Report and Recommendation of the President to the Board of Directors

Project Number: 52173-001 October 2019

Proposed Programmatic Approach and Policy-Based Loan for Subprogram 1 Republic of the Philippines: Local Governance Reform Program Distribution of this document is restricted until it has been approved by the Board of Directors. Following such approval, ADB will disclose the document to the public in accordance with ADB's Access to Information Policy after excluding information that is subject to exceptions to disclosure set forth in the policy.

CURRENCY EQUIVALENTS

(as of 4 October 2019) Currency unit – peso (₱)

₱1.00 = $0.01932 $1.00 = ₱51.763

ABBREVIATIONS

ADB – Asian Development Bank DOF – Department of Finance GDP – gross domestic product LGC – Local Government Code LGU – local government unit LIFT – LGU Integrated Financial Tools PBL – policy-based loan PFM – public financial management RPT – real property tax SEAL – Standardized Examination and Assessment for Local Treasury Service TA – technical assistance RPVARA – Real Property Valuation and Assessment Reform Act

NOTE

In this report, “$” refers to United States dollars.

Vice-President Ahmed M. Saeed, Operations 2 Director General Ramesh Subramaniam, Southeast Asia Department (SERD) Directors Jose Antonio R. Tan III, Public Management, Financial Sector, and Trade

Division, SERD Kelly Bird, Philippines Country Office, SERD Team leaders Robert Boothe, Public Management Specialist, SERD Hanif Rahemtulla, Senior Public Management Specialist, Sustainable

Development and Climate Change Department (SDCC) Team members Benita Ainabe, Financial Sector Specialist (Capital Markets), SERD Joven Balbosa, Advisor, SERD Aekapol Chongvilaivan, Economist (Public Finance), SERD Baurzhan Konysbayev, Principal Counsel, Office of the General Counsel Cristina Lozano, Senior Economist (Public Finance), SERD Lila Mallory, Senior Procurement Specialist, Procurement, Portfolio, and

Financial Management Department Jenelyn Mendez-Santos, Project Analyst, SERD Joehanne Kristal Santos, Operations Assistant, SERD Stephen Schuster, Principal Financial Sector Specialist, SERD Jhelum Tini Thomas, Senior Public Management Specialist, SERD Peer reviewer Claudia Buentjen, Principal Public Management Specialist, SDCC In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area

CONTENTS

Page

PROGRAM AT A GLANCE

I. THE PROPOSAL 1

II. PROGRAM AND RATIONALE 1

A. Background and Development Constraints 1 B. Policy Reform and ADB’s Value Addition 4 C. Impacts of the Reform 8 D. Development Financing Needs and Budget Support 8 E. Implementation Arrangements 9

III. DUE DILIGENCE 9

IV. ASSURANCES 10

V. RECOMMENDATION 10

APPENDIXES

1. Design and Monitoring Framework 11

2. List of Linked Documents 13

3. Development Policy Letter 14

4. Policy Matrix 16

Project Classification Information Status: Complete

PROGRAM AT A GLANCE

Source: Asian Development BankThis document must only be generated in eOps. 22072019172620419708 Generated Date: 21-Oct-2019 16:40:49 PM

1. Basic Data Project Number: 52173-001Project Name Local Governance Reform Program

(Subprogram 1)Department/Division SERD/SEPF

Country Philippines Executing Agency Department of Finance

Borrower Republic of the Philippines

Country Economic Indicators

https://www.adb.org/Documents/LinkedDocs/?id=52173-001-CEI

Portfolio at a Glance https://www.adb.org/Documents/LinkedDocs/?id=52173-001-PortAtaGlance

2. Sector Subsector(s) ADB Financing ($ million)Public sector management

Decentralization 300.00

Total 300.00

3. Operational Priorities Climate Change InformationAccelerating progress in gender equality

Strengthening governance and institutional capacity

Climate Change impact on the Project

Low

Sustainable Development Goals Gender Equity and MainstreamingSDG 5.b, 5.cSDG 11.aSDG 16.6, 16.7

Some gender elements (SGE)

Poverty Targeting

4. Risk Categorization: Complex .

5. Safeguard Categorization Environment: C Involuntary Resettlement: C Indigenous Peoples: C.

6. Financing

Modality and Sources Amount ($ million)

ADB 300.00 Sovereign Program (Regular Loan): Ordinary capital resources 300.00

Cofinancing 0.00 None 0.00

Counterpart 0.00 None 0.00

Total 300.00

Currency of ADB Financing: US Dollar

I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on (i) a proposed programmatic approach, and (ii) a proposed policy-based loan (PBL) to the Republic of the Philippines for subprogram 1 of the Local Governance Reform Program. 2. In line with the Philippine Development Plan (PDP), 2017–2022, the program supports inclusive and sustainable growth by increasing the capacity of local governments to provide accountable service delivery and boost local economic development.1 The program supports government reform priorities by (i) strengthening the local governance framework, (ii) modernizing and professionalizing subnational public financial management (PFM), and (iii) improving the local government unit (LGU) financing and investment framework. Subprogram 1 is included in the country operations business plan for the Philippines, 2019–2021 of the Asian Development Bank (ADB).2

II. PROGRAM AND RATIONALE A. Background and Development Constraints 3. The programmatic approach and budget support. The Philippines is rebalancing its central–local relations to promote more accountable service delivery and local economic development (para. 10). Since 2006, ADB has played a leading role in supporting government reform efforts through programmatic lending and technical assistance (TA). Past efforts have achieved important results. With ADB support, the government conducted a major review of the 1991 Local Government Code (LGC) starting in 2013, focusing on expenditure management, and in 2014 introduced a medium-term LGU PFM reform strategy.3 The proposed program builds on these efforts by expanding reform efforts to local governance and local economic development, and by aligning ADB support with government reform strategies and plans. Building on the earlier review of the LGC, subprogram 1 advances a comprehensive set of amendments to the LGC across fiscal, institutional, and administrative dimensions; professionalizes local PFM; and promotes local investment and economic development. Subprogram 2 will support implementation of amendments to the LGC and expand coverage of the tools and systems introduced in subprogram 1.4 The program will be complimented by a project loan, which will increase local own-source revenues by supporting real property tax (RPT) reforms for targeted LGUs, setting up a real property valuation service, developing systems for property valuation and tax payments, and professionalizing local assessors.5 The government has expressed their commitment to the program in the attached development policy letter (Appendix 3).6

1 Government of the Philippines, National Economic and Development Authority. 2017. Philippine Development Plan,

2017–2022. Manila. 2 ADB. 2018. Country Operations Business Plan: Philippines, 2019–2021. Manila. 3 ADB. 2016. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Loan

for Subprogram 2 to the Republic of the Philippines for the Local Government Finance and Fiscal Decentralization Reform Program. Manila.

4 ADB may consider a third subprogram, subject to discussions with the government. 5 The real property tax is a local tax levied on “real properties” in the Philippines, including land, building and machinery. 6 The Local Governance Reform Program was originally conceived as a sector development program incorporating

both a policy-based loan and a project loan; however, the sector development program has been separated into two independent loans at the government’s request. The separation request stems from timing differences in government approvals for the project versus program and does not compromise the integrity of the program as originally conceived. The project loan is targeted for board consideration in early 2020.

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4. Strong economic growth has not translated into inclusive development in the Philippines, where disparities in income, access to services, and economic opportunities persist. The economy grew 6.2% per year on average from 2011 to 2017, driven by robust domestic investment and strong performance in agriculture and construction. Although external volatility from uncertain trade conditions is affecting growth prospects, gross domestic product (GDP) is projected to grow 6.4% in both 2019 and 2020. However, income inequality exceeds that of regional peers, and national averages mask significant regional disparities.7 Poverty incidence fell from 26.6% in 2006 to 21.6% in 2015, but remains among the highest in Southeast Asia. Contrary to national trends, poverty incidence is on the rise in parts of the eastern Visayas and in southern and western Mindanao; in these areas, poverty incidence can exceed 30.0%. The 22.5% of women in poor families have higher poverty rates than the general population; poverty incidence among women was highest in the Bangsamoro Autonomous Region in Muslim Mindanao (BARMM), at 55.1%.8 Significant geographic diversity in the Philippines creates unique development challenges, where service delivery costs can be extremely high in the many remote parts of the country. Access to and quality of public services vary greatly across the Philippines: scores for grade 10 students on the National Achievement Test range from 61.4 (out of 100.0) in Region XIII to 43.3 in Region I.9 Economic opportunities are also unevenly distributed. At ₱425,000 per year, the average household income in the National Capital Region (Metro Manila) is almost double the average for the rest of the country and almost triple the average of poorer areas such as Region V (Bicol Region), Region XII (comprising South Cotabato, Cotabato, Sultan Kudarat, Sarangani, and General Santos in Mindanao), and BARMM.10 5. Role of local governance. Compared with regional peers, the Philippines is very decentralized. A global decentralization index measuring fiscal, administrative, and political decentralization places the Philippines 27th out of 182 countries, compared with Thailand (38th), Indonesia (40th), and Viet Nam (60th).11 Local government in the Philippines is broadly divided into three levels, including provinces and independent cities, municipalities, and barangays. There are approximately 81 provinces, 145 cities, and some 1,490 municipalities, along with thousands of barangays. The LGC provides a formal basis for local management of public resources and service delivery. In recognition of the disparities noted above, the government is engaged in major reforms to translate decentralization into inclusive growth, quality service delivery, and economic opportunity. With ADB support, these efforts have begun to improve service delivery. For example, early childhood mortality rates declined from 31 per 1,000 in 2013 to 27 per 1,000 in 2017,12 and the maternal mortality ratio decreased from 129 in 2010 to 114 in 2015, although access to skilled birth attendants remains a challenge for the poor.13 These improvements are partly driven by growth in local revenue collection and spending, which increased by more than 20% from 2011 to 2016. Likewise, overall citizen satisfaction, as measured by the government’s Citizen Satisfaction Index, has steadily improved since 2013.14 However, more remains to be done. The legal framework has not kept pace with the government’s evolving vision of decentralized local governance in the Philippines, and ambitious initial efforts have not translated

7 The Philippines’ Gini coefficient is 0.44, compared with 0.38 in Thailand, 0.39 in Indonesia, and 0.34 in Viet Nam. 8 Government of the Philippines, Philippine Statistics Authority (PSA). 2017. Farmers, Fishermen and Children

Consistently Posted the Highest Poverty Incidence Among Basic Sectors—PSA. News release. 30 June. 9 The Philippines is divided into 17 regions which are not LGUs, but are administrative units used by national

government. Region I is the Ilocos Region in Luzon, and Region XIII is the Caraga Region in Mindanao. The national average score for grade 10 students is 49.5 out of 100.0.

10 2018 figures. Government of the Philippines, PSA. 2018 Philippine Statistical Yearbook. 11 M. Ivanyna and A. Shah. 2012. How Close is Your Government to Its People? Worldwide Indicators on Localization

and Decentralization. Policy Research Working Paper. No. 6138. Washington, DC: World Bank. 12 Government of the Philippines, PSA. 2018. Philippines: National Demographic and Health Survey, 2017. Manila. 13 Maternal Mortality Estimation Group. 2015. Maternal Mortality in 1990–2015 (accessed 31 January 2019). 14 Data provided to ADB by Department of the Interior and Local Government, Government of the Philippines. 2019.

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into balanced development outcomes. LGU expenditures comprise about 18% of general government spending. About 29% of LGU revenue comes from local own-sources, with the balance coming from central transfers. Accountability and quality of service delivery are stronger in LGUs with a greater share of own-source revenue and weaker in LGUs where central transfers dominate, as such LGUs enjoy the “pleasure” of spending without the “pain” of taxation. 6. Development constraints. To translate improved local governance into positive development outcomes, the government must address several constraints, including: (i) the need for an updated legal and regulatory framework to empower local governments to meet citizen needs; (ii) capacity constraints and fragmentation of PFM tools and systems, which impede efficient and effective service delivery; and (iii) investment barriers that hinder equitable and inclusive economic development. 7. Outdated legal and regulatory framework constrains good local governance. Several legal and institutional constraints impair the governance of LGUs and limit LGUs’ accountability for service delivery. Fiscal, institutional, and administrative arrangements for decentralized local governance in the LGC are not well-aligned with the service delivery needs that LGUs face in practice. Moreover, reaching a consensus on amendments is difficult because of the sensitivity of decentralization reforms and the wide range of stakeholders involved. For example, insufficient clarity on the legal mandate for inter-LGU cooperation limits LGUs’ scope to jointly address regional challenges—for instance, by partnering for service delivery in waste management or regional transport—where economies of scale would support such an approach. The complexity of the reforms and the low capacity of LGUs exacerbate these challenges. In addition, weaknesses in the legal framework for local revenue create a mismatch between areas where business costs are incurred and areas where taxes are collected. This discourages LGUs from mobilizing local own-source revenues and weakens the social compact between taxpayers and service delivery providers. 8. Fragmentation of systems and capacity constraints limit efficacy of PFM reforms. Significant variation in skills and competencies exists among local PFM officials, and career advancement is disconnected from capacity development. These constraints have made it difficult for local governments to implement the LGU PFM reform roadmap. Weak treasury management has led to low budget execution rates, consistent underspending, and unanticipated budget surpluses, which doubled as a share of GDP from 2012 to 2016. Moreover, because of their unpredictability, these surpluses have not been efficiently allocated.15 Central government agencies have introduced electronic platforms and tools which have improved the quality, timeliness, accountability transparency of local PFM, such as the Electronic Statement of Receipts and Expenditures and the Local Government Financial Performance Monitoring System, but the tools are fragmented and have increased the administrative burden on local officials. 9. Financing constraints must be addressed if LGUs are to provide proper support for infrastructure investment, disaster resilience, and local economic development. Regulatory and administrative barriers constrain LGU access to finance; and outside of major metropolitan areas, the creditworthiness of LGUs is low because of an absence of effective fiscal rules. Poor access to credit financing constrains the ability of LGUs to invest in infrastructure and deliver high-quality services. Local investment is further stymied by poor understanding and low use of public–private partnerships. High-cost and inefficient local business environments discourage investment and crimp local economic development. The disaster resilience of many LGUs is low, partly because of an absence of mechanisms to finance disaster risk at the local level.

15 Government of the Philippines, Bureau of Local Government Finance. 2017. LGU Fiscal Performance. Manila.

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B. Policy Reform and ADB’s Value Addition 10. The government’s reform agenda. The PDP 2017–2022 targets efficient, effective, and equitable public service delivery, specifically recognizing the role of local governments. In line with these objectives, the Philippines is reexamining its system of decentralized local governance. One option being considered is major constitutional reforms toward a federal system of decentralized local governance. While decisions on federal versus unitary systems belong to Philippine citizens, all stakeholders agree that a more effective system of local governance is needed. In a major shift, LGUs are moving away from acting as simple vehicles for public service delivery toward catalyzing private investment and local economic development. Underpinning these discussions, the ADB-supported Local Government Finance and Fiscal Decentralization program resulted in the first systematic review and update of the LGC since it was passed in 1991.16 In parallel with the review of the LGC, key stakeholders, including the Bureau of Local Government Finance, the Department of the Interior and Local Government, the Department of Budget and Management, and the National Economic and Development Authority have introduced reforms to improve the quality and efficiency of service delivery and to enhance private sector participation in local economies. 11. Programmatic approach. The program supports three primary reform areas: (i) strengthening the local governance framework for service delivery; (ii) modernizing and professionalizing local PFM; and (iii) improving the LGU financing and investment framework. Under subprogram 1, the government has accomplished 15 policy actions related to these reform areas: nine high-impact policy triggers and six policy milestones.17 12. Strengthening the local governance framework for service delivery. Under subprogram 1, a broad, consultative drafting process resulted in a suite of amendments to the LGC that have been filed with the Congress. Amendments included: (i) clarification on who is responsible for delivering and paying for public services across government levels; and (ii) new measures to empower and promote inter-LGU cooperation; these allow LGUs to address inter-jurisdictional issues where economies of scale invite a joint approach, such as for solid waste management or urban transport. Major amendments to the framework for revenue mobilization have also been filed with Congress, including provisions to (i) align business tax collection with the geographic area in which the business activities took place, (ii) reduce uncertainty for private investment by harmonizing fees and fines across LGUs, and (iii) increase local autonomy in the use of natural resource revenues. To promote local revenue mobilization, the government officially incorporated local property tax reforms as part of the national Comprehensive Tax Reform Program, and an updated real property valuation and assessment reform act (RPVARA) was filed with the Congress as part of the government’s tax reform agenda. The RPVARA aims to broaden the property tax base, institutionalize property valuation standards, and provide for professionalized property-value assessment consistent with international good practices. These reforms are expected to remove political economy barriers to regularly updating local market-value schedules, allowing LGUs to dramatically increase revenues from local property taxes. The project (footnote 6) under preparation contemplates support for the implementation of the RPT reforms. 13. Subprogram 2 will target implementation of key LGC amendments drafted and filed under subprogram 1, such as developing and publishing implementing rules and regulations for RPT reforms and rolling out a unified property tax database and transaction system. Subprogram 2 will

16 ADB. Philippines: Local Government Finance and Fiscal Decentralization Reform Program—Subprogram 1. 17 The policy matrix is in Appendix 4.

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also address weaknesses in coordinating policies, planning, and budget execution between central and local governments and among local governments within a given region. The government plans to operationalize an online e-planning system for real-time submission and tracking of 3-year public investment programs, and will require national government agencies to prioritize projects and activities in the Local Development Investment Program rather than identifying stand-alone departmental priorities.18 Finally, the government will refine functional roles and responsibilities of LGUs in line with the 2018 Supreme Court decision to broaden the definition of centrally-collected revenues to be shared with local governments, effectively increasing fiscal transfers. 14. Modernizing and professionalizing local public financial management. This reform area addresses public service delivery failures brought about by weak capacity in the local bureaucracy and inefficient PFM. One major accomplishment under subprogram 1 is the Standardized Examination and Assessment for Local Treasury Service (SEAL) program. The SEAL program introduced a three-tier competency and assessment framework to professionalize local treasurers, representing a significant departure from the past practice of the local executive selecting a treasurer irrespective of professional merit. As a testament to the rigorous nature of the SEAL program, the first round of examinations resulted in a pass rate of just 35% for the more than 1,000 examinees, offering greater confidence that successful candidates have the skills necessary for responsible stewardship of public resources. To accompany people-centered reform, the government has also introduced tools to defragment, simplify, and improve the cross-platform functionality of local PFM. Such tools include the LGU Integrated Financial Tools (LIFT) PFM system, which standardizes fiscal reporting and consolidates subnational financial accounts. LIFT establishes cross-platform functionality between the different subnational PFM systems. The government has also formally adopted a fiscal sustainability scorecard for LGUs to grade both quantitative and qualitative fiscal performance. 15. Under subprogram 2, the government will expand the professionalization of PFM officers in the local bureaucracy by introducing a competency measurement and assessment system for local budget officers, similar to the SEAL program, with supporting electronic capacity development tools. Subprogram 2 will also introduce new institutional incentives for accountable public finance, through the inclusion of national minimum standards for PFM performance as part of the Seal of Good Local Governance’s eligibility criteria. Proposed indicators include comprehensiveness of budget coverage, strength of budget execution, timeliness and transparency of financial reporting including gender responsive budgets, and alignment of subnational procurement with nationally recognized good practices.19 The government also plans to further improve linkages between subnational PFM tools and systems by linking the LGU e-Budget preparatory system and the LIFT PFM system to produce a single consolidated set of fiscal data for the whole of local government. 16. Improving the local government unit financing and investment framework. Under this reform area, the government addressed LGU financing constraints to support investment, service delivery, and local economic development. Major accomplishments under subprogram 1 include passage of the Ease of Doing Business Act, 2018, which is designed to improve service efficiency and reduce the cost of doing business for private sector actors. In addition, a new local financing and debt framework was filed with Congress to improve LGU access to credit financing.

18 The Local Development Investment Program allocates investment funds for programs, projects and activities under

the Comprehensive Development Plan. 19 The Seal of Good Local Governance evaluates performance across a range of dimensions such as responsiveness

and business friendliness and is linked to the provision of performance-based grants for qualifying LGUs.

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The government introduced fiscal rules to strengthen LGU creditworthiness, making LGUs more attractive and less risky for private lending institutions. The government also increased LGU access to disaster risk financing by establishing a legal mandate for parametric localized disaster risk insurance.20 Finally, the government is improving the quality and transparency of LGU performance monitoring through an LGU client rating system. The system allows citizens to easily provide feedback on LGU service delivery performance to management at both central and local government levels, so systematic weaknesses can be identified and addressed. 17. Under subprogram 2, the government plans to strengthen LGU disaster risk preparedness by introducing a new law requiring all LGU public assets to have property insurance. Building on the Ease of Doing Business Act, the government plans to consolidate the issuance of local licenses and permits under an electronic single service window, further reducing transaction costs for the private sector. This will encourage the launch of more business start-ups and smooth their operations—measures that will particularly benefit women, who registered more new business names (55.51%) than men in 2018.21 Finally, the government plans to enhance the online LGU client rating system to cover a wider range of public services and provide real-time comparative information to citizens on the performance of their local governments. 18. ADB’s experience and strategy. ADB has played a leading role in supporting local governance in the Philippines through TA, programmatic lending, and investment projects (see the figure below). The Local Government Financing and Budget Reform Program from 2006 to 2010 helped institutionalize the timely and transparent release of LGU shares in national government revenues to improve the quality and efficiency of service delivery.22 It also operationalized local budgeting reforms in all provinces and highly urbanized cities. From 2010 to 2016, ADB expanded engagement with LGUs through the Local Government Finance and Fiscal Decentralization Reform Program (footnote 16), conducting the first review of the LGC in 25 years (para. 12), operationalizing the Performance Challenge Fund and the Seal of Good Local Governance to incentivize service delivery performance, and developing and implementing a medium-term LGU PFM reform strategy.23 Project completion reports rated both ADB program clusters highly relevant and satisfactory overall.24

ADB’s Engagement on Local Governance and Public Financial Management

ADB = Asian Development Bank, TA = technical assistance. Source: ADB staff.

20 Parametric insurance ex ante agrees to make payments upon the occurrence of a triggering event, rather than

indemnifying pure loss. As such, payouts are typically faster and more flexible. 21 PSA. Statistics on Women and Men in the Philippines (accessed 1 February 2019). 22 ADB. Philippines: Local Government Financing and Budget Reform Program Cluster (Subprogram 1). 23 Government of the Philippines, Department of Budget and Management. 2015. Local Government Unit PFM Reform

Roadmap and Local Government Unit PFM Implementation Strategy. Manila. The Performance Challenge Fund is a performance based fiscal transfer for qualifying LGUs to incentive good local governance.

24 ADB. 2014. Local Government Financing and Budget Reform Program Cluster Evaluation Document. Manila; and ADB. Forthcoming. Completion Report: Local Governance Finance and Fiscal Decentralization Program Cluster in the Philippines. Manila.

2015: TA for Support to Local Government Accountability Systems

2010–2016: Loan for Local Government Finance and Fiscal Decentralization Reform Program

2005 2010 2015 2020

2006: TA for Local Governance and Fiscal Management

2006–2010: Loan and TA for Local Government

2011: TA for Support to Local Government Revenue Generation and Land Administration Program

2013: TA for Support to Local Government Finance and Fiscal Decentralization Reform Program

2019–2021: Proposed Policy-based Loan for Local Governance Reform Program

2019–2021: Proposed Local Governance Reform Project

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19. The proposed Local Governance Reform Program builds on previous programs while introducing two new elements. First, while previous programs focused on promoting decentralization to support local service delivery, the proposed program focuses on improving the quality and efficiency of service delivery under existing structures while equipping LGUs with the tools and skills to better perform their roles. Second, in line with ADB’s country partnership strategy for the Philippines, 2018–2023, the program serves as an umbrella program for ADB engagement in local economic development in the Philippines, providing a policy anchor for sector-specific operations such as the Regional Development Facility, the Livable Cities Investment Project, the Philippines City Disaster Insurance Pool, and several local infrastructure projects.25 The program is also aligned with ADB’s Strategy 2030 (Table 1).26

Table 1: Alignment with Strategy 2030 Strategy 2030 Priority Program Activity

Addressing remaining poverty and reducing inequalities

Strengthen local service delivery and foster development of local job opportunities to address regional disparities

Tackling climate change, building climate and disaster resilience

Promote disaster preparedness through a parametric local disaster insurance scheme; promote resilience through mandatory insurance of local assets

Making cities more livable Improve quality and responsiveness of municipal services through the local government unit client rating system; promote local infrastructure investment

Strengthening governance and institutional capacity

Professionalize local public financial management officials

Source: Asian Development Bank.

20. Lessons learned. Several lessons have emerged from ADB’s engagement in local governance across the region. First, decentralization is a process for achieving the proper balance between central–local relations, and a clear vision with time-bound milestones is needed to avoid a state of perpetual decentralization. Past decentralization efforts in the Philippines have focused on supporting more decentralization with each iteration, increasing the relative share of responsibilities and powers for LGUs. The evolving focus of the program is to place more emphasis on better local governance and service delivery for a given balance of central-local relations, rather than perpetuating a cycle of ever-increasing decentralization. Second, complex multi-stakeholder reforms often require more support for implementation than they require for policy formulation. Earlier efforts to provide a strong framework for own-source local revenue mobilization have not yet solved LGUs’ heavy reliance on intergovernmental fiscal transfers.27 To promote greater revenue autonomy, extensive support is needed for reform implementation, including tools, systems, and capacity development at multiple government levels. The design of this program, as complimented by the project loan (footnote 6) will bridge this gap between policy development and reform implementation. 21. ADB’s value addition. Through its long-term engagement in local governance in the Philippines, ADB has supported the development of a targeted, problem-driven reform agenda in the country. ADB provided TA to support revising and ultimately filing LGC amendments in Congress.28 ADB also supported the development of the LIFT system as well as the SEAL

25 ADB. 2018. Country Partnership Strategy: Philippines, 2018–2023—High and Inclusive Growth. Manila. 26 ADB. 2018. Strategy 2030: Achieving a Prosperous, Inclusive, Resilient, and Sustainable Asia and the Pacific.

Manila. 27 From 2012 to 2016, more than 65% of local revenues came from the internal revenue allotment transfer to LGUs. 28 ADB. 2015. Technical Assistance to the Republic of the Philippines for Support to Local Government Accountability

Systems. Manila.

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program for local treasurers (para. 14). Under the Domestic Resource Mobilization Trust Fund contributed by the Government of Japan, ADB supported preparation of the RPVARA to increase own-source local revenues from RPTs (para. 12). This trust fund also supported the development of the Philippine Valuation Standards, which ensures that property assessment and valuation practices are in line with international practices.29 Going forward, ADB will continue to support local governance reforms through a new regional trust fund.30 22. Development partner coordination. ADB is the leading partner on local governance in the Philippines but works closely with other development partners to ensure that efforts are aligned and complementary. ADB meets regularly with the United States Agency for International Development on local infrastructure development and regional assistance to Mindanao. It has also coordinated closely with the International Monetary Fund, and policy actions under the program are consistent with the International Monetary Fund’s broad assessment and recommendations for the Philippines. ADB also coordinates with the World Bank, particularly on ensuring links between national PFM reforms (World Bank) and subnational PFM reforms (ADB). The Agence Française de Développement has also provided technical assistance, including a study on the French approach to inter-LGU service delivery coordination. C. Impacts of the Reform 23. In line with the Philippines Development Plan (PDP) 2017–2022, the program has the following impact: efficient, effective, and equitable public service delivery enhanced (footnote 1). The program will have the following outcome: service delivery ability and local governance performance of LGUs improved. The impact of the program is demonstrated through the performance indicators in the design and monitoring framework.31 24. The economic impact of the local governance reforms under the program is expected to be substantial. The program impact assessment estimates the program’s potential net economic benefits at $1.5 billion–$1.7 billion, using conservative assumptions.32 The primary transmission channels for benefits are improved quality and efficiency of public service delivery in line with local preferences, reduced reliance on other distortionary tax and nontax revenue sources, and lower cost of doing business for the private sector. D. Development Financing Needs and Budget Support 25. The government has requested two regular loans of $300 million each for subprograms 1 and 2, from ADB’s ordinary capital resources to help finance the program. The PBL will provide budget financing to support improved service delivery and local governance performance as well as priority activities in the government’s development policy letter.33 The loan for subprogram 1 will have a 15-year term, including a grace period of 3 years; an annual interest rate determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility; a commitment charge of 0.15% per year; and such other terms and conditions set forth in the draft

29 ADB. 2011. Technical Assistance to the Republic of the Philippines for Support to Local Government Revenue

Generation and Land Administration Reforms. Manila; and ADB. 2013. Promoting Gender Equality in Land Access and Land Tenure Security in the Philippines. Consultant’s report. Manila.

30 ADB. 2019. Southeast Asia Public Management, Financial Sector, and Trade Policy Facility. Manila. $500,000 has been earmarked to support local governance reforms, with the possibility to augment based on support needs.

31 The design and monitoring framework is in Appendix 1. 32 Program Impact Assessment (accessible from the list of linked documents in Appendix 2). 33 The development policy letter is in Appendix 3.

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loan agreement. Based on the annuity repayment method, the average maturity is 12.1 years, and there is no maturity premium payable to ADB.34 The loan for subprogram 2 is in the pipeline for 2021. 26. The Philippines’ total financing needs for 2018–2021 are expected to be substantial, with annual budget deficits projected to increase from 3.0% of GDP in 2018 to 3.2% of GDP in 2019. In 2019, the government’s gross financing need is $20.1 billion. To finance the deficit, the government plans to raise $17.4 billion from the issuance of securities and $2.7 billion from official foreign loans. The loan size for subprogram 1 reflects the government’s financing needs, the strength of the program, and the net economic benefits (para. 24). E. Implementation Arrangements 27. The Department of Finance (DOF) is the executing agency for the program. The Bureau of Local Government Finance, Department of Budget and Management, the Department of Interior and Local Government, National Economic and Development Authority, and Public–Private Partnership Center are the implementing agencies. The implementation period is June 2017–June 2019. A steering committee chaired by the DOF oversees program implementation. The proceeds of the loan will be withdrawn in accordance with ADB’s Loan Disbursement Handbook (2017, as amended from time to time).

III. DUE DILIGENCE 28. Safeguards. The program does not trigger ADB’s safeguard policies and is classified category C for the environment, involuntary resettlement and indigenous peoples. 29. Poverty and social. Reforms under the program will help the government achieve its poverty reduction targets by expanding the quality and range of public services available to the poor and by providing opportunities for inclusive local economic development. Specific measures will include the introduction of (i) an LGU client rating system to provide the poor with a feedback channel to improve service delivery, and (ii) local parametric disaster insurance to help ensure a timely fiscal response to the needs of the poor in a post-disaster situation. Subprogram 1 is classified some gender elements. Linking the comprehensive development planning process (through which LGUs determine development priorities) with the Local Development Investment Program (through which LGUs identify investment projects) will provide a platform for mainstreaming gender dimensions. Reforming the local business environment will have a particularly important impact on women small business owners and entrepreneurs. The LIFT system will provide a mechanism for gender-responsive budgeting and tracking of expenditures in line with government regulations. 30. Governance. A public expenditure and financial accountability assessment conducted in 2017 by the World Bank found that three of seven core PFM areas have improved: policy-based budgeting, transparency, and asset–liability management. Financial management is weaker, but efforts to improve budget credibility, predictability, execution, and external scrutiny and audit are ongoing. Reforms under the program will significantly strengthen local PFM. The government is also implementing a results-based anticorruption plan that will strengthen the judicial branch of government and the Office of the Ombudsman. ADB explained its Anticorruption Policy (1998, as amended to date) to the government including the DOF. The overall governance risk for the

34 The loan may be disbursed in one or more installments.

10

program is low to moderate. Risks will be mitigated through programmed capacity building for government stakeholders under the ongoing TA provided by ADB. 31. The overall risk for the program is moderate. Major risks and mitigating measures are summarized in Table 5 and described in the risk assessment and risk management plan.35

Table 5: Summary of Risks and Mitigating Measures Risks Mitigation Measures Changes in political priorities prevent implementation of identified reform areas.

Decentralization is a key focus of the current administration. The Asian Development Bank is actively pursuing policy dialogue on better local governance and continues to develop reform options that can be implemented by technical stakeholders.

Resistance to local government reforms by central government stakeholders impedes the passage of amendments.

A strong consultative process was used to review the Local Government Code, 1991 and to draft the amendments. Buy-in was sought from all key stakeholders, including the central and local government, academia, the private sector, and civil society.

Source: Asian Development Bank.

IV. ASSURANCES

32. The government including the DOF have assured ADB that implementation of the program shall conform to all applicable ADB policies including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement as described in detail in the loan documents.

V. RECOMMENDATION 33. I am satisfied that the proposed programmatic approach and policy-based loan comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve

(i) the programmatic approach for the Local Governance Reform Program; and

(ii) the loan of $300,000,000 to the Republic of the Philippines for subprogram 1 of the Local Governance Reform Program, from ADB’s ordinary capital resources, in regular terms, with interest to be determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility; for a term of 15 years, including a grace period of 3 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft loan agreement presented to the Board.

Takehiko Nakao President

4 October 2019

35 Risk Assessment and Risk Management Plan (accessible from the list of linked documents in Appendix 2).

Appendix 1 11

DESIGN AND MONITORING FRAMEWORK Country’s Overarching Development Objectives Efficient, effective, and equitable public service delivery enhanced (Philippine Development Plan, 2017–2022)a

Results Chain Performance Indicators with Targets and Baselines

Data Sources and Reporting Mechanisms

Risks

Effect of the Reform By 2024: Service delivery ability and local governance performance of LGUs improved

a. At least 20% of total LGUs (provinces, cities, and municipalities) passed the 2018 enhanced SGLG criteria (2018 baseline: 15%) b. At least 54% of total LGUs (provinces, cities, and municipalities) submitted their 2022 gender and development plans and budgets to DILG in compliance with SGLG requirements (2018 baseline: 37%) c. Total own-source LGU revenues increased by 30% in nominal terms over 2017 baseline (2017 baseline: ₱206 billion)

a. DILG’s SGLG assessment b. DILG reports c. BLGF local government financing performance monitoring system

Changes in political priorities prevent the implementation of identified reform areas

Reform Areas Key Policy Actions By 2019:

1. Strengthening the local governance framework for service delivery

1a. 10 amendments to the Local Government Code of 1991 filed with Congress (2017 baseline: not submitted) 1b. Consolidated bill on real property valuation and assessment reform act passed by House of Representatives (2017 baseline: not passed)

1a. Legislative report published in the official gazette, DILG 1b. Legislative report published in the official gazette, DOF

Resistance to local government reforms by central government stakeholders impedes the passage of amendments

2. Modernizing and professionalizing local PFM

2a. LIFT PFM system, reinforcing gender-responsive planning and budgeting, operationalized (2017 baseline: not operationalized) 2b. 500 treasurers, 40% of whom are female, assessed under the SEAL system (2017 baseline: 0)

2a. Snapshot of LIFT system, DILG–NEDA issuance on localization of national planning 2b. BLGF’s SEAL assessment report, Civil Service Commission issuances on local treasurers’ examination

3. Improving the LGU financing and investment framework

3a. Ease of Doing Business Act for reducing red tape and fast-tracking business permits and licensing enacted (2017 baseline: legislation not enacted)

3a. Legislative report published in the official gazette, DOF, DILG

12 Appendix 1

Results Chain Performance Indicators with Targets and Baselines

Data Sources and Reporting Mechanisms

Risks

3b. Online LGU client rating system operationalized (2017 baseline: not operationalized)

3b. DILG reports and website

Inputs Asian Development Bank Subprogram 1: $300.00 million (policy-based loan) Subprogram 2: $300.00 million (policy-based loan, indicative) BLGF = Bureau of Local Government Finance, DILG = Department of the Interior and Local Government, DOF = Department of Finance, LGU = local government unit, LIFT = LGU Integrated Financial Tools, NEDA = National Economic and Development Authority, PFM = public financial management, SEAL = Standardized Examination and Assessment for Local Treasury Service, SGLG = Seal of Good Local Governance. a Government of the Philippines, National Economic and Development Authority. 2017. Philippine Development Plan,

2017–2022. Manila. Source: Asian Development Bank.

Appendix 2 13

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=52173-001-3

1. Loan Agreement

2. Sector Assessment (Summary): Public Sector Management

3. Contribution to the ADB Results Framework

4. Development Coordination

5. Country Economic Indicators

6. International Monetary Fund Assessment Letter

7. Summary Poverty Reduction and Social Strategy

8. Risk Assessment and Risk Management Plan

9. List of Ineligible Items

Supplementary Documents

10. Program Impact Assessment

11. Public Financial Management Assessment

14 Appendix 3

DEVELOPMENT POLICY LETTER

Appendix 3 15

16 Appendix 4

POLICY MATRIX

Subprogram 1 Policy Actions June 2017–June 2019

(Policy Triggers in bold)

Subprogram 2 Indicative Actions July 2019–June 2021

(Policy Triggers in Bold)

To update and address structural deficiencies such as unclear functional assignment, limited and unproductive sources of local revenue, and weak LGU borrowing powers, the government produced a series of major amendments to the 1991 LGC. Accomplishments include:

1. To improve local service delivery, the government submitted a suite of amendments to the 1991 LGC for congressional approval to strengthen the framework for central-local relations. Measures include: (i) clarification of functional and expenditure assignments across national and subnational levels of government; (ii) promotion of inter-LGU cooperation for service delivery agreements; and (iii) updated income requirements for creation of municipalities, provinces, and highly urbanized cities. [DILG]

2. To strengthen the legal framework for local revenue

mobilization, the government submitted amendments to the 1991 LGC for congressional approval. Amendments include: (i) rebalancing share of business tax revenue collected based on location of activity; (ii) increased local autonomy in use of natural resource revenues; (iii) limiting central and local government power to issue tax exemptions for LGUs; (iv) improving consistency of rate setting for local fees and charges; and (v) institutionalizing local PFM including gender responsive budgeting (PFM). [DILG]

3. To support a national priority policy for increasing LGU

own-source revenue, the House of Representatives

The government continues to strengthen the legal and institutional framework for decentralized local governance, and introduces new measures to incentivize systematic, coordinated medium-term development planning. Indicative actions include:

1. The government implements policies institutionalizing the principles of decentralized local self-governance, including clarification of roles and responsibilities and strengthening own-source revenue generation measures. [DILG, DOF, DOF-BLGF, DBM, NEDA]

Appendix 4 17

Subprogram 1 Policy Actions June 2017–June 2019

(Policy Triggers in bold)

Subprogram 2 Indicative Actions July 2019–June 2021

(Policy Triggers in Bold)

passed on third reading, the Real Property Valuation and Assessment Reform Act. [DOF - BLGF]

4. To strengthen accountability of local service delivery, the government facilitated linking LGU planning to annual budgets by requiring the submission of the CDP and LDIP as documentary requirements for the SGLG. [DILG]

5. To strengthen responsiveness of local service delivery, the

government linked LGU plans and investment programs in the CDP and LDIP with the PDP and strengthened the role of Regional Development Councils. [DILG]

2. To operationalize the real property valuation reform, the government: (i) establishes the Real Property Valuation Service; and (ii) designs a unified property tax database and transaction system. [DOF - BLGF]

3. To strengthen the local planning and budgeting

framework for local service delivery, the government designs and operationalizes an online e-Planning system for real-time submission and tracking of 3-year public investment programs of cities and municipalities. [DILG]

4. To align national strategies and plans with local

priorities for service delivery, the government requires national government agencies to select and prioritize local projects and activities in the LDIP. [DILG, DBM, DOF, DOF-BLGF, NEDA, PPP Center]

5. To enhance oversight of local planning and

budgeting, the government (i) facilitates the formulation of provincial results matrices for the PDP, and (ii) strengthens capacity of provinces to review local plans, revenue mobilization, and budgets of component cities and municipalities. [DILG, DBM, DOF-BLGF, NEDA]

18 Appendix 4

Subprogram 1 Policy Actions June 2017–June 2019

(Policy Triggers in bold)

Subprogram 2 Indicative Actions July 2019–June 2021

(Policy Triggers in Bold)

To address public service delivery failures brought about by weak capacities in the local bureaucracy and inefficient PFM, the government has modernized PFM systems and professionalized local treasurers and budget officers. Accomplishments include:

6. To address weaknesses in the accuracy, integrity, timeliness, and accountability in subnational financial reporting, the government designed and operationalized the LIFT PFM system in all LGUs standardizing fiscal reporting and consolidating subnational financial accounts. [DOF-BLGF (lead), DILG, DBM, NEDA]

7. To strengthen the capacity and professionalize the local treasury service, the government designed and operationalized the Standardized Examination and Assessment for Local Treasury Service program. [DOF-BLGF]

The government continues to professionalize core public finance functions and expands tools and incentives to promote efficient and high-quality delivery of public services. Indicative actions include:

6. To address weaknesses in local budget credibility, the government links the LGU e-Budget Preparation Module and LIFT PFM systems to produce a single consolidated set of local financial data. [DOF-BLGF, DBM]

7. To incentivize LGUs to adhere to principles and

practices of good governance and PFM, the government introduces national minimum standards for PFM performance as part of SGLG. [DILG, DOF-BLGF, DBM]

8. To further improve the capacities of the local treasury

service, the government designs and operationalizes an e-Learning capacity development platform to build core competencies for treasurers. [DOF-BLGF]

9. To strengthen the capacity and professionalize

the local budget officers, the government launches a competency measurement and assessment system for Local Budget Officers [DBM]

10. To complete the professionalization of the local treasury service, the government rolls-out the Advanced Competency in Local Treasury

Appendix 4 19

Subprogram 1 Policy Actions June 2017–June 2019

(Policy Triggers in bold)

Subprogram 2 Indicative Actions July 2019–June 2021

(Policy Triggers in Bold)

8. To guide and strengthen LGU PFM, the government resolved inconsistencies and developed a consolidated database for DOF rulings, issuances, and policy guidance covering the years 1993–2017. [BLGF-DOF]

9. To emphasize the national government intent to

recognize and reward good performance in local PFM and service delivery, DOF has made the LGU Fiscal Sustainability Scorecard a national policy. [DOF, DOF-BLGF]

Examination and Certification System for Local Treasurers. [DOF, DOF-BLGF]

11. To guide and strengthen LGU PFM, the government

operationalizes an electronic compendium of DOF rulings, issuances, and policy guidance. [DOF-BLGF]

12. To improve measures in local PFM, the DBM

upgrade the system on Public Financial Management Assessment Tool for LGUs. [DBM]

To address LGU financing constraints for investment and service delivery, the government introduced new measures to expand infrastructure-financing modalities, strengthen local resilience against natural disasters, and improve the ease of doing business locally. Accomplishments include:

10. To improve LGU access to credit financing, the government submitted amendments to the LGC for congressional review introducing a local financing and debt framework and fiscal rules to improve creditworthiness of LGUs. [DILG]

11. To strengthen resilience of LGUs and improve disaster

risk preparedness, the government introduced a new parametric insurance modality. [DOF]

12. To strengthen disaster performance assessment systems,

the government has introduced the LGU Resilience Readiness Monitoring Framework, enhanced from the Disaster Preparedness Assessment System, to more

The government continues to expand space for private investment at the subnational level and introduces new measures to support transparency and resilience. Indicative actions include:

13. The government submits to Congress a bill for mandatory property insurance for all LGUs. [DOF-BLGF]

14. To implement effective performance

measurements, the government facilitates the use of the LGU Resilience Readiness Monitoring Framework and Tool in priority LGUs, with results used to inform capacity development initiatives addressing identified capacity gaps.

15. To facilitate LGU access to PPP financing, the

government enhances the capacity of the PPP Center to provide project design, evaluation, and

20 Appendix 4

Subprogram 1 Policy Actions June 2017–June 2019

(Policy Triggers in bold)

Subprogram 2 Indicative Actions July 2019–June 2021

(Policy Triggers in Bold)

effectively measure and encourage LGUs' recalibration of efforts from disaster preparedness to resilience.

13. To enhance LGU access to non-traditional private financing,

the government extended access of an advisory panel of experts including women advisors, and established knowledge centers in NEDA regional offices. [PPP Center, NEDA]

14. To improve efficiency in the delivery of public services

and reduce the cost of doing business, the government enacted the Ease of Doing Business Act for red-tape reduction and fast tracking and streamlining of business permit and licensing issuance across all levels of government, including publication of a citizen’s charter in local dialect to inform all citizens of the act. [DTI, DILG, DOF-BLGF, DICT]

15. To enhance LGU performance and citizen feedback on

local service delivery, the government has developed and operationalized an online LGU client rating system for business permit application and releasing. [DILG]

execution assistance to LGUs, with LGU project supported under PDMF. [PPP Center]

16. To enhance the quality of PPP project design and

implementation at the subnational level, the government strengthens LGU capacity to plan PPPs. [DILG, PPP Center, DOF-BLGF]

17. To further reduce the cost of doing business and improve the timeliness in the issuance of business permits, the government consolidates local licensing and permit issuances under a single service window entitled a Business One Stop Shop. [DILG, DOF-BLGF]

18. To enhance LGU performance and enhance citizen feedback on local service delivery, the government develops and expands coverage of an online LGU client rating system for key local client processes and service delivery areas. [DILG, DOF-BLGF]

19. To strengthen LGU transparency and accountability,

the government introduces an online public fiscal reporting dashboard and local tax calculator. [DOF-BLGF]

BLGF = Bureau of Local Government Finance; CDP = Comprehensive Development Plan, DBM = Department of Budget and Management; DICT = Department of Information and Communications Technology, DILG = Department of the Interior and Local Government; DOF = Department of Finance; LDIP = Local Development Investment Program, LGC = Local Government Code, LGU = local government unit; LIFT = LGU Integrated Financial Tool, NEDA = National Economic and Development Authority, PDMF = Project Development and Management Facility, PDP = Philippine Development Plan, PFM = public financial management , PPP = public-private partnership, SGLG = Seal of Good Local Governance.