60

LIST OF FIGURES

FIGURE 1 . ANNUAL GDP GROWTH. % .............................................................................. 10 FIGURE 2 . PARAGUAY: REVENUES. EXPENDITURES AND FISCAL BALANCE. 1990.04 ....... 12

FIGURE 4 . PARAGUAY: EXPENDITURES. % OF GDP .......................................................... 15 FIGURE 5 . TAX AND NON-TAX REVENUES. % OF GDP ..................................................... 17

FIGURE 3 . PARAGUAY: GROWTH OF GDP VS . GROWTH OF CURRENT SPENDING .............. 14

FIGURE 6 . PARAGUAY: PUBLIC SECTOR SALARIES. % OF TOTAL SPENDING ..................... 31 FIGURE 7 . CENTRAL GOVERNMENT SALARIES % OF TOTAL SPENDING. 2003-04 ............. 31 FIGURE 8 . CENTRAL GOVERNMENT SALARIES % OF GDP. 2003-04 ................................. 31 FIGURE 9 . SPENDING ON SALARIES. GOODS & SERVICES AND CAPITAL. % OF GDP ......... 32

FIGURE 10. PARAGUAY AND SELECTED COUNTRIES: WAGE COMPRESSION, 1996-2000 .. 33 FIGURE 1 1. PARAGUAY: SPENDING IN THE SOCIAL SECTORS AS A PERCENTAGE OF GDP,

1998-2000 ....................................................................................................... 41 FIGURE 12. PARAGUAY AND SELECTED COUNTRIES: ACTUAL AND PREDICTED INFANT

FIGURE 13. PARAGUAY AND SELECTED COUNTRIES : ACTUAL AND PREDICTED MATERNAL

FIGURE 14. PARAGUAY AND SELECTED LCR COUNTRIES: PUBLIC SPENDING ON HEALTH,

FIGURE 15. PARAGUAY: COMPOSITION OF EDUCATION SPENDING, % OF TOTAL . . . . . . ... . . . .44 FIGURE 16. PARAGUAY: NET ENROLLMENT BY LEVEL OF EDUCATION, URBAN AND RURAL

AREAS, % ........................................................................................................ 46

MORTALITY RATES, 2004 ....................... ... ..... . ..... ................. .... . ................... 42

MORTALITY, 2004 ........................................................................................... 43

% OF GDP ........................................................................................................ 44

FIGURE 17. PARAGUAY: COMPOSITION OF MSPY BS EXECUTED BUDGET ....................... 48 FIGURE 18. PARAGUAY & SELECTED LCR COUNTRIES: PUBLIC SPENDING ON PENSIONS,

% OF GDP ........................................................................................................ 50 FIGURE 19. PARAGUAY: ROAD CONDITION BY SURFACE TYPE, 2005 ............................... 55 FIGURE 20. BUDGET EXECUTION AT THE ROADS AUTHORITY ........................................... 57

LIST OF BOXES

BOX 1. GENERAL CHARACTERISTICS OF PUBLIC SECTOR EMPLOYMENT AND PAY ............ 34

PREFACE

The analysis included in this Report reflects information available through December 2004. The Report was reviewed with the Government o f Paraguay in March 2006, and was at that time updated to include selected references to 2005.

1

EXECUTIVE SUMMARY

Introduction

1. Paraguay’s growth pattern over recent decades has differed from that o f many other countries in Latin America. Between 1960 and 1995, annual GDP growth averaged 5 percent, although growth was uneven over the decades; this was one o f the highest growth rates of the hemisphere. Paraguay is also one o f the few countries in the region that enjoyed significant growth (at an annual rate o f 4 percent) during the 1980s. This economic expansion reflected a number o f factors including agricultural expansion, the development o f Paraguay’s considerable hydroelectric resources, an open economy trading with larger, highly protected neighbors, and a small public sector (especially prior to the 1990s) that absorbed relatively few resources and generated few distortions. During the 1990s, however, as other countries in the region were beginning the process o f stabilization and reactivation o f their economies, Paraguay lagged in reforms and was not able to resume the high rates o f economic growth it had experienced in earlier years, Since 1995, notwithstanding the recent upturn in growth in 2003-04, economic growth in the country fe l l to an average o f 1 percent per year, far below the rate o f population expansion o f 2.5 percent. Per capita income i s lower today than it was in 1990 and poverty has risen from 30 percent in 1995 to 41 percent today.

2, The central causes for this low growth have been identified in various studies as poor governance and weak institutions, and the existence o f large unmet needs in human capital and infrastructure. This report therefore focuses on the institutional and procedural weaknesses in the operations o f the Paraguayan State. Two o f these problems, a distorted budget process and an inadequate public employment framework, form the core themes o f the Public Expenditure Review. Analysis o f infrastructure and the social sectors picks up the thread and discusses these themes as they apply to the individual sectors, in addition to putting forward sector-specific recommendations related to reforming public spending in order to increase its effectiveness and efficiency.

Aggregate Fiscal Analysis

3. The prospects for fiscal sustainability in Paraguay in the medium term have significantly improved over the past two years as a result o f the current Administration’s efforts at better fiscal management and wide-ranging reforms. There has been a major shift in the fiscal stance from deficit to surplus. Between 2002 and 2004, the overall balance improved from -3.1 to 2.4 percent o f GDP, and primary balances improved from -1.3 to 3.6 percent of GDP. Despite the buildup o f fiscal pressures during the last decade and the dramatic growth o f Paraguay’s external public debt-to-GDP ratio between 2001 and 2002, this ratio i s s t i l l relatively low for regional standards, and almost all of i t is owed to multilateral and bilateral institutions, resulting in low interest rates and long

2

maturities. The public external debt-to-GDP ratio declined from 42.9 percent o f GDP in 2002 to an estimated 36 percent in 2004. Paraguay i s also fortunate to enjoy a relatively benign medium-term public debt sustainability outlook.

4. Debt sustainability analysis and fiscal projections nevertheless point to the limited fiscal space available to Paraguay. Primary surpluses needed to stabilize public debt at manageable levels are achievable if current policies stressing fiscal prudence and economic growth are maintained. There i s little latitude, however, for the significant expansion o f investment in basic infrastructure and social service coverage that Paraguay needs in order to sustain higher growth levels in the future. A relatively low tax burden and substantial evasion, a high level o f spending on public salaries, limited access to capital markets, a large informal sector and modest growth prospects are some o f the factors that make it difficult for Paraguay to generate significant primary surpluses.

5. A high level o f current expenditures, amounting to 75 percent o f total revenues and 137 percent o f tax revenues, is crowding out needed investments in infrastructure and in the social sectors (especially in health and social assistance). The wage bill constitutes the bulk o f th is spending (55 percent), followed by transfers to cover the deficit o f the public sector pension fund, the Caja Fiscal. In regional terms, Paraguay's wage bill i s particularly high' and there are likely to be pressures to increase salaries given the wage freeze that has been in effect since 2001, The deficit o f the public pension fund, the Caja Fiscal, covered by treasury resources, is substantial (1.5 percent o f GDP in 2004). In order to secure additional resources for spending on investments and goods and services, it would therefore be important to ensure that aggregate salary and pension spending be maintained - and preferably reduced - as a proportion o f revenues. Fully implementing the recently approved tax reform, and maintaining the very significant improvements in revenue administration could provide Paraguay with much-needed additional revenues; continued reform o f the Caja Fiscal would do the same. Removal o f the untargeted consumer subsidy on diesel fuel and raising the excise tax on diesel to levels comparable to those o f Paraguay's neighbors, could together add one percentage point o f GDP in resources which may be used for social services and infrastructure, sectors essential to growth and poverty reduction.

The Budget Process

6.9 The budget process in Paraguay has often been an obstacle to effective public expenditure management. Rather than being a tool for planning, prioritization and disciplined resource allocation, the budget has frequently - and often ineffectively - been used as a short-term fiscal tool, to the detriment o f effective and efficient service delivery. While the budget laws can be significantly improved, the dysfknctional character o f the process i s not primarily due to a poor legal framework, but to the wide gap that exists between formal rules and actual behavior, and to built-in incentives that diminish the importance of comprehensive sector planning, aggregate resource envelopes, and monitoring and evaluation.

' Although the number o f public sector employees as a proportion o f the population or o f total employment i s not excessive by regional standards.

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7. Options are available to the Government to rationalize the budget process and to transform it into an effective resource management tool. Given sufficient political support, annual agreements between the Executive and Congress that define the total amount o f the budget as well as revenue levels could be a useful tool for achieving greater discipline during budget discussions in Congress. Efforts to strengthen relations between the Ministry o f Finance and Congress - including the preparation o f more user- friendly information for lawmakers, for example - would help to transmit the priorities and constraints faced by the Ministry, and could generate a more stable environment for debate, replacing ad-hoc lobbying and individual interests.

8. In order to raise the value o f planning and to provide greater certainty regarding resource envelopes, a change in the format in which the budget i s presented would be beneficial. The annual budget could be sent to Congress divided into broad programs and sectors, rather than in line-item detail as i t i s at present. This would help to limit micro- level alterations and would reduce the number o f modifications to the budget that are needed during budget execution. The introduction o f commitment budgeting across the public sector would not only improve expenditure management and fiscal discipline, but would also give more weight to the budget planning process.

9. To increase the predictability o f resource availability during budget execution, quarterly cash plans could be implemented, although th i s would necessitate a significant improvement in internal control mechanisms. An option would be to pilot such an initiative for certain categories o f spending, such as investment expenditures in selected entities. Ministries could be empowered to reallocate resources within their programs, eliminating the need for the numerous annual resolutions and decrees required under current practices for resource reprogramming. The mechanisms for utilizing institutional resources could also be simplified without compromising transparency and accountability. The introduction o f multi-year budgeting, particularly for capital investment, would enable the longer-term planning necessary for bulky infrastructure investments. Significant improvements in technical capacity would be needed for such planning to take place.

Public Sector Employment

10. Public employment in Paraguay faces a number o f challenges. Total spending on wages and salaries i s high by regional standards, but wages o f skilled and professional employees at higher levels o f responsibility are low relative to those o f the private sector. Human resource information and management systems are weak, and there are few controls on payroll, no position descriptions or performance evaluations, and hiring i s rarely based on rules o f competition. There is no unified salary structure and wages and other compensation are largely unrelated to competence or productivity.

11 The dilemma facing Paraguay in terms o f government employment i s twofold: how to reduce the overall public sector wage bill while improving remuneration o f some personnel to attract and retain skil led staff given the apparent disparities between public

4

and private sector pay at higher s k i l l levels, and how to improve human resource management and raise the productivity o f public sector workers. The Government has recognized these problems and has embarked on a number o f efforts to remedy the situation, including carrying out a civil servant census and preparing a draft civil service law. The rationalization and professionalization o f government employment i s a long- term challenge that will require steadfast support from the highest levels o f Government in order to succeed, and will need to be built on solid legal, institutional and informational bases.

12, The revision, approval and implementation o f a new civil service law would be a logical Government objective in the short term. This is a necessary, though not sufficient, condition for progress in reaching a comprehensive and long term solution to Paraguay's public employment problems. To complement the establishment o f a workable legal framework, institutional strengthening o f the SFP (Secretaria de la Funcibn Pziblica, Secretariat o f Public Administration) would be an important step. This would enable i t to carry out i t s mandate as the entity charged with rationalizing the public administration. Reinforcement o f the human resource offices (Unidades de Recursos Humanos) that operate in individual ministries would also help in th is regard.

13. Improving the quality and quantity o f information regarding public sector employment i s another requirement for improved human resource management. Data deficiencies make a thorough analysis o f employment conditions in the public sector virtually impossible. To begin to remedy this situation, provisions could be made for the continued maintenance and upkeep o f the database created by the 2003-04 census.

14. Employment and pay reform i s an essential ingredient not only for improving public service management and service delivery in Paraguay but also for macroeconomic stability. In order to maintain salary spending as a proportion o f revenues and avoid further crowding out o f other current and capital expenditures, across the board wage increases are not recommended without an assurance o f increased public sector revenues. Evidence would favor focusing wage increases on key labor categories for which current salary levels are well below market (namely, managerial, technical and professional staff).

15. There has been a relative absence o f strong political support and consensus in Paraguay regarding the need to implement a substantive reform o f govenynent employment. The political costs o f such a rationalization and reform program are high as it would affect the balance o f power between various actors. In order to succeed, a technical design for public sector reform would need to be accompanied by a political consensus-building strategy within the public sector, with the legislature, and with the public at large. The support o f Congress at the initial stages o f reform i s especially important.

5

The Social Sectors

16. Public sector social spending today represents about 11 percent o f Paraguay's GDP, and has been the motor behind the growth o f public spending as a whole. Nevertheless, social spending in Paraguay i s somewhat below the Latin American average, adjusting for income levels, Spending on education and social insurance* constitutes about three-quarters o f total social sector spending. Spending on health, and especially on social assistance and poverty alleviation programs, i s modest by regional and international standards.

17, In tandem with the increase in spending, important achievements have been made. In terms o f educational attainment and coverage, particularly initial and basic education, Paraguay now compares fairly well with other countries in the Region. In health, the record in terms o f improvements in health indicators i s mixed, with better progress in reducing infant mortality than maternal mortality. In social assistance, however, coverage i s very limited relative to other countries in the Region.

18. Challenges remain in all sectors. In education, enrollment in middle education continues to be among the lowest in Latin America, Completion rates are low, with dropouts concentrated in low income rural areas and the quality o f education continues to be a problem. The coverage o f health services i s low, and Paraguay's commitment to primary care is not well reflected in actual resource allocation, There are difficulties in supplying health services, particularly in terms o f ensuring the even geographical distribution o f inputs. Limited resources and system fragmentation are challenges in the area o f social assistance. In all three areas, concerns over equity and coverage are central issues. In education, equity between rural and urban areas and between households in different income quintiles is low. In health, access to services i s highly inequitable, with a significant portion o f the population receiving no health care. Utilization o f health services i s lower in rural than in urban areas. Contributory social insurance consumes significantly greater public resources than social assistance, and the pension system's coverage i s very low, with highly unequal access to benefits by income level. In education and in health, salary expenditures represent a very high portion o f total spending, forcing a reduction in spending on other key inputs and investments and restricting the possibilities o f improving coverage and service quality. Fragmentation of responsibilities, planning and service delivery in health and in social assistance is an obstacle to the development o f comprehensive sector policies and action plans.

19. Without an increase in public revenues, an overall increase in social sector resources i s probably not feasible given their relatively high share in total expenditures and overall resource constraints. There is, however, some scope for resource reallocation within social spending, such as the shifting o f savings from fiscal adjustments in the deficitary Caja FiscaZ into social assistance. The elimination o f some vacant teacher positions could be considered in order to enable the reallocation o f resources towards investment and other non-salary spending. Additional marginal resources available from savings or resource reallocations would be best allocated to health and social assistance,

' Social insurance includes contributory pensions and health insurance.

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rather than to education or social insurance given the relatively low level o f spending on the former sectors.

20. A nurnber o f policy options exist in order to increase the efficiency and equity o f social sector spending. More' rational planning regarding the filling o f vacant teacher positions could be implemented, in order to provide more flexibility for moving vacant positions to needier areas with higher student-teacher ratios. Similarly, in the health sector, vacant positions may be pooled and reassigned on a strategic basis, improving both the equity o f spending incidence across regions and efficiency o f resource use.

21. To increase coverage o f secondary education, an expansion o f the existing scholarship program could be contemplated. Such a measure may be able to stem or reverse currently high drop-out rates, and may be financed by savings from salary expenditures or from increased cost recovery through university fees, In health, more resources flowing to where primary services are delivered would help to raise coverage levels. This i s in contrast to the current situation where the emphasis i s on supply and with a significant bias towards tertiary care.

22. In social assistance, implementation o f Paraguay's Poverty Reduction Strategy (Estuategia Nacional de Reduccicjn de la Pobreza y la Desigualdad, ENREPD) would add coherence to social assistance and poverty reduction efforts. The effectiveness o f resources would be increased if the large number o f existing programs were brought together under one coordinating institution. Resources for key selected social assistance programs could be obtained by the pooling o f national and donor resources into a 44poverty fund", charged with coordinating and channeling resources under the ENREPD.

Infrastructure

23, The challenge facing Paraguay in the infrastructure sector is how to maintain and expand infrastructure assets to support growth (particularly in the transport and water and sanitation sub-sectors that form the focus o f the PER) given fiscal constraints. Needs in both the transport and water and sanitation sectors are high. By regional standards, the state o f large portions o f Paraguay's road network i s poor, Resources available for maintenance cover only about a quarter o f the network's requirements, conservatively estimated. Coverage o f water supply and sanitation service in Paraguay is low and lags behind other South American countries, even when it is adjusted for differences in purchasing power and per capita GDP. The quality o f wells, surface reservoirs and latrines i s poor in many parts o f the country. Thus, in addition to the immediate need o f maintaining existing infrastructure assets, coverage expansions and service quality improvements are urgently required if public infrastructure is not to become a bottleneck to Paraguay's growth and social development.

24. Although resource constraints and large m e t needs imply that public infrastructure spending will probably have to be complemented by significant private resources to maintain and expand existing assets, both the effectiveness and efficiency o f public infrastructure expenditures can be considerably increased. Some o f the key

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challenges to improving the quality o f public spending on infrastructure include fragmentation of institutions in the sector that has led to deficient planning and priority setting, human resource issues, and a budget process that exacerbates the existing problems in resource allocation and management.

25. The institutional organization o f the infrastructure sectors has promoted a rather narrow approach to the definition o f sector priorities. Even though infrastructure sectors are under the formal tutelage o f the Ministry o f Public Works and Communications ( ~ i n i s t e r i o de Obras Pziblicas y Comunicaciones, MOPC), many other agencies intervene independently in policy definition, resulting in a high degree o f fragmentation in sector planning and investment and in a lack o f policy coordination. In the water and sanitation sector, there i s no Government body to oversee national sector policy partly as a result o f the functional division between rural and urban service delivery. Rural water and sanitation services are supplied by SENASA (Sewicio Nacional de Agua y Saneamiento), which operates under the Ministry o f Public Health, while ESSAP (Empresa de Sewicios Sanitarios del Paraguay) i s a public corporation with budgetary autonomy. Nevertheless, i t should be noted that initial steps towards establishing a national framework for the sector are underway. Whi le the development and implementation o f five-year investment plans requires a high level o f technical capacity, expanding efforts in this area to cover the sector as a whole would be a worthy medium- term objective.

26. Beyond institutional fragmentation, planning and priority setting are also weakened by the multiplicity o f donors financing the infrastructure sector and the lack o f coordination amongst them. External credit sources finance the bulk o f investment planning in Paraguay, and international donors play a major role in the definition o f investment priorities, Despite important donor assistance, the technical capacity required to formulate new investment plans is s t i l l deficient. Improved donor coordination and enhanced planning and selectivity by the Government could begin to address concerns regarding priority setting in the sector.

27. Inadequate budget policies and institutions can have particularly negative impacts on the effectiveness and efficiency o f infrastructure spending due to the unique characteristics o f infrastructure investment, such as long-term planning horizons, unpredictable costs, and infrequent, lumpy payments. The options outlined above on the overall budget process would all be relevant to the infrastructure sector. The recommendations for the gradual introduction o f multi-year budgeting are particularly relevant to infrastructure, as i s the possibility to implement cash budgeting on a quarterly, rather than monthly, basis in order to provide greater resource predictability and enhance the efficiency o f spending. The lengthy and complex process o f congressional approval o f individual investment loans has also had a negative effect on public investment in the country, An option to address this would be to move from a project-by-project approval process in Congress to the approval o f an overall ceiling on public external debt during the fiscal year.

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Conclusions

28. In order to attain the Millennium Development Goals, nearly 600,000 Paraguayans would have to move out o f extreme poverty by 2015, potable water would need to be provided to an additional 2.5 mill ion citizens, 133,000 children who are today outside the education system would need to gain access to basic education, and maternal mortality would need to fall by 140 women every year. In order to make these Goals a reality, perhaps the most important challenge facing Paraguay today i s how to increase the pace o f economic growth in order to recover lost ground and advance in the fight against poverty. Institutional reform to build an effective and efficient public sector, carrying out prudent macroeconomic and fiscal policies and ensuring the equitable delivery o f services, i s a key ingredient in this effort. Over the past two years, the Government has taken significant strides to bring order to i t s fiscal accounts and has embarked on a solid program o f structural reforms. Paraguay is fortunate not to be burdened with an unsustainable debt situation.

29. Nevertheless, resources are scarce, and there i s limited fiscal space to increase expenditures on much-needed coverage and quality improvements in the social sectors and infrastructure. This points to the importance o f staying the course in terms o f full implementation o f the recently approved tax reform. In order to increase the efficiency and effectiveness o f the public sector, other fundamental reforms include a rationalization o f the budget process and substantial improvements the management o f public sector workers.

30. Technical reforms are, however, unlikely to advance on their own merits, and would need to be accompanied by a political consensus-building strategy within the public sector, with the legislature, and with the public at large. The political costs o f rationalization and reform are high as they are certain to affect the balance o f power between actors. To advance th is demanding agenda a vehicle to reach collective decisions among the key actors within Government i s indispensable.

UNDP, UNICEF and UNFPA. Invertir en la Gente. ~.gastosocial.org.pyiobjetivos-~le~o.php

9

OVERVIEW AND RECOMMENDATIONS

1. INTRODUCTION

31. Recent work by the Bank in Paraguay4 has underscored the country’s low growth rates (Figure 1) and declining per capita incomes as the key concern for policy-making today. The central causes for th is low growth have been identified as poor governance and weak institutions, and the existence o f large unmet needs in human capital and infrastructure. This was more recently reflected in the World Economic Forum’s Global Competitiveness Index, where Paraguay was rated towards the very bottom of the growth competitiveness5 ranking, with public institutions, one o f the four pillars o f the growth ranking, coming in 98th o f 104 countries.

Figure 1. Annual GDP Growth, %

2o ~

15

10

5

0

-5 ’ I

Source: World Bank, World Development Indicators.

32. The Paraguayan public sector constitutes a large part o f the problem, and o f any potential solution. The Bank has not carried out a Public Expenditure Review since 1992, when a Social Sectors PER was prepareda6 An informal report on fiscal issues was

The World Bank, 2003, Country Assistance Strategy for the Republic of Paraguay 2004/2007; The World Bank, 2003, Paraguay: Creando las Condiciones para un Crecirniento Sustentable - Opciones de Politica para la Nueva Adminis~aci~n.

At number 100 out o f 104 countries. The World Bank, 1992, Paraguay Public Expenditure Review: The Social Sectors. Report 10193-PA.

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prepared in 2002.7 The Bank’s limited activity in Paraguay during the late 1980s and again for a number o f years in the 1990s explains this gap. This PER attempts to fill part o f the knowledge gap and has a dual objective. The first i s to respond to the Government’s need for an integrated view o f public expenditure issues, and to i ts request for a focus on issues that are key to its current efforts at public sector reform, The second is to fulfill the Bank’s due diligence needs, particularly at a time when lending to Paraguay is growing following a long period o f inactivity, and to provide a knowledge base for the development o f fisture operations.

33. A 1996 Bank report on Paraguay* highlighted the key problems o f institutional and procedural weaknesses in the operations o f the Paraguayan State, although it stated that “[the] problems which recent Paraguayan administrations inherited, unabated by limited reforms, have begun to have adverse effects on the economy. These are not dramatic or even very readily apparent, In fact, the national economic statistics generally convey a picture o f a stable situation with reasonably robust growth, comfortable international reserves, and recurrent public sector surpluses.” In the intervening decade, much has changed: growth can no longer be described as robust, and public sector surpluses have not been the norm and, as argued in this report, the adverse effects o f institutional weakness have had an increasingly important impact on the economy.

34, While the Government’s reform agenda has been particularly ambitious over the past two years and the results achieved are promising, these weaknesses remain and, unaddressed, will continue to contribute to fiscal problems, raise the risk o f renewed stagnation in economic growth and rapid decline in living standards. Two o f these problems, a distorted budget process and an inadequate public employment framework, form the core themes o f the Public Expenditure Review. Sector-specific analysis o f infrastructure and the social sectors pick up the thread and discuss these as they apply to the individual sectors, in addition to putting forward sector-specific recommendations related to public spending reform. Before delving into those subjects, the following section reviews overall fiscal conditions and sustainability in the country,

The World Bank, 2002, Paraguay: A Selected Fiscal Agenda, Mimeo. The World Bank, 1996, “Paraguay: The Role of the State,” Report No. 15044-PA.

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2. FISCAL CONDITIONS AND DEBT SUSTAINABILITY

35. The prospects for fiscal sustainability in Paraguay in the medium term have significantly improved over the past two years as a result o f the current Administration’s efforts at better fiscal management and wide-ranging reforms. The l i s t o f the Government’s achievements since late 2003 i s impressive. Tax revenues increased by nearly 3 percentage points of GDP, from 9.2 percent o f GDP in 2002 to 12.1 percent in 2004, largely through efforts to improve tax administration. Current and total expenditures were cut by 1.4 and 2.5 percentage points o f GDP, respectively, between 2002 and 2004, through the passage o f austere budgets supported by stringent cash management practices. This included politically difficult measures to maintain a virtual freeze on nominal public sector salaries.

36. The result has been a major shift in the fiscal stance from deficit to surplus. Between 2002 and 2004, the overall balances improved f iom -2.3 percent o f GDP to 1.9 percent at the Central Government level and from -3.1 to 2.4 percent o f GDP for the Consolidated Public Sector. Primary balances improved from -1.7 to 2.7 percent o f GDP and from -1.3 to 3.6 percent o f GDP for the Central Government and Consolidated Public Sector, respectively (Figure 2). The public external debt-to-GDP ratio declined from 42.9 percent of GDP in 2002 to an estimated 36 percent in 2004. The Government was able to make orderly debt service payments to both domestic and external creditors as a result o f renewed donor support (including that o f the Bank) and debt restructuring efforts in 2003.

1 Lure 2. Paraguay: Revenues, Expenditures and Fiscal Balance, 1990-04

c 15 ‘ 13 4

a 9 2 d 7

g 11 c

5

111 TaxRevenues Total Expenditures -Fiscal Balance

Note: Data refers to the Central Administration. Source: Ministry o f Finance.

12

37. The Executive, with broad support from Congress and civil society, was able to pass a number o f important reforms to begin to address medium-term concerns. These included a pension reform, tax reform, customs code, and a law to strengthen the financial system. The reform o f the Government pension fund (Caja Fiscal) was approved in December 2003. The Caja Fiscal has been a major cause o f fiscal imbalance, with deficits often exceeding 2 percent o f GDP. The reform lengthens the time period over which the salary base for pension benefits i s calculated, increases the rate o f contribution from 14 to 16 percent, includes additional payments (e.g., overtime) in the salary base, reduces replacement rates and some o f the asymmetries between different pension plans, gradually raises the age and years o f contribution required for early retirement, and eliminates the year-end extra payment ( a g ~ ~ ~ a 2 ~ ~ ) for pensioners.’

38. The tax reform, approved in June 2004, supports the improvements in revenue collection by strengthening tax administration, broadening the tax base for VAT, introducing a personal income tax, an income tax on agricultural firms, and eliminating several loopholes and exemptions, while lowering corporate tax rates from 30 to 10 percent over two years. A new Customs Code professionalizes the customs administration, streamlines procedures and strengthens administration o f taxes on imported goods. It also grants budgetary and administrative autonomy to the customs administration, a key ingredient for successful administrative reform.

39. In the financial sector, a bill was passed in December 2003 which addresses a key contingent risk to the Government and the economy by introducing a modem bank resolution and privately financed deposit guarantee system. A complementary law to improve the governance and capital structure o f financial institutions via revisions to the general banking law has been sent to Congress, as have laws to restructure public financial institutions. lo

40, A great deal has obviously been achieved in a short time to bring order to Paraguay’s fiscal accounts. Nevertheless, while debt sustainability analysis suggests that the primary surpluses needed to stabilize public debt at manageable levels are achievable with the continuation o f current policies for fiscal prudence and structural reform, i t also demonstrates that there i s little fiscal space for an expansion in spending. Given Paraguay’s limited access to international capital markets, the country’s significant investment needs in basic infrastructure and social services, essential to achieving and sustaining higher economic growth rates, will have to be financed largely by increased revenues, complemented with improvements in the effectiveness and efficiency o f resource use. I t would therefore be especially important to ensure that the potential revenues associated with the recently enacted tax reform materialize. Another key issue in Paraguay’s public finances today i s the untargeted consumer subsidy on diesel fuel. This subsidy, amounting to over 1 percent o f GDP, comes at the expense o f more

The aguinaldo was re-introduced for the 2005 exercise, and there i s a draft law in Congress that proposes to permanently reinstate it. The draft law would introduce a 16 percent contribution on active workers’ aguinaldos and a reduction in the amount of the aguinaldo for pensioners. lo The second tier public banks reform was approved by Congress in July 2005.

13

resources being available for social services and infrastructure, sectors essential to growth and poverty reduction.

Policy Options

Current Expenditures

41. One of the keys to fiscal sustainability in Paraguay i s controlling the growth of current expenditure, maintaining or reducing it as a proportion of total spending and of GDP. Since the early 1 9 9 0 ~ ~ the financial dynamics o f the public sector in general, and o f the Central Government in particular, have been driven to a large extent by a persistent increase in current spending. Total current spending as well as spending on wages and salaries far outpaced GDP growth throughout the 1 9 9 0 ~ ~ and only since 2001 has their paced slowed significantly (Figure 3). The Central Government’s current expenditures nearly doubled f iom 8.3 percent o f GDP in 1990 to 16.2 percent in 2000, declining thereafter to their level o f 12.5 percent o f GDP in 2004. Wage and salary spending more than doubled during the 1 9 9 0 ~ ~ fiom 3.2 percent o f GDP in 1990 to 8.9 percent in 2000. They have since fallen to 7 percent o f GDP. However, it would appear that this significant reduction that has taken place in total spending as a percent o f GDP since 2001 may be difficult to sustain as it has largely relied on a freeze in nominal wages (Figure 4). Not raising wages until additional revenues are secured would be a prudent course o f action.

Figure 3. Paraguay: Growth of GDP vs. Growth of Current Spending I

- current spending 0 wages and salaries - GDP

Source: WDI, Min. of Finance and IMF.

42. Modernization of personnel management practices i s urgently needed. Effective management of personnel expenditures i s critical for both maintaining aggregate fiscal control and ensuring efficient delivery of public services, While the size o f Central Government spending is not large by regional standards, over three quarters o f current spending goes to wages and salaries and to pension payments o f Central Government employees (Caja Fiscal). Albeit starting from a low level, the

14

public payroll tripled from 3 to 9 percent o f GDP between 1990 and 2000 following the political liberalization at the beginning o f the decade that brought large wage increases and a shift in emphasis towards teachers, health professionals, and military and police personnel. The 1992 Constitution also created new institutions, such as the Comptroller General's Office, the Public Prosecutor's Office (Fiscalia General), and Governorates. As public hiring was stepped up during the mid-l990s, the ranks o f c iv i l servants swelled considerably. Nominal wage freezes reduced Central Government personnel expenditures to 7 percent o f GDP in 2004, although continued freezes may not be sustainable." Increases in public sector employment and in wages and salaries, even in the social sectors, are unlikely to result in improved services unless they are accompanied by an end to discretionary hiring practices, by incentives to improve performance and mechanisms to hold staff accountable for their conduct and performance.

Figure 4. Paraguay: Expenditures, YO of GDP

25

20

15

10

5

0 2000 2001 2002 2003 2004

El Current Spending Capital Spending

Source: Ministry o f Finance and IMF.

43. Continued attention to pensions and to associated contingent liabilities i s important. Shortfalls in the public pension system contributed around 2-2.5 percentage points o f GDP to the deficit in recent years. The reform o f the Cuju Fiscal, approved in late 2003, has managed to reduce this deficit somewhat, although it is sti l l substantial, at over 1.5 percent o f GDP in 2004. The current difficulties o f the Cuju Bancaria, with only 2800 pensioners and other beneficiaries and 4000 active contributors, may cost the Government 0.2-0.3 percent o f GDP per year, an amount equivalent to the entire budget for poverty alleviation programs. This further illustrates the importance o f decisively tackling pension issues. As i t s reserves will soon be unable to cover pension payments,12 an effective management o f the Caja Buncavia by the Ministry o f Finance (MoF), including establishing a committee to intervene the entity, an audit o f both existing

'' Despite the wage freeze, however, anecdotal evidence points to covert salary increases through such measures as the re-grading o f personnel and the granting o f additional benefits and salary supplements.

Reserves may not cover payments by as early as July 2005. The Cuju Buncariu has already begun to sell i t s assets in order to meet i t s cash needs.

15

reserves and liabilities, and affiliation o f current beneficiaries and contributors to the IPS (for the private sector) could be important next steps.

Capital Expenditures

44. Fiscal difficulties have led to a significant curtailing o f public investment spending. As total spending has fallen as a proportion o f GDP since 2000, capital spending has fallen even faster, given the difficulty o f cutting wage and salary spending, Public enterprises, for instance, currently generate a surplus o f between 0.5 and 1 percent o f GDP - contributing significantly to the consolidated public sector surplus. This i s in large part a result o f their inadequate levels o f investment.

45. Paraguay would benefit greatly by making a more coordinated effort to deal with the development assistance community as a whole. Capital spending in Paraguay has been tied to the availability o f external loans as current spending consumes the bulk of current revenues. The vast majority o f public investment (85 percent o f Central Government fixed capital investment) i s carried out with external financing. Yet Paraguay has never convened or benefited from a general meeting o f development partners, preferring until now to deal with each one separately. This is partly responsible for the endemic delays in project implementation and low quality o f project execution. A study by the MoF in 2003 showed that only 30 percent o f projects funded with external loans and 25 percent funded with grants were executed as programmed between 1998 and 2003. Other factors include: the lack o f coordination between the budgeting process and debt policies, resulting in shortage o f counterpart financing; a complex and lengthy loan approval process within Government, including in particular extended delays in the loan approval process by Congress; a distorted budget process that results in severe cash rationing throughout the year leading to delays in project execution; and lack o f technical capacity in project implementation and supervision.

46. Paraguay could make better use of donor resources through improved sector planning. Project loans in Paraguay generally reflect the priorities and strategies o f the creditors which may have competing interests or overlapping objectives. This is the result o f public debt policies that have responded to short-term financing requirements with little in the way o f a long-term strategy for development financing or o f strategic planning o f social and infrastructure spending (see section on debt management, below).

Revenues

47. Paraguay’s revenue system i s comparatively lean, being primarily based on consumption taxes and on royalties from electricity generation. Total revenues have averaged just over 20 percent o f GDP over the past five years. Wh i le tax revenues are low when compared with other countries in the Region, Paraguay is fortunate that non- tax revenues, particularly royalties, contribute a significant amount to State coffers (Figure 5). The most important non-tax revenues o f the Central Administration are

16

royalties from the Itaipu - and to a lesser extent, Yacyreth - hydroelectric dams (over 20 percent o f total revenues) and pension contributions to the Caja FiscaE (6 percent o f total revenue^)'^, followed by transfers from other Government entities, including SOEs (2.5 percent o f total revenues in 2004). The latter have been erratic and considerably below unrealistically high budgeted amounts.

Figure 5. Tax and Non-Tax Revenues, YO of GDP

20 I 1 18 16 14 12 10 8 6 4 2 0

I 0 Tax revenues &,a Fiscal 13 ItaipulYacyreta El Othe

Source: Ministry o f Finance and IMF.

48. Tax Revenues. The ratio o f tax revenues to GDP has increased in the last two years, but remains relatively low for the Region. The recently approved tax reform widens the tax base, extending a more effective tax regime to large farmers, eliminating large exemptions, and introducing a new personal income tax. As the law i s to be implemented gradually over the coming 5 years, it is crucial for the country’s fiscal health that the momentum o f implementation is maintained. The law is estimated to yield 0.5 percentage points o f GDP through its direct effects during the f irst full year o f application, and about 1.3 percent o f GDP by 2010.

49. The success of the tax reform’s application will depend to a great extent on ensuring that sufficient operational and financial support i s given to the tax and customs administrations. A new Customs Code grants financial and administrative autonomy to the Customs Administration and this should enable it to institutionalize some o f the impressive gains it has made in terms o f revenue collections over the past eighteen months. The Executive’s budget proposal for 2005 included an allocation o f 1.5 percent o f tax revenues to the MoF’s Sub-secretariat o f Tax Administration in order to enable it to undertake a much-needed upgrading o f human resources and processes, but th is fimding was rejected by Congress, It i s important that the recent improvements in tax administration be institutionalized in order to avoid excessive dependence on a

l3 Government accounts in Paraguay do not include pension contributions as taxes. In the case o f the Caja Fiscal, pension contributions are not a true payroll tax as contributions include only those o f Government workers. The Government as employer does not “deposit” any contributions into a pension fund.

17

favorable political environment for results and to ensure that improvements endure beyond the tenure o f any particular administration.

50, The Government can generate additional revenues by increasing the excise tax on diesel fuel to levels more aligned with those of i t s neighbors. The excise tax “impuesto seZectivo a2 consumo ” (ISC) on diesel was reduced from 26 percent back to 14 percent in August 2004 in response to political pressures from the agriculture and transport sectors. Following a series o f increases in 2005 and a change in the taxable base,14 the excise tax now stands at 20 percent. Nevertheless, the ISC i s s t i l l significantly lower than in other Mercosur countries, where taxes on diesel are in the range o f 30 percent (including VAT - diesel is exempt from VAT in Paraguay). The increase can be effected by Executive decree, without recourse to Congress and could bring in an addition hal f a percentage point o f GDP in revenues. The ISC on diesel is an efficient tax to collect, since it i s paid at the wholesale level at the time o f import, and there i s l i t t le scope for evasion. Related to this are the tax expenditures associated with the price subsidy on diesel fuel. Abolishing this subsidy could make an additional percentage point o f GDP available to priority spending areas such as goods and services and capital investment.

51. A long term solution to Paraguay’s small effective tax base would need to address the causes of informality. While the tax reform i s expected to generate significant improvements in both quality and quantity o f revenues, Paraguay’s tax burden will remain low relative to other countries in the Region. This i s partly attributable to the large level o f informality o f the economy, estimated at near 50 percent.

State-Owned Enterprises

52. Paraguay’s public sector includes seven State-owned Enterprises (SOEs): the gasoline and diesel wholesale distribution company, PETROPAR, the electricity distribution company, ANDE; the cement company, INC; the national port and geography and hydrology institute, ANNP; the airport authority, DINAC; the telecommunications’5 company COPACO (ex- ANTELCO); and the urban water and sewerage company ESSAP (ex-CORPOSANA). The latter two were restructured in 2002 into corporations with 99 percent State ownership, and are defined as long-term concessions for operation. They have somewhat more operational and financial autonomy than other public enterprises, and their budgets do not have to be approved by Congress. PETROPAR, ESSAP and INC face serious financial difficulties, as do the port and airport authorities, ANNP and DINAC, although to a lesser degree (and given their relatively small size they do not pose a fiscal problem for the state at this time). Only ANDE and COPACO are in relatively good financial health.

53. Government policies towards SOEs have often undermined the ability of enterprises to function as efficient service providers. Price setting for the goods and services provided by SOEs, in many cases below marginal cost, is one o f the key culprits

l4 The tax base was changed from the retail price of diesel to PETROPAR’s sale price. I s Fixed telephony.

18

responsible for the enterprises’ poor financial condition (others are poor management and illegal connections to services). At the same time, many SOE costs fluctuate with the dollar price of inputs. This has been one o f the main causes o f the financial troubles o f ESSAP and PETROPAR. Other Government requirements, such as the provision o f specific services free o f charge, e.g., river dredging and geographical survey services by ANNP and meteorological services by DINAC, also reduce the competitiveness o f the state companies. Moreover, SOEs are required to transfer ever-increasing amounts to the Central Government each year, which i s also incompatible with their character as public enterprises and reduces their ability to increase investments and improve staffing quality and management.

54. The fiscal surpluses generated by SOEs are misleading indicators of financial health and are unsustainable. Despite their financial difficulties, as mentioned above, the SOEs together generate a fiscal surplus. Th is is in large part because o f inadequate levels o f investment. The exceptions are ANDE and COPACO, the better-run companies, which have been able to generate a small surplus while increasing their levels of investment in recent years. Total capital spending by SOEs has fallen by about 30 percent, from 2.5 percent o f GDP during the 1995 to 2000 period to 1.7 percent in 2001- 04.

55. The Government’s expressed strategy of proceeding with independent audits of the SOEs, followed by the development of long-term restructuring plans, need to be fully implemented as a matter of urgency. All SOEs will unavoidably need to be restructured, with PETROPAR, ESSAP and INC suffering more serious and immediate problems. This is important for both fiscal and service delivery reasons. Whi le outright privatization i s not considered politically viable after the failed attempt at privatization of ANTELCO and CORPOSANA in 2002, the Government’s i s considering various options for the participation o f private capital (e.g., in ESSAP and COPACO).

Debt ~ ~ ~ t a i n a b i l ~ ~

56. Paraguay i s fortunate to enjoy a relatively benign public debt sustainability outlook. This advantage needs to be protected with improved debt management practices.16 Despite the buildup o f fiscal pressures during the last decade and the dramatic growth o f Paraguay’s external public debt-to-GDP ratio, this ratio i s s t i l l relatively low by regional standards (at about 35 percent o f GDP for external public debt in 2004). Approximately 98 percent o f public external debt is owed to multilateral and bilateral institutions. T h i s has allowed Paraguay to enjoy very favorable terms for its debt: 60 percent o f loans are contracted with a maturity o f over 15 years, and 30 percent are contracted at a fixed annual rate o f less than 3 percent. Although 65 percent o f the debt i s at variable rates, these correspond to concessional rates offered by multilaterals and bilaterals. The implicit interest rate paid on external public debt in the past five years has averaged 2.8 percent per year. In order to maintain the current debt-to-GDP ratio, assuming 3.5 percent GDP growth and an average interest rate o f 6 percent (Le.,

l6 In this context, recent discussions o n the possibility o f contracting large tied bilateral debts at high interest rates should be approached with care.

19

assuming, as i s likely, that interest rates will rise in the near hture), Para ay would need to achieve primary surpluses o f about 1.1 percent o f GDP per annum' The required surplus would decline to 0.9 percent o f GDP if economic growth were to increase to 4 percent, and would increase to 1.8 percent o f GDP if growth declined to 2 percent. The Central Government's primary surplus in 2003-04 averaged 1.8 percent o f GDP (with GDP growth rates o f 2.6 and 2.9 percent, respectively). Therefore, primary surpluses adequate to stabilize or lower the public debt burden are an achievable target given the continuation o f policies stressing fiscal prudence and economic growth. However, there is l i t t le scope for upward adjustment in govement salaries or increases in social or infrastructure spending without structural increases in revenues.

57. Domestic debt of the non-financial public sector constitutes 20 percent o f total public debt and just under 10 percent o f GDP. The largest debtor i s the Central Government, while the largest creditor (80 percent o f domestic debt) is the Central Bank. This debt originated during the financial crises o f the 1990s and in 2001-02. The remainder of domestic debt i s in government bonds issued in the domestic market. Although government bonds only account for about 5 percent o f Paraguay's total public debt, the Government has faced serious difficulties in the recent past in servicing them.

58. The main risk facing Paraguay in terms of public debt (both external and domestic) i s rollover risk. Over the next five years, Paraguay's debt amortizations (excluding interest payments) are expected to average US$250 mi l l ion per year, As Paraguay's sources o f financing are largely limited to multilateral and bilateral investment loans, this presents a clear challenge in terms o f the ability to ro l l over debt. The only year where credit disbursements exceeded US$200 mill ion was 1999 with the credit0 chino (a US$400 mill ion loan &om Taiwan, Province o f China). In 2001-02, the Government was able to access financing in amounts equivalent to i t s amortization needs with bond placements in the domestic market, although this option i s unlikely to be available today (at least not through voluntary purchases by commercial banks) due to the reluctance o f investors following Paraguay's severe recession and liquidity crisis o f 2002. Paraguay may want to begin the process o f accessing private capital markets as a medium term strategy (but with an improved debt management capacity in the public sector). In . order to achieve this, the adoption by the Government o f a more structured approach to debt issues and management would be important in development the government bond market.

" GDP growth o f 3 percent i s insufficient, however, to recoup ground lost in terms o f per capita incomes during the 1990s. '' The Financial Sector Assessment Program currently under preparation will provide additional options for improving market access.

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3. THE BUDGET PROCESS AND PUBLIC EXPENDITURE MANAGEMENT

59. The basic functions o f budgeting are ensuring aggregate fiscal control, the strategic allocation o f public money to govement programs, and the efficient delivery o f public services. Rather than being a tool for planning, prioritization and disciplined resource allocation, however, the budget in Paraguay i s frequently an obstacle to effective public expenditure management, being a rigid set o f instructions and institutions that often provide contradictory incentives to actors involved in the process. Moreover, the budget process i s largely - and often ineffectively - used as a short-term fiscal tool, to the detriment o f effective and efficient service delivery.

60. Although rationalizing and streamlining the numerous existing legal provisions i s likely to bring benefits, problems afflicting the budget process are not mainly the product o f a particularly poor legal framework by regional standards. Budget and financial management laws in Paraguay are broadly adequate, although a number o f problems do exist (see below). An evaluation o f Paraguay’s Public Financial Management (PFM) Performance Measurement Framework,” which stresses formal rules governing various aspects o f financial management and the budget process, supports this general conclusion. While there are important areas that could be enhanced, Paraguay’s ratings are comparable to those o f some other countries in the Region. Thus the legal framework may be one of the culprits responsible for the poor functioning o f the budget process, but i t i s not the key problem; despite a number o f improvements to laws and to the financial management system, the budget process continues to be dysfunctional. There i s a wide gap between formal rules and actual behavior.

Stages ofthe Budget Process

61. Problems at all stages o f Paraguay’s budget process negatively affect the attainment o f fiscal discipline and the efficiency o f resource allocation and o f operations. At the preparation stage, the problems include a lack o f emphasis on planning and prioritization o f resource use. This is not helped by the existence o f a plethora o f laws and regulations, which burden the budget preparation process and increase its rigidity, without adding value given the lack o f capacity for their implementation. These include laws calling for budgeting by programs and results, zero-based budgeting, STP (Secretaria Tkcnica de PZaniJcacidn) requirements for Annual Operational Plans (PZanes Operativos Anuales, POAs) and Annual Investment Programs (Programa AnuaZ de Inversidn, PAIS), and the MoF’s requirement that line agency budgets be submitted in three distinct scenarios. Another significant problem i s the generally unrealistic revenue estimates within which entities are expected to draft their budgets. Revenues are consistently overestimated, by an average o f 25 percent between 1999 and 2002 (the exceptions were 2003 and 2004, where the improvements in tax administration generated

A draft PFM Performance Measurement Framework has been developed by a working group involving staff from the World Bank, IMF and the Public Expenditure and Financial Accountability (PEFA) Secretariat.

21

much larger tax revenues than initially projected). Once entities submit their budgets within the macroeconomic constraints defined by the MoF, there is l i t t le interaction between the M o F and l ine ministries.20 Given Paraguay’s highly hierarchical budget preparation system, Finance consolidates the budget, making cuts and alterations as it sees fit, generally with l i t t le information on sector programs and priorities. This i s in line with the emphasis in the budget on aggregate fiscal control rather than on effective and efficient resource allocation.

62. During budget approval by Congress, problems begin with the submission by the Executive o f the draft budget with an excessive level o f detail, down to the line-item level. This, combined with Congress’ limited capacity and information to analyze adequately the budget, leads to numerous changes in the distribution o f resources between and within entities and programs, with little regard to the overall logic o f resource allocation or service delivery needs. This i s exacerbated by the intense lobbying o f legislators by most ministries and state entities, by the lengthy time period that Congress has to approve the budget (nearly four months) and by the fact that under Paraguay’s laws, Congress has virtually unlimited powers to modify the Executive budget proposal.21 I t uses this power to increase revenue estimates, to augment current - particularly personnel - spending (although, interestingly, the aggregate budget i s not always increased by a significant amount), and alter the distribution o f resources within the budget.

63. As a result o f the lack o f planning at the preparation stage and the multitude o f changes effected during budget approval, the MoF relies on cash management to control expenditures during the year. This is one o f the key problems at the budget execution stage. Programmed month-to-month, and often including significant resource cuts with respect to the approved budget, the cash plan provides little certainty to entities regarding the resources that will be available to them over the year. This i s particularly detrimental to the planning and execution o f capital expenditures. Whi le the underlying logic o f cash management i s the assurance o f fiscal control, cash plans have not historically been able to ensure fiscal results. Entities have not in the past recorded their commitments, generating ‘‘floating debt” to suppliers and other creditors that escapes the control o f the M o F . ~ ~ By law, this floating debt must be re-paid during first two months o f the following year; this consumes the bulk o f many entities’ resources for those months, effectively delaying implementation o f current year programs until March. In addition to

2o Although ministries and other entities must respect the MoF’s macroeconomic constxaints as they enter their budget proposals into the budget information system (Sistema Integrado de Programacidn Presupuestaria, SIPP), they also make “extra-system” requests for additional resources that surpass the l im i t s assigned by the MoF. In 2003, for instance, these excess requests represented an additional 30

Although there are laws intended to set l imi ts during the budget approval stage, e.g. that a l l interactions between the Executive and the Legislative branches must be funneled through the MoF, and that Congress can only augment resources for capital spending, not for current spending, these are by-passed by legislators using the argument that as Paraguay has no “Organic Laws”, no law can restrict any subsequent laws - including the budget law. 22 Commitment accounting i s just beginning to be implemented in Paraguay as part o f the SIAF. I t i s currently limited to the Central Administration.

ercent over the established limit,

22

the uncertainties generated by cash management, the lack o f initial planning in the budget and the many changes included by Congress to the distribution o f treasury resources results in the need for extensive reprogramming o f budget items and requests for budgetary supplements over the year. The processes for approving supplements and for reprogramming spending are lengthy and bureaucratic and hrther increase the unpredictability o f resources available to executing agencies.

64. Monitoring and evaluation i s the least developed stage o f the budgeting process. In Paraguay, monitoring and evaluation concentrates almost entirely on ex-post financial audits by the Comptroller General (Contraloria General de la Repziblica, CGN), rather than an evaluation o f results and products. This i s typical o f many countries; the progression is usually fkom an initial concern with financial results, evolving over time to an interest in institutional and program outcomes, There are some initial efforts underway to move towards evaluation o f results, such as the creation o f a department in the MoF to monitor budget-related program results (Departamento Gestibn por Resultado). This is made particularly difficult in Paraguay by the characteristics o f the budget process described above which affect not only resource allocation but also institutional and program objectives.

Budget Process and Results

65, Paraguay’s budget system, characterized by line-item budgeting, has the theoretical advantage that it encourages fiscal prudence through the control o f public spending and the safeguarding o f public assets. In practice, however, the budget process has not been particularly successfid at ensuring aggregate fiscal control. In 11 out o f the past fourteen years, the Central Government’s fiscal accounts have returned deficits, and in 6 o f these years, the deficit exceeded 1 percent o f GDP. Excessive rigidity and a poor incentive structure for ensuring control negates the advantages that the budget process may have and leads to problems at all stages o f the process. These problems affect all three key objectives o f the budget process: (i) aggregate fiscal control, (ii) strategic resource allocation, and (iii) efficient service delivery.

66. Aggregate Fiscal Control. The absence o f planning by public sector entities related to budget preparation, combined with rigid rules and poor coordination with the MoF during budget consolidation creates incentives to inflate resource requests as a means o f increasing flexibility and room for maneuver during budget implementation. The result i s unrealistic budgeting, made less viable by unrealistic revenue estimates, increases mandated by Congress during legislative discussion o f the budget and budget supplements approved during the year. This i s reflected in high levels o f under-execution o f the budget (Table 1).

67. Incentives to engage in budget planning are substantially weakened as a consequence o f the changes made to entity budgets by the MoF and Congress. A repetitive budgeting3 situation ensues during the execution stage with a large number o f

23 Repetitive budgeting refers to the remaking o f the budget during the year through frequent modifications and supplements.

23

modifications to the originally approved law (Table 2). Recourse to cash management i s also partly the result of problems at the budget planning and approval stages and o f poor information systems (e.g., the lack o f commitment recording until very recently). I t leads to significant under-execution o f the budget in most areas, with the exception o f fixed salary and pension payments.24 The combination. o f unrealistic budgeting and cash management then results in deferred budgeting, where needs, such as investment maintenance expenditures or coverage o f liabilities (such as bills due) are not fimded in order to reduce the apparent deficit.

Law

Decree

Resolution

Table 1. Budgets and Budget Execution, billion guaranties and percent

1 2 3 4 Budget Execution

411 412 413 Budget Draft Budget Law Budget Law + Executed (Executive) Supplements Budget Year

2000 14469 15518 15646 11516 79.6% 74.2% 73.6% 2001 15240 13790 15358 11300 74.1% 81.9% 73.6% 2002 15114 14794 15307 12465 82.5% 84.3% 8 1.4% 2003 15753 15546 18246 13761 87.4% 88.5% 75.4% 2004 16844 17112 18915 13866 82.3% 81.0% 73.3%

Source: Ministry o f Finance.

Budget supplements or 29 reductions Transfers of resources between 229 programs and changes in sources of revenue Transfers of resources within the same program

127

Table 2. Legal Alterations to the Budget Law (2000-04)

124

248

166

79

169

329

88

204

337

79

160

180

462

1,753

2,208

68. Strategic resource allocation refers to the capacity to allocate resources in accordance with a government's stated strategic objectives and to prioritize competing claims on scarce resources; it implies a high degree o f consistency between original budgets and actual expenditures. In Paraguay, as has already been argued, there i s a significant gap between original budgets and actual spending. Government priorities are unclear due to lack of effective planning and to the allocation o f ever-increasing resources to salaries and wages at the expense o f other important areas. Recourse to cash management reduces the incentives and the ability to engage in strategic resource allocation. There i s a prevalence o f short-term budgeting over multi-year resource

24 I t should be noted however that under-execution i s also the result o f lack o f capacity.

24

programming without consideration o f medium-term implications. This particularly affects investment expenditures. Despite the fact that most public investment projects are funded out o f external resources, which almost always are executed over a longer period than one to the same budgeting constraints as treasury resources.25 It would be important to avoid year, the funds are budgeted annually and received monthly through the Cash Plan.

69. Enclave budgeting i s another practice that reduces the effectiveness o f strategic resource allocation. This practice refers to efforts to protect certain priorities through the use o f special funds and other devices that separate these priorities from the rest o f the budget. Although enclave budgeting exists to some extent in Paraguay (e.g., provisions for 20 percent o f total spending to be allocated to education and a minimum o f 3 percent for the Judiciary) i t i s not yet a major issue. This i s perhaps the result o f the existence o f institutional resources (own revenues generated by commercial activities in a number o f entities) that are not subject the creation o f enclaves (often supported by international organizations) in order not to increase the already high level o f rigidity in the budget.

70. Eflcient service dezivery. While this i s a notoriously difficult area to judge or quantify, there exist many indications that the efficiency o f service delivery in Paraguay could be significantly improved. The process o f reallocating resources between or within spending units as needed i s bureaucratic and time consuming. The delivery o f budgeted resources to spending uni ts is unreliable and unpredictable due to the prevalence o f cash management. There is little encouragement to focus on performance and strategic objectives; managers have little flexibility and are not held accountable for performance; and there i s little information on performance and costs. Whi le external audits are on the whole timely, they are not particularly effective in ensuring efficiency as the concentration i s on financial audits, with very little in terms o f performance audits or monitoring and evaluation o f results. On the other hand, there has been a significant positive development in recent years in the improvements in transparency o f the public procurement process.

7 1. In Public Expenditure Management (PEM) terminolow, efficient service delivery in Paraguay i s hampered by compensatory spending where the size o f the c iv i l service balloons but real public wages decline. The weight o f spending on personnel, transfers and debt service means that limited funds are available for other key areas such as purchase o f goods and services and public investment. This contributes to declining productivity which i s exacerbated by the existence o f ghost workers, a lack o f adequate investment in training and information technology, and generally poor working conditions.

72. Operational efficiency i s reduced by the existence o f informal arrangements alongside formal rules. While spending control i s highly centralized, with detailed rules concerning civ i l service, procurement and other items o f expenditure, these formal controls are often violated in practice. Informal arrangements dictate how government

25 In Paraguay, treasury resources are referred to as “hente 10” or FF10, resources from external credit as “fuente 20”’or FF20. and institutional resources as “fuente 30” or FF30.

25

operates, how civ i l servants get jobs or promotions, how their pay scale is determined and how procurement i s contracted. When formal rules are unworkable and government operates through extralegal means, corruption rises although it often goes undetected or unreported.

Policy Options

73. Strengthening the budget preparation stage. One conclusion o f the discussion o f budget issues in Paraguay i s that in order to improve the process, incentives need to be created for the actors involved to take the budget preparation stage more seriously. This may be achieved by reducing the possibilities for significant changes to the draft budget at the approval and execution stages. The following policy options could help to address this issue.

Avoiding direct links between executing agencies and legislators by strengthening the role of the Economic Team and Social Cabinet in the process of budget preparation within the Executive. This would help to achieve greater internal cohesion within the Executive on the budget bill submitted to Congress and limit the number o f changes made by the Legislature to the budget. The direct involvement of the President in outlining the overall constraints for the annual budget would give this process significantly greater weight (as occurred during the preparation o f the 2003 budget, where there was virtually no lobbying o f Congress by members o f the Executive branch on the orders o f the President).

e Establish annual agreements between the Executive and Congress that define the total amount of the budget as well as revenue levels, and improve the quality of revenue projections. Such an agreement could take place prior to the start o f parliamentary debate. Several developed countries (e,g., Sweden) have successfully implemented budget approval processes in two stages, f irst for overall amounts, followed by sector budgets. With sufficient political support, the establishment o f such annual framework agreements could be a useful tool for achieving greater discipline during budget discussions in Congress. More realistic revenue projections would help in the preparation o f more realistic budgets.

74. Improve the quality and relevance of the budget approval stage.

e Change budget presentation from line-item detail to broader programs and sectors. This would help to limit the changes made by Congress, and reduce the number o f modifications to the budget that are needed during budget execution, The aggregation could also be applied to the Personnel Annex, which i s approved year by year alongside budget law at a high level o f detail that includes each position and i ts corresponding remuneration. This i s obviously a politically contentious issue that would require support from the highest level o f the Executive. The shift to a more aggregate presentation o f the budget could be

26

balanced by improved information to Congress regarding broader programs and priorities

0 Consider reducing the period which Congress has to review the budget. Congress studies and debates the budget law over nearly four months, between September 1 and December 20 o f each year. In addition to reducing the period available for lobbying and horse-trading, a shorter approval period - one that ends, for instance, on November 20 - would allow executing agencies to better prepare for the following year. An option would be to reduce the period that the budget i s considered by the Joint Budget Committee (Comisibn Bicameral) by one month, from September 1 - October 30, to the September 1 - 30 period.

0 Improve the quality of budget information available to Congress. This may be achieved by establishing a non-partisan budget office, staffed by professionals, in Congress. This could partially compensate for the reduction o f the period available for Congress to consider the draft budget, and could help raise significantly the level o f the discussions surrounding budget approval by strengthening the technical capacity within Congress. Stronger relations between the Ministry o f Finance and Congress may also benefit the budget approval stage. As noted in the Paraguay Institutional and Governance Review (IGR),26 the majority o f legislators (60 percent) view their relationship with the Ministry as poor, and they complain that the Executive provides them with inadequate information during the budget approval process. One option for the Ministry o f Finance would be the preparation o f more user-friendly information for lawmakers, based on the information needs and requirements o f the former, so as to transmit the priorities and constraints o f the MoF in relation to the budget. This would help generate a more stable institutional environment for debate, replacing ad-hoc lobbying and individual interests.

75, Options here include actions to:

Increase the predictability o f resource availability during budget execution.

0 Apply the decree (No. 8127, articles 46-52) that calls for the establishment of quarterly cash plans, disbursed on a monthly basis. Even better would be the bi- monthly or quarterly disbursement o f funds, although th is would necessitate a significant improvement in internal control mechanisms. An option would be to pilot such an initiative for certain categories o f spending, such as investment expenditures in selected entities.

0 Simplify procedures to shift resources within programs. This could be followed by simplifying procedures to move resources between programs within each entity. Changes in sources o f funding would continue to require external approval, as would increases in personnel spending. As th is increased flexibility to reallocate may weaken the incentive for improved planning, it would therefore

26 The World Bank, 2005, Breaking with Tradition: Overcoming I n s t i ~ t i o n a ~ Impediments to Improved Public Sector Pegormance.

27

need to be implemented along with an increased emphasis on monitoring and evaluation. The promise o f greater control over resources can be used as an incentive to take monitoring and evaluation more seriously in executing agencies.

0 Simplify the mechanisms for utilizing institutional resources (FF30) without compromising transparency and accountability. An automatic crediting o f institutionally-generated own resources, rather than the routing o f requests through Cash Plan mechanisms, could overcome the delays in resource transfers from the MoF to executing agencies. Funds could s t i l l be remitted to the Treasury to ensure appropriate accounting and financial management procedures are followed.

76. Enhance the quality of control and monitoring of resource use. Besides the need for improved budget planning and preparation, another conclusion o f the foregoing discussion o f the budget process i s the need to significantly improve monitoring and evaluation, Some options for improvements in this area include the measures described below.

0 Introduce commitment budgeting across the public sector. Paraguay has made an important recent advance by beginning to implement commitment recording as part o f i t s Integrated Financial Management System, S I A F (Sistema Integrodo de ~ d m j ~ j ~ t r a c j ~ ~ Financiera). However, th is is currently limited to the Central Administration. The introduction o f commitment accounting across all entities o f the public sector would not only improve expenditure management and fiscal discipline, but would also serve to give more weight to ex-ante planning.

0 Strengthen budgeting monitoring, control, and evaluation units within the MoF and spending agencies. External financial monitoring and evaluation procedures in Paraguay are o f reasonable quality (although much can be done to improve the control environment and to follow up on the results o f such m~nitoring).’~ Internal audits, however, need to be strengthened in order to enable an improvement in the budget process and in the achievement o f spending efficiency and effectiveness.

77. premature today - that may be implemented over the medium term.

Beyond the options outlined above, there are a number o f changes - while

0 Implementation of a multi-year budgeting framework. The absence o f a multi-year budgeting framework reduces the predictability o f public finances, particularly for expenditures executed over more than one fiscal year, as is the case with the bulk o f investment spending. The development o f a multi-year framework could be considered once the annual budgeting process i s adequate.

’’ The World Bank, 2004, Paraguay Country Financial Accountability Assessment, Report No. 30084-PY.

28

e

. Gradual implementation of fiscal rules. Before introducing fiscal rules i t i s important to begin establishing the conditions necessary for their implementation; these are not currently present in Paraguay. Nevertheless, building on the positive fiscal record o f the past two years, the gradual implementation o f fiscal rules for the medium term could be envisaged. This process could be started by establishing annual agreements between the Executive Branch and Congress that set the total amount o f the annual budget to be approved as well as revenue levels.

e Budgeting for results. The premature, and largely formal, introduction o f budgeting by programs, for results and zero-based budgets has led to a disassociation o f productive processes and budget planning. Reestablishing the link between budgets and service delivery i s thus a priority. Nevertheless, a PEM good practice is that govemments need to budget for inputs before aiming to budget for outputs, and to budget for work to be done before budgeting for results to be achieved. In other words, it i s better to first “get the basics right” before embarking on more ambitious budget targets and procedures. The pilot programs being established in a number o f ministries for budgeting for results are a good start for the gradual introduction o f these changes.

78. To improve the quality of the budget process as a whole, civil society could be engaged in order to ensure a greater level of transparency. This would require a greater emphasis on the production o f easy-to-use information on budgets and their execution by the MoF. For instance, the Ministry o f Finance possesses a powerful tool, the SIAF (Sisternu lntegrudo de A d ~ i n i s t r a c i ~ n Finunciera), which enables it to publish timely information on budget execution, Nevertheless, a distinction needs to be made between infomation and data. To ensure that research centers, civil society organization and academic institutions use this information, they need to participate in decisions regarding the formats for i t s presentation.

29

4. PUBLIC EMPLOYMENT

79. Public employment is of central importance to an analysis o f public expenditures in Paraguay because o f i t s weight in the country's fiscal accounts and as it constrains the ability o f the State to hlfill i ts role in terms o f economic regulation and service delivery. The PER takes a first look at employment in the public sector in Paraguay, relying on the recently available public employee census and on the 2003 Household Survey. The objective i s to take measure o f the issues concerning public employment, and to offer a l i s t o f initial options for the Government to consider in moving forward in what i s certain to be a long-term process o f government employment reform, This coincides with growing awareness in the Government o f the importance o f the topic and with a renewal o f attempts to address public employment issues in a systematic manner, Recent steps include the completion o f the public employee census; the preparation o f a draft c iv i l service law to replace the existing, though suspended, law; efforts to rationalize and strengthen the Secretariat o f Public Administration (Secretaria de la Funcicjn Ptiblica, SFP); as well as individual efforts in some areas o f Government to tackle employment issues. The report also carries out a comparison o f public and private sector wages.

80. Paraguay, with about 40 percent o f total outlays going to wages and salaries, is spending far beyond i t s means on th i s category, The growth in Government employment is largely the result o f the expansion o f the public policy agenda in the 199Os, particularly in the social sectors, and specifically in education, This, combined with poor mechanisms for controlling the size o f government employment, has resulted in the rapid growth o f the public wage bill. A rough rule-of-thumb i s that spending on wages and salaries should not exceed 25 percent o f total expenditures.28 The outlays on public wages and salaries in Paraguay are high, both as a proportion o f total expenditures (42.6 percent and 41.5 percent o f Central Government and Consolidated Public Sector spending, respectively, in 2004, Figure 6) and as a percent o f GDP (7 percent and 8.9 percent o f GDP for the Central Government and the Consolidated Public Sector, respectively, in 2004) (Figures 7 and 8). In th is respect, Paraguay is a high-spender by Latin American standards. Excessive spending on wages and salaries comes at the expense o f other critical areas, including the goods and services necessary to complement human capital in service delivery, and also at the expense o f capital investment (Figure 9).

28 The World Bank, Administrative and C iv i l Service Reform - Aggregate Employment and Wage Bill Concerns website, httD:llwww 1. worldbank.or~l~ubl icsector lc iv i lse~cefwageconce~.h~.

30

Figure 6. Paraguay: Public Sector Salaries, % of Total Spending

12

10

8

45 40 35

f 3 0 B &- 25 612

‘ 15

c1 0 20 4 s

I - % o f Spending -% o f GDP

Source: Ministry o f Finance, IMF.

Figure 7. Central Government Salaries % of Total Spending, 2003-04

45% 40% 35% 30% 25% 20% 15% 10%

Figure 8. Central Government Salaries % of GDP, 2003-04

0%

8%

6%

4%

2%

0%

Regional Average

Source: World Bank, WDI. Source: World Bank, WDI.

8 1. Whi le the growth in the number o f public employees has been rapid, increasing by over 30 percent between 1996 and 2004 (whereas real GDP grew by less than 8 percent over the same period), the fiscal weight o f public sector employment is due to the level o f wages, not employee numbers.29 Relative to the private sector, public sector wages in Paraguay are, on average, high.30 More detailed analysis carried out for the

29 The number of public employees in Paraguay is not excessive by regional standards, either as a

A 1999 study (Panizza, LJ., 1999, “Khy Do Lazy People Make More Money?’ Mimeo, Inter-American Development Bank) found that public sector employees receive a wage premium o f 17 percent over their private sector counterparts. As th is estimate does not correct for hours worked or include non-wage

roportion o f the total population (3 percent) or o f total employment (7.3 percent).

31

PER, however, reveals that the public sector wage premium disappears at higher levels. At the very highest levels o f responsibility, public sector employees receive a monthly salary that is only 40-60 percent of that received by their private sector counterparts,3' whereas at lower levels, there i s a public sector wage premium that ranges between 3 and 53 percent. T h i s pattern i s fairly typical: a stylized fact o f the literature i s that the public sector wage premium i s inversely correlated with earnings, and it may turn into a penalty for higher earners.

Figure 9. Spending on Salaries, Goods & Services and Capital, YO of GDP

12

10

8

6

4

2 A A

T -

-Wages & Salaries *Capital Expenditures

+ Goods & Services

Source: Ministry o f Finance and IMF.

82. A corollary o f this i s that wage compression in the public sector i s significant, and has worsened in recent years as a consequence o f Government policies to give significant increases to the lowest-level public employees. In 1980, the highest level earned 5.3 times more than the lowest level; by 1994 th is had fallen to 3.3. Calculations carried out for this report (which may not replicate the methodology o f revious studies) show a compression ratio o f 5.1 for the Central Administration in 2005Pz This indicates a highly compressed salary scale when compared with other countries in the Region (Figure 10). 33

benefits, it i s l ikely to underestimate the rent enjoyed by public sector workers. The 2003 Household Survey indicates that average pay in the public sector i s about 44 percent higher than it is in the private sector. T h i s i s a rough estimate, and should be taken with caution, as it does not distinguish between educational levels, nor account for hours worked. 3 1 Anecdotal evidence suggests that monthly salaries in the public sector, particularly at higher levels, can be substantially increased by salary supplements to compensate for overtime work, for representation, per diems, etc. As data on the individual distribution o f the salary supplements (asignaciones complementarius) i s not available, i t i s not possible do detennine to what extent th is i s true. On average, for the public sector as a whole, salary supplements add 16% to the basic salary. T h i s rises to 40% in the Decentralized Administration (public enterprises, etc.) but falls to 10% in the Central Administration. 32 The compression ratio for Paraguay i s calculated as the ratio o f the average level o f pay in the highest category to that in the lowest category o f the c iv i l service. 33 A low value for the compression ratio (i-e., relatively sma l l differences between the highest and lowest salaries) indicates high salary compression. In the OECD, compression ration are even lower, ranging f rom 2.3 in Finland to 3.6 in Italy and Australia. These and the L A C figures cited above (all for the 1996-2000

32

A highly compressed wage structure reduces civ i l servants’ incentives to pursue a long- term career in the civ i l service by reducing the appeal o f promotions. Incentives for productivity are rendered less powerful, and in some cases, wage compression may also encourage taking on second jobs, or moonlighting.

83. Beyond the disproportionate portion o f total public spending that i s consumed by salaries and the high degree o f wage compression that makes it difficult to attract and retain skilled staff, there are many other problems related to human resource management in Paraguay’s public sector, Until the recent public employee census, there was no reliable information on the number o f public employees. There are no position descriptions or performance evaluations, and career development i s limited. Hiring i s not based on rules o f competition or meaningful eligibility criteria. There is no unified salary structure and wages and other compensation are largely unrelated to competence or productivity. Managers are prevented from using economic or administrative incentives to reward superior performance and no systematic training programs exist.

Figure 10. Paraguay and Selected Countries: Wage Compression, 1996-2000

25

20

15

10

5

0

I

Note: Paraguay data i s for 2005. Source: The World Bank, Public Employment and Wage Data by Country.

84. There are no central controls on employment, nor are there ceilings imposed on the number o f employees being paid. The Budget Office maintains a registry o f job positions (cargos) which are allotted to institutions largely on a historic basis. Agencies resist efforts at clarifying the number o f positions, employees and vacancies in their purview, as they perceive the size o f their staffs as the basis for bargaining power in the

period) are calculated as the ratio of the highest to the lowest salary on the Central Government’s main salary scale, somewhat differently from this report’s Paraguay calculations, It should also be noted that the usefulness o f compression ratios declines as non-salary compensation gains in importance. The source for the compression ratio data i s the World Bank’s Public Employment and Wage Data By Country, web address: www. worldbank,orglpublicsectorlcivilserviceldevelopment.h~

33

system and are fearful of losing autonomy and control over the handling o f employment and pay issues. As the wage and salary budget i s difficult for the Budget Office to trim, institutions have an incentive to allocate as large a portion as possible for personnel expenditure in their budgets.

85. This situation i s a remnant o f Stroessner-era policies which used weak institutions and ineffective formal controls to favor personal loyalty and connections. The administrations that followed did not succeed in designing a strategy to undo this legacy, partly because democracy brought the incentive to use public employment as a means o f winning broad electoral support, and the situation has worsened over time. The lack o f a coherent, rational and transparent government employment fiamework, and the prevalence o f staff hiring practices based on favors and political patronage, have resulted in a public workforce that is often poorly trained to carry out i t s job and is inadequately distributed across institutions and sectors. It has also led to the expansion o f the public sector wage bill to levels that undermine the ability o f the Paraguayan State to fulfill i t s basic functions. The current administration has clearly recognized this, and has embarked on a number o f efforts to remedy the situation. The rationalization and professionalization o f government employment i s a long-term challenge that will require steadfast support from the highest levels o f Government in order to succeed

Box 1. General Characteristics of Public Sector Employment and Pay

In the public sector as a whole, 48 percent o f employees are women, although women form a majority in the Central Government as a result o f their preponderance in the Ministries o f Education and Health, whereas men far outnumber women in the decentralized agencies. Over a third (35 percent) o f public sector employees report holding a university degree, and a further 33 percent hold post-secondary qualifications (the bulk o f these being teachers, military and police).

Nearly 77 percent o f total public employment i s in the Central Administration, and o f this, 91 percent is in the Executive branch. The Central Administration accounts for 75 percent o f wage and salary spending. Within the Executive branch, the Ministry o f Education represents 45 percent o f total salaries, with the Ministry o f Interior coming second at 18.5 percent o f total salaries.

The basic remuneration package consists o f salary (90 percent o f basic remuneration), uguinaldo (13' month salary, 7 percent o f basic remuneration), and representation and other payments (3 percent o f basic remuneration). Basic remuneration accounts for 75 percent o f total personnel spending. Complementary compensation account for a M e r 12 percent o f personnel spending and comprise extra payments for academic achievement, family subsidy, employer contributions to pension payments, and other items.

Average salaries are highest in the Legislative branch, and lowest in the Executive. The ratio o f the average salary in the Legislature to that o f the Executive is 2.5, Th is variation within branches o f the Central Administration i s also reflected in the average salaries by grade. Within the Executive branch, however, average monthly salaries for a given grade vary to a lesser extent between Ministries (the variation ranges between 10 and 40 percent). Differences in pay between men and women are insignificant.

34

Policy Options

86. Given the reasonable size, by regional standards, o f public employment @e., in number o f employees, though not in terms o f total spending) this PER does not stress the importance o f reducing public employment. As public sector wages have been frozen since 2001, rather than stressing spending cuts, the emphasis would be best placed on controlling the growth o f the wage bill, increasing the effectiveness o f personnel spending, and making it more transparent and results-oriented. Government employment reform in Paraguay i s therefore unlikely to have a strong fiscal impact; the impact will be in terms o f results, effectiveness and efficiency o f the public sector.

87. One dilemma facing Paraguay in terms o f government employment i s how to control the overall public sector wage bill while improving remuneration to attract and retain skilled staff given the apparent disparities between public and private sector pay at higher skil l levels. Another objective o f government employment reform in Paraguay i s to professionalize de-politicize public employment and to construct a transparent and coherent compensation structure. This will need to be built on solid institutional, informational and legal bases.

88. outlined below.

Options to address the fiscal implications of public sector employment are

e Controlling the growth of the total wage bill as a proportion of total spending and GDP i s important. This means that improving public sector wages across the board i s not recommended without an equivalent growth in revenues and in economic activity. Paraguay spends a large proportion o f i t s revenues on personnel. This, combined with evidence that public wages in mid and lower levels are high relative to those in the private sector, would argue against public sector wage increases across the board, Evidence would favor focusing wage increases on key labor categories for which current salary levels are well below market (namely, managerial, technical and professional staff) as evidenced by Paraguay’s high salary compression.

e M o r e specifically, teachers’ salaries do not appear to be undervalued. While a salary review o f teachers i s beyond the scope o f the PER, and more detailed analysis i s required in this area, existing evidence indicates that in Paraguay (as in many other countries in the Region), correcting for hours worked, teachers receive a premium over other workers.34 An OECD publication finds that teachers’ salaries in Paraguay compare favorably with those in other countries o f the Region.35 This, combined with the large number o f teachers employed in the

34 Liang, X., 1999, “Teacher Pay in 12 Latin American Countries.” LCSHD Paper Series No. 49, The World Bank. The premium in Paraguay i s estimated at 29 percent. The study does not distinguish between public and private sector teachers; 80 percent of teachers in Paraguay work in the public sector.

OECD, 2004, Education at a Glance. Teachers’ salaries in Paraguay represent 2 and 3 times per capita GDP at the primary and secondary levels, respectively. Th is i s higher than the levels in Brazil, Chile, Peru

35

public sector - filling 47.5 percent o f total public sector positions (cargos).36 - points to the need for a carehl review o f teachers staffing needs, and restraint in the filling o f teacher vacancies.37

More generally, the Government needs to gather information on its staffing needs in order to proceed with government employment reform, For this, resources will be required as functional reviews are both technically and politically costly to carry out.

89. Institutional strengthening i s a key ingredient of medium-term public employment reform.

The SFP (Secretariu de la F u n c i n Ptiblica, Secretariat o f Public Administration) as the institution charged with rationalizing the public administration will require support in order to be able to carry out its mandate. The SFP was created by Law 1.626 in 2000. As i t i s a relatively new institution, i t lacks the human resources and infrastructure that are needed for i t to carry out i t s role effectively. The suspension o f the law creating the SFP has not helped it gain the necessary institutional weight or authority over other entities to implement changes to government employment.

e Fortification of the human resource offices (Unidades de Recursos Humanos) that operate in individual ministries would allow them to fulfill their role in the government employment system. Their financial resources are small, and they have a very low profile within the public sector organizational structure. A large part o f their staff lacks the knowledge and experience to support policies for the fbture transformation o f government employment.

90. Improving the quality and quantity of information regarding public sector employment i s another central input. This i s a key complement to strengthening institutional capacity for the management o f government employment and establishing a solid legal framework. Significant data deficiencies make a thorough analysis o f employment conditions in the public sector virtually impossible. As there i s no central registry or effective monitoring or control o f turnover or employment expansion, there i s no reliable, up-to-date information on public employment. Options to begin to address these deficiencies are outlined below:

and Uruguay. I t i s also higher than teachers’ relative salaries in the OECD, where they are 1.3 times per capita GDP. As in Paraguay these statistics apply to a position o f 20 hours while most teachers in the country hold two positions, the relative salaries o f Paraguayan teachers are even higher (with the exception of Peru and Uruguay, most teachers in OECD countries and in Argentina, Brazil and Chile hold only one position). 36 Censo Integral de Funcionarios PGblicos, Aiio 20031’2004. T h i s does not imply that 47.5 percent o f ‘’ The PER does not specifically address the question o f the appropriate distribution o f public employees across sectors a i d institutions.

ublic sector employees are teachers, as teachers are allowed to hold more than one position, or cargo.

36

e Ensuring the continued maintenance and upkeep of the database created by the 2003-04 census. This i s a fairly urgent task in order not to waste the opportunity created by the recent census. The census is not an end in itself, but i s the basis for establishing a permanent and constantly updated registry o f public employees. Experience has shown that there appears to be an inverse correlation between the frequency o f censuses and the quality o f public administration. In Latin America, censuses have become less common as government employment controls have improved and governments have been able to rely on management information systems for data on the size and composition o f the c iv i l service. This approach reflects the shift in government employment reforms from simple downsizing toward enhancing public sector productivity. The recent census in Paraguay can be used as a baseline measure for future restructuring o f government employment to enhance productivity by restructuring departments and functions, redeploying staff, building capacity, and improving human resource management.

0 I t i s important to develop SINARH into a payroll and information system that covers the public sector, and to strengthen internal audit in as many ministries and other entities as possible. The human resources payment system, SINARH, was designed as a payroll system following the 1991 government employment census, which led, as did the 2003-04 census, to the creation o f a c iv i l servant database. SINARH was never fully implemented, however. The MoF faced at the time a number o f problems in gaining the full cooperation o f other public sector agencies for adequate completion o f the census, and was only able to obtain aggregate numbers on the distribution o f employee^.^' This resistance was likely due to a reluctance to submit to greater MoF control over the use o f salary payments, raising questions regarding the accuracy o f figures on personnel spending. Since then, the database has not been maintained. There i s a danger that this will be repeated with the recently completed census.

0 A comprehensive analysis of total public sector remuneration in different categories i s a prerequisite for future public employment reform.39 The poor quality o f information on total remunerations (salaries as well as other benefits) in the Paraguayan public sector makes it difficult to proceed on the basis o f available data. The ultimate objective would be the development o f a salary scale aligned with job profiles and market-based remunerations.

91. A functioning legal framework i s a necessary, though not sufficient, requirement for public employment reform. The revision, approval and implementation of a new civil service law would be a logical Government objective in the short term. This could be achieved with support from the highest levels o f Government. The absence o f a legal fiamework for the c iv i l service i s a serious handicap

~

38 The World Bank, 1996, ‘%raguay: The Role of the State,” Report No. 15044-PA. 39 In an analysis of total remunerations, pensions should be considered at the same time as wage bill costs as the net present value of pensions may be a significant incentive for staff to remain in otherwise underpaid jobs.

37

which has led to inaction on public employment issues, and, in a few instances, to the implementation of fragmented, short-term solutions to structural problems. The Civi l Service Law (Ley No. 1.626) i s suspended due to numerous legal challenges brought against it. An important achievement has been the drafting o f a new law to replace it, although progress in discussing the new draft law and proceeding with the revision and approval process has been slow. The main principles o f Law 1,626, namely the promotion o f merit-based recruitment, promotion, and dismissal, are also central in the new draft law and deserve to be protected, An option to consider would be the limitation o f the new law to the Executive Branch as the extension o f the now suspended civ i l service law to the Legislature and the Judiciary had raised significant resistance.

92. Other options for the short-term. Although the purpose o f the analysis o f public employment and wages in the PER is to review available data and not to recommend at this early stage any specific path towards rationalizing or reforming public employment, a few specific actions that may be taken in the near term do bear mention.

A rationalization of the Personnel Annex may be feasible. The lack o f a permanent, unified, government employment remuneration system that regulates all public sector pay has led to the current system which i s based on an annual definition o f positions and their respective salaries and benefits, This annual definition i s included in the budget discussion under the Anexo de PersonaZ, and i s updated annually. The result has been a discretionary and highly politicized recruitment process. Measures could include collapsing the very large number o f categories into more consolidated groups. This would not only help the cause o f transparency, but would also diminish the politicization o f the process by moving away f iom the practice o f defining the salaries o f each public sector position. A worthy medium-term objective would be the replacement o f the current year-to- year practice with a permanent, stable remuneration system.40

e There are a number of measures that would help to both reduce total salary outlays and increase transparency and efficiency. Measures along these lines have in some cases already been undertaken by the Government, but would need to be maintained and expanded. These measures include: (a) rationalization of employment rolls and removal o f “phantom” c iv i l servants; (b) enforcement o f the mandatory retirement age41; and (c) de-linking o f pension payment adjustments from modifications to government salaries. There are a number o f ways in which these measures can be undertaken: through information provided by the government employee census, using auditing institutions (such as the

Although the Personnel Annex i s overly detailed in that it includes al l positions (i.e., cargos, not actual fil led public sector positions) and their respective salary and grade categories, it does not include the relevant information to build a useful database o f government employment. Only basic remuneration (not any supplementary payments or benefits) i s included in the Annex, and the various components o f basic remuneration are presented in a fragmented manner that makes it impossible to reconstruct the remuneration package that corresponds to any given position. 41 In 2000, in preparation for a public sector downsizing initiative, obligatory retirement was quantified as potentially affecting 10,000 government employees. Shepherd, G., 2000, “Note o n Public Sector Reform in Paraguay,” Mimeo, The World Bank.

40 ‘

38

Comptroller General’s Office or ministerial internal audit units, some o f which are fkirly strong), or via information through the payroll system, i.e., through S l N A R H . I t i s important to have a centralized unit with the capacity and authority to keep payroll and other employee information up to date.

93. Throughout the 1990s and until today, the Government has issued decrees to rationalize public employment, with varying degrees o f short-term success, but little long-term impact on overall wage and salary expenditures or on the effectiveness or efficiency o f the public sector. Rationalization measures have typically included the suppression o f vacant positions, the suspension o f double- remunerations, measures to allow and encourage the mobility o f public employees, the suspension o f payments to those receiving both a public salary and a pension, and the implementation o f mandatory retirement, among others. The latest round o f rationalization efforts i s associated with the completion o f the 2003-04 public employee census.

Building political consensus.

94, One o f the likely reasons for th is lack o f success in implementing broad-ranging and substantive public employment reform is the absence o f strong political support and consensus. The political costs o f such a rationalization and reform program are high as i t would affect the balance o f power between various actors - political parties, c iv i l servants, ministers, legislators, and central executives. Government employees fear a loss o f jobs or benefits, legislators worry that reform will enhance executive power and diminish their own, and political parties resist c iv i l service reforms for fear o f reducing the amount o f patronage they can distribute. Paraguay’s Congress i s independent and relatively powerfbl, particularly in terms o f budget-related issues. This, and the failure o f Government efforts to implement even minor employment-related reforms, is exemplified by the refbsal o f the Legislature, in both the 2004 and 2005 budget approval exercises, to include resources for merit-related salary increases or for compensation payments in cases o f retrenchment.

95. A technical reform design would need to be ,accompanied by a political consensus-building strategy within the public sector, with the legislature, and with the public at large. In some ways, Paraguay is fortunate that the total number o f government employees i s not excessive by regional or international standards, Thus the presentation o f the problem and o f proposed reforms can be made easier by the fact that the f irst required steps are to improve information and strengthen institutions rather than embark on a massive retrenchment program. The support o f Congress at the initial stages o f reform is critical given i t s role in approving the legal fiamework for government employment, in granting the needed resources to implement reform measures and in rationalizing the Anexo de Personal. A focused, intensive informational and outreach effort to Congress could help convince legislators that the rationalization o f government employment and salaries is a key ingredient for the improvement o f service delivery, poverty reduction and fiscal health, and that their support i s fundamental for success. For th is strategy to bear fruit, sustained support fkom the highest level o f Government - a “champion” - i s indispensable.

39

96, I t i s worth noting that experience in the Region and elsewhere seems to show that ambitious attempts at reform regularly fail, while more cautious and sequenced reforms have a better record of success. Failed reforms reduce the credibility o f the process and make the next effort at reform politically more difficult. A “programmatic” approach that assesses current reform possibilities and the actions that can successfully be implemented, and lays the groundwork for further future reforms, i s l ikely to be a more promising avenue to follow.

40

5. SOCIAL EXPENDITURES AND OUTCOMES

97. Since i ts transition to democracy at the end o f the 1 9 8 0 ~ ~ the role o f the State in Paraguay has changed hndamentally, with one o f the key transformations being the rapid expansion o f the Government's involvement in the social sectors. Today, public sector social spending represents roughly half o f non-financial public sector spending. Over the past decade, the growth o f social sector spending has been the motor behind the growth of public spending as a whole. Nevertheless, at 11.6 percent o f GDP on average during 2000-04, social spending in Paraguay i s somewhat below the Latin American average, adjusting for Paraguay's income level (Figure 11).

Figure 11. Paraguay: Spending in the Social Sectors as a Percentage of GDP, 1998-2000

20.0

10.0

5.0

0.0

18

Note: Paraguay data i s for 2004. LAC countries are arranged in order o f descending per capita GDP. Source: OECD Social Expenditures Data.

98. In educational attainment and coverage, Paraguay compares relatively well with other countries in the Region (Table 3). Working-age adults have an average o f seven years o f education, while the average number o f years o f schooling in the Region ranges from a low of four years in Guatemala to a high o f ten years in Argentina. In health, Paraguay's indicators are mixed, faring reasonably well relative to other countries in the Region in terms o f infant mortality, but very poorly in terms o f maternal mortality (Figures 12 and 13). h social protection42, program coverage i s very limited relative to other countries in the Region. Although data i s hard to come by, a proxy for the extent o f protection in the population is the extent o f coverage o f social insurance (since social insurance i s the dominant branch o f social protection.) Only about 13 percent o f the

42 Social protection includes social insurance (contributory pensions and health insurance) and social assistance (non-contributory programs for poverty alleviation).

41

economically active population in Paraguay makes regular pension contributions and only 17 percent o f the elderly receives a pension benefit.

Table 3. Paraguay and Selected LCR Countries: Years of education of adults 25 - 65, by income quintile

Figure

Quintiles 1 2 3 4 5

Argentina (I) 7.3 8.3 9.2 10.6 13.4 Bolivia 2.8 4.9 6.6 8.9 11.4 Brazil (I) 3.0 4.2 5.3 6.9 10.4 Chile (2) 7.4 8.3 9.2 10.6 13.2 Ecuador (4) 4.8 6.1 7.1 8.2 11.4 El Salvador 3.8 4.4 5.3 6.5 9.0 Guatemala (*) 1.4 2.2 2.8 4.1 8.5 Honduras 2.8 3.4 4.5 5.9 9.1 Paraguay P) 4.0 5.1 6.2 7.7 10.1 Peru ('1 5.9 7.5 9.1 10.4 12.5 Uruguay (') 7.0 7.8 8.6 9.8 12.1

Notes: Source: de Ferranti, et a1 (2004).

2001, (*) 2000, (31 1999, (4) 1998.

Average

10.1 7.3 6.4 10.0 7.8 6.1 4.2 5.5 7.0 9.4 9.3

12. Paraguay and Selected Countries: Actual and Predicted Infant Mortality Ra I

H a t i

Bolivia

0 4 I I 1 I I

7 8 9 10 11 In GDP

I Source: World Bank (2005), based on data from PAHO, DHS (2004).

es, 2004

42

F

99.

04

7 8 9 10 In GDP

11

I Source: World Bank (2005), based on data from PAHO, DHS (2004).

Paraguay’s expenditures in the social sectors have been driven by spending on education and social insurance (pensions and health), which have averaged 4.1 and 3.6 percent o f GDP respectively, between 1997 and 2004, and which together constitute about three-quarters o f total social sector spending. Spending on health (2.5 percent o f GDP between 1997 and 2004)’ and especially on social assistance and poverty alleviation programs (less than 0.2 percent o f GDP43), i s modest by regional and international standards (Figure 14). The concentration o f 40 percent o f social spending on social insurance has serious equity implications as lower income households do not have access to contributory pensions and health insurance.

Issues in Public Expenditure in the Social Sectors

Education

100. The increase in education spending over the 1990s was driven by a reform that expanded basic education to nine years and created rapid growth in the demand for educational services. The large increases in public spending on education since the early 1990s have led to significant accomplishments in school enrollment, with the net enrollment rate for initial education44 expanding fkom 17 percent in 1992 to 70 percent in 2002, and with significant expansion also in the third cycle o f basic education, fkom 30 to

43 Social assistance expenditure does not include spending on the Chaco war veterans non-contributory ’ ensions.

Formal education in Paraguay is divided into four levels: initial education (pre-school, up to age 5); basic education (ages 6-14) which is compulsory, free o f charge, and i s divided into three cycles o f three years each; middle education (15 to 17 years); and university education, teacher-training institutes and tertiary technical non-university institutes.

43

52 percent over the same period. Over 75 percent o f funds are allocated to initial, basic and secondary education (Figure 15), a proportion that has remained relatively stable since 1997. 45

Fig ? 14. Paraguay and Selected LCR countries: Public Spending on Health, 'YO of

8 ,

c c

E

peru Dominican Rep. 1 Ecuador

7.5 8.0 8.5 9.0 9.5 10.0 10.5 1 1 *o Ln per capita GDP

Note: The line corresponds to a logaritbmic trend line. Source: WDI 2005.

igure 15. Paraguay: Composition of Education Spending, % of total

100%

90%

80%

70%

60%

50%

40% 1997 1998 1999 2000 2001 2002 2003 2004

m Initial & Basic a Secondary 0 Tea. Non-Univ.

Admin. & Re@. iil Adm.and Regulation

Source: Ministry o f Finance and MEC.

iDP

'' education i s in public schools), with the exception o f tertiary education.

Education in Paraguay i s largely publicly provided (e.g., 82 percent o f total enrollment in basic

44

101. education sector.

Despite the increase in enrollment, a number o f important challenges persist in the

e

0

At 32 percent (2002), enrollment in secondary education continues to be among the lowest in Latin America. Completion rates are low. For the cohort that entered basic education in 1990, out o f each 100 students, only 58 entered the third cycle o f basic education, 38 began middle school in 1998, and only 20 graduated in 2001. Dropout rates remain a serious problem, and dropouts are concentrated in low income rural areas. The quality o f education remains a problem. Evaluations show that half o f sixth grade students did not reach the language proficiency to proceed to the next grade. The equity o f educational coverage can be significantly improved. Equity between rural and urban areas and between households in different income quintiles is low (Figure 16 and Table 4),46 The geographic incidence o f public spending on education disproportionately benefits richer departments (relative to the proportion of the population in poverty).47

e

e

102. A large portion o f the increased spending in education since 1990 has been specifically due to the expansion o f teaching and school management positions needed to increase coverage, and to salary increases. Salary expenditures have averaged 94 percent o f the Ministry o f Education and Culture’s (MEC) annual budget between 1998 and 2003 and as the growth in the number o f teachers has continued student-teacher ratios have fallen (see below). This has crowded out spending on goods and services and on investment and has contributed to the mixed results in terms o f educational outcomes. Poor educational outcomes have been associated with a lack o f basic teaching and learning materials, textbooks, and new education technology in schools, poorly stocked and under-used libraries, and few available facilities for hands-on science education.

103. L o w outcomes are also in part due to deficiencies in human resource policies. Current pre- and in- service teacher training i s fkagmented, i t s quality i s low, and policies for the establishment o f new teacher training institutes are virtually absent. Few teachers have received bilingual training (in Spanish and Guarani). There are no provisions for monitoring the performance o f either teachers or headmasters to hold them accountable for results or to encourage their professional development. Teaching and learning methods are characterized by teachers who apply traditional frontal pedagogical techniques that are not student-centered. Moreover, decisions on school openings and teacher assignments have increased the cost o f education per student. Lack o f planning has allowed the opening o f school sections without consideration for student-teacher

46 For the third cycle o f basic education, for instance, net enrollment i s 70 percent in urban areas but only 30 percent in rural ones (2000). While 80 percent o f 13 to 18 year-olds was enrolled in schools in 2002, the

” There do not appear to be important inequalities in access to education by gender, although disparities in access to specific programs exist. Vocational training programs are geared towards boys, who represent 98 percent o f enrollment, and resource distribution within adult education discriminates against programs targeted to the illiterate poor, among whom women dominate

roportion in the lowest two income quintiles was only 66 and 70 percent respectively.

45

ratios. The consequence has been a drop in these ratios from 20:l to 15.5:l over the 1990s in the first two levels o f basic ed~cation.~'

Figure 16. Paraguay: Net Enrollment by Level of Education, Urban and Rural Areas, YO

Initial Education

80

60

40

20

-+-Urban -Rural *Total

Basic Education (cycle 3)

loo 3 80

60

40

20

+Urban -Rural +Total

Basic Ecfucation (cycles 1 & 2)

120 I 100

80

40 6o I 0 4

+Urban -Rural -Total

Secondary Education

60

40

20

0

+Urban -Rural *Total

Source: Ministry o f Education.

Table 4. Paraguay: Enrollment by Income and Age Group, 2002 1 2 3 4 5

3 to 5 year-olds 39.0 39.0 35.0 49.0 55.0 6 to 12 year-olds 90.0 92.0 96.0 96.0 96.6 13 to 17 year-olds 66.0 70.0 75.0 79.2 79.0 18 to 23 year-olds 21.0 22.0 28.0 28.0 43.0

Source: CEDLAS (2004) based on Permanent Household Survey (2002), DGEEC.

48 The new school management positions were categorized as teaching position in the personnel annex of the Educatioa-Budget.

46

Health

104. Total public spending on health49 has represented between 9 and 10 percent o f consolidated public sector spending in recent years, and has declined from a peak o f 2.7 percent o f GDP in 1999 to 2.3 percent in 2004. Public spending on health is low when compared to other countries in the Region, accounting for differences in per capita income (Figure 14). Out-of-pocket expenditures by households and private insurance represent about 70 percent o f total spending on health in Paraguay.

105. There are three main providers o f health services: the public sector, through the Ministry o f Health and Social Welfare (~ in is ter io de Salud Pziblica y Bienestar Social, MSPyBS) and a number o f autonomous entities including the National University and the military and police; the IPS; and the private sector. Each finances health care in i ts own facilities, with l i t t le coordination among them. The MSPyBS provides care at subsidized prices, charging user fees for most procedures; the IPS is financed by payroll taxes split between its various insurance schemes; and private sector fees are unregulated.

106. Coverage o f health services is, by international standards, low and access to health services i s inequitable, The IPS provides health care to about 17 percent o f the population, and the private sector covers another 10 percent o f the population. The MSPyBS is responsible for health care provision to the low-income population and for public health activities, and should in principle provide care to the remainder o f the population. There i s a significant portion o f the population, however, that receives no health care. Almost hal f those who reported being ill did not seek medical assistance, with the utilization rate o f service being even lower among the first two income quintiles o f the population (Table 5). Other countries in the Region show similar levels o f inequality, but higher rates o f utilization o f medical services for every income quintile o f the population. Utilization i s lower in rural areas than in urban ones.

Table 5. Paraguay: Access to Health Services by Income, YO (2000

Quintiles 1 2 3 4 5

People with public or private health insurance 1.4 7.5 17.2 26.8 46.5 Became sick in the last 3 months 36.2 33.8 35.1 35.0 31.8 Working days lost to illness in last 3 months 7.3 5.8 4.9 5.2 5.9 Became sick and did not consult 70.0 59.2 48.9 47.9 33.2 Became sick and consulted 18.4 30.7 41.8 44.9 59.5

Consulted IPS 0.5 3.5 9.8 12.0 13.1 Consulted public facility (not IPS) 13.8 19.3 18.9 12.2 12.7 Consult Private Facility 4.1 7.9 13.1 20.7 33.7

Total - 19.9 34.4

5.8 52.2 38.6 7.7

15.4 15.5 -

Source: CEPPRO (2001) based on “Poverty and Income Distribution” DGEEC, (2000).

107. Whi le there has been progress in the supply o f health services over recent years, the effectiveness and efficiency o f resource distribution in the health sector could be

49 Total public spending o n health includes the Social Security Institute (IPS).

47

improved. Across programs, for instance, the Government’s stated commitment to primary care is not well reflected in actual resource allocation (Figure 17). A relatively high proportion o f MSPyBS spending (30 percent o f i t s budget) goes to specialized care while primary health services receive 40 percent o f the total and provide 90 percent o f all demanded services. While the Government i s taking steps to decrease the rate of maternal mortality, a major concern in basic health care, allocations and resource execution under family planning programs have been erratic.

Figure 17. Paraguay: Composition of MSPy BS Executed Budget

100%

90% 80% 70% 60%

50% 40% 30% 20%

10% 0%

r

200 1 2002 2003 2004 0 Primary Attention 13 Specglued Attention Health Care Programs

Physical Invest. Adminlstration I

Source: Ministry o f Finance.

108. The distribution o f resources by economic classification could also be improved. Salary expenditures represent a high portion, over 70 percent, o f the MSPyBS budget, leading to fewer resources being available for goods and services and investment. Overall, there i s an excess o f health personnel v i s - h i s Ministry guidelines, with a high proportion o f administrative personnel in particular (administrative personnel represent 51 and 39 percent o f payrolls o f IPS and MSPyB, respectively). Physical investment i s frequently cut to accommodate budget shortfalls and varies significantly from year to year in its level o f execution. Investment declined from 16 to 7 percent o f the executed health budget (Figure 17) between 2002 and 2004. While this may be a reflection o f current adequate levels o f physical infrastructure in the health sector (see below), it i s important that enough resources continue to be allocated to maintain the health infrastructure network in order to avoid problems in the future.

109. A recent study traces the low take-up o f health services to both demand and supply factors. 50 Demand variables, such as the high cost o f services and long distances to facilities, are important determinants o f the low rates o f health service utilization by the poor in Paraguay, especially in rural areas. On the supply side, bottlenecks are associated with shortages in human resources, medications and other supplies

World Bank. 2005. “User Fees and the Quality o f Public Health Care in Paraguay.”

48

(“software”), rather than with the existing stock o f infrastructure. The average utilization rate o f installed health infrastructure capacity across the country i s 50 percent.

110. Human resource policies in the sector are key to understanding some o f these supply issues and problems in resource distribution. There are shortages in the availability o f trained staff and full-time personnel, leading to restricted opening hours for many facilities. There are also significant inequalities in the distribution o f personnel, with richer areas, especially Asuncion, receiving a much higher share o f health resources than would be expected were the distribution guided by a poverty criterion. There are 23 doctors per 10,000 inhabitants in Asuncion, whereas in the rest o f the country the number of doctors ranges from 1.1 to 4.6 per 10,000 inhabitants.

11 1. These supply problems are often exacerbated by a lack o f incentives. As a rule, personnel working at health care facilities enjoy few incentives to improve their performance. Health facilities do not retain proceeds from user fees. Revenues from user fees raised at the health facility level contribute significantly towards overall system resources. Proceeds are transferred to the MoF for accounting and then re-sent - if at all - to the collecting units after considerable delays. This diminishes the incentives to improve service quality at the local level.

Social Protection

112. Social Assistance. Paraguay spends a very low 0.2 percent o f i t s GDP on social assistance programs, although the level o f spending in real terms has increased significantly in recent years (by 180 percent between 1994 and 2004). Social assistance expenditures in Argentina are around 2 percent o f GDP, while in Ecuador, with a per capita income similar to Paraguay’s, the social welfare budget is close to 0.7 percent o f GDP . 113. A strategic approach to social assistance has been developed but not yet implemented. The Social Action Secretary (Secretaria de Accidn Social, SAS) ’developed a Poverty Reduction Strategy (ENREPD) over three years ago which includes a number o f specific programs such as a conditional cash transfer for households in extreme poverty, and a Poverty Fund. Delays in implementing ENREPD have meant that the existing system continues to be fragmented and strategic vision limited. The system i s not structured as a response to specific risks and vulnerabilities, and there are many actors, including several independent Government agencies, that function with l i t t le coordination or strategic planning. Most social assistance programs are limited to supporting non-governmental organizations that provide goods and services to the poor, with l i t t le if any direct transfers to the most vulnerable sectors. There are no impact evaluations, few attempts to ensure that spending reaches those most in need and l i t t le if any control over spending.

114. Old Age and Survivor Pensions. Between 1997 and 2004, Paraguay spent an average o f 3.6 percent o f GDP on o ld age and survivor pensions, about average for i t s level o f per capita GDP when compared to other countries in the Region (Figure 18).

49

The system’s coverage is, however, very low for both active workers and the elderly, and is inequitable. Eight percent o f the economically active .population makes regular pension contributions, and income protection for the elderly is limited, with about 21 percent o f the population over 60 receiving a pension. Access to benefits by income level is highly unequal, with only 0.3 percent o f the elderly in the first income quintile enjoying pension benefits, while the percentage among the wealthiest i s close to 40 percent. Because of the high informality in labor markets, it will be difficult to significantly increase coverage of contributory systems in the short to medium term.

- c .Id 0 1 0 -

8 -

a OD 6 - B L 4 - m

Figur 18. Paraguay & Selected LCR Countries: Public Spending on Pensions, % d

16 #

14 UWWY

8 ” 1 Brazil #

USA

Argentina 4 # Canada Bolivia

# # CostaRica

+ Peru Chile L Ecuador 4 + Colombia

El Salvador bominican Rep. 0

7.5 8.0 8.5 9 .o 9.5 10.0 10.5 11.0 Ln Per Capita GDP

Note: The line corresponds to a logarithmic trend line. Source: WDI 2005.

’ GDP

1 15. Coverage and financial problems are related to the lack o f a strategic vision in the pension system as a whole. Pension-related initiatives are usually developed at the Ministry o f Finance, but there is little integration with other social policy programs or collaboration with other institutions. The system is, as a result, fiagmented and policy coordination and planning are weak. Due to the autonomy o f the various existing pension fimds, different rules apply regarding contribution rates and benefit formulas; there i s no portability o f years o f service or contributions; and workers switching from one system to another risk forfeiting their savings.’l T h i s leads to inequities and inefficiencies.

The Social Security system in Paraguay includes eight public institutions. The largest i s the IPS, which covers private sector employees not covered by any of the other smaller funds, followed by the Caja Fiscal covering public sector employees and some non-contributory beneficiaries (Chaco war veterans). The IPS and the Caja Fiscal comprise about 95 percent o f pension coverage in Paraguay. Six other pension funds cover employees at specific institutions or activities: railroads, municipalities, the h ip6 hydropower plant, members o f Congress, the ANDE electricity company and the banking sector, All systems are defined benefit, pay-as-you-go schemes. Voluntary private pension plans (Caja Mutuales) are offered by non-profit organizations. Both the IPS and the Caja Fiscal are estimated to be in actuarial deficit, although the IPS runs cash surpluses. The IPS pension system should remain in surplus or balance until about 2025. In contrast, the Caja Fiscal has been recording cash deficits, financed from general tax revenues, for over a

50

116. In Paraguay as in other countries in the Region, social insurance (pensions) consumes significantly greater public resources than non-contributory social assistance. I t has displaced social assistance interventions aimed at lowering the r isk o f poverty among the vulnerable non-poor and helping to bring the current poor out o f their destitution. This displacement arises from the Caja Fiscal, despite the recently approved reform to the public sector pension fund. Although the reform has contributed to bringing the Caja towards financial equilibrium, it continues to run significant deficits and i s overly generous in benefits to selected groups. The displacement i s aggravated by the fiscal burden o f the non-contributory pension payments which, despite some recent administrative improvements, continue to be beset by fraudulent claims.

Policy Options

117. There i s scope for resource reallocation within social spending. Resources available from savings or resource reallocations would be best allocated to health and social assistance, given that Paraguay’s spending on health and social assistance i s low for i t s income level. Without an increase in public revenues, an overall increase in social sector resources is probably not feasible given their relatively high share in total expenditures and the country’s overall resource constraints. There is however some scope for re-allocation within the sector. One option would be to shift savings from fiscal adjustments in the deficitary Caja Fiscal into social assistance. Some savings can be achieved in the Caja Fiscal through the completion o f an institutional audit and reduction o f fraudulent pension payments.

118. efficiency and equity of spending:

In education, a number of policy options exist in order to increase the

0 More rational planning that promotes the efficient allocation of teachers across the system and provides greater flexibility for moving positions, particularly vacant ones, to areas with higher student-teacher ratios, The elimination o f some vacant positions may be considered in order to enable the reallocation o f resources towards investment and other non-salary spending.

0 The introduction of a monitoring and reward system for teachers and school managers could be considered. This would provide much-needed incentives for good performance, and could be tied to the new certification system and clearer performance measures which are being established to determine promotions, thus helping to increase the effectiveness o f resources use.

decade. Of the s i x autonomous Cajas, two present the most immediate problems. The Caja Bancaria, covering banking sector employees, has been running deficits and i s nearing a situation o f virtual default. The Caja Municipal, which manages the pension plan for municipal public servants, s t i l l has a positive cash flow although it has the potential o f reproducing a crisis quite similar to that o f Caja Bancaria in the future. Of the six specialized pension funds, the Caja del Personal de l a Itaipu Binacional i s the only one that has accumulated significant reserves.

51

An evaluation and possible expansion of the existing secondary scholarship program could be contemplated. Given the low transition rate o f poorer students from third cycle o f basic education to secondary school, such a measure may stem or reverse current trends. This expansion could be financed by increasing cost recovery o f university fees or through another sustainable financing mechanism.

119. In health:

More resources need to flow to where primary care i s actually demanded, given the finding that demand i s the primary bottleneck to utilization and the existing bias towards tertiary care. The Government is pursuing this through the planned implementation o f a mother and-child non-contributory health insurance system..

e The revamping of human resource policies could lead to important improvements in both service effectiveness and efficiency. As with education, vacant positions may be pooled and reassigned on a strategic basis, in order to improve coverage, equity o f spending incidence across regions and efficiency o f resource use. Harmonizing the fragmented remuneration policy, which rewards permanent staff in the center while under-paying contractual employees in rural areas, would also promote greater equity and efficiency.

e The flow of proceeds from user fees between the central level and local facilities could be improved. The current policy does not provide incentives for local revenue collection or quality improvement. A simplification o f the process o f fund transfers may be achieved by revising the guidelines for exemptions to current user cost fees wherever possible. It is important that such measures be preceded by significant improvements in information systems and in internal and external auditing and control mechanisms for service-providing facilities. Improved accounting and financial management practices could in the medium- term pave the way for a revenue-sharing system that would allow facilities to keep some o f the proceeds from user fees.

120, In social assistance:

e The effectiveness of resources would be increased if the multitude of existing programs were brought together under one coordinating institution. Efforts could be concentrated on fewer programs that are better targeted to supporting the most vulnerable groups in society, One such program i s the conditional cash transfer program (Red de Proteccibn Social) linked to the provision o f education, health and nutrition services. This program could be initially piloted in order to determine the most effective targeting strategy.

e Resources for a few selected social assistance programs could be obtained by the pooling of national and donor resources into a “poverty fund”. This fund

52

would operate as an institution to effectively coordinate and channel resources under a common program charged with the implementation o f Paraguay's Poverty Reduction Strategy (ENREPD).

121. Overall, rationalizing certain aspects of the budget process could help improve social service delivery. Budget planning i s detached from strategic sector planning regarding what i s to be achieved with the assigned resources. Greater emphasis on priority-setting and on specification o f targets - however limited - would help establish this important link A greater participation o f line ministries in the final preparation o f the budget sent to Congress would help clarify budget allocation decisions and changes in resource envelopes. Alterations by Congress o f the budget proposal at the line-item level result in major resource allocation implications that are not generally based on hard information or program evaluations, and negatively affecting policy and program implementation (Table 6). The limiting o f changes to broader categories would reduce these distortions.

Table 6. Paraguay: Legislative debate impact during the approval stage on 2005 Budget Law

Executive's Joint Budget Chamber of Senate and Budget Committee Deputies Budget Law

Proposal @ase=lOO)

Ministry of Education 100.0 106.0 105.0 104.0

Secretariat of Social Action 100.0 NA 73.7 70.9 Ministry of Health 100.0 115.0 116.0 118.0

Source: Financial Management Information System (SIAF), Ministry o f Finance.

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6. ENHANCING THE EFFECTIVENESS OF INFRASTRUCTURE SPENDING

122. The challenge facing Paraguay in the infrastructure sector is how to maintain and expand infrastructure assets to support growth - particularly in transport and water and sanitation services that form the focus o f the PER - given fiscal constraints. The magnitude o f the challenge was summarized in a recent Bank document52 which noted that if road maintenance spending i s not increased at least five-fold, Paraguay’s road network could collapse within a few years, crippling agricultural exports that are dependent on the all-weather accessibility o f the road network. A similarly stark scenario faces the urban water supply sector. The State Water supply and Sewerage Company (ESSAP) has revenues that only allow it to meet about 40 percent o f i t s debt service obligations, and these obligations will exceed i ts net income every single year through 2020,53 This has meant that ESSAP has not been able to dedicate resources to much- needed investments, and that the Government (as the p a n t o r for ESSAP’s loans fi-om international financial institutions) will need to assume over US10 mill ion in debt service obligations each year, depriving it o f resources to address other priorities.

123. Paraguay’s needs in terms o f infrastructure are high, both in terms o f quality and coverage. A survey o f business people rated Paraguay at the bottom o f a number o f Latin American countries in the level o f development and service efficiency o f i t s infrastructure (Table 7). Only about a quarter o f the road network i s paved, and over 40 percent o f the paved network is in fair or poor condition (Figure 19). The state o f the unpaved network i s more precarious, with only 15 percent in good condition. Overall water supply coverage lags behind other South American countries (Table 8).

Table 7. Selected Countries: Perceptions of Degree of Infrastructure Development, 2003 Airports , Electricity Ports Railroads Roads Water All

Infrastructure Chile 4.8 5.4 5.5 4.6 2.2 4.6 6.1 Argentina 3.9 3.9 5.0 3.7 2.5 5.0 6.1 Brazil 3.8 5.1 4.7 3.3 2.2 4.4 5.8 UWWY 3.8 3.0 5.4 4.0 1.5 5.0 6.6 Mexico 3.6 4.6 3.9 3.3 2.4 5.0 4.6 Colombia 3.1 4.2 4.5 2.6 1.4 3.7 5.6 Peru 2.5 3.0 4.5 2.3 1.7 4.3 4.6

Thailand 4.9 5.6 5.3 4.5 3.7 5.3 5.4 Indonesia 3.7 4.1 3.6 3.7 3.2 3.9 4.7 Philippines 2.3 3.9 3.6 2.4 1.5 3.5 4.4 Note: Scores range from 1 to 7 and measure the perception o f survey respondents with respect to the quality o f infrastructure (1 = underdeveloped and inefficient, 7 = as developed and efficient as the world’s best). Source: Global Competitiveness Report (CGR) 2003-2004, World Economic Forum, except roads, which i s from GCR 2002-2003.

~

52 The World Bank, 2003, Paraguay: Policy Options for the New ~ d m i n i s ~ a ~ i o n , Volume I, Report No.

53 ESSAP’s debt service payments stood at close to US$17 million in 2004. 25894-PA.

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Figure 19. Paraguay: Road Condition by Surface Type, 2005

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0% Paved Unpaved

Suface Type

Good Fair M Bad I

Source: Roads Authority (Direccidn de Vialidad), visual inspections, March 2005.

Table 8. Urban Water and Sanitation Supply, Selected Latin American Countries

YO of Households with access to piped water situ)

% of households with sewerage (network or in-

Network Network + in si tu Argentina 85 55 88 Brazil 96 59 94 Chile 99 90 93 Mexico 94 75 87 Paraguay 78 20 85 Uruguay 98 51 95 Source: World Bank, 2004, internal report

124. At the Asuncion airport, radio telecommunications technology i s more than 20 years old and i ts geographical coverage i s limited. The radar system has not been hnctioning adequately for several years and does not cover al l o f the national territory. The runway i s deteriorated and existing bridges and gateways at the airport are not sufficient to attend to peak demand. It i s estimated that resolving these problems would require investments o f about US$lOO million. Port productivity in Asuncion i s low due to poor cargo handling equipment, and access to public ports is inadequate.

Lack o f investment also affects Paraguay’s air and river transport.

125. Additional resources to meet the country’s large infiastructure gap are required. In the face o f fiscal constraints, these resources will need to come primarily from an increased effectiveness and efficiency o f infrastructure spending, com lemented with new private sector investment and additional revenue mobilization?’ This section

54 A full discussion of the options in terms o f private sector involvement in infrastructure i s beyond the scope o f the PER, and the issues have been addressed in other recent Bank documents (e.g., Paraguay: Policy Options for the New Adminis~atio~, Vol. I, Report No. 25894-PA). Given Paraguay’s rich tradition

55

focuses on ways in which the quality o f sector expenditures can be improved, with a specific emphasis on bottlenecks related to the Paraguayan budget process.

Key Issues in Public Infrastructure Spending

126. Poor planning and Driority-setting. Although some advances have been made, investment planning in infrastructure i s weak and i s primarily undertaken as part o f the due diligence process in project appraisal required to access bilateral and multilateral financing. The problem i s compounded by the large number o f donors financing the sector and the lack o f coordination amongst them. International donors play a major role in the definition o f investment priorities and thus, to some extent, deficiencies in infrastructure planning in Paraguay also reflect their lack o f coordination. Despite important donor assistance in this area, the technical capacity required to formulate new investment plans could be strengthened significantly. Planning units within infrastructure agencies rarely engage in comprehensive planning activities. Their fuflctions are largely limited to contracting out feasibility studies for donor-funded projects and preparing the administrative documentation required to get loans approved.

127. Insufficient infrastructure investment. As discussed in previous sections, fiscal constraints and high personnel expenditures have reduced the envelope o f public resources available for infrastructure investment. The lack o f investment in road maintenance, for example, combined with poor planning and prioritization has led, to the continued deterioration o f the road network, particularly the unpaved network (Figure 20). At the same time, the road authority’s (Direccidn de Vialidad, DV) budget allocation dropped by about 35 percent between 2001 and 2004. It i s estimated that Paraguay spends only 20 percent o f the minimum needed to maintain i t s road network from further deterioration. The creation o f the road maintenance fund, SIVIPAR (Sisternu Vial del Paraguay), has not yet resulted in new resources for maintenance and even when it comes into operation may provide less than hal f o f the DV’s road maintenance needs as currently structured.55 In water and sanitation, service coverage o f only 70 percent, well below the regional average (93 percent) i s also the result o f low investment and o f the lack o f a unified sector policy. 56 Both SENASA (Sewicio Nacional de Sanearniento), serving rural areas, and ESSAP, serving urban areas, lack the resources to increase coverage levels significantly in the short term.

o f local private sector investor-operators in the water sector in periurban areas (aguateros), the urban water supply sector may be in a position to attract more private sector investment if credible institutions and transparent processes can be assured. Similarly, in the roads sub-sector, maintenance o f some roads may be outsourced to the private sector under multi-year performance-based contracts that have already reduced maintenance costs in other Lat in American countries (Argentina, Colombia and Peru, for example), 55 The current structure o f SIVIPAR does not clearly its link revenue sources with roads or road maintenance. The Government may need to consider restructuring S r v I p A R before its implementation. 56 “Agua Potable y Saneamiento- Estado Actual y Perspectivas” (2000), Pan -American Health Organization. Coverage figures include Lat in America and the Caribbean, Water supply coverage includes service from household connections or protected public sources within easy reach (public standposts, wells, springs, rainwater collection systems).

56

Figure 20. Budget Execution at the Roads Authority

100

80

*E 60

5 40

20

0 .C - - (13

I - ~ m w ~ c a m o - ~ r n w

Construction & Rehabilitation

m m m m m m o o o o o 0 0 0 0 z z z ? 2 ? 2 ? 2 z , , , ,

Source: Roads Authority (Direccidn de Vialidad).

128. Unfavorable government policies. A number o f government policies affecting the infrastructure sector M e r reduce the resources available to entities in the sector. Tariffs, especially in the water sector, have not been adjusted in over f ive years and have fallen in both real and relative terms behind prices o f other public services, hurting the revenues o f ESSAP, already burdened by high levels o f debt. Public enterprises and decentralized entities are required to make annual transfers to the Government; in a context o f high needs, constrained resources and budget cuts, th i s adds to the difficulty o f improving service delivery and infiastructure maintenance. Public enterprises are also required to provide some services free-of-charge (e.g., port and canal dredging by ANNP, meteorological services by DINAC), which reduces their competitiveness vis-A-vis the private sector and results in foregone revenues.

129. Human resource issues. The rigidity o f public sector human resource policies hampers entities' ability to improve operational effectiveness and efficiency. In some agencies, there i s a shortage o f staff, and salaries are too low to attract and retain qualified personnel (e.g., in the Directorate o f Roads and the National Aerospace Directorate). In others, there i s excess staffing (e.g., ANNP). The agencies are severely restricted in the options available to them.for rationalizing their staffing levels by current personnel policies and practices.

The Budget Process and Infras~~cture

130. Infkastructure investments have some unique characteristics, including their high capital intensiveness, their need for long-term planning horizons, unpredictable costs, and infrequent, lumpy payments. Infrastructure assets are long-lasting and have significant and continuous maintenance needs that can multiply exponentially, to the point o f demanding full reconstruction, if they are not implemented. These characteristics accentuate the negative impact o f inadequate budget policies, institutions and distorted incentives. In Paraguay, as in many other countries, infrastructure sectors are more

57

vulnerable to the rigidities, arbitrary changes, cyclicality and negative incentives embedded in the budget process. This vulnerability i s compounded by the overall context in which budgetary decisions are made, characterized by resource scarcity, weak institutions, and corruption. Infrastructure is particularly exposed to budget cuts during times o f fiscal adjustment, I t i s usually less politically costly to cut infrastructure investment than to lay off public employees. When resources are available, as there i s little political capital to be gained &om investing in infrastructure maintenance, politicians tend to favor new investment over maintenance.

131. For these reasons, public sector agencies often feel compelled to seek ways to escape the budgetary process, for instance by relying on user charges or through a proliferation o f earmarked funds. Interestingly, th is i s not the case in Paraguay. Most infrastructure services in Paraguay are provided by agencies that are part o f the national budget; although a road fund (S IVIPAR) has been created, it has not yet been regulated or implemented. The PER analyzes the impact of the budget process on the performance o f infrastructure service providers and on the effectiveness and efficiency o f in~estment.’~ The sector analysis validates the conclusions on the shortcomings o f the overall budget process in the country.

132. Priority setting and planning. Overall responsibility for the infrastructure sectors, including the formulation of policy, planning and coordination lies, de facto, with the Ministry of Public Works and Communications (Ministerio de Obras Publicas y Cornunicaciones, MOPC). Although the STP (Secretaria Tkcnica de Planijicacicin) i s responsible for coordinating and prioritizing public investment, th is role i s not yet effective, and the vacuum has not been filled by the MOPC. This has led to a high degree of fragmentation in sector planning and a lack o f policy coordination. Policy recommendations frequently do not take account o f the investment and activities being undertaken by decentralized agencies and SOEs. In the water sector, for example, there i s no governmental body overseeing a national policy for water and sanitation. While SENASA falls under the Ministry o f Health, ESSAP is a public corporation with budgetary autonomy. This fragmentation and a lack o f technical capacity have weakened the importance o f planning as a tool for effective infrastructure investment.

133. The budget process does not promote the incorporation investment planning into resource management. Budget policies do not require an ex-ante evaluation o f investment projects and the nature o f the interventions by the MoF and Congress - often

5’ The budget process for entities in the infrastructure sector depends o n whether they are public institutions under the sphere o f a sector m in i s t r y or decentralized institutions that collect revenue directly. The Civil Aviation Directorate (Direccidn Nacional de Aeronhutica Civil, DINAC), the National Ports and Navigation Agency ( A d r n i n ~ ~ a c i d n Nacional de Navegacidn y Puertos, A m ) , and the Transport Directorate (Direccidn Nacional de Transporte) DMATRAN are decentralized agencies, while the Directorate o f Roads (Direccidn de Vialidad, DV) and the National Sanitation Service (Sewicio Nacional de Saneamiento Arnbiental, SENASA) fal l under the Ministries o f Public Works and Health, respectively. The former institutions submit their budgets directly to the Ministry o f Finance (MoF), while the DV and SENASA form part o f the sector Ministries’ consolidated budgets. The budgets o f a l l these institutions go through Congress for negotiation and final approval. ESSAP i s a public corporation that i s not required to submit i ts budget for review and approval.

58

resulting in ad-hoc cuts and resource allocation changes at the micro-level - as well as the limited capabilities o f executing agencies, diminish the relevance o f making conscious use o f investment planning tools.

134. Despite these weakness, there are promising planning initiatives underway. For example, SENASA is in the process o f consolidating a planning methodology based on service coverage targets in water and sanitation. DINAC has developed a strategic plan that seeks to internalize into i ts daily operations some o f the priorities identified in investment studies and recommendations made by international organizations. Improvements such as these would need to be linked to the overall budget process in the sector.

135, Budget preparation. Despite laws to the contrary, current practice i s to elaborate budgets incrementally, i.e., based on resources available for the previous year. One reason for th is is the rigidity o f expenditures in the infrastructure sector with a high weight on personnel expenditures, particularly in DINATRAN, DINAC and ANNP. Moreover, decentralized entities must set aside part o f their budgets for transfers to the Central Government. Beyond rigid expenditures, the budget preparation process i s not given adequate weight in sector institutions (as in DTNAC and ESSAP), diminishing the credibility o f the budget process as a tool for resource planning and management. The result i s an annual budget that reflects neither the priorities o f the agencies nor those o f the sector as a whole.

136. Revenues are frequently overestimated, leading to the preparation o f unrealistic budgets. This applies in particular to SENASA, DINATRAN and ESSAP, which do not make transfers to the Central Government and thus tend to overestimate their revenues in order to introduce more flexibility in the re-allocation o f spending during budget execution. ANNP and DINAC tend to estimate their revenues more accurately as their income i s derived exclusively from their own institutional resources (FF30), giving them an incentive to produce conservative estimates in order to avoid having to transfer larger amounts to the Central Government.

137. A t the MoF, entity budgets undergo important changes. As previously noted, the MoF introduces changes to the allocations included in the budget proposals at the line- item level, the lowest level o f aggregation. The Ministry also reassigns the financing sources used for different budget items. Infrastructure sector entities often receive significant resources from both credits (FF20) and own revenues (FF30), in addition to treasury resources (FF10). For instance, during the 2005 exercise, although the MoF allowed a larger envelope for investment programs in the MOPC, it did this by shifting the source o f funds from treasury resources to institutional funds dependent on the application o f the SIV IPAR law and overall revenue collection.

138. The budget preparation process thus encourages entities to overestimate revenues in order to increase flexibility during execution although this in itself compels the MoF to subsequently cut inflated spending requests. Significant time and other resources are

59

wasted in the process, and the final result does not adequately reflect either national or sector priorities.

139. The budget approval process. To some extent, Congressional changes to the budget during the approval process tend to rebalance the cuts imposed by the MoF on sector budgets. Line ministry representatives and agency heads lobby Congress during the approval stage in a series of informal discussions to increase their budgets. Congress paradoxically may act as the arbiter between entities within the Executive.

140. But Congress does not limit i tse l f to overseeing overall budget envelopes and financing sources. It intervenes in budget l ine items, adding a layer o f changes. In 2005, for instance, Congress increased personnel spending and reduced amounts requested for human resource management schemes such as early and voluntary retirement plans in some institutions (e.g., D INAC and ANNP). The legislature also modifies line-items within externally funded investment projects.

141. Budget execution. Under-execution o f budgets i s high in the infrastructure sector, particularly in the MOPC and entities under the Central Government, and somewhat less so in the decentralized agencies and ESSAP (Table 9). The difference in execution levels is explained by the relative size o f the entities' capital investment programs. The MOPC, DV and SENASA dedicate a much larger proportion o f their budgets to investment (90 percent in the DV and SENASA in 2004), the category that i s substantially under-executed year after year. In addition to poor prioritization and planning at the entity level, operational capacity and the budget process both affect budget execution.

142. The cuts implemented by both MoF and Congress to entities' budget proposals, without the necessary discussion with the concerned l ine ministry, significantly affect program ownership and execution. For instance, resources for investment background and feasibility studies are frequently cut, while the funds for the corresponding construction are maintained. The modification o f funding sources has a similar effect.

Table 9. Budget Execution, 2002-04

2002 2003 2004 p MOPC 52% 56% DV 86% 52% 61% SENASA 65% 54% 59% ANNP 87% 82% 63%' DINAC 95% 75% 53%' DINATRAN 94% 91% nla ESSAP nla 73% 56% ' Budget execution to end-November Source: Government of Paraguay

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143. Execution delays have in the past resulted from the accumulation o f floating debt, or arrears to suppliers, because o f the failure to record commitments in budget information systems. Arrears must then be paid during the first two months o f the following year, occupying the bulk o f the available budget in January and February. Activities can only begin in earnest in March. These delays are compounded by the frequent reprogramming o f resources during the year. The deficiencies in budget planning are such that l ine ministries often prepare their reprogramming and budget supplement requests before the Budget Law i s approved. The lengthy approval process for reprogramming requests generates further delays. Finally, cash management practices slow down execution even further, particularly in investment. Insufficient counterpart funds for externally h d e d projects are included in the monthly cash plans, hindering the execution o f many projects for which external resources are available.

144. The lack o f planning has meant that the introduction o f a new procurement framework for the public sector i s generating numerous delays as more stringent controls are imposed. As entities fail to adequately include provisions for procurement in their budgets, they must resort to resource reprogramming requests during the year, delaying program execution. Inadequate information systems hamper budget execution; most entities lack adequate financial information systems to control revenue collections, expenditures and disbursements and in none o f the institutions analyzed are there linkages between financial and physical execution.

Limited operational capacity also affects resource execution.

145. Weak operational capacity i s also the result o f shortcomings in human resource policies. The entities analyzed are not able to implement policies to create incentives or to improve the quality o f human resources because o f the legal rigidities that stipulate that only Congress can modify the size o f the payroll and change salary ranges. SENASA, ANNP and DINAC all have programs to reduce staffing by voluntary retirement, but Congress has eliminated or reduced budgetary provisions for this activity. In many entities salaries are too low to attract and retain qualified personnel.

146. Monitoring and evaluation. Although some initiatives are underway, monitoring and evaluation is largely non-existent in infrastructure entities. Data collection and management, the basis o f monitoring and evaluation, i s weak, and there are few efforts to conduct monitoring activities that do not form part o f externally financed projects. Some isolated efforts at improving the situation exist; SENASA, for instance, produces periodic reports on progress in the execution o f investment program that are sent to donor agencies, contrasting progress with established targets.

Policy Options

147. With respect to the budget process, the options outlined above on the overall budget process would all be relevant to the infrastructure sector. The recommendations for the gradual introduction o f multi-year budgeting are particularly relevant to infrastructure. The lack o f priority-setting and planning i s at the root o f many o f the sector’s difficulties. Whi le the development and implementation o f five-year investment

61

plans requires a high level o f technical capacity, expanding efforts in th is area from the current isolated instances to eventually cover the sector as a whole could greatly improve resource use and results.

148. In this regard, donors bear a particular responsibility. As has been noted, the bulk o f investment financing i s through external credit sources. Donor activities, however, are often uncoordinated and have little impact on expanding the planning capacity in Government institutions. Action in this area, by both the Government and key donors, i s overdue.

149. The limitations on counterpart funds in approved budgets have a negative effect on public investment in Paraguay, as does the lengthy and complex process o f Congressional approval o f individual investment loans. With respect to counterpart funds, improved donor coordination and better planning on the part o f the Government regarding investment priorities would contribute to resolving this issue. An option to address the second issue would be to move from a project-by-project approval process in Congress, to the approval o f an overall ceiling on public external debt during the fiscal year, as i s done i s some countries (e.g., Chile). Project-related expenditures would still be included in the annual budget for legislative approval.

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7. CONCLUSIONS

150. Paraguay has taken important steps over the past two year to improve fiscal management, and has put in place a number o f structural reforms that are beginning to correct persistent sources o f fiscal and financial vulnerability. However, vigorous and sustained economic growth remains elusive. In order to secure higher levels o f growth and social development, improved social services and infrastructure are two necessary ingredients.

15 1. The Government faces a number o f challenges to expanded and improved service delivery, at both aggregate and sector levels. The need to sustain primary surpluses in order to ensure debt sustainability, particularly given Paraguay’s severely restricted access to capital markets, limits the fiscal space available to increase expenditures on priority social and infrastructure areas. A weak budget process overall makes it difficult to prioritize the allocation o f scarce resources, and does not encourage the effective delivery o f services. Public employment, in addition to consuming an overly large portion o f total public spending, i s structured according to the logic o f patronage rather than the discharging o f the h c t i o n s o f the State. At the sector level, institutional fragmentation and poor planning have had detrimental effects in both infi-astructure and social services. The de-facto absence o f a planning stage in the budget process has militated against coherent policy-making at the sector level.

152. Given these constraints, additional resources to meet Paraguay’s significant investment needs in basic infrastructure and social services may be obtained through a combination o f increased revenues and control o f current expenditures. A priority for the Government would thus be the full implementation o f the recently legislated tax reform, combined with a rationalization o f policies on the diesel fuel excise tax and price subsidy. In spending, the control o f public sector wage growth i s particularly important, particularly ensuring that i t does not exceed the growth o f revenues or total expenditures. Continued attention to pensions and to their associated contingent liabilities i s also key to avoiding fkture fiscal troubles.

153. In parallel with these tax and expenditure measures, however, additional reforms wil l be needed in order to ensure that increased spending on social and infrastructure services has the desired impact o f improved coverage, enhanced service delivery as well as more robust growth and poverty reduction. Stronger institutions - in th is case an improved budget process and an effective c iv i l service - are critical to enhance the effectiveness and efficiency o f public resource allocation. Such reforms will require a high level of consensus regarding the role o f the State in Paraguay, and a high degree o f involvement o f c iv i l society in order to promote transparency and good governance.

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World Economic Forum. Global Competitiveness Report. Various years,

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