Documentof The WorldBank FOR OFFICIAL USEONLY ReportNo. 48589-GT INTERNATIONAL BANKFORRECONSTRUCTIONAND DEVELOPMENT PROJECTDOCUMENT FORTHE PROPOSED SECONDPROGRAMMATIC FISCALAND INSTITUTIONAL DEVELOPMENT POLICY LOAN INTHE AMOUNT OFUS$350MILLION TO THE REPUBLIC OFGUATEMALA June24,2009 PovertyReductionandEconomicManagement CentralAmerica CountryDepartment LatinAmerica and CaribbeanRegion This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. Its content may not otherwise be disclosed without World Bank authorization. REPUBLICOFGUATEMALA-FISCAL YEAR January 1-December 31 CURRENCY EQUIVALENTS As ofJune 18,2009 US$1.OO = 8.09 QZ (Quetzales) WEIGHTSAND MEASURES Metric System SELECTEDACRONYMS AND ABBREVIATIONS AML Anti-MoneyLaundering BANGUAT GuatemalanCentralBank ICA InvestmentClimateAssessment CAS CountryAssistance Strategy IDB Inter-AmericanDevelopment Bank CBI CaribbeanBasinInitiative IETAAP Impuesto Extraordinariode Apoyo a 10s CEA Country EnvironmentalAssessment Acuerdos de Paz(Temporary IncomeTax CEM Country Economic Memorandum on Businesses) CFAA Country FinancialAccountability IMF InternationalMonetaryFund Assessment LAC LatinAmerica and the Caribbean CGC ControlariaGeneral de Cuentas (General MARN Ministry ofEnvironmentandNatural Comptroller's Ofice) Resources CHN State MortgageBank MDG MillenniumDevelopment Goals CPAR Country Procurement Assessment Report MSME Micro Smalland MediumEnterprise DPL DevelopmentPolicyLoan NGO Non-GovernmentalOrganization DR-CAFTA DominicanRepublic-CentralAmerica OBA Output-BasedAid FreeTrade Agreement PER PublicExpenditureReview EU EuropeanUnion PRONACOM NationalProgramfor Competitiveness FDI ForeignDirect Investment SAT , SuperintendenciadeAdministracih FSAL Financial Sector AdjustmentLoan Tributaria(Tax Administration FSAP Financial Sector Assessment Program , Superintendency) FTA FreeTradeAgreement SIAF IntegratedFinancialManagement GANA GranAlianzaNacional(GrandNational Systems Alliance) SME Smalland MediumEnterprise GCC GuatemalaChamber ofCommerce SWAP Sector-wideApproach GDLN GlobalDistance LearningNetwork TA TechnicalAssistance GDP GrossDomestic Product UN UnitedNations GNI GrossNationalIncome UNE UnidadNacionalde la Esperanza GPOBA Global Partnership on Output-BasedAid (NationalUnionfor Hope) GUAPA GuatemalaPovertyAssessment WBI WorldBank Institute IBRD InternationalBank for Reconstructionand Development Vice President PamelaCox Country Director LauraFrigenti SectorDirector MarceloGiugale SectorManager RodrigoA. Chaves SectorLeader J. HumbertoLopez Task Managers David Gouldand Rashmi Shankar FOROFFICIAL USE ONLY Table of Contents Loan andProgram Summary........................................................................................................... IINTRODUCTION....................................................................................................................... . i 1 I1.COUNTRY CONTEXT. MACROECONOMIC DEVELOPMENTS. AND ECONOMIC OUTLOOK ..................................................................................................................................... A Country Context................................................................................................................. 1 1 B Economic Context.............................................................................................................. 3 C.Recent Economic Developments and Outlook................................................................... .. 5 9 I11 GOVERNMENTPLANAND KEY ISSUES INFISCALAND INSTITUTIONAL . D. Debt SustainabilityandMacroeconomicPolicyFramework ........................................... DEVELOPMENT......................................................................................................................... 11 A. Solidarity: Priority Spending for ReducingPoverty and Inequality................................ 11 B.Strengthened Governance andTransparency................................................................... 15 C D PromotingFinancialMarket Stability, Deepening, and Strengthening Debt Markets ..Sustainable Growth and Productivity............................................................................... 16 ....18 IV.THEPROPOSED LOAN....................................................................................................... 21 A.Links to the Country Partnership Strategy....................................................................... 21 B.Collaborationwiththe IMFand other External Partners................................................. ........................................................................... 30 D Analytical Underpinnings ................................................................................................ C ..Relationship to Other Bank Operations 30 E Lessons LearnedFromPrior Operations.......................................................................... 30 32 F Poverty and Social Impacts and Country Consultations................................................... .. 33 H.MonitoringandEvaluation.............................................................................................. 36 G.EnvironmentalAspects .................................................................................................... 35 I.FiduciaryAspects.............................................................................................................. J Loan Administration.......................................................................................................... 36 37 37 ANNEX 1: GOVERNMENTDEVELOPMENTTHEMES........................................................ .. . . K Risks................................................................................................................................. 39 ANNEX 2: LETTEROF DEVELOPMENTPOLICY ................................................................ ANNEX 3: POLICY ACTIONS................................................................................................... 40 55 ANNEX 4: IMFPUBLIC INFORMATIONNOTICE ................................................................ 59 ANNEX 6: FINANCIAL SECTOR BACKGROUNDAND TRENDS ...................................... ANNEX 5: PUBLIC AND EXTERNALDEBT SUSTAINABILITY ANALYSIS ...................62 72 ANNEX 7: GUATEMALAAT A GLANCE............................................................................... 77 ListofTables Table 2: Financial Soundness Indicators ........................................................................................ Table 1: Guatemala KeyEconomic Indicators 2004-2013 ............................................................. 7 Table 3: Guatemala: Gross External FinancingRequirements.. ................................................... 8 10 Table 5: Additional Fiscal Measures ............................................................................................ Table 4: Fiscal ModernizationProposal...................................................................................... 13 Table 6: CPS Program Objectives and Select Areas o f Action................................................... 14 22 Table 7: DPL Series Contributes to Expected CPS Outcomes .................................................... 23 Table 8: Original and Revised PolicyActions for the SFI DPL ................................................... 25 This document has a restricted distribution and may be used by recipients only in the performance of their official duties.Its contents may not be otherwise disclosed without World Bank authorization. Table 9: Links betweenthe proposedDPL-DDO and Prior Analytical Work ............................. 31 Table A5.1: Key macro and external baseline assumptions ....,...,,,,,,..,,,......................................63 Table A5.2: Public Debt - Baseline Medium-Term Projections................................................... 65 Table A5.A: Public Debt ratios under sensitivity tests (in% o f GDP)......................................... 71 Table A5.B: External Debt ratios under stress tests ....,,,,..,,..,,..,,.,,,,,..,,,..,...................................71 Table A6.1: Selected Banking Sector Indicators ........................,,.,., ....... .. ..,,, . .............................75 List of Figures Figure A5.1: Public debt-to-GDP ratio in2008............................................................................ 62 Figure A5.2: Public sector debt: evolution and decomposition. ...,,.,,,..,,,.....................................64 Figure A5.3: Total public debt trajectory under different stress scenarios (presents projections o f Figure A5.4: Stochastic Simulations o f the Public Sector Debt................................................... Table A5.A inthe appendix) - (Net Public Debt, inpercent o f GDP) ..................66 66 Figure A5.5: Total outstanding external debt: evolution and decomposition. .............................. 67 Figure A5.6: Total outstanding external debt trajectory under different stress scenarios - repeated shocks (presents projections o f Table A5.B inthe appendix) .............................. 69 Figure A6.1: Domestic credit provided by banking sector as percent o f GDP............................. 74 List of Boxes Box 1. 2008 Guatemala Investment Climate Assessment (ICA) Findings.....................................4 Box 2. Progress on Public Financial Management......................................................................... 6 Box 3. Amendments to the Banking Law to be Submitted to Congress ...................................... Box 4: Good Practice Principles on Conditionality ...................................................................... 18 Box 5. Guatemala Country Environmental Analysis -FindingsandNew Developments ........34 35 Box A6.1: Progress inthe Guatemalan financial safety net ......................................................... 73 Map o f Guatemala (IBRD#33413). ,,, , , ,, .. ... .. ..............,,..,...,.,,...................inside cover ACKNOWLEDGEMENTS This DPL was prepared by a Bank team led by David Gould and Rashmi Shankar, consisting o f sectoral teams: Finance and Private Sector (Ilias Skamnelos); Public Sector (Enrique Fanta, Jose Eduardo Gutierrez Ossio, and Albert0 Leyton); Economic Policy (Barbara Cunha, Maria Lucia Guerra Bradford, and Marie Georgiana J. Vidal); Banking and Debt Management (Elizabeth Currie and Ricardo Tejada); Human Development (Anna Fruttero, Manuel Salazar); Poverty (Carlos Sobrado); and Legal (Alejandro AlcalB and Reynaldo Pastor). We are grateful to our peer reviewers, Gabriel Lopetegui, Pablo Morra and JehanArulpragasam. We appreciate the helphl guidance o f Rodrigo A. Chaves (Sector Manager, LCSPE) and J. Humberto Lopez (Lead Economist and PREM Sector Leader LCC2C) and support given by Anabela Abreu (Country Manager). Document and processing support was much appreciated from Patricia Chacon Holt, Martha Garcia, Tammy Lynn Pertillar, Elizabeth Percespe-Wallace, and Marlene Sims. We would also like to thank the IMF team (Gabriel Lopetegui, Pablo Morra, Alfred Schipke and Ivanna Vladkova) for its much appreciated help and collaboration. Finally, the Bank team also would like to express its gratitude for the collaboration o f the Government o f Guatemala in the preparation o f this Development Policy Loan. Loan and Program Summary Republic of Guatemala SecondProgrammatic Fiscal and InstitutionalDevelopment Policy Loan Borrower: Republic of Guatemala Implementing Agency: MINISTRY OF PUBLIC FINANCE IBRDLoanAmount: USD350 million. Terms: Commitment-linked fixed spread loan (FSL), denominatedinU S dollars, FinancingData: with level repayment of principal payable in 26.5 years (including 8.5 years of grace period). The borrower wishes to maintain all risk management options embedded inthe loan andto finance the front-end fees out ofthe loan proceeds. OperationType: Second loan in a two-part programmatic DPL series. The borrower has requesteda single-trancheloan. I MainPolicy I The proposedoperation builds on the FirstProgrammatic Fiscaland Institutional DPL and supports Government efforts aimed at: (i)enhancing macroeconomic Areas: stability, governance, and transparency; (ii)expanding opportunities for vulnerable groups through improved targeting of social programs; and (iii) promoting sustainable growth and productivity for betterjobs. Key outcomesexpectedby end 2010under the operation include: (i)Enhancingmacroeconomicstability, governance, andtransparency Fiscal reform measures mitigate the impact of the crisis so that Central Governmenttax collections do not fall below 10.4 percent of GDP in 2010. (Baseline:11.3 percent in 2008) 0 Results indicators have been developed for fifty percent of Central Government's expenditures inorder to introducethe results informed budget Key Outcome framework. (Baseline:22 percent in2008) Indicators(end (ii)Expanding opportunities for vulnerable groups through improved and FY2010): transparenttargetingof socialprograms 0 Co-responsibilitiesverified for 50 percent of the Conditional Cash Transfer Program beneficiaries, half of 'which are extreme poor, based on a framework for monitoring.and evaluation. (Baseline:0 inAugust 2008); (iii) Promoting sustainable growth and productivity for betterjobs 0 Customs times for clearance and average release time of exportedimported goods has declined by 5 percent. (Baseline:Time to export 19 days, time to import 18 days in2007). ProgramDevelopment Objectives: Program 0 Maintain fiscal space for priority spending through tax policy and tax Development administrationreforms. Objectivesand Strengthen the effectiveness of the Mi Familia Progresa Conditional Cash Contributionto CPS Transfer Program through enhanced monitoring and evaluation of program design and outcomes. i Improve governance and transparency o f public financial management and expenditures. 0 Improve access to finance and deepen financial markets through reforms to the financial legalframework and public debt management. Contributionto the CountryPartnershipStrategy (CPS). The objectives o f the DPL are fully aligned with the medium term strategic objectives o f the CPS (FY2008-12), including: (i)enhancing development fundamentals through macroeconomic stability, fiscal reform, and governance and transparency; (ii)expanding opportunities for vulnerable groups; and (iii) promoting sustainable growth and productivity. There are three primary risks associated with the proposed operation. These risksandthe ways they arebeingmitigatedinclude: Political. Congressional deadlock may stall progress on the policy reforms supported by the DPL, particularly those related to tax reform. This concern has increased as growth has slowed significantly in the context o f the global economic downturn. In addition, ongoing challenges with crime and violence and concerns over governance and the rule o f law may slow progress on the reform agenda. These risks are mitigated by the Government's consultative approach to reform implementation, the move toward greater transparency, and the facilitation o f dialogue with stakeholders. The operation is also beingcoordinated with the budget cycle to increase legislative engagement. Economic. The main risk derives from the current global crisis and Risks and Risk likelihood o f a deep and prolonged global deceleration. This risk is Mitigation: mitigated by the design o f the program and by recent steps taken by the authorities to enhance crisis preparedness; including securing a Precautionary Stand-by Arrangement from the IMF to provide a liquidity cushion should a greater than expected economic deteriorationmaterialize. Natural disasters. Guatemala is highly vulnerable to multiple natural disaster risks-floods, hurricanes and earthquakes-that pose a significant direct threat to economic growth and poverty reduction, as well as indirect threat by redirecting government resources away from long-run development plans. This risk i s mitigated through programs under the CPS to support efforts to update and validate the National Program for Disaster Mitigation and Response. A CAT-DDO (approved in April 2009) supports implementation o f comprehensive disaster risk reduction measures and, in the event of a disaster, gives the Government access to bridge financing while it mobilizesfunds from other sources for disaster recovery. OperationID Number: P114373 .. 11 GUATEMALA SECONDPROGRAMMATIC FISCALAND INSTITUTIONALDEVELOPMENT POLICY LOAN I.INTRODUCTION 1. This Program Document describes a proposed Second Programmatic Fiscal and Institutional Development Policy Loan (SFI DPL) in the amount of US350 million for the Republic of Guatemala. This operation builds on the progress made under the First Fiscal and Institutional DPL and supports the country's strategic program to strengthen Guatemala's capacity to grow and provide adequate resources to reduce poverty and inequality. Progress on critical reforms is being made, including strengthening tax administration, promoting financial market stability, improving monitoring and evaluation of the country's new conditional cash transfer program, modernizing customs processes, as well as enhancing governanceandtransparency. Inresponseto the global crisis and economic slowdown, the Government has prioritized its development plan on near- term steps to mitigate the impact o f global crisis, including focusing efforts on expanding its new conditional cash transfer program and creating a task force to monitor the economic situation and take policy actions, as needed, to respond to the crisis. The Government has adjusted its reform program to reflect additional actions and priorities, including reforms to increase access to finance and address financial sector stability, while other actions anticipated by the Government prior to the crisis, particularly implementation ofmeasuresto boost tax collections, have been delayed. 2. The SFI DPL reflects the progress and prioritiesof the Government's developmentplan envisagedfor FYlO underthe currentCountry PartnershipStrategy (FYO8-12). Dueto changing priorities and the need to address the impact of the global economic crisis, the Government has requested a reallocation ofresources within the CPS envelope, increasing the budget support of the SFI DPL to US$350 million, from the originally anticipated US$200 million. The reallocation represents frontloading of US$lOO million that was designated for a third DPL to this second DPL, as well as reallocation from planned investment lending. In addition to supporting the country's development policies, the SFI DPL complements programs o f other International Financial Institutions (IFIs) that aim to mitigate liquidity risks during the global economic crisis, including the IMF's precautionary Standby Arrangement for Guatemala (US$935 million approved on April 22 2009). Financing from IFIs is key for the Government's efforts to maintainpoverty reduction and social protection programs in the context of the global crisis. The country context, impact of the deteriorating external environment, the Government response, and proposed World Bank support are described in the following sections. 11.COUNTRYCONTEXT,MACROECONOMIC DEVELOPMENTS,AND ECONOMIC OUTLOOK A. CountryContext 3. With a multi-ethnic population of about US$13 million and a per-capita GNI of about US$2,710in2008, Guatemalais the largesteconomy in CentralAmerica-but onewhere poverty and inequality remain high and social indicators are low compared to other middle-income countries. Poverty declined from 56 percent to 51 percent between2000 and 2006, while inequality decreased only marginally. Extreme poverty (measured by the headcount ratio of persons earning or consuming below the poverty line) declined slightly from 13.1 to 12.7 percent over the same period. Much of the extreme poverty is among the rural indigenous, with chronic malnutrition of children in this group running as high as 69 percent. Important impediments to gains in reducing poverty and inequality are the lack of consistent and broad-based growth as well as programs that specifically target the poor. This, inturn, depends not only on improving the attractiveness o f the country for both domestic and foreign investment, but also on the fiscal and institutionalmeans to execute efficient and well targeted social programs andpublic investment. Relyingexclusively on growth to cut poverty by half by 2015 to meet the Millennium Challenge development goals would require an average annual per capita growth rate of 2.4 percent, a goal that Guatemala has infrequently achieved and one that would be particularly challenging giventhe current global crisis andeconomic slowdown.' 4. Guatemala has made considerable development progress since the signing of the Peace Accords in 1996. Particularly, improvements have been made in consolidating peace and building democratic institutions. The country has been taking steps to address crime and strengthen the rule of law, including empowering the UNInternational Commission Against Impunity in Guatemala in2007 as well as enhancing the governanceandtransparency of public finances. The process of consolidating democratic institutions was strengthened last year with the peaceful transition to the new government of Alvaro Colom o f the Union Nacional de la Esperanza(UNE) party in January 2008, following the administration o f Oscar Berger of the GranAlianza Nacional (GANA) party. Nonetheless, the lack of a simple majority inthe National Assembly (38 out o f 158 seats) and ongoing concerns about the rule of law and governance, pose challengesfor garnering political support for the country's reform agenda. These challenges have made the current administration's focus on social cohesion and building strategic alliances particularly relevant. Building a broad consensus i s important for the successful implementation o f its ambitious development planinpromotinginclusive growth and reducing poverty andinequality. 5. The Colom administration has taken significant steps to minimize the macroeconomic and financial impact of the global crisis. While Guatemala is well positioned to weather external shocks the global economic crisis given its historically prudent macroeconomic policies and low debt, it has undertaken additional measures to minimize near-term financial market risks and ensure fiscal and debt sustainability. Inaddition to prioritizing its development plan on near-term steps to mitigate the impact of global crisis, the Government has created a task force to monitor the economic situation and take policy actions, as needed, to respondto the crisis. Among various measures, the Government has been taking steps to fortify bank capital as well as facilitate access to credit by small and medium enterprises most likely to be affected by the difficult external environment andresultant liquidity drain. 6. The Governmenthas also highlightedits commitmentto mitigatethe impact of the crisis on the poor. Indeed, the Government has placed renewed emphasis on policy reforms aimed at supporting growth and productivity, governance, transparency, and expanding opportunities for the poor by providing basic services (education, healthcare, nutrition, etc). Its program aims to address deep pockets o f poverty in the country, particularly in the rural areas, where prior years of strong economic growth have not made significant inroads. As the global financial crisis has significantly slowed economic activity and wage remittances, the risk o f a greater number of people falling into poverty has increasedandthese actions havebecome evenmore critical. Guatemala: Country Economic Memorandum, World Bank, 2005. 2 B. Economic Context 7. The structure of Guatemala's economy has shifted substantially since the 1980s, moving from a principally agriculture (coffee-dominated) base to a muchmore diversified economy, with increased reliance on commerce, tourism and financial services. Commerce and services together accounted for about 34 percent o f GDP in 2008, followed by industrial manufacturing (about 19 percent of GDP), and agriculture (about 11 percent of GDP). In the period 2004 - 2008, transporthommunication and financial services were the fastest growing sectors, followed by tourism, energy and commerce. In terms of employment, commerce and financial services increased participation to 20 percent of formal employment, followed by industry and agriculture (16 and 14 percent, respectively). Consumption remains dominated by the private sector (89 percent o f GDP), supported inpart by steady growth inworker's remittances, while public sector consumption i s small, close to 9 percent of GDP. Likewise, fixed gross domestic investment (18-20 percent of GDP) i s dominated by the private sector-accounting for about four-fifths o f the total or about 14 percent o f GDP. 8. Economic growth has been relatively stable compared to the rest of Latin America. Since 1960, annual per capita real GDP growth in Guatemala has averaged about 1.4 percent, nearly the same as Latin America's rate as a whole, but the country's growth volatility was less than half the regional average.2Much of Guatemala's relative stability can be attributed to prudentmacroeconomic policies that have kept inflation and public debt manageable, while avoiding fiscal imbalances that have plagued much of the region. While stability remains high, low productivity remains an important obstacle to higher growth, highlighting the importance of improving the institutional and business environment. 9. Sound macroeconomic management has allowed Guatemala to capitalize on favorable external conditions in recent years. Despite Guatemala's susceptibility to natural disasters (e.g. Hurricane Stan in 2005), financial market shocks (e.g., the failure of two commercial banks in 2006- 2007), and terms of trade shocks (e.g., the coffee crisis in 2003-2004, the food and fuel crisis in late 2007), the economy grew 4.2 percent on average from 2004 to 2007, reaching 6.3 percent in 2007, its highest growth in three decades. Reforms to improve the investment climate and reduce borrowing costs contributed to accelerating private consumption and investment. On the external front, high inflows of wage remittances and favorable external conditions helped create strong demand for Guatemala's exports and stable balance ofpayments financing. 10. Since 2003, Guatemala has achieved substantial progress in improving its investment climate. While Guatemalawas among the top reformers worldwide inthe last 3 years, and perceptions of the business environment have improved substantially, significant challenges remain.3 Economic integration is moving forward with DR-CAFTA, which became effective in 2006, and new free trade agreements ratified with Colombia and Panamathat will take effect in 2009. The National Assembly i s now considering the ratificationof an FTA with Chile. Since DR-CAFTA came into effect, exports and imports have grown more rapidly than in previous years.4 FDI increased more than threefold * Volatilitymeasuredby the coefficient ofvariation ofannualreal GDPgrowth. DoingBusinessIndicators, WorldBank, 2007,2008, and2009. 4 The Dominican Republic - Central American Free Trade Agreement (DR-CAFTA) became effective in Guatemala on July 1, 2006. More than providing new incentives, DR-CAFTA offered more permanent access to the US. market compared to that of the 1993 Caribbean Basin Initiative (CBI). Under DR-CAFTA, tariffs on about 80 percent of US exports to Central America were eliminated, and the rest will be phasedout over the next decade. US trade barriers also 3 between2004 and 2008 innominal dollar terms, one percentagepoint o f GDP. Guatemala's sovereign risk ratings also improved (i.e., S&P's, BB w/stable outlook; Fitch, BB+ w/stable outlook; and Moody's, Ba2 w/stable outlook) and have, to date, withstood the global economic crisis despite downgrades in other countries. Still, challenges remain, and the 2008 Guatemala Investment Climate Assessment highlights corruption, energy supplies and crime as the greatest obstacles faced by business (see Box 1). Box 1.2008 Guatemala InvestmentClimate Assessment(ICA) Findings The second Investment Climate Assessment for Guatemala was completed in 2008 based on 2007 survey data and allows for a comparison with 2004 data. The survey interviewedmore than 500 firms from the manufacturing, servicesandconstructionsectors. Since 2003, Guatemala made substantial progress in improving its business climate, but there i s roomfor improvement, especiallycomparedto its competitors. Firms still report corruption as their number one obstacle, but only 61 percent of firms did so in2007 versus 81 percent of firms in 2004. Perceptions of macroeconomic instability, informal competition, and access to finance also improved.Only electricity, transport andaccess to landdeteriorated since 2003. In fact, electricity was the second major obstacle in 2007, while perception of crime improved substantially (from 80 to 37 percent). However, crime affects firms differently depending on their size, region of operation, and exporter status. Smallfirms suffer the most, and Guatemala continues to suffer more from crime than comparator countries. As for electricity, the ICA highlightsthat accessto reliable electricitysupply has become a major concern for firms. Inthe last three years, the frequency of power outages has increased, and there have been problems satisfyingpeak demand. 11. Financial sector legal and regulatory reforms implemented since 2002 have improved banks' solvency and resilience to market volatility, but much remains to be completed and lack of access to finance remains a major issue for the financial sector. The strengthening o f the financial sector regulatory and supervisory framework and practices inGuatemala has helpedto reduce the risk of a systemic banking crisis and avoid associated high social costs. In fact, international experience shows that financial crises entail large fiscal costs that crowd out social spending with dramatic effects on poverty. However, the failure of two banks in 2006/07, although successfully resolved, pointed to remaining vulnerabilities in the sector, specially the existence of unsupervised intermediation. This experience has prompted the financial authorities to strengthenthe regulation of financial conglomerates and accelerate the transition from a compliance based supervision approachto a risk-based consolidated supervision approach. 12. A key challenge for Guatemala will be to preserve, and eventually increase, fiscal space to support priority public investment and social spending. Since the 1996 Peace Accords, Guatemala's target has been to raise tax revenues to 13.2 percent o f GDP.' Despite significant improvements in tax administration, including the passage o f an Anti-Tax Evasion Law in 2006, political opposition and unfavorable constitutional court rulings on taxes have kept tax collections as a fell, but because most products already entered the U S market under CBI preferences, the effect of their removal was modest. The DR-CAFTA requires the implementation of complementary regulatory and institutional reforms that Guatemala completedprior to treaty effectiveness. 12percent usingGDPbaseyear 1958. 4 share of GDP relatively flat and below the Peace Accords target.6 Guatemala's light tax burden, currently about 10-11 percent of GDP, is much lower than comparable countries and does not provide sufficient fiscal space to address social needs. 13. Despite government efforts in recent years to improve governance and strengthen institutions, perceptions of governance remain low. Among World Bank governance indicators, regulatory quality and voice and accountability showed some improvement in recent years, but the rule of law remains one of the most important challenges as it falls well below averages for Latin America and countries with similar income. In an effort to fight impunity in the country, in 2007 Congressapprovedthe creation o fthe International Commission against Impunity.The UnitedNations Secretary appointed its Commissioner, who has been working in close collaboration with the judicial, legislative andexecutive branches, andthe UNHighCommissioner for HumanRights. 14. Guatemala made steady progress on the transparency and financial management in recent years. The implementation of the integrated financial management system (SIAF), which was builtupon a goodnormative framework andamodern technological platform, contributed to efficiency in financial transactions and the production of timely, transparent information on most government finances (See Box 2). Moreover, Guatemala's Transparency and Anti-corruption Agenda is one o f the new Government's main priorities, whichis being ledby the Vice President along with the Minister of Finance, who is leading efforts on fiscal transparency. C.RecentEconomicDevelopments and Outlook 15. Growth started to slow in 2008 and is expected to continue to decline in 2009 as the impact of the global financial turmoil takes hold. The Guatemalan economy beganto slow initially in2008 due to the impact of oil and commodity price increases andthenwas subsequentlyhit by the impact of the global financial crisis in the last quarter o f 2008. Preliminary estimates for 2008 show that growth fell to 4 percent, from 2007's fairly robust rate o f 6.3 percent. Continued financial turbulence and the deepening of the crisis inthe U S (the main commercial partner of Guatemala) and Europe are projected to cause a contraction inGDP by 0.5 percent in2009. This reflects an expected decline in export performance, tightening domestic credit markets (and lower domestic investment) and falling remittances. As the global environment begins to stabilize, a modest recovery of 1.4 percent is projected in2010, followed by an average growth o f 3.8 percent over 2011-2013 (Table 1). 16. After surging in late 2007 and early 2008 due to high food and fuel prices, inflation fell and is expected to continue to moderate. Inflationary pressures began to accelerate in 2007 with consumer price index-based inflation averaging 8.7 percent and continued to rise for much o f 2008 as international commodity prices, particularly oil and grains rose to historic levels. Food price inflation peakedat 19.4 percent inJuly 2008, which contributed to an overall inflationrate of 14.2 percent that same month. Overall inflation moderated in the last quarter o f 2008 as food and oil prices softened, monetary policy tightening took effect, and the economy slowed. Inflation is expected to continue to moderate to 5.5 percent in 2009 and then gradually slow to 4 percent by 2013. Risks to the inflation projection are associated with the volatility of commodity prices and pass-through effects from currency movements. One major result of the Anti-Evasion Law has been the significant reduction on VAT tax evasion from 34.4 percent in 2004 to 26.1 percent in2007, below the LAC average (IMF/WB(2008)). 5 Box 2. Progresson PublicFinancialManagement After more than a decade of continuous work in modernizing and reforming core elements of public sector institutions and systems, Guatemala is now one o f the leading countries in the implementation of Public Financial Management (PFM) reform. Implementation o f integrated financial management system SIAF and public procurement system GUATECOMPRAS constitute the main elements o f a more effective and transparent public administration. Most notable achievements reachedthus far include: The SIAF system is now considered one of the best regional practices in automated public financial management. The system was upgraded to operate under web-based technology and is now fully operational in all central government agencies and most o f the decentralized entities, and furthermore covers approximately 300 executing-level units. It includes most o fthe public financial management functions New financial management procedures and systemswere successfullyimplementedin all municipalities. A new framework for municipal financial management SIAFMUNI has allowed for a more efficient and transparent model. New municipal financial management procedures and systems are gradually being implemented in all municipal governments in Guatemala. The e-procurement applicationGUATECOMPRAS is now operatingand registeringall central government agencies' transactions and is gradually being expanded to decentralized entities and municipalities.Although the application has yet to support online transactions (such as electronic biddingor electronic purchasing), this system has successfully promoted higher degrees o f transparency in the public procurement practices evidenced by improvements in users' perceptions and a recent award granted by the private sector association inGuatemala. An automatic and fully integrated payroll system is being implemented throughout all centralgovernmentagencies,includingthe healthand educationsectors. Nearly all central government employees are now paid through the banking system and an updated database of public sector employees has been developed and integrated with the SIAF system. An automated workflow system to support the Comptroller General Office's audit processes has been developed and is under implementation.A1though not completely operational and subject to further evaluations, the government audit system (SAG) is supportingthe core businessprocessesof the Comptroller's Office. Fiscal policy has remained prudent in recent years and low debt and deficit levels provide space for countercyclical measures. Preliminary estimates indicate that the fiscal deficit o f the central government narrowed to 1.7 percent o f GDP in 2008 from 1.8 percent in 2007, corresponding to a primary deficit o f 0.3 percent o f GDP. The narrowingo f the deficit in2008 reflected expenditure control and slow execution of the budget as the new government transitionedinto power. The low level of non-financial public sector debt-20.2 percent o f GDP-gives the authorities headroom to address the new challenges created by the external environment. A s countercyclical fiscal policy i s implemented (particularly through increased targeted spending on the poor) andtax revenues fall as the economy slows, the central government's 2009 fiscal deficit is forecast to widen to 2.8 percent o f GDP. In the first four months of 2009, direct and indirect taxes declined by 8.5 percent and 11.3 percent respectively, compared to the same period in 2008. These declines come primarily from declining VAT collections (a fall of 13.1 percent) and falling tariff revenues (a decline of 17.8 percent) as imports fall. At the same time, the central government's social sector expenditures are expected to increase from 5.9 percent o f GDP in 2007 to 7.4 percent of GDP in 2009. The larger, but still 6 sustainable, deficit is expected to be financed through domestic borrowing and loans from multilateral development banks. Additional internal bond issues will be restricted to approximately US$225 million, inorder to avoid crowding out ofprivate borrowers inan already tight domestic credit market. Public debt is projected to increase modestly to an average of 25 percent of GDP between 2009 and 2013, from anaverage of 21 percent o f GDP between2004 and 2008. Table 1:Guatemala Key Economic Indicators 2004-2013 (Percentage of GDP, unlessotherwise indicated) 2005 2006 2007 2008 2009 2010 2011 2012 2013 Incomeand prices GDP growth ("hchange) 3.3 5.4 6.3 4.0 -0.5 1.4 3.5 4.0 4.0 GDP per capita (% change) 0.6 2.5 3.1 1.3 -3.2 -1.3 0.8 1.3 1.3 Inflation (CPI end ofperiod % change) 8.6 5.8 8.7 9.4 5.5 4.7 4.5 4.5 4.0 Investmentand savings Gross domestic investment 19.7 20.9 20.4 20.5 15.7 16.1 16.7 17.2 17.2 Gross domestic savings 15.2 15.9 15.4 15.1 11.8 12.3 15.2 15.7 15.8 ConsolidatedPublicSector Accounts Total revenues and grants 12.0 12.7 12.9 12.0 11.3 11.5 12.1 12.2 12.3 Total tax revenues 11.2 11.9 12.1 11.3 10.5 10.6 11.2 11.3 11.4 Total expenditure 13.7 14.7 14.7 13.7 14.1 14.1 14.1 14.2 14.2 Central Governmentprimary balance -0.3 -0.6 -0.3 -0.3 -1.2 -1.0 -0.4 -0.3 -0.2 Central Governmentoverall balance -1.7 -1.9 -1.8 -1.7 -2.8 -2.6 -2.1 -2.0 -2.0 Non Financial Public Sector overall balance -0.6 -1.3 -0.7 -0.7 -2.4 -2.1 -1.6 -1.5 -1.6 Publicdebt NonFinancial Public Sector total debt 20.8 21.8 21.7 20.2 23.8 26.0 26.9 27.5 27.9 o/w External 13.1 13.1 12.5 11.2 14.2 15.7 15.7 15.6 15.1 Balanceof payments Current account balance -4.5 ;5.0 -5.0 -4.8 -4.5 -5.1 -4.8 -4.3 -4.2 Trade balance -15.3 -16.1 -16.2 -14.2 -12.1 -13.2 -13.9 -14.4 -14.4 Exports (including maquila) 16.1 16.6 18.0 17.9 16.0 16.6 17.0 17.2 17.3 Imports (including maquila) -31.4 -32.7 -34.2 -32.1 -28.1 -29.8 -30.9 -31.5 -3 1.7 Foreign direct investment 1.7 1.8 2.0 2.1 1.5 1.6 1.7 1.8 1.9 Remittances 11.0 12.1 12.5 11.3 9.6 10.1 11.3 12.3 12.6 Memorandum item: Nominal GDP (billions ofUS dollars) 27.3 30.3 34.0 39.0 37.6 38.4 40.1 42.5 45.3 Source: Ministry of Finance, Central Bank and IMF and WorldBank staff estimates. 18. On the external front, the current account deficit is forecasted to narrow slightly to 4.5 percent of GDP in 2009, as exports, remittances, and FDI decline. The current account deficit over the past few years (hovering around 5 percent o f GDP) has been fairly stable as high remittance inflows (which reached 11.3 percent o f GDP in2008) remained strong. Exports and imports increased considerably following the implementation o f CAFTA-DR in 2006. Indeed, exports grew by 20.3 percent and 15.5 percent in 2007 and 2008 respectively driven mainly by traditional exports (which experienced a growth rate o f more than 25 percent in2007). Strong capital inflows helpedfinance the current account deficit, which was kept modest by the significant flow of remittances from 7 Guatemalans living abroad. Remittances have increased tenfold over the past ten years. In recent months, however, the global economic crisis, particularly in the U.S, has begun to have an impact. Year-on-year growth in remittances dropped 11.4 percent in February 2009, compared to an overall increase of nearly 16percent between2004 and 2007. 19. Lower oil prices and weak demand for imports will more than offset the decline in exports and remittances. Projections anticipate a narrowing of the trade deficit by 2.1 percentage points of GDP compared to 2008. The current account deficit is forecast to average 4.7 percent o f GDP over 2009-2013 relative to an average o f 4.8 percent over 2004-2008 on the assumption that remittances will decline by 1.7 percentage points of GDP in 2009 (to 9.6 percent of GDP), and will start to recover slightly by 2011. Foreign direct investment (FDI) i s expected to decline to around 1.5 percent o f GDP,in2009 and2010 comparedto 2.1 percent o f GDP in2008. 20. The impact of the global financial crisis has been limited so far by the financial system's limited exposure to toxic sub-prime assets, but i s apparent through a squeeze in credit lines from international banks. So far the crisis has been felt through a drop in credit lines from international banks to Guatemalan banks, reportedly ofthe order of25 percent. The majority ofthe credit lines have been renegotiated, albeit at less favorable terms. Domestic credit to the private sector fell to 2007 levels in real terms over the second half of 2008, and the growth rate has continued to fall through 2009. In summary, International credit lines are becoming more expensive and difficult to roll-over and banks are tightening lending standards and substituting market liquidity with balance-sheet liquidity. 21. Performance and solvency of banks remain adequate. Financial sector legal and regulatory reforms implemented since 2002 have improved banks' solvency and resilience to market volatility. Official figures indicate a capital to asset ratio close to the statutory minimum o f 10percent. Since the onset of the global financial crisis, the quality o f banks' lending portfolios has remained roughly unchangedwith non performing loans (NPLs) as a percentage o f total loans at 2.4 percent in March 2009 compared to 2.5 percent a year earlier (Table 2). Profitability indicators remain stable, but second-roundeffects may come through the ongoing impact of the economic slowdown. Table 2: Financial Soundness Indicators March-OS March-09 Profitability ReturnonEquity 26.3 25.1 ReturnonAssets 2.5 2.4 Asset Quality and Provisioning NPLsto TotalLoans 2.9 2.6 ProvisionshIPLs 59.1 73.6 Other Indicators Capitalto Assets Ratio 9.4 9.85 LiquidAssets/TotalAssets 14.9 na LiauidAssetsDeDosits 20.2 na ~Source: Superintendencyof Banks 22. The Guatemalan authorities have responded to tightening domestic credit conc tions with measures aimed at increasing liquidity in the hopes that banks will increase lending. The main response by the Central Bank has been to ease the requirements on banks' accounting o f reserves, in force since November 2008; establish a temporary US-dollar fund facility for banks, and cut the policy rate to 5.75 percent. The U S dollar facility of 290 million was initiated on November 2008 and was 8 extended until May 2009, but less than 35 percent o f the funds have been utilized by banks as many have been able to manage needs though the market. The decrease in interest rates was accomplished through four distinct interventions (25bps in Jkuary, 50bps in February, 25bps in March, and 50 bps inApril 2009) following a slowdown ininflation. These decisions followed two consecutive years of overshooting o f the Central Bank's inflation target and negative real interest rates in 2008. So far the policy rate cut has not led to an adjustment in banks' lending interest rates, but there has been an impact on interbank rates. Other measures have also been implemented, such as the utilization of the 2005 introduced facility for liquidity in quetzals, the withdrawal o f treasury bonds and the Central Bank deposit certificates held by banks, and increased bank premiums to the deposit insurance mechanism (FOPA). The Superintendency of Banks (SIB) has also intensified supervision, with meetings among Central America Superintendents taking place on a monthly basjs, and introduced regulation to increase bank provisioning for NPLs, gradually from 60 percent to 100 percent in 2011. Furthermore, the Congress approved Decree 64-2008, establishing a financial panic offence against false communications that may undermine the confidence o f clients, users, depositors or investors of institutions under SIB supervision. D. Debt Sustainabilityand MacroeconomicPolicy Framework 23. The level of public debt is expected to be sustainable over the coming years. This assessment is basedon the debt sustainability analysis (DSA) contained inAnnex 6. The DSA i s based on the medium term macroeconomic framework described by Tables 1 and 3. Under the baseline scenario the ratio of the stock of public debt to GDP i s expected to increase due to fiscal pressures imposed by the unfavorable external environment. Less favorable alternative scenarios are also considered such as (i) higher real interest rates (1 standard deviation or about 0.6 percent above the historical average); (ii) growth (by 1 standard deviation or about 1.3 percentage points); (iii) lower a lower primarybalanceresultingfrom lower tax collection (1 standarddeviation or about 0.6 percent of GDP); and (iv) a combination of the previous three shocks using 0.5 standard deviation shocks. Inall these alternative scenarios, however, the stock o f public debt would be at or below 30 percent o f GDP in2013. Inaddition to standardstresstests, a stochastic fiscal sustainability analysis is also undertaken and presented inAnnex 6. Key debt determinants are subject to stochastic shocks with the objective of capturing possible trajectories of public debt in the context o f a rapidly changing and increasingly uncertain external environment. 24. The Government's macroeconomic program for 2009 and 2010 focuses on consolidating macroeconomic stability in the face of volatile external conditions. This strategy is built around four key pillars: (i)a moderate countercyclical fiscal policy to support domestic demand, largely financed out of external resources to prevent crowding out the domestic private sector; (ii) monetary policy focused on reducing inflation and a flexible exchange rate to facilitate economic adjustment; (iii)strengtheningbank regulation and supervision, and enhancing the banking sector safety net and bank resolution procedures; and (iv) refocusing public expenditures to priority areas, i.e. social spendingand labor-intensive public projects. 25. Overall, the macroeconomic policy framework is assessed to be adequate for the purposes of this operation. While the economic slowdown and global economic crisis pose a significant challenge for the country, the macroeconomic policy framework is adequate and sustainable. The fiscal deficit and level of public debt is expected to increase over the near-term, but the country has ample head-room going into this crisis to remain on a sustainable fiscal and debt trajectory. Monetary policy i s being eased in a prudentmanner as inflation continues to moderate inflation is targeted at 5.5 9 percent this year with a tolerance margin o f +l/-1 percent and the medium-term inflation target i s 4 percent. Steps taken to strengthen secondary markets will also provide improved market signals to guide formulation of monetary policy. Changes in intervention rules have led to a more flexible exchange rate policy. The level of net international reserves at about US$4.7 billion in May 2009, which is equivalent to 4 months of imports, i s adequateand stable. 26. Guatemala's external financing requirements are expected to be met. The current account deficit plus total debt amortization is projected to be 16.2 percent o f GDP in 2009, compared to 17.7 percent in2008. While financingneeds are relatively large, they are expectedto be covered by net FDI inflows, other private capital inflows, and public borrowing, particularly from multilateral institutions. Nonetheless, should downside risks from a further deterioration in the external situation materialize, Guatemala's precautionary Standby Arrangement with the IMF adds a substantial liquidity cushion to meet external financing needs (US$935 million, or 2.5 percent o f GDP). Table 3 below presents projected external financing requirements for 2009. Table 3: Guatemala: Gross ExternalFinancing Requirements 2008 2009 estimated projected Gross ExternalFinancingRequirement(US%,millions) 6910 6363 (in percent of GDP) 17.7 16.9 Current Account Deficit 1861 1692 PublicSector 260 242 PrivateSector 4789 4429 Short-term debt on original maturity 4077 3536 Banks 940 857 Non-bankprivate sector (commercial credits) 3137 2680 Short-term debt on remainingmaturity (amortizations due) 712 893 SourcesofFinancing(in US$ millions) 6910 6363 Net FDIinflows 815 553 Gross medium-andlong-term borrowing (public sector) 382 860 Roll-over of ST debt 4789 4429 New Borrowing 754 0 Other capital flows 1/ -163 521 Change in gross reserves(decrease =+) -333 0 Financing Gap (in US$ millions) 0 0 (inpercentofGDP) Assumptions: Rollover of short-termdebt (excl. commercialcredit) 100% 100% I/Includeserrorsandomissions Source: IMF and WorldBank Staf Calculations 10 111.GOVERNMENTPLANANDKEYISSUESINFISCALANDINSTITUTIONAL DEVELOPMENT 27. The administrationhas focused itsefforts on increasinggrowth and reducingpovertyand inequality while maintaining macroeconomic stability. The Government plan is built on eight fundamental principles (prioritizing the poor, gender equality, investing in children, multiculturalism, ethics, environmental conservation,citizenparticipation, and respectfor human rights) that cut across four development themes: (i)Solidarity; (ii)Governance; (iii)Productivity; and (iv) Regionalism. It places particular emphasis on the goal of maintaining macroeconomic stability and expanding the fiscal space to finance the implementation o f its medium-term plan as well as improving transparency andefficiency inthe public sector. The Government's development themes are presented inAnnex 1. 28. The Government's multi-faceted development program contains a broad array of measures to combat poverty and inequality in Guatemala, including policy reforms and investments in infrastructure, social programs, and actions to mitigate the impact of natural disasters, among others. The elements o f the Government's program described below highlightthe key fiscal and institutional challenges the country faces and policy measures the Government is pursuing, including measures to mitigate the impact o f the global crisis and increase financial market access and stability. Many o f the actions described below are supported by the SFI DPL presented in Section IV. A. Solidarity:PrioritySpendingfor ReducingPovertyandInequality Priority Spendingfor ReducingPoverty and Inequality 29. A key focus of the Government's first development theme, solidarity, includes reducing poverty and inequality through the conditional cash transfer (CCT) program, M i Familia Progresa. This Conditional Cash Transfer (CCT) programtargets the most vulnerable, particularly the rural and indigenous poor, by providing cash incentives to poor families to take advantage o f health and educational opportunities, as well as income to meet basic needs. The Government launched the pilot phase in five municipalities in March 2008, and the program will be extended to cover 400,000 families in 140 municipalities. As o f January 2009, the Mi Familia Progresa Program is being implemented in 89 municipalities benefiting more than 280,000 families. This program is not only intended as a mechanism to address deep pockets o f poverty, but also as a means to offset the adverse impact o f the current economic downturn on vulnerable groups. Depending on the number o f children andtheir ages, beneficiary families could receive upto 4300 per month(about US$40 as o fend-March 2009) on the condition that children between 7 and 15 years o f age regularly attend primary school and all children are examined at health centers (the education and health benefits are Ql50 each). Families with all children less than 7 may receive an additional benefit o f QlOO per month subject to compliance with a nutrition-related conditionality. The full program is expected to cost around Q1.3 billion annually (about $175 million). The program's main challenges going forward are ensuring effective implementation, adequate fiscal resources, and the supply o f complementary services. 30. The Government has placed a strong emphasis in the development of mechanisms for program monitoring and evaluation to assess the actual targeting and impact of Mi Familia Progresa. To this end, the Government o f Guatemala requested support from the World Bank and the IDB on the CCT program's design, including mechanisms to enhance monitoring, evaluation, and transparency, and support to help address supply side issues in coordination with the health and education ministries. Furthermore, inaccordance with the access to information and transparency law, 11 the authorities have made publicly available key program information, including beneficiary lists, total amount o f monthly transfer per family, selection criteria, as well as total program sources o f financing, expenditure, andpayments (bydepartment) for the year 2008. 31. The programhas made significantprogress and the Governmentis addressingremaining challenges. The program has been initiated with a temporary information management system (IMS), but to consolidate data from family registers, and monitor compliance with conditionality and co-responsibility and coordinate payments, a more comprehensive systemis beingdeveloped. The new system i s currently beingtested and i s expectedto be fully operational by early 2010. This system will be fully integrated with the Ministries of Education and Health. Social controls and audits are also beingdeveloped as part ofthe new system. Finally, with the support ofthe IDB, the impact evaluation o f the program is fully designed and baseline results will be available later in 2009, with the first follow up survey plannedfor 2010. Maintaining Fiscal Space 32. T o meet priority social spendingand investmentgoals, the Colom government is seeking to maintain, and eventuallyexpand, fiscal resources. Recognizing the political factors constraining a deep and far-reaching program and the near-term challenges of the global economic crisis, the authorities drafted and are pursuinga modest but important fiscal reform. Consensus on tax reform has remained an elusive goal in Guatemala, with only minimal success inrecent years. Giventhe political context and challenging economic environment, the Government is pursinga flexible and consultative approach to ensure near-tern fiscal needs are met, while laying the foundation for medium-term revenue goals. 33. Originally intended as a single stage reform, the Government's proposed fiscal modernizationwas ultimately divided into two phases to facilitate consensus and congressional approval. The proposal was presented to Congress on August 11,2008 after consultations with a wide array of stake-holders. It includes actions to reduce tax evasion, improve the customs legal framework and enforcement, and increase tax collections (see Table 4 for details). The first phase includes two components: (i) provisions for the modernization o f the tax system (including the vehicle tax regime and tax administration) and customs, and (ii)a transitional tax on business income, called the "Solidarity Tax" (ImpuestoSolidaridad, ISO), which replaces the IETAAP (Impuesto Extraordinario de Apoyo a 10s Acuerdos de Paz, a temporary income tax on businesses that expired in2008). While both components were expectedto be approved by end-2008 and become effective inearly 2009, only the I S 0 has been approved and implemented. Despite this delay, the I S 0 i s a significant accomplishment for the Government and replaces an estimated 0.7 percent o f GDP in tax revenues from the expiration o f the IETAAP. The second phase includes a new income tax proposal that is expectedto be submittedto Congress after the complete first phase ofthe package is passed. Once the secondphase income tax proposal i s implemented, the Solidarity Tax will expire. The administration's goal is to improve the tax system's efficiency and fairness as well as helpthe country eventually reach the Peace Accord target for tax collections of 13.2percent o f GDP. 12 Table 4: Fiscal Modernization Proposal' PHASENo. Law Proposal Specific Measures Include: (A) Vehicles Tax Regime: (i).Establish a tax on initial vehicle registration and (ii) gradually double the annualtax rate appliedto vehiclecirculation startingin2009. (B)NationalCustomsSystem: (i)A national legal customs framework to complement the international (1) Provisionsfor customs framework, including the Cddigo Aduanero Uniforme modernizationof the Centroamericano (CAUCA) and its rules (RECAUCA) and (ii)specific tax system and measuresto strengthenenforcement. customs (C) Value Added Tax (VAT): (i)IntroducenewcontrolsforpurchasesexemptfromVAT; (ii)administrative - Submitted to improvements in the small taxpayers regime and the VAT system applied to Congress onAugust real estate property transfers; (iii)12 percentVAT on the first purchasehale of 1I,2008; real estate property, the second and further purchasedsaleswill be subject to a fixed tax of 3 percent. - Expected toprovide additional revenues (D) Legal Provisions for the Strengthening of Tax Administration and forabout 0.3 Reformsto the Tax Code: FIRST percent of G D P (i)advance on the implementation of the electronic mechanisms for tax PHASE declarations (ii)reduce the minimum sum limit above which electronic submission of tax declarations is allowed; and (iii)strengthen SAT'S legal capacity to control and penalize tax evasion including the ability to retrieve financial transactions information from financial institutions and measures to allow the tax authority to temporarily close a business for tax compliance issues. (2) New tax on (E) Transitional tax on business income. This transitional tax will be businessincome: replacedby apermanent tax on incomein the secondphase of the reform. The "Solidarity Tax (ISO)" new transitional tax proposed has the same characteristicsas the IETAAP and - includes: Passed by Congress fixed rate on gross income of businesses(1.O percent) in November 2009; -- quarterlypayments and became effective -. tax paid on I S 0 can be applied as a credit to other business income - on January 1,2009. taxes Expected toprovide - expires with implementationofthe new incometax law revenues of about 0.7percent of GDP to replace losses from the expiration of the IETAPP. The draft proposalincludes : New Income Tax Law - (i)gradual reductionof the tax rateappliedon net profits (from 31 to 25 Expected to be percent); (ii)gradual increase of the tax rate applied on distribution of profits SECOND submitted to (from 3 to 10percent); (iii)strengtheningof controls on deductiblecosts under PHASE Congress after the net profits regime; (iv) gradual increase of the single rate on gross income passage of tax (from 5 percentto 7 percent) starting in2010; (v) broadeningof the incometax modernization base for employed persons by gradually eliminating the VAT tax credit; and reforms infirst (vi) simplification of the individualhousehold tax regime by applying a single phase; rate for incomeupto Q240,OOO (5,percent) andfor incomeafter Q240,OOO a tax rateof 7 percentplusafixed tax amount of 412,000. 'The fiscal modernization reform proposal has been developed by the multi-sectoral Fiscal Dialogue Group, a technical- working group created in2006 under the auspices o f the National Commission for the PeaceAccords. 13 . Table 5: Additional FiscalMeasures Actions Results Expected CompletionDate 1. Controlover VAT A. Control on VAT exemptions (EXENIVA) ....Registerupdateofexemptedpeoplemdinstitutions. .... December2008 andwithholdings on businessincometax Definitionofthe InformationSystem. December2008 (RETENISR) Normdefinition for exemptionscontrol. July 2009 Boardapproval for theuseof controlcardEXENIVA. August2009 Beginningofthe controlprogram. September 2009 . B.Controlonbusiness income tax (ISRIretentions .... Applicationdefmitionto registerISRretentions. December2008 Boardapprovalfor the mandatoryuseofthe RetenISRtool. March 2009 Normandproceduresof conirol. April 2009 2. Cross-CheckofVAT A. Identificationofpotentialcross-checksto increasethe control January 2009 declarations andISR universe. declarations. B.Normdefinition for control application. February 2009 C. Beginningo fcross-checks as apermanentmonthly activity. Feb.-Nov.2009 D. Evaluationofthe cross-checkeffectiveness. June2009 3. Control on the VAT A. Analytical study for evaluationofthe fiscal creditexporters. May 2009 fiscal creditgrantedto B. Definitionofthe IntegralControlPlanofh e FiscalCreditto exporters. Exporters. June 2009 C.New normfor the implementationo fan IntegralPlanto coItrol June 2009 fiscal credit D.Implementationofthe IntegralPlan July 2009 4. Effectivefiscal control A. Sectoridentificationor economicactivitiesthat presentldisplay Feb.-Sept.2009 o f certainactivities such as inconsistencieswithtax compliance. sportsclubs, livestock, B.Normto correct discrepancies. April 2009 transportand exports. C. Client servicesfor sectors with difficulties intax compliance. ......April October 2009 D.Audit for cases that refuseto useclient services. . May October2009 -- 5. Controls against A. Identificationofthe entry pointsofcontraband. December 2008 contrabandby meansof B. Beginningofspecific controlsoverthe identifiedentry points. the Inter-institutional C. Formalizationofthe Inter-institutionalCommission. March2009 Commission. D. Definitiono faStrategicPlanandOperative Plans. , May 2009 E. Measurementofthe level ofContrabandandFraudand Customs June2009 Fraud. F. Beginningofthe executicmo fthe Operative Plans. June 2009 July 2009 ... 6. Technological A. Pilot probesfor the inplementationofthe GPS as atransit control improvementsm the mechanism. December 2008 control oftransits by B. Termsofreferencefor the controlsystem design ard ... meansofthe obligatory implementation. March 2009 useo f new deviceGlobal C. Boardapprovalfor GPS implementab'on. May 2009 PositioningSystem D. Contract signingfor the implementationofthe system. June2009 (GPSAT). E. Pilot implementationinselectedcustoms. July2009 7. Controlover the A. Measurementofthe level non complianceofthe ICV December2009 Vehicles CirculationTax B.Operative planfor ICV control. iirw January 2009 Source: SAT 34. During the current global crisis and growth slowdown, a Government priority is to mitigate the expected cyclical decline in tax revenues. The Government i s taking new administrative measures under the purview of the tax administration (SAT), to respond quickly to the current environment by increasing tax compliance and eliminating tax loopholes. Inthis context, and with the support of the Ministryof Finance, the SAT has been designing and implementing measures to improve tax controls. It is expected that such measures will mitigate the decline inrevenues by one 14 percent of GDP inthe medium-term.These measuresinclude: i)limitingtax exemptions; ii)control on withholdings of employee's income declaration on mandatory basis; iii)cross-checking on VAT and business income declarations; iv) control on VAT payments for transport services and exports; and v) measuresto contravene contraband activities as part of a National Strategy for border security. Table 5 above presents actions, results, and the expecteddates o f compliance o fthese measures. B. Strengthened Governanceand Transparency 35. The Government's second development theme, governance, focuses on strengthening institutions and enhancing transparency. For many years, governance and transparency-related indicators have ranked low in Guatemala. Weak rule o f law and insufficient efforts to combat corruption have been perceived as the most important challenges for the country, while there is recognition that the Government has advancedinimproving government effectiveness and simplifying regulations to improve the businessenvironment. The present administration has identifiedgovernance as one of its top priorities and has announced the implementation o f comprehensive actions to tackle the governance issue in the country. The Vice-president has convened a participatory commission including specialized NGOs and donors to provide support in this area, and an action plan was put together to identify specific short-term measures. As part of this agenda, the Ministry o f Finance is leading the efforts to enhance fiscal transparency. Guatemala is a C-GAC (Country-Governance and Anti-Corruption) pilot country, andthe Bank i s providing support to the governance agenda, including support for the monitoring and evaluation program Mi Familia Progresa CCT program. 36. The passageof the new Access to Public InformationLaw (Ley deAcceso a la Informacidn Pciblica) in September 2008 was a significant step forward as was the creation of the Vice- Ministry of fiscal transparency and evaluation within the Ministry of Finance. The law was approved after a broad consultation process and following several interactions between Congress, the Executive and civil society. According to recent evaluations, the law matches international best practices and fulfills standards in terms o f both scope o f information to be disclosed and monitoring capacities for the law to be enforced. Additionally, the Vice-Ministry o f fiscal transparency and evaluation will focus on integrity systems, accountability, public participation and social auditing, and fighting corruption. In addition to supporting the objective of governance reform, the Vice-Ministry will bolster the efficiency of spending, and therefore is also helpful to the goal of maintaining fiscal space. The Ministry of Finance has already implemented the SAIP (a web-based portal open to the generalpublic) to facilitate access to fiscal information (SistemadeAcceso a Inforrnacidn Ptiblica). 37. Publicsector accountability is being reinforced. Public accountability is improvingthrough the creation of a specialized office inthe Ministry of Finance to facilitate access to fiscal information, and guarantee transparent use of public resources; the strengthening of the regulatory framework to better control and enhance the transparency of trust funds; and the strengthening o f the Comptroller General office to facilitate processing o f citizen claims and allegations on misuse of public funds and fraud cases. As promised, the Government has already issued regulations to fully include expenditures under special public trust-funds inthe budget. For the first time in several years, plannedexpenditures o f formerly undisclosed trust-funds were registered and included in the 2009 budget proposal and, in addition, budget regulations (Normas Presupuestarias) have also included provisions to guarantee timely auditing exercises and disclosure policies inthe use ofthese resources.The Government is also strengthening controls and monitoring capacities to secure transparent and adequate management of public funds under special public Trust-Funds and other similar mechanisms. The Government has 15 issued regulations to fully include the registration of expenditures under these Trust-Funds into the budget. 38. Complementing these efforts are advances on the public financial management modernizationagenda.The Government has initiateda gradual processto institutionalize and absorb management responsibilities over SIAF and Guatecompras systems. This has primarily been done by implementinga major restructuring of the Ministry of Finance to establish new specialized units to deal with system management and transparency issues. The Vice-ministry o f Financial Management was createdto overview core financial management functions andto absorb responsibilities over SIAF subsystems (Budget, Treasury, Public Credit, and Accounting). Secondly, a Vice-ministry o f Internal Administration and Information Systems Development hasbeencreated to overview internal processes in MINFIN and will administer SIAF modules. Finally, a new Vice-ministry of transparency and evaluation will take care of fiscal transparency related policies and will also absorb responsibilities over the Guatecomprassystem. 39. The Governmenthas also advancedin the development and conceptualdefinitionof new instruments geared to the modernization of financial management functions. To this end, the Ministry of Finance has issued binding guidelines for the formulation of 2010 budget including: a) implementation of new budget classifications linkedwith the charter o f accounts in accordance with international standards; b) implementation o f a multi-year fiscal framework; c) expansion of municipal coverage through the SIAFMUNI application; and d) refinement o f results and outcomes indicators to set the baselines for the implementation of a results informed budgeting system. Although these actions will be introduced on experimental basis duringthe 2010 budgetcycle, they will provide input and feedback to the budgetmodernization process immediately. Plus, as baselines will be established as a result of this exercise, it is expected that future budgeting processes in the central administration will be able to focus on results and performance information and that financial recording will be able to gather all necessary data in line with best international practice in terms o f classification and accounting procedures. The expected outcome of the implementation o f these new techniques should be reflected in a more comprehensive control of public sector expenditures as well as in a more effective and efficient allocation o f public sector resources during the budgeting process. A PEFA assessment exercise is underway and will further provide inputs for the continuous development and improvement of financial managementfunctions inthe country. C. SustainableGrowthandProductivity 40. The Government's development theme of productivity focuses on sustainable growth. The Government, by stimulating domestic and foreign investment, reducing costs by diversifying sources o f energy, supporting tourism and mediumand small size enterprises, enhancing opportunities to export goods and services, while improving integration of payments systems inthe Central America region in recognition of the growing importance o f intra-regional trade and other flows. To reduce business costs, reduce customs processing times, and increase compliance with the tax and customs rules, the Government i s simplifying rules and enhancing information systems. The tax administration (SAT) is adapting its information systems to support new tax reforms fully. The information systems andproceduresfor VAT withholding will be adaptedto include importers andmajor local distributors. In addition, an internet service portal will be implementedand distributedto voluntary taxpayers to improve income tax withholding. Finally, the new information system will allow for greater control in the collectionof taxes. On the organizational side, SAT will implementa unit for control o f worldwide income, price transfers, and rules for capitalization, relativelymodern concepts intax legislation. 16 41. The SAT will continue with its plans to promote the use of electronic invoices to modernizeproceduresand enhance transparency. It is expectedthat the use of electronic invoices will reducethe cost o f filing and records maintenance. Inorder to simplify and reduce the transactions costs for taxpayers, SAT will implement an Integrated Tax Current Account system for the 300 largest taxpayers after the consolidation into a single data base of their tax records. For the small and medium size enterprises (SMEs), the SAT will implementan internet-basedportalto ease tax compliance. As a first step, the SAT will design and begin distribution o f a tax accounting software application 2009, on a pilot basis. Finally, the SAT will implementan alternative application to BANCASAT for submitting VAT and income tax declarations through the internet by August 2011. This system will not require a contract for use as does BANCASAT, aproprietary product ofthe banking system. 42. During 2008-2009 SAT has been implementing its Customs Management System (SAQB'E) in the main customs ports. The first selected facility was Puerto Barrios in which the system implementation started inSeptember2007. The second was Puerto Castilla inNovember 2008, the third was Puerto Quetzal in February 2009 (cargo management only), and the fourth, nearly completed, is the airport custom of Aeropuerto Aurora. With these, customs ports handling over 35 percent of total cargo traffic are covered by the system. Accordingto SAT staff the following customs are planned to follow during 2009: i)the custom border with Mexico, T e c b Umb 11, and ii)the custom border with El Salvador Pedro de Alvarado. By 2011,SAQB'E will have been expandedto at least 10 o f the major customs ports. Inaddition, as a means to harmonize the national customs legal framework with international and regional norms, the Government has proposed legal reforms to complement the international customs framework, including the Cbdigo Aduanero Uniforrne Centroarnericano(CAUCA) andits rules (RECAUCA) as well as measuresto strengthenenforcement. 43. The Treaty on Payment and Securities Systems of Central America and the Dominican Republic (Tratado sobre Sistemas de Pagos y de Liquidacidn de Valores de Centroamdrica y Repziblica Dominicana) was approved by Congress in August 2008 and came into effect on September 2008. In2003, the ConsejoMonetario Centroarnericano(SECMCA) beganwork with an IDB donation on a project towards strengtheningthe stability and cross-country harmonization of the regional payments system through the creation o f basic norms. A model law was initially drafted, but, since it was not a bindinginstrument, it was replaced by a Treaty, reflecting the contents o f the model law and aiming towards the legal and technical regulation of the regional systems. The Treaty, drawing on Spanish legislation, contains all basic rules on irrevocability o f orders, finality and protection of transfers and collateral from bankruptcy of a participant. As of today, it has been ratified by all central banks and approved by the Congress of El Salvador, Guatemala, Nicaragua and the Dominican Republic, but is pending inCostaRicaand Honduras. Inorder to fully implementthe Treaty, follow up activities at the country level include regulation establishing the requisites and processes for the recognition of the systemically important payment systems in Guatemala and the establishment of the related oversight functions of the central bank (both at early planning stages), while at the regional level other countries are currently concentrating inthe acquisition o f Large Value Transfer Systems or have only recently acquired such systems, with pending interoperability issues to be possibly resolved with SECMCA oversight. 17 D.PromotingFinancialMarket Stability, Deepening, and StrengtheningDebtMarkets Financial Market Stability 44. Current global financial conditions have increased the importance of financial sector reforms to reduce the economy's vulnerability to external and internal shocks and improve access to finance. The SIB i s continuously improving its supervisory capacity, including consolidated supervision and an evolution towards a more balanced, less compliance oriented, risk focused approach to supervision. To implement the new risk-based supervision approach, a new manual on risk-based and consolidated supervision i s being implemented(supported by IDB-FOMINfunding and Bank technical support), in line with recommendations from the joint IMF-WB FSAP Update 2005- 2006. The new manual allows the SIB to evaluate and follow up the financial and non-financial risks that apply to the supervised entities before they affect their financial and operative situation. Based on the risk profiles (liquidity, interest rate, credit, operational and market risks) o f the supervised institutions, the SIB can determine the level of supervision and the strategies that need to be applied commensuratewiththeir vulnerabilities or exposurelevel. Box 3. Amendments to the BankingLaw to be Submitted to Congress The authorities are planningto submit to Congressby end June 2009 amendmentsto the Banking Law that will strengthen the system's regulation and supervision and are in line with FSAP recommendations. Key provisions of the draft amendments include: (i)reducing risks from offshore operations by limiting retail operations, eliminating the obligation o f the offshore's domestic partner to cover capital deficiencies, and cooperating closely with home supervisors to ensure corrective action o f solvency concerns; (ii) reducing connected lending, by setting a limit to the aggregate exposure with connected parties; (iii)enhancing enforcement powers o f the Superintendency by allowing the supervisor to request corrective action (Le. limits to dividend distribution) when bank solvency is threatened; and (iv) strengthening the instruments and size o f the banking sector safety net, including giving the central bank larger room for lender o f last resort functions and increasing the deposit insurance premium. To improve resolution procedures, the authorities will propose additional options for the transfer o f assets of failed banks, quick licensing o f top-rated foreign institutions to participate in resolution, and possibly, allowing the bank recapitalization fund to supplement capitalization o f banks by the private sector, should the need arise. 45. The SIB is makingsubstantialprogresson evaluating systemic risks. The 2006/2007 failure o f two banks, although successfully resolved, pointed to remaining vulnerabilities in the sector and prompted the financial authorities to strengthen the regulation of financial conglomerates and accelerate the transition to a risk-based consolidated supervision approach. As o f March 2009, SIB has completed the supervision o f the majority of risk profiles (liquidity, credit, market and partially the operational profile) on 4 financial groups, representing about 70% o f the financial groups by assets, and another group is close to completion. The SIB expects to complete the supervision of all the risk profiles for all the financial groups intwo years. Also, a new unit has been established in the SIB to undertake supervision on a "horizontal" basis (i.e. across different financial groups, compared to the "vertical" supervision within financial groups), beginning with one risk profile for the 100 largest borrowers in the system. Other improvements include work to strengthen the legal and regulatory 18 framework (with amendments on the banking law expected to be presented to Congress for approval by June 2009, see Box 3), extension of prudential rules, including on credit risk limits, to offshore banks, and supervision ofpayment systems and liquidity management. It is noteworthy that since mid- 2008, staff of the SIB i s permanently inthe field, implementing a strategy o f continuous supervision to anticipate risks and ensure prompt corrective action if needed. An important challenge remains the development o fregulation to foster non-banking sectors. IncreasingAccess to Finance 46. Policy interventions designed to modernize the regulatory framework for deepening financial markets and modernization of the payments system remain a priority of the Government. These include the standardization o f the Central Bank's debt instruments and regular issuanceto help develop an interest rate yield curve. A stable yield curve will help guidethe market to accurately judge risk and price debt instruments. Also, banks and financial institutions are now required to report to the Central Bank financial terms of trading operations related to certificates of deposit (CDs) and Government bonds, and this information is consolidated and published in the Central Bank's internet site to enhance transparency and the development o f secondary securities markets. Progress related to the payments systems continued to take place, including regulatory changes for reducing operational risks o f the electronic clearing house for checks (ACH, "Cdmara de Compensacibn Bancaria") an electronic network for financial transactions-in a joint effort by the Central Bank and the Stock Exchange-and regulations for the automated clearing house (Cdmaru de Compensacibn Automatizada, CCA), to be managed and operated by the Bank Association and is expectedto follow the international standards for ACH. ~ 47. The Movable Property Guaranties Law (Ley de Garantias Mobiliarias) aims to unlock access to credit for enterprises, especially MSMEs. This legislation was approved by Congress in the form of two laws, approved in October 2007 and September 2008 to provide firms with the possibility o f usingmovable assets as collateral while retaining possession. Guarantees on bank loans so far have been mostly fiduciary, counting for 47 percent of the total inMarch 2009, with another 24 percent being real estate and 5 percent a mixture of fiduciaryheal estate. Greater acceptance of movable collateral by financial institutions will help unlock access to credit for enterprises, especially micro small enterprises. While large firms can generally offer real estate as collateral, smaller companies have lower collateral as a percentage of loan value, which consists more commonly of movable assets. The law effectively gives small business owners more access to credit by makingthe guarantees required by banks more flexible. Intangible assets such as commercial patents and other intellectual property are acceptable when requesting a non-fiduciary loan. Also, business owners are able to use hture yields, shipment guarantees, and livestock, among other things, to leverage loans. One of the benefits of the law is that it standardizes assets, which, untilthe legislationwas passed, had been treated in different ways by diverse institutions and legislations. The new legal framework has also enabled the creation of the Registry of Non-Real-Estate Assets (Registro de Garantias Mobiliarias) in the Ministry o f Economy, which has been active since January 2009, though still consolidating its role in the sector. To further foster credit growth and increase the efficiency of collateral, work could include the strengthening o f creditor rights, insolvency proceedings and extra judicial restructurings. 48. The Law on Electronic Communications and Signatures (Ley para el Reconocimiento de las Comunicacionesy Firmus Electrbnicas)will facilitate e-commerce and electronic transactions. Itwas approvedbyCongressinAugust 2008 andcame into effect on October 2008. The Law enhances legal certainty in electronic communications, provides legal clarity to existing digital certificate use 19 and facilitates e-commerce (for example opening up new possibilities for the Government e- procurement system Guatecompras). Initially, only the Cdrnara de Comercio de Guatemala (GCC) will be issuing the certificates for the electronic representation and confirmation o f the identity o f individuals and SMEs, while more providers of certification services are expected soon, including the Central Bank for Large Value Transfer Systems certification. The Law mirrors the three main texts recently elaborated by the UN Commission on International Trade Law (UNCITRAL) on electronic commerce. It is consistent with international standards and best practice and, to some extent, goes beyond the international texts that are constrained by their inherent scope. In line with international best practice, it contemplates, for instance, a differentiated legal treatment for simple vs. advanced electronic signatures. The use o f advanced electronic signatures is better protected from forgery and may be endorsed by a certification authority, therefore giving it wider evidentiary scope. Inthe same vein, the Law regulates the providers o f certification services by submitting them to strict requirements. Finally, it takes into consideration consumer protection issues and establishes separate treatment for a number o f electronic commerce activities. The related regulation will be published by April 2009, with the approval o f providers o f certification services expected by the end o f the year. Additional measures, still at a preliminary stage, include a planto review the framework for creditors' rightsandbankruptcyproceedings inorder to facilitate the restructuring o fcompanies under stress. Deepeningthe Marketfor Credit 49. The Central Bank implemented reforms that contribute to market development of an interest rateyield curveand developmentof the secondary marketfor public debt. Inaddition to standardizing short term Certificates o f Deposit and shifting to electronic issuance o f 7-day CDs, the Central Bank has permitted a broad participation in the weekly auction by investors o f the financial sector, the private non-financial sector and the public sector, thereby promoting greater competition and lowering costs. It has promoted a more efficient rep0 market by migrating from Exchange transactions to OTM transactions. Banks are now transferring information to the central bank on repos, CDs and government bond transactions, both inthe exchange and out o f the exchange, on a daily basis. The central bank is consolidating and publishing on its internet site the information o f interbank transactions inthe securities secondary market. 50. The Ministry of Finance (MoF) has also undertaken reforms which strengthen the developmentof the domestic debt market. MoF currently issues once a week inthe primarymarket (instead o f twice a week); the continuous issuance by both entities in the past meant banks were less inclined to provide short-term loans to each other, to the detriment o f money market development. In addition, MoF maintained a presence in the market during most o f 2008, while in previous years it concentrated its issuance program inthe first half o f the year, leaving the market with no reference for long-term rates in the second semester. In addition, MoF introduced bond issuance in medium-term maturities-namely, 3, 5, 7 and 10 years-an important progress from having a small short-term issuance and a concentration o f long-term maturities o f 8, 10, 12 and more than 20 years. Furthermore, MoF reduced time from transaction to settlement in bond auctions from T+2 to T+1, and updated the legal framework inNovember 2008 for MoF to issue electronic securities. The ultimate aim i s to have completely electronically issued debt instruments, but this will take time. Currently the MoF issues both electronically and in paper form, which impedes fungibility and creates disincentives for the development o f the secondary market liquidity. The Central Bank's 7-day CDs are now all electronically issued, but CDs with longer maturities can have either characteristic, according to the investor's preference. 20 51. The Ministry of Financehas carried out reformsstrengtheningpublic debt management. It formalized a "Debt Management Strategy", approved by the Finance Minister in November 2008, which lays out general guidelines for public debt risk management. It initiated restructuring of the Directorate of Public Credit, along the lines of a front, middle and back office structure. Finally, it strengthenedthe back office's IT systems and links withthe Central Bankplatformon domestic debt. IV.THEPROPOSEDLOAN A. Linksto the CountryPartnershipStrategy 52. The proposed SFI DPL builds on the progress made under the first DPL in the Programmatic Fiscaland InstitutionalDPL series and supports key developmentpolicy actions of the Guatemala Country Partnership Strategy FY09-12, which was presented to the World BankExecutiveBoardfor discussion on September 23,2008. The Guatemala CPS is aligned with the Government's development plan and supports the Government's commitment to make growth more inclusive andto address the country's highlevels o f poverty and inequality. The CPS proposed a total lending envelope of US$970 million over the fiscal years 2009-2012, o f which US$470 million would be investment lending and a CAT DDO operation to manage the risk o f natural disasters. The remaining $500 million would be inthe form of budget support through a programmatic DPL series o f which the SFI DPL i s the second operation. Each operation in the programmatic DPL series i s a single-tranche loan. 53. The design of the DPL series is closely alignedwith the Government's own prioritiesand detailed sectoral plans, and draws on the Bank's analyses of key issues and desirable policy directions through the country and regionalanalyticalwork, including:the Guatemala Poverty Assessment, CEM, Central America and Guatemala ICAs, DR-CAFTA study, PER, FSAP,. CFAA and CPAR. Within this framework, it focuses on policy and institutional aspects related to inclusive growth andpoverty reduction that are most amenableto support via a programof loans. The DPL series is also designed to complement, from a policy and institutional standpoint, the ongoing investment lending program within the CPS. This includes ongoing investment lending for the SIAF and Financial Sector projects, as well as new operations supporting Expanding Opportunities for the Poor and Enhancing Productivity. Table 6 below outlines the CPS program objectives and selected areas o f action. Bolded items in this table are areas supported under the DPL programmatic series. Also, Table 7 outlines the DPL program outcomes and illustrates the close congruence between program outcomes and key CPS outcomes. The Government's policy actions to be supported by the programmatic series are outlined inthe policy matrix inAnnex 3. 54. The focus of the SFI DPL is on deepeningthe medium- and long-term structuralreform program contained in the Government's developmentplan, as well as near-term measures that are critical to mitigating the impact of the global crisis. In response to the global crisis and economic slowdown, the Government has adjusted its reform program to reflect additional actions and priorities, including reforms to increase access to finance and address financial sector stability, while other actions anticipated by the Government prior to the crisis, particularly implementation of reforms to modernize the tax system and boost tax collections, have been delayed. Table 8 below shows the original triggers for the SFI DPL anticipated inthe First Fiscaland InstitutionalDPL, how the program has changed, andcomments onprogressmadeto date. 21 Table6: CPSProgramObjectivesand Select Areas of Action Broad objectives to which the CPS will contribute Enhance Fundamentals Promote SustainableGrowth Expand Opportunities (Macroeconomic Stability and and Productivity (Expanding Opportunitiesfor Fiscal Reform, Governanceand (ImprovingtheInvestment VulnerableGroups, Education, Transparency) Climate, Rural Development and Health) Productivity, SustainableEnergy, Risk Management) SelectedProgramsand Areas of Support* 0 Maintain fiscal space for 0Enhanceinvestment climatein 0 Support design and targeting priority publicspending the context DR-CAFTA and for new CCT program 0 Strengthenintegrated public regionalintegration 0 Developmonitoring and financial managementand tax 0Promote SME access to evaluation framework for administration financeand deepen micro- effectiveand transparent CCT 0 Strengthensupervision and finance market program risk managementof financial Promote development o f eco- Improve access to and quality o f system tourism industry basic health and education 0 Reduce opportunitiesfor 0Improve quality and access to services, especially among rural corruption water, sanitation, housing and and indigenous populations. 0 Enhance transparencyand roads 0 Mitigate impact on poor o f high efficiency of publicspending Promote Public Private fuel and food prices 0 Improve decentralized Alliances monitoringand evaluationand homote rural productivity and resultsbased budgeting expansion o f economic 0 Improve access to justice and opportunities provide opportunities for youth Support development o f hydroelectric and alternative energy sources 0Manage the risk o fnatural disasters Cross-cuttingthemes Facilitate discussion among country stakeholders on reform priorities (fiscal reform to maintain fiscal space, governance and the anti-corruption agenda); and strengthen institutionalcapacity for improved monitoringand evaluationof public expenditures. Note: *Bolded items are supported within the programmatic Fiscal and Institutional DPL series. 55. The long-termstructuralreform program emphasizes promotingfiscal space for priority spending, governance and transparency of public expenditures,improvedexecutiontargeting of socialspendingand sustainablegrowth and productivity. The programaddresses three critical and interrelated development challenges inGuatemala. 0 First, the need for increasedtargeted social spending and investment to improvegrowth and reducepovertyandinequality. As mentioned earlier, analytical work suggests that while economic growth is critical, focusing on this solely is unlikely to be sufficient to achieve the country's medium-term poverty reductiontargets. 0 Second, the importance of fiscal transparency and maintaining and promoting greater fiscal space to fund increased targeted social expenditures. Government revenues are modest compared to other similar income countries and in order to maintain Guatemala's sustainable fiscal stance while expanding social programs, further deepening of fiscal reforms is key. Inthe context of challenges posed by the global crisis, this entails mitigating the near- 22 term impact of the slowdown on fiscal revenues. The Government's flexible and consultative approach to reform implementation and the facilitation o f dialogue on fiscal actions among country stakeholders should helpto inform the populationon the economic trade-offs. Indoing so, it is attempting to build a focus on social needs, their costs and the revenue requirements of meetingthem, while also pursuingcomplementary fiscal actions, mainly to enhancecontrol and transparency inthe use o fpublic finances. Table7: DPL Series Contributesto ExpectedCPS Outcomes LA PromoteMacroeconomicStability and Maintain FiscalSpace for Priority Programs I.A.l Maintain Central Government fiscal deficit does not rise The fiscal deficit does not rise above FiscalSpace for above 2.8 percent in2010, as priority social 2.2 percent o f GDP, on average, for the Priority Spending spending increases, inthe context o f the global CPS period as priority social spending crisis and growth slow-down. (Baseline 1.7 increases. (Baseline: 1.8percent, in percent, in 2008) 2007) Fiscal reform measuresmitigate the impact o fthe crisis so that Central Government tax collections Fiscal reform implementation do not fall below 10.4 percent o f GDP in2010. contributes to additional revenues so (Baseline: II.3percent in 2008) that tax collection as a share o fGDP rises to 13.2 percent. (Baseline:I2.3 percent in 2007) I.A.2 Promote Consolidated supervision has beencompleted inat Improvements inthe supervision o f FinancialMarket least halfo fthe financial groups by assets and financial conglomerates including: Stability and regular supervision completed for all four risk completed implementation o f enhanced Deepening, profilesunderthe new risk manual. (Baseline: 0 supervision or regular supervision o f Strengthen Debt percent in 2007) the majority o frisk profiles underthe Markets, and new risk manual. Consolidated Improve Access to Regular issuance by MoF startingthe second half supervision completed inat least halfo f Finance o f 2008. (Baseline: Only irregular and sporadic the financial groups by assets. issuance by MoF in 2007) (Baseline: 0) Three percent financing volume increase generated with the use o f Garantias Mobiliarias. (Baseline: 0 percent in 2008) Transparency I.B.1 Enhanced MinistryofFinanceandGeneralAuditor's Office Enhanced transparency and governance Governance and using annualaudits andmonthly financial and inthepublic sectorthrough (a) Transparency execution reports from at least ninety percent o f sustained strengthening o f public the public trust funds to improve oversight, financial management and procurement management, and efficiency o f public trust finds. and (b) enhanced efficiency and (Baseline: 0, 2008) capacity o fpublic control institutions Specialized offices to facilitate accessto public by the use o fthe Government Audit I I informationhave been established inat least 30 System ina majority o f control entities. percent o f Central Government agencies. (Baseline: 0, 2008) 23 11. ExpandingOpportunitiesfor VulnerableGroups(Linkedto CPSObjectiveZI: ExpandingOpportunities) 11.1 Improved Co-responsibilities verified for 50 percent o fthe Reduced inequality intargeted Executionand CCT beneficiaries, half o fwhich are extreme poor, municipalities through: (a) Increased Targetingof based on a framework for monitoring and Gross Completion Rates inprimary SocialSpending evaluation. (Baseline: 0 in August 2008) school by at least 10percentage points (b) Improved access to public services to meet basic needs in 15 percent o f targeted municipalities inat least one o f the following areas: water & sanitation, housing, accessto electricity. 111. SustainableGrowth and Productivity(Linked to CPSObjectiveIIZ, DromoteSustainableGrowthand Productivity) 111.1 Tax declarations submitted through the Internet The SAT has expanded coverage o f Simplificationof have increased by 3 percentage points. (Baseline: SAQB'E systemand initiated the I S 0 tax and customs 34percent in 2007) 9000 certification inone large product administrationfor category. (Baseline: SAQB 'E in I improving Customs times for clearance and release o f majorport, Puerto Barrios) businessefficiency exportedimported goods has declined by 5 percent. (Baseline: Timeto export 19 days, time to import 18 days in 2007; Doing Business Report, 2008) *Note: CPS expecte outcomes are subject to change inthe CPS Progress .eport. 0 And third, the crucial role of improved governance and effective monitoring and evaluation of social spending to generate confidence and political support for reforms and help to ensure that increased spending is executed efficiently. While many stakeholders in Guatemala recognize that there is a need to expand social spending and investment, there are relevant concerns that such spending be efficient and well monitored. The Bank has been working with the Government and other institutions, including the Instituto Centroamericano de Estudios Fiscales (ICEFI, a regional think-tankspecialized on fiscal policy issues), to help provide information for an informed debate on fiscal policy challenges inGuatemala. 24 e B. Collaborationwith the IMFandother ExternalPartners 56. TheBankcontinues to work closelywith otherIFIsinGuatemala.The BankandIDB are coordinating support for monitoring and evaluation of the Mi Familia Progresa CCT program, as well as tax administration support. The Bank i s also i s continuing to work closely with the IMF on macroeconomic monitoring, financial sector stability issues, and tax administration reforms. Collaboration with the IMF has been particularly close inthe context o f preparingthe assessment ofthe macroeconomic framework inthis document. 57. The Bank team has consulted with both the IMF and the IDB during the preparation of this operation. Consultation with the IMF has been particularly close in the context o f carrying out the Debt Sustainability Analysis summarized in Annex 6 and in the assessment of macroeconomic and financial risks. 58. This DPL is part of broader IF1financing arrangementswith Guatemala. The SFI DPL complements programs of other International Financial Institutions (IFIs) that aim to mitigate liquidity risks during the global economic crisis, particularly the IMF's precautionary Standby Arrangement for Guatemala (US$935 million approved on April 22 2009). Financing provided by IFIs in the context of the global crisis i s key for the Government's efforts to maintain poverty reduction and social protection programs. C. Relationshipto Other BankOperations 59. This loanis the secondoperation inthe Programmatic Fiscal andInstitutionalDPL series. Complementary bank operations include ongoing investment lendingsuch as the Integrated Financial Management I11- Technical Assistance Project (which supports SIAF and has been extended until FY201l), Financial Sector Technical Assistance Loan (which is closing at the the end of FY2009), and Expanding Opportunities for Vulnerable Groups (which is scheduled to go to the Board inFY2010). Inaddition, a CAT-DDO was approved on April 14,2009, and is a key component o f the Government's risk management strategy given Guatemala's exposure to potential natural disasters. This operation also draws on lessons learned from the ongoing Financial Crisis Preparedness Program and Financial Modeling Project (non-lending technical assistancescheduledfor delivery at the end of FY2009). D.AnalyticalUnderpinnings 60. The DPL series is underpinned by the substantial body of analyticalwork carried out by the Bankinpartnershipwith the Governmentof Guatemala(See Table 9),the design o f key prior actions, triggers and indicators for DPL Isupports progress in each o f the above three main areas. The primary analytical underpinnings, policy objectives, and development constraints indentified are highly relevant to the country and have informed the design of the DPL programmatic work. 30 Table9: Linksbetweenthe proposedDPL-DDOandPriorAnalytical Work A. AnalyticalReports-Recommendations Links to DPL actions Poverty 1. Improving economic growth is criticalto reducingpoverty, but growth alone I1 Study (2008) is unlikely to be sufficient to achieve targets in lowering poverty and inequality inthemedium-term A CCT program couldplay animportant role inan integrated poverty reduction strategy inGuatemala. Improving the pro-poor targetinginthe context o fthe CCT program is a central component o fthe Government's program to reduce inequality. 2. Inthe wake o fthe DR-CAFTA and an era that presents Guatemala with 111.1 opportunities to deepenthe progress achieved inthe last few years, the country should benefit fiom improving its competitiveness by reducing business constraints and setting conditions for development and broad-basedjobs creation. Investment 1. Improve competitiveness to maximize exports andinvestment inlight o f 111.1 Climate DR-CAFTA. Based on enterprise surveys and consultations with the Assessment businesses, streamlining tax-administration and customs procedures is a key (2008) component to improvingthe business climate. 2. Strengthen governance (especially corruption and crime control). I.B.l& Increasingconfidence ingovernment expenditure decisions and reducing costs I.B.2 to crime control would improve the investment climate. 3. Improvement intax administration, particularly inmodernizing the tax 111.16% system, customs controls, and reducing avenues for tax evasion, could be I.A.l further strengthened after the reforms o f 2006 and2007. 4. Increase accessto a broader menu o f financial services. I.A.2 Country 1. Consolidate macroeconomic growth, while improving fiscal discipline and I.A.1 Economic strengthening the tax base. Memorandu 2. Improve investment climate by simplifyingregulations. 111.1 m (2005) 3. Reforms that improve overall access to credit (legislation relatedto non- I.A.2 bankfinancial intermediaries and securedtransactions.) 4. A critical component o f reducingpoverty and inequality is to promote 11.1 progressive public spending, esp. human capital and rural infiastructure. Public 1. Improve and increase level o f public spendingthrough fiscal savings I.A.l& Expenditure generated by greater efficiency gains and increased taxation. I.B.2 Review 2. Foster effectiveness o fpublic spending inpriority sectors like health, 11.1 (updated education andhousing. March 2007) 3. Enhancemunicipal capacity to provide basic services, especially through I.B.2 higher localtax collection andincreased accountability. Financial 1.Improveconsolidated supervision andregulation ofthe bankingsector to I.A.2 Sector enhance capital adequacy and access to finance. Assessment Program Update (2006) B. FiduciaryReports-Recommendations Links to DPL actions Country 1. Continue expanding the integrated fmancial management system (SIAF) to I.B.l & Fiduciary decentralized agencies and municipalities. I.B.2 Assessment 2. Continue expanding use o fthe procurement information system (CFANCPA (Guatecompras), under a comprehensive strategic plan for e-procurement. R, updated 3. Enhance quality of budget and fiscal reporting, and compliance with rules for March 2007) budget execution accounting. 4. Continue enhancing transparency o fmunicipal fiscal information. 31 A. AnalyticalReports-Recommendations Links to DPL actions Country 5. Strengthen the Government procurement policy and oversight functions, and Fiduciary modernize implementation tools. Assessment 6. Prepare andexecute action plansto addressresults o f institutional (CFANCPA assessments o f internal controls. R, updated 7. Strengthen the external audit function with, inter alia, effective use o fthe March 2007) Government auditing system (SAG) inplanningand execution of fmancial audits. E.LessonsLearnedFromPriorOperations 61. The Guatemala CAS FY05-08 Completion Report (FY09) concluded that "The move towards programmaticDPL lendingprovedsuccessful." While results insome areas of DPL support were less than expected, particularly in the area o f fiscal reform and increased social spending, the report found that the implementation o f the programmatic lending series (three DPL operations) contributed towards many CAS outcomes. First, these operations helped maintain continuous country dialogue and provided technical support around key priorities. Second, as part o f DPL activities, the Bank informedthe international community on progress on stabilizing the economy and Peace Accords goals that remain areas o f international interest. Lastly, the DPL served as a conduit for two-way communication between the Government and international community onthe country's development strategy andprogress on policy reforms. 62. It was also concluded that, if amenable to the Government, the DPL structure should be continued. The report recommended that the positive DPL experience indicated retaining this instrument with a manageable agenda to avoid program overload. The focus on key priorities should be kept infurther operations andbe complemented by support to improve public project evaluation in line with ongoing efforts to introduce results-based budgeting. The importance of coordinating DPL budget support operations with the presentation o f the national budget to Congress was also noted as important for enhancing internal dialogue on Bank supportedgovernment policies. 63. These lessons have shaped the design of the Fiscal and Institutional DPL series. First, program components have been kept to a manageable number and have focused on government priorities, including results-based budgeting. Second, the DPL is supporting government actions in developing a broad consensus on critical reform areas, particularly inthe highly contentious area o f fiscal reform. An important lessonthat emerged from the First Fiscal and InstitutionalDPL was the key role played in Guatemalaby effective consensus-building and the support provided to this process by well-targeted AAA-work. This cross-sectoral collaboration remains a part of the SFI DPL and has also been highly effective in developing a strong and internally coherent program. Finally, the DPL series will continue to be coordinated with the Government's budget submission to Congress, and, as such, supported policies will be discussedopenly to increaselegislative engagement. 32 F.Povertyand SocialImpactsandCountryConsultations 64. The actions supported by this DPL are likely to have positive social and poverty impacts particularly for the indigenous and rural poor. To the extent that the measures supported by the DPL series will play a role inGovernment's ability to enhance social spending levels, their impact on income distribution, particularly for the indigenous and rural poor, i s likely to be positive. This is confirmed by public expenditure incidence analysis undertaken in the context of the Poverty Assessment which indicates that public social expenditures (Peace Accords definition) are generally pro-poor. Likewise, the distributive impact of fiscal reforms supportedby the DPL series is likely to be mildlyprogressive. 65. The Mi Familia Progresa CCT program, and its enhanced monitoring and evaluation as supported by the SFI DPL, are expected to have a positive impact on reducing poverty while keepingcosts low. Estimates from the Guatemala Poverty Assessment (2008) suggest that a proxy-means targeted CCT program can reduce extreme poverty by 24 percent. Targeting can (i) reduce the leakage o f the program, by improving the ability of the Government to identify the target population, (ii) costs and (iii)maximize poverty reduce reduction per unit cost. For example, the use of a proxy means test lowers costs from 2.33 percent o f GDPto 0.53 percent and reduces leakagesby almost half. 66. The DPL series has been developed within the framework of the country's development plan and the CPS, which was widely consulted and disseminatedwithin the country. Specific laws, institutional reforms and programmatic actions supported by the loan series were also discussedwidely with different groups, including civil society organizations, the private sector and the research and academic community. In particular, the Government has consulted intensively with country stakeholders, including members o f Congress, on fiscal reformproposals-including participation inlocalpublic fora.' 67. The Bank is also providingongoing support for civil society activities to help build capacity to evaluate government information, increase transparency, and build public sector accountability. The Bank has been working closely with the Government and donor groups (e.g., Grupo de Dialog0 (G-13), which includes the main bilateral donors as well as the WB, IDB, UN and European Union) on enhancing governance, as well as supporting various dialogues on social auditing with a range of civil society organizations including: Coalicibnpor la Transparencia (a group of CSOs engaged in social auditing in Guatemala including Accibn Ciudadana (the national chapter of Transparency International), CIEN (a domestic think tank), and the Guatemala Chamber of Commerce. Guatemala was selected as a C-GAC (Country- Governance and Anti-Corruption) pilot country, and the Bank is providing full support to this agenda. In addition, the World Bank Institute (WBI) is supporting a regional initiative to strengthen social auditing in Central America, which is being supported by the DPL team as complement to other consultation activities. This initiative intends not just to share the experiences, but to build a regional network formed by national civil society groups involved with public expenditure monitoring as a way to strengthenthe groups' work in their respective countries. * For example, on August 21, 2008 the Government participated in a public event organized by ICEFI (Central American Institute of Fiscal Studies) on the fiscal challenges of Guatemala and experiences of neighboring countries. 33 Box 4: GoodPracticePrincipleson Conditionality Principle1:Reinforce Ownership The operation was developed within the objectives of the 1996 Peace Accords and the Colom Government's development plan, which establishes clear priorities developed through wide consultationwith stakeholdersand broader civil society. The priority legislative agenda is developed in consultation with the Congressional leadership on an ongoing basis. Bank support focuses on promoting enhanced capacity and fiscal space for increased public spending in priority sectors, improving public governance, transparency and expenditure management, and promoting sustainable growth and productivity. These focus areas haveall benefitedfrom broad political support. The DPL series i s strongly underpinned by prior analytical and fiduciary work, including the Poverty Assessment (2008), InvestmentClimate Assessment (2008), Country Economic Memorandum (2005), Public Expenditure Review Update (2007), the regional DR-CAFTA study (2005), CFMCPAR Update(2007) and Financial Sector Assessment ProgramUpdate(2007). Principle 2: Agree upfront with the Government and otherfinancial partners on a coordinated accountabilityframework The Bank's support is summarizedin a brief and focusedpolicy matrix. Currently, only the Bank and the IDB are providing budget support to Guatemala. These institutions draw on the country's developmentplan, thereby ensuring coordination amongthem and consistency of support. They have also supported enhanced public financial management, progress in social sector expenditures, and improved competitiveness. Principle 3: Customize the accountabilityframework and modalities of Bank support to country circumstances In addition to supporting the Government's development of its integrated financial management system (SIAF) and e-procurement system, the Bank is also providing support for capacity building activities to evaluate government information, increase transparency, and build public sector accountability. The Bank has been working closely with the Government and donor groups (e.g., Grupo de Dialogo (G-13), which includesthe main bilateral donors as well as the WB, IDB,UN, IMF and European Union) on enhancing governance, as well as supporting various dialogues on social auditing with a range of civil society organizations. Guatemala was selected as a C-GAC (Country- Governance and Anti-Corruption) pilot country, and the Bank is providing full support to this agenda, including some aspects ofthe monitoring and evaluationassistance relatedto the CCT program. Principle4: Chooseon& actions criticalfor achievingresults as conditionsfor disbursement The Bank's policy matrix uses a limited set of main prior actions (10). They address key development policies including actions in promoting fiscal and institutional development to enhance growth and reducepoverty and inequality. Principle5: Conducttransparentprogress reviews conducive topredictable andperformance-based financial support As agreed with the Government, this programmaticDPL series consists of three operations, timed to the country's budget cycle, with each operation evaluatedand monitored for results. Monitoring and evaluation of the program will take place within the Government's own processes. Subject to satisfactory overall program implementation, this process allows for a predictablerelease of tranches during each fiscal year, allowing incorporation of financing into the subsequent year's budget. The policy matrix contains a range of outcome indicators (1l), which are assessed as part of the operation implementationand are closely linked to the supportedpolicy actions. 34 G.EnvironmentalAspects Box 5. GuatemalaCountryEnvironmentalAnalysis -Findingsand NewDevelopments Guatemala has made important efforts to ensure the long-term sustainability o f the country's development program through the systematic attention to environmental issues. This approach was strengthened under the recent Central American Presidents' Summit on climate change (May 2008), which set principles for the sustainable development agenda in the region. Despite some institutional and legal improvements, Guatemala still faces considerable environmental challenges, including: (a) over-exploitation of water resources; (b) water pollution; (c) deforestation; (d) soil and land degradation; and (e) vulnerability to natural disasters. Given the new opportunities facing the country with the signing o f DR-CAFTA and the proposed scaling-up o f infrastructure investments, there i s a need to acceleratethe consolidation of institutional and organizational tasks inGuatemala. Underthe MinistryofEnvironment andNatural Resources' (MARN)leadership, the new administration is focusing its environmental agenda in four areas: (a) ecological debt, (b) environmentaljustice, (c) natural freedom, and (d) bioethics. The CEA report concluded that if MARN concentrates on its core functions, such as the planning and application of environmental policy and enforcement o f environmental regulation, while working incoordination with other environmental agencies, ministries, and municipalities, most of these challenges can be met in a short period o f time with minor adjustments to the existing framework o f environmental management. Three important issues that need to be addressed are: (a) the establishment o f a cohesive and coordinated environmental framework, (b) an improvement inthe effectiveness and efficiency of the Environmental Impact Assessment system (EIA), while introducingthe use of other tools (i.e. Strategic EnvironmentalAnalysis); and finally (c) promotion of compliance with environmental law. Since the broad dissemination o f the CEA, positive developments have occurred in the previous andcurrent administration, including: (a) the approval o fthe National EnvironmentalPolicy by the cabinet and the President (that is currently in implementation and subject to expand its scope); (b) the initial supplementary allocation of Q5 million to MARNinthe previous administration and the pledge of additional Q l O million for 2009; (c) the expansion and consolidation o f initiatives, such as environmental laboratories with two mobile units (the use of these vehicles can be expanded, with a possible further expansion to the rest o fthe Central American region); (d) establishment o f a donor roundtable on environmental issues led by MARN, which i s seeking to prioritize and harmonize environmental initiatives, guided in part by the priorities established in the CEA; and (e) the establishment o f an environmental and social cabinet with the participation o f the civil society, and the private and public sectors. At the institutional level, the GoG is evaluating the possibility o f consolidating the Meteorology Institute (INSIWMEH)and the National Geographic Institute(IGN) with MARN. The CEA report also emphasizes the need to provide a more flexible and efficient regulation, that will nevertheless provide strong incentives for polluters to change their behavior (the GoG i s focusing its efforts on working with private sector-managed mining companies (gold, coal) and hydroelectric plants). Market-based instruments, such as pollution taxeskharges, could be introduced in a gradual manner, pending the implementation o f a reasonable and acceptable monitoring and enforcement mechanism. The right incentives would also include engaging civil society by improving information and public participation mechanisms. In the long term, deeper reforms to the legal framework for water and transparency are needed, but require longer periods o f maturation, consensus building, negotiations, and ultimately, congressional approval. 35 68. The specific policies supported by this DPL operation are not likely to entail negative effects on the environment, forests or other natural resources. However, to the extent that measures supported by the DPL program are successful, over time, in attracting new investment (including in infrastructure), there will be a need to strengthen Guatemala's national institutional capacity to identify and address environmental policy and regulatory issues. With this in mind, a Country Environmental Analysis (CEA) was undertaken in 2005-2006 (Box 5 above) and discussed with the Government. The CEA provides cost effective recommendations for closing gaps in institutional capacity for environmental regulation. As a first step, the CEA conclusions and recommendations helped to prepare the ground to obtain approval of the National Environmental Policy (Politica de Consewacibn, Proteccibn y Mejoramiento del Ambiente y 10s Recursos Naturales). The Government is continuing to update its National Environmental Policy and expects to undertake a Strategic Environmental Analysis with Bank support. H.MonitoringandEvaluation 69. The Ministry of Finance will play the primary role in coordinating monitoring and evaluation of program implementation. The Government and the Bank will take advantage o f severalimportant data sourcesto assess progressofthe DPL, including: 0 Central and nonfinancial public sector budget monitoring from the Ministryo f Finance 0 NationalInstitute for Statistics reports and annual tracking surveys e Investment climate surveys e Central Bank of Guatemalareports and analysis e Reviewsandanalyses of laws and implementing regulations by the Bank andother stakeholders 0 Data from key Government agenciessuch as SAT, PRONACOM andMinistryo f Economy 0 Financial audits and follow up of CPAR and CFAA recommendations 0 Bankand IDBsupervision missions andreports e IMF supervisionreports underits Standby Arrangement. e CEPAL and SIECA surveys. I.FiduciaryAspects 70. The 2007 Update of the Country Fiduciary Assessment (CFMCPAR) indicates that the fiduciary environment in Guatemala is adequate, as evidenced by the improvements in the public expenditure management systems made over the previous decade and the actions being taken by the Government to continue to increase transparency. While challenges remain, the current administration is moving ahead to strengthen its public fiduciary control framework further and has shown strong commitment to tackling fiduciary issues in many key areas identified by the Country Fiduciary Assessment. 36 Drawing from this ongoing effort, certain key actions and selective milestones in the context of the DPL program have been identified to help track the public financial management reform progress. The latter, in turn, are largely supported by the Bank-financed Third Integrated Financial Management Additional Financial Project under implementation. The foreign exchange control environment of the Central Bank i s adequate and, subsequent to the IMF Assessment Report (2002), external auditing is now in place and international foreign currency reserves are managedaccording to prudent international practice. J. LoanAdministration 71. The Bank would disburse the loan proceeds into an account of the central bank (BANGUAT) denominatedin US dollars. BANGUAT will immediately credit the disbursed amounts to the Ministry of Finance Treasury Single Account ("common fund"), thus becoming available to finance budgeted expenditures. Within a week of this finds transfer, the Ministry will accordingly provide the Bank with a written confirmation. The loan is to be a single-tranche operation. K.Risks 72. Programimplementationis subject to three main risks during the implementation of the DPL series: (i) political risks; (ii) stemmingfrom a further deepening o f the global risks crisis; and (iii) risks relatedto natural disasters. These are described below. 73. Political risk is inherent in Guatemala, where high income inequality has led to a polarizedsociety and electorate,and the Government lacks a simple majority in Congress. While the UNE has an important block o f congressional seats (38 out o f 158), the lack of a simple majority makes passage of deep reforms challenging, especially given that the political economy has historically been dominated by certain interests. Especially controversial is the tax reform agenda. This posesa risk for the DPLprogram implementation. Political as well as social tensions also arise in other controversial areas including, regional integration and rural development, which are crucial to accelerating growth, reducing poverty, and are part of the Government's agenda. Ongoing challenges with crime and violence and concerns over governancemay also slow progressonthe reform agenda. 74. The current administration's focus on social cohesion, transparency, and building strategic alliances to facilitate broad consensus is therefore especially pertinent in mitigatingthis risk. The Government's consultative approach to reform implementation and the facilitation o f dialogue on fiscal actions among country stakeholders should help to mitigate this risk, as evident from the success in replacing the IETAAP with the I S 0 business tax. It is also attempting to address the issue through shifting the focus o f the public dialogue to social needs, their costs and the revenue requirements of meeting them. The Bank is engaged in promoting dialogue with all relevant stakeholders on the development challenges o f the country, including the taxation issue, as a means to facilitate an informed debate on Guatemala's development needs. 75. Close on the heels of the food and fuel crisis, the global crisis has meant that Guatemala is entering a third difficult year plagued by external shocks. Guatemala, as a small, open economy, has been affected by the contraction in trade, investment, credit, and remittances bought about by the global crisis. The resulting slow-down in growth has led to a 37 sharp, cyclical downturninfiscal balances. A further deepeningof the crisis could slow program implementation if the fall in growth necessitates higher than currently foreseen increases in expenditure inthe context of falling revenue. 76. The Government has shown strong commitment to mitigate these risks. The Government has secured a precautionary Stand-by Arrangement from the IMF to provide a liquidity cushion should an unforeseenexternal financing gap arise. Additionally, the authorities have formulated a National Plan of Emergency and Recovery, which reaffirms that the measures being taken by the Government in response to the crisis are consistent with the long-run objective of sustainable growth and development. A broad-based committee has been formed, consisting o f the Central Bank President, Minister of Finance, prominent private sector participants and membersof civil society to monitor the economy on a highfiequency basis and direct policy actions, if needed, on a monthly basis. The Bank's ongoing macro-monitoring and country dialogue, in addition IMF quarterly reviews of the SBA, would allow identification of critical issuesshould any emerge. 77. Guatemala is also susceptible to external risks deriving from natural disasters. As with the other Central American countries, Guatemala is highly vulnerable to multiple natural disaster risks-floods, hurricanes and earthquakes-that pose a significant direct threat to economic growth and poverty reduction, as well as indirect threat by unanticipated spending for emergency assistance and reconstruction, thereby affecting achievement o f established development goals inthe short term. Experience with Tropical Storm Stan shows, however, that fiscal discipline has been a high priority for the country even in the face o f an emergency. Providing additional support to Government measures, the Bank is assisting with efforts to update and validate the National Program for Disaster Mitigation and Response. A Catastrophic Risk Deferred Draw-Down operation (CAT-DDO, approved April 2009) will also provide contingent financing in the event o f a natural disaster, and would be accompanied by implementation o f comprehensive disaster risk reduction measures. A non-lending technical assistance program, the Development of Scientific Information to Promote the Municipal Planning to Reduce Disaster Risks in FY08, has been continued through the Global Facility for Disaster Reduction and Recovery grants. 38 ANNEX 1:GOVERNMENTDEVELOPMENTTHEMES I.Solidarity 1. SocialDevelopment(includes ruraldevelopment,education, healthand nutrition): Generate employment, reduce poverty and ensure access to basic infrastructure and services, in keeping with the Peace Accords Agenda, the Agenda Nacional Compartida(National SharedAgenda) and the Millennium Development Goals. These objectives are to be reached through an integrated approach, which includes among others: actions to increase productivity and generate employment, expanding fiscal space, SME development, and increasing the effectiveness o f social spending through a targeted CCT program. In addition, large investments in school infrastructure are being implemented with strong donor support from Germany, Spain, and the IDB. 2. Municipal Development: Promote democratic principles and processes at the local level by strengtheningthe role ofthe municipality indevelopment and service provision through measures that facilitate citizen participation at the local level andthat increase municipal capacity. II.Governance 1. Security and Rule of Law: Consolidate rule of law and provide citizen security. Strengthen constitutional rights, fight corruption (for example, by providing citizens with the means and protection needed to denounce corrupt actions), strengthen institutions that provide citizen security and the penal system, support violence preventionprograms, etc. 2. Democratic Development: Promote the democratic development model by strengthening the role o f the state. Promote a true pluralistic political culture by strengthening representative democracy and supporting the modernization o f the party system, while increasing decentralization o f political processes. Promote the rights and development o f indigenous populations. 3. Legislative Policy: Enhanced legislative processes to provide security and citizen wellbeing. Actions under this area include capacity development for Congress, increasing transparency and informingcivil society about legislative activity (especially inthe social sphere). III.Productivity 1. Economic Development: Deepen and enhance conditions for sustainable economic growth that translate into fair economic development, job creation, higher salaries, and reduced poverty and inequality. Policies in this area include tourism and SME development, infrastructure, and agricultural modernization. 2. Risk Management and Natural Disaster Prevention: Mitigate and reduce human losses and physical damage originating from risks associated with natural disasters and, thus, create the conditions for sustainable development. A step to achieve this objective is the implementation o f an effective Natural Disaster Mitigationand Management Strategy. IV.Regionalism 1. RegionalIntegration: Develop a proactive, creative and autonomous foreign policy to position Guatemala in a leadership position within the region and promote a joint effort in areas o f common regional interests such as environment, energy, banking, customs and security. 39 ANNEX2: LETTEROFDEVELOPMENTPOLICY Seiiora Pamela Cox VicepresidentaparaAmerica Latinay El Caribe Banco Mundial Washington, D.C. Estados Unidosde America EstimadaSeiioraCox: El Gobierno de Guatemala presidido por el fngeniero Alvaro Colom Caballeros, ha fijado m n o una de sus principales metas promover el desarrollo economico sostenible y equitativo que responda a las necesidadesde toda la poblacion, pero en particular las de aquellos que viven en'situaci6nde extrema pobreza. En ese sentido, el compromiso de la actual Adrninistracion se centra en avanzar en el cumplimiento de 10s Acuerdos de Paz y en lasmetas establecidasdentro de 10s Objetivos del Milenio Con ese prop6sito, el Gobiernode la Republicade Guatemalaest6 implementandoun plan basado en cuatro programas estrategicos que son: i) Solidaridad; ii) Gobemabilidad; iii)Productividad; y, iv) Regionalidad En adici6n a este Plan, y a fin de contrarrestar 10s efectos de la desaceleraci6n de la econornla rnundial, el Gobierno ha formulado el Prograrna Nacional de Emergencia y Recuperacion Econbmica, el cual dentro de su Politica Financiera, contempla la gesti6n de recursos que permitan al pais hacer frente a choques extemos. La estrategia de asistencia acordada con el Banco Mundial para el period0 2009-2012, contempfa, entre otros, apoyar las acciones impulsadas por el Gobierno de Guatemala, a trave& del otorgamiento de Prbtamos Programaticos de Polltica Fiscal y Desarrollo Jnstitucional Desde la aprobaci6n del primer prestamopor partedel Banco, el Gobierno ha mostrado avances continuos en las areas clave definidas en la matriz de implementaci6n del Programa, raz6n por la cual se encuentra en capacidad de solicitar la negociacion y aprobacidn del Segundo Prhstamo, por un monto de US$3500 millones AI igual que la operacidn anterior, este prkstamo apoyarA 10s esfuerzos del Gobierno de Guatemala para incrementar el crecimiento, mejorar la gobernabilidad, reclucir la pobreza. profundizar 10s mercadosfinancieros, asi como mejorar la eficienciadel gasto publicoy transparencia de la adrninistraci6ndel sector publico 40 A continuacibnse detallan 10s principales avances registrados en dichas areas: 1. Promover la estabilidad macroecon6mica y mejorar el espacio fiscal para ProgramasPrioritarios a) Mantenerel espaciofiscal para priorizaciondel gasto, Un objetivo clave del Programa del actual Gobierno ha sido mantener unas finanzas pirblicas disciplinadas y ordenadas, que a la vez que coadyuvan al desarrollo y a la disminucion de la pobreza del pais, no comprometen su estabilidad macroecondmica con deficit fiscales elevados e insostenibles Las cifras preliminares disponibles muestran que 10s ingresos tributarios de 2008 superaron en 0 8% su meta presupuestaria, factor que incidio en que el resultado presupuestario acumulado mensual fuera un supedvit fiscal hasta agosto. Sin embargo, pese a exceder las previsiones presupuestarias, la carga tributaria en 2008 fue de 113%, menor al I 2 1%alcanzadoen 2007 Dentro de 10s faitor& que explican la caida en la carga tributaria destacan una desaceleracion importanteen la recaudacion d-el lmpuestoal Valor Agregado, resultado de una combination de eventos, incluyendo acumulacion de cr6dito fiscal en el sisterna de retenciones y una contraccidn en el consumo interno asociado a 10s efectos de la crisis econbmica mundial La contracci6n en el consumo afect6 tarnbien la recaudacion de 10s impuestos especificos o selectivos al consumo, particularmente sobre la distribuci6n de combustibles La recaudacibn aduanera mostro una merma importante, principalmente en el ultimotrimestredel atio En su compromiso de continuar mejorando la recaudacidn tributaria, este Ministerio Iogrd que el Congreso de la Republica aprobara por medio de Decreto 73-2008 la Ley para la implernentacion del lmpuesto de Solidaridad (ISO), el cual reemplaz6 al lmpuesto Extraordinarioy Temporal de Apoyo a 10s Acuerdos de Paz, cuya vigencia caduci, el 31 de diciembre de 2008. El IS0 permanecerhvigente en tanto se introducela modernizaci6ndel lmpuesto Sobre la Renta, contenido en la segunda etapa de la modernizackh fiscal contempladapor este Gobierno. En consonancia con las medidas adoptadas, y con el objeto de generar mayor captacibn de recursos, la Superintendencia de Administracion Tributaria (SAT), desarroll6 un software, denominado "RetenlSR", para la realizacion de las retenciones del lmpuesto Sobre la Renta (ISR) y del lmpuesto Sobre Prqductos Financieros (IPF), el cual les facilita a 10s contribuyentes y responsables el cumplimiento de .las obligaciones tributarias correspondientes, y mejora la capacidad de. la Administracidn Tributaria de verificar el cumplimiento de dichas obligaciones Este software es distribuido gratuitamente a traves del sitio Web de la SAT y tambien puede ser obtenida una copia del mismo en las oficinas y agenciastributariasde la SAT. 41 Desde su implementacion a finales del afio 2007, la utilizaci6n de este software fue optativa, per0 con fecha 6 de abril de 2009, se public6 en el Diario de Centroamerica el Acuerdo del Directorio de la SAT No. 5-2009, a traves del cual se aprueba la implementacionde "RetenISR. Asimismo, se establecesu us0 obligatorio a partir del 1de junio de 2009, para 10s bancos del sistema, comerciantes, personas individuales o juridicas, entes o patrimonios, que paguen, pongan a disposici6n o acrediten en cuenta a terceras personas, rentas sujetas a retencionconforme lo dispuesto en la Ley del lmpuesto Sobre la Renta o intereses de cualquier naturaleza, de conformidad con lo estipuladoen la Ley del lmpuesto Sobre Productos Financieros (IPF).. El us0 obligatorio de esta herramienta informhtica aumentarfr la capacidad de control de la SAT sobre el cumplimientode las retencionesdel ISR y del IPF. Adicionalmente y con miras a reducir la evasi6n tributaria en el pafs, la SAT ha realizado cruces masivos de informacibn con el objeto de detectar inconsistencias entre las ventas que reportan 10s contribuyentes en sus declaraciones del lmpuestoa1Valor Agregado (IVA) y la renta imponible que consignan en sus declaraciones del ISR A partir de la deteccion de estas inconsistencias se ha programado el envio de cartas para cornunicarles a 10s contribuyentes'que deben wmparecer ante la SAT para explicar el por que de tales inconsistencias Para tal efecto, la SAT ha elaborado un modelo de carta para citar a 10s contribuyentes o responsables identificados, en la cual se les informa el lugar al que deben acudir y 10s documentos a presentar, a fin de resolver las inconsistencias. Tambien se ha elaborado una "Guia Operativa para Verificar la Razonabilidadde las Declaraciones", que le servirh a 10s oficiales de la SAT que seran asignados a la atencion de 10s contribuyentes o responsables que llegardn a lasoficinas de laSAT en respuesta a estas cornunicaciones. b) Promocionde la estabilidady profundidaddel MercadoFinancier0 En materia financiera y en linea con las reformas financieras que se han venido impulsando, la Superintendenciade Bancos (SB) ha avanzado en la implementaci6nde un nuevo enfoque de supervisi6n basada en riesgos, en 10s cinco principales bancos del sistema que forman parte de cinco grupos financieros del total de diez autorizados para operar en Guatemala, cuyos activos constituyen el 79.4% del sistema bancario al 30 de abril de 2009. Para el efecto, la SB esta aplicando 10s principales perfiles del Manual de Supervision Basada en Riesgos, dentro de 10s cuales, sobresale la evaluaci6n de la liquidez, riesgo de credito'y gobiero corporativo. 42 Respecto al analisis de otros riesgos, tales como mercadooperacional, tasa de interes y el tip0 de cambio, la SB esta efectuando un diagnostic0 sobre el avance que tienen en materia de gestion de dichos riesgos las referidas entidades bancarias..Adicionalmente, a efecto de lograr la convergencia de practicas de supervision con paises de la regidn, la Superintendencia de Bancos tambien est$ trabajando en coordinaci6n con dichos palses en un proyecto de supervision consolidada para Centroam&ica, lo cual contribuira a complementar el esquema de supervisi6n basada en riesgos que se esta implementando en Guatemala.. Por otro lado, se han logrado importantes avances en la estandarizacibn de 10s instrumentos de deuda ernitidos por el Banco de Guatemala y el Ministerio de Finanzas Publicas, asi como en el establecimiento de emisiones regulares de colocacion, con el proposit0 de facilitar el desarrollo del mercado de deuda, por medio de la aplicacion de: a) una subasta sernanal de valores por el BANGUAT y este Ministerio con una amplia participacion del sector financiero, no financiero, sector privado y sector publico; b) emisiones electronicas de 7 dias; y, c) la colocacidn coordinada por el Banco y este Ministerio. La reglamentacidn de estos procesos para el BANGUAT est6 contenida en la Resoluci6n de Junta Monetaria No. JM-154-2007; y, para el MlNFlN est& contenida en el Decreto No. 72-2008 del Cangreso de la RepQblica, Ley del Presupuesto General de lngresos y Egresosdel Estadoparael aAo 2009 y en el Acuerdo GubernativoNo 30-2009, relativoa1Reglamentopara la Emisidn, Negociacion, Colocacibn y Pago del Servicio de 10s 8onos def Tesoro c) Promocion del acceso al financiamientopara micro, pequefiasy medianas empresas El Gobierno con el objeto de prornover et desarrollo econ6mico del pais, rnediante la creaci6n de condiciones adecuadas para el surgimiento de nuevos agentes economicos y lograr un us0 adecuado y eficiente de 10s recursos financieros dirigidos hacia 10s sectores de la poblacioncon menor acceso al desarrollo, impulso en el Congreso de la Repdblica la aprobaci6nde la Leyde Garantias Mobiliarias, mediante Decreto 51-2007 y sus reformas a travb del Decreto46-2008, El objetivo de la citada Ley es crear un marco juridico que fomente el us0 de garantias rnobiliarias de diversa indole para garantizar adecuadamente fas obligaciones crediticias que contraigan las diferentes personas individuales o juridicas en el pais, principalmente, 10s sectores de micro, pequefia y mediana empresa Dicho marco legal permitirii la constitucibn, modificacibn, prorroga, extinci6n y ejecuci6n de dichas garantias y la publicidad de las mismas, a efecto de utilizarlas para respaldar 10s financiamientos que Sean otorgados a 10s sectores productivos de la economia informal del pals. Asimismo, permitira a 10s sectores referidos-el acceso al credito, asi como el aumento de capital de trabajo, lo cual redundara en un incremento de la producci6n real, y la reduccion de los costos de producci6n 43 La mencionada Ley de Garantias Mobiliarias, establece que el derecho real de garantia puedeconstituirsesobre bienescorporales, incorporaleso derivados; bienes inmuebles por incorporaci6no destino; y, derechos sobre 10s mismos.. Por ultimo, y con base a lo estipulado en el Decreto 46-2008, a partir del 2 de eneto de 2009, esta constituido y operando el Registro de Garantias Mobiliarias, a fin de garantizar el cumpfimientode esta Ley. d) Gobernabilidadytransparencia El Gobierno de Guatemala ha continuado con la implementaci6nde medidas orientadas a mejorar la eficiencia y transparencia en el us0 de 10s recursos del erario publico, principaJmenteen el tema del acceso a la informacionpublica y la rendicion de cuentas, a fin de coadyuvar a fortalecer la auditoria social Dentro de las principalesacciones que se han venido impulsando, este Ministerio estableci6 a travbs del Decreto 72-2008 del Congreso de la Republica, Ley del Presupuesto Generalde lngresos y Egresosdel Estado para el aAo 2009, normas especlficas para contribuir a una ejecucibn mhs efectiva y transparente del presupuesto. Se fortalece la obligatoriedad de registrar en el Sistema Nacionalde InversionPdblica los'proyectosejecutados medianteconvenios, y las unidades ejecutoras de fondos en fideicomisos quedan obligadas a registrar 10s contratos que suscriban, ademhs de requerirles informes que deben presentar a la Contraloria General de Cuentas Por otro lado, la Constitucion Politica de la Republica de Guatemala, establece con absoluta determinacidn la publicidad de 10s actos y la informacidn en poder de la administracidn publica, asi mmo el libre acceso a todas las instituciones, dependencias y archivos de la misma, sin mds excepciones que las previstas en el citado texto constitucional.. De conformidad con lo anterior, el Gobierno por medio de Decreto 57-2008 del Congreso de la Republica Ley de Acceso a la Informacion Publica, emitio las normas y 10s procedimientos para garantizar a toda persona, natural o juridica, el acceSo a la informacion o actos de la administracion pljblica que se encuentre en 10s archivos, fichas, registros, base, banco o cualquier otra forma de almacenamiento de datos que se encuentren en 10s organismos del Estado, municipalidades, instituciones autbnornas y descentralizadas y las entidades privadas que perciban, inviertan o administren fondos pl5blicos, incluyendo fideicomisos constituidos con fondos publicos, obras o servicios pljblicossujetos a concesi6n o administracidn Dicha Ley se encuentra vigente a partir del 21 de abril de 2009. 44 Como parte de la polltica de transparencia del MlNFlN y dentro de las actividades que se estan desarrollando para la implementacion de la Ley de Acceso a la Informaci6nPljblica fue inaugurada la Unidad de lnformacibn Publica, encargada de recibir y orientar a las personas hacia la obtencion de la informadon publica de su interes Y tambien esti disponibledentro del portalWeb w.minfin.gob.gt,el Sistema deAcceso a la lnforrnacih Publica (SAIP), lo cual permitird que las personas interesadas puedan realizar las consultas en linea. e) Fortalecimientode la administracionfinanciera publicay las contrataciones Medianteel Acuerdo Gubernativo No. 394-2008, el Gobierno aprobo un nuevo Reglamento Orgdnico lnterno para el MINFIN, el cual pus0 en funcionamiento una nueva estructura organizacional, funciones y mecanismos de coordinacidn que persiguen entre otros, absorber las funciones y responsabilidades a cargo del Proyecto Sistema lntegrado de AdministracibnFinanciera(SIAF) y GUATECOMPRAS. La nueva estructuraincorpa~el Viceministerio de Transparencia, el cual tendra a su cargo las Direcciones de Transparencia Eiscaly de Fideicomisos Dicha estructura permitirg lograr un balance de responsabilidades en las estnrcturas administrativa y funcional del MINFIN En particular, descarga al Viceministerio de Administracion Financiera con las responsabilidades propias de su ambito de accibn, especlficamentecon las DireccionesTknica del Presupuesto, de Contabilidaddel Estado, Credit0 Publico y Tesoreria Nacional a su cargo, Por otro lado, el Viceministerio de Adrninistracion lnterna y Desarrollo de Sistemas tiene a su cargo las unidades administrativas, y como parte del area de desarrollo de sistemas, incorpora a la nueva Direccidn de Asistencia a la Adrninistracion Financiera Municipal Esta nueva Direccidn constituye fa contraparte institucional adecuada a las acciones para el seguimiento del promo de incorporacion del Sistema lntegrado de Adrninistracion Financiera en las municipalidadesdel pais. Por otro lado, y en linea con las acciones impulsadas para el fortalecimiento de la administracion de las finanzas publicas, el MlNFlN aprobb las Normas Tecnicas para la Formulacibn del Proyecto de Presupuesto Ejercicio Fiscal 2010 y Multianual 2010-2012, las cuales induyen provisiones e indicadorest&nicos para iniciar la implementaci6n de un presupuestopor resultadosen las entidadesdel Gobierno Central I Estas normas han sido publicadasen el portal web de este Ministerio y distribuidas a las entidadesdel Gobierno Central para lafornjulaci6ndel proyectode presupuestocitado. 45 II. Expandiendooportunidadesa GruposVulnerables Para implementar el eje de Solidaridad mencionado supra, el Gobierno de Guatemala ha establecido un mecanismo de coordinacih denominado Consejo de Cohesion Social, el cual tiene entre otros, como objetivos especificos elevar el impact0de la inversionsocial y establecer prioridades de atenci6n geogrhfica (municipios con 10s mayores niveles de pobrezaextrema) y programatica(programasmas costo-efectivos) Para alcanzar esos objetivos, el Gobiemo ha implementado un Programa de Transferencias Monetarias Condicionadas (PTMC) denominado "Mi Familia Progresa -MIFAPRO-" El alto nivel de priorizacion otorgado al PTMC se ha traducido en un fuerte llamado a la accidn por parte de 10s Ministerios y entidades involucradas, asi como en la demanda por un acelerado ritmo de su implementaci6n Este Programa tiene caracter integraly actlja en 10s municipios y localidadesde mayor pobreza y vulnerabilidad, mismos que se deterrninaronen base a1mapa de pobreza, cuya primerafase comprendealcanzar hasta 50 municipios prioritarios, y se proyecta cubrir un total de 125 municipios de 10s 333 que conforman el pais, a fin de Sortalecer-e incrementar la oferta de 10s servicios de educaci6n, salud y nutrici6n El Programa MIFAPRO, con el objeto de poder administrar t6cnica y financierarnente ias Transferencias Monetarias Condicionadas, a partir del ultimo trimestre del aiio 2008, diseii6 un Sistema de Informacion que consta de 4 m6dulos: a) Censo; b) Registro lntegrado de Beneficiarios; c) Seguimiento a corresponsabilidades; y d) Ptanillas Dichos m6dulos se estan sometiendo a revisiones periodicas para adaptados a las necesidades que en la practicarequiereel Programa Este sistema de informaci6n lleva incorporadas variables que permiten considerarlo un Sistema de Seguimientoy Monitoreoque comprende entre otros, las corresponsabilidades, actualizaciondel Padronde beneficiarios; inscripcidn; y, seguimientoa 10s servicios.. Respecto a 10s sistemas de evaluaciijn extema de MIFAPRO, el Programa realiz6 una evaluacih a 10s instrumentos diseiiados para operarlo y conform6 el Manual de Operaciones, el cual sirve como una guia para marcar las condicionalidades de flujos de infonnaci6ny otros.Dicho manualcontemplauna seccihque incluye 10s lineamientosbajo 10s cuales opera el programa. De igual forma para reducir. el riesgo de realizar pagos en efectivo fuera de tiempo, MIFAPROha informadoque ya se cuenta con un calendariode pagos bimensualespara el aAo 2009, y que 10s mismosse efectuarhnsegun lo planificado. 46 111. CrecimientoSostenibtey Productividad El Gobiernode Guatemala esta convencido de que la apertura de mas y mejores mercados tan solo tendrs beneficios en la medida en que el pais continue mejorandoel clima para la inversiony 10s negocios, y con la infraestructuraapropiada para ello. Un objetivo clave del Programa de Gobierno es mantener unas finanzas publicas disciplinadas y ordenadas, que a la vez que coadyuven af desarrollo y a la disminucionde la pobreza del pais, no comprometan su estabilidad macroecch6mica con deficit fiscales elevados e insostenibles Con este proposito, el Gobierno tiene como objetivo generar recursos fiscales adicionales para financiar un incremento significativo de las inversiones publicas, y en particular, de 10s gastossociales.. Como partede este objetivo, la SAT ha venido irnpulsadouna estrategia de modernizacion aduanera. Durante el 2007, se desarrollo una herramienta informflticadenorninada Gestor de Flujosde Trabajo, que es tambibn conocido como SAQB E (vocablo maya que significa camino blanco o camino recto), para sistematizar la gestion aduanera, la cual serfl irnplementadaen todas las aduanasdel pais A la fecha, SAQB`E se ha implementado en tres aduanas: Puerto Barrios, Puerto Santo Tomas de Castilla y Express Aereo (esta ultima ubicada en el Aeropuerto lnternacional La Aurora), lo cual ha sido divulgadoa1personal de la SAT y a otras personas, principalrnente usuarios del sistema aduanero, a travb de una publicaci6n denominada `Aduana Moderna"que la SAT distribuye peribdicamentepor correo electrdnico Estas tres aduanas manejanmas de un30% de las importacionesy exportacionesque se realizanen el pais La implernentacidn de SAQB`E en Puerto Barrios se inici6 el 17 de agosto de 2007, y actualmente se aplica tanto para 10s procesos de gestion de la carga, wmo de despacho aduanero..La implementacibnde SAQB'E en PuertoSanto Tomas de Castilla se inici6 el 7 de agosto de 2008, mientras que la implernentacidnde SAQB"Een ExpressABreo se inicid el 13 de marzo de 2009. En ambas aduanas se ha completado su aplicacion para 10s procesos de gesti6n de la cargay de despachoaduanero.. IV. Conclusidn Como se puede observar, el Gobierno de Guatemala esta altamente comprometido con la promoci6n e implementacion de las acciones necesarias para atcanzar un mayor crecimiento econbmico sostenido, un incremento en la inversion productiva, priorizada en las fireas de salud, educacion y proteccion social, asi como, el fortalecimiento de la transparencia y eficiencia en la gestion del gasto publico, todo ello con el proposito de aumentar el desarrollo econ6mico del pais y mejorar la calidad de vida de la poblacion guatemalteca, en especial de 10s grupos mas vulnerables 47 Es en este contexto, que el apoyo financier0 del Banco Mundial a traves del Segundo Prestamo ProgramAtico de Politica Fiscal y Desarrollo Institucional hasta por US$350,0 millonescobra particularrelevancia,y se enmarcadentro de la estrategia definanciamiento del PresupuestoGeneralde la Nacibn, AI agradecer el continuoapoyo que nos brindael Banco Mundial,aprovechola oportunidad paraexpresade'lasmuestrasde mi consideraciony estima.. Atentamente, .- ..(-xi?% " MINISTRO DE flNA 48 Letter o f Development Policy (English version, unsigned) Ms.PamelaCox Vice-president, Latin America and the Caribbean Region World Bank Washington D.C., USA EsteemedMs.Cox: The Government o f Guatemala, presided by Alvaro Colom Caballeros, has set as one o f its principal goals the promotion o f sustainable and equitable development that responds to the needs o f the entire population, but in particular to those who live in conditions o f extreme poverty. The current administration is committed to continued compliance with the Peace Accords and progress toward the Millennium Development Goals. With this aim, the Government o f the Republic of Guatemala is implementing a plan based on four strategic programs: (i)Solidarity; (ii)Governability; (iii)Productivity; and (iv) Regionality. In addition to this plan, and with the goal of mitigating the effects of the world economic deceleration, the Government has formulated the National Emergency and Economic Recuperation Program, which calls for resources to help the country face external shocks. The assistance strategy agreed on with the World Bank for 2009-2010 includes, among other items, support for Government actions via Fiscal Policy and Institutional Development Programmatic Loans. Since the approval o f the first loan by the Bank, the Government has made continuous advances in the key areas defined in the program's implementation matrix, and as a result is requesting the negotiation and approval o f the second loan, for an amount o f US$350 million. As with the previous operation, this loan will support the Government o f Guatemala's efforts to increase growth, improve governability, reduce poverty, deepen financial markets, and improve the efficiency o f public spending and transparency o f public sector administration. The principal advances inthese areas are detailed below. I.Promotemacroeconomicstabilityandimprovefiscalspaceforpriorityprograms a) Maintaining fiscal space for prioritized spending One key objective o f the Government program has been to maintain disciplined and orderly public finances, which both support development and poverty reduction in the country and also do not compromise macroeconomic sustainability with elevated and unsustainable fiscal deficits. Preliminary figures show that 2008 tax revenue surpassed its budgetary target by 0.8 percent, which led to the monthly accumulated budgetary result up to August 2008 being a fiscal surplus. Nonetheless, despite exceeding budgetary provisions, the tax burdenin 2008 was 11.3 percent, below the 12.1 percent achieved in2007. The deceleration o f the value-added tax stands out among factors explaining the fall in tax revenue, the result o f a combination o f events including an accumulation o f fiscal credit in the tax retention system and a contraction o f internal consumption associated with the effects o f the world economic crisis. This contraction also affected the revenue o f specific consumption taxes, particularly on the sales o f fuels. Customs revenue showed a significant reduction, principally in the last quarter o f the year. 49 In its commitment to continue improving tax revenue, this ministry encouraged the Congress o f the Republic to approve via Decree 73-2008 the Law for the Implementation o f the Solidarity Tax (Impuesto de Solidaridad-ISO), which replaces the Temporary Tax to Support the Peace Accords, which expired on 31 December 2008. The I S 0 will remain in force while the income tax i s being reformed as part o f the second stage o f the planned fiscal modernization. In accordance with the adopted measures, and with the objective o f generating greater resources, the Tax Administration Superintendency (Superintendencia de Administracih Tributaria-SAT) developed software--called "RetenISR'--to retain income tax and the financial products tax, which facilitates payments by contributors and those responsible for corresponding tax obligations, and improves the capacity o f SAT to verify compliance with these obligations. This software is distributed free via the SAT website and can also be obtained at the offices and tax agencies o f SAT. Since its release at the end o f 2007, the use o f this software was optional, but on 6 April 2009, the Diario de Centroamkrica published SAT Directive 5-2009 which approved the implementation o f RetenISR. As well, this established its obligatory use as of 1 June 2009 for banks, businesspeople, individuals or companies that pay, place at disposition or accredit in the account o f a third party income subject to retention according to the Income Tax Law or interest o f any type according to the FinancialProducts Tax Law. The obligatory use o f this information tool will increase the capacity o f SAT to control the retention o f income and financial products taxes. Additionally, and with a view to reducing tax evasion, the SAT has undertaken massive information cross- checks to detect inconsistencies between sales reported by contributors in their value-added tax declarations and the taxable income declared on their income tax declarations. When inconsistencies are detected, a letter will be sent to inform contributors that they must come to SAT to explain these inconsistencies. To do so, the SAT has drawn up a template for the letter to cite contributors or identified responsible parties, which informs them where they should go and which documents to present to resolve the inconsistencies. As well, an "Operative Guide to Verify the Reasonableness o f Declarations'' has been created to guide SAT officials assigned to attend contributors or other responsible individualswho come to SAT offices in response to these letters. b) Promotingthe stability and deepening o fthe financial market In financial matters, and in line with the financial reforms underway, the Bank Superintendency (Superintendencia de Bancos-SB) has advanced in the implementation o f a new focus o f supervision based on risks. This new focus is used inthe five principal banks that form part o f the five financial groups o f the total o f 10 authorized to operate in Guatemala, the assets o f which constitute 79.4 percent o f the banking system as o f 30 April 2009. To do so, the SB is applying the principal profiles o f the Risk-Based Supervision Manual, notably the evaluation o f liquidity, credit riskand corporate governance. The SB is also undertaking a diagnosis on progress in the use o f market, interest rate and exchange rate risk management in the above-mentioned banking entities. Additionally, with the aim o f converging supervisory practices with countries in the region, the SB is also working in coordination with those countries on a consolidated supervisory project for Central America, which will complement the risk-based supervision scheme being implemented inGuatemala. 50 Important advances have been made in standardizing debt instruments issued by the Bank o f Guatemala and the Ministry o f Public Finance (MINFIN), as well as regular bond placements, with the aim o f facilitating the development o f an internal debt market via the use of: a) a weekly auction by the Bank o f Guatemala and MINFIN with wide participation o fthe financial and non-financial sectors, both public and private; b) seven-day electronic issues; and c) coordinated placement by the Bank o f Guatemala and MINFIN. The regulations for this process for the Bank of Guatemala are contained in Monetary Committee Resolution JM-154-2007, and for MINFIN in Congressional Decree 72-2008, the General Budget Law for 2009 and Governmental Accord 30-2009 related to Regulations for the Emission, Negotiation, Placement and Payment Service o f Treasury Bonds. c) Promoting access to financing for micro, small andmediumcompanies To promote economic development by creating adequate conditions for the upsurge o f new economic agents and the efficient use o f financial resources toward populations with less access to development, the Government supported Congress's approval o f the Collateral Law, via Decree 51-2007 and its reforms via Decree 46-2008. The objective of the law is to create a judicial framework the encourages the use of various types of collateral to adequately guarantee credit obligations taken on by different individuals or companies, principally the micro, small and medium enterprise sector. This legal framework allows the constitution, modification, extension, termination and execution of these guarantees such that they can be used to back credit flows to productive sectors in the country's informal economy. This will in turn increase working capital and helppromote an increase inproduction and a reduction inproductioncosts. The Collateral Law establishes that the right of guarantee can be constituted on tangible, intangible or derivative good, and the rights over these. Based on Decree 46-2008, as o f 2 January 2009 the Collateral Registry has been constituted and is in operation, meaning the Collateral Law can be complied with. d) Governability andtransparency The Government of Guatemala has continued to implement measures oriented toward improving the efficiency and transparency o fpublic resources,principally inthe areas o fpublic access to information and accountability, with the aim o f strengthening public oversight capabilities. Among the principal actions underway, the MINFIN established-via Congressional Decree 72-2008 on the 2009 Budget Law- specific norms to contribute to a more effective andtransparent budgetexecution. All projects executed via contracting agreements must be registered in the National Public Investment System, and units executing trust funds are obliged to register contracts they enter into and provide reports to the Comptroller General o f Accounts. As well, the Constitution o f the Republic of Guatemala clearly requires that all actions by the public administration and all information under its the power be made public, and that free access to all institutions, dependencies and archives be allowed, with the only exceptions being those specified in the Constitution itself. In conformity with this, the Government, via Congressional Decree 57-2008 on the Law o f Access to Public Information, issued regulations and proceduresto guarantee all individuals and corporations access to information or actions o f the public administration found in archives, files, registries, databases, banks or any other form o f data storage in institutions o f the state, municipaliti'es, autonomous or decentralized institutions and private entities that receive, invest or administer public funds, including trusts constituted 51 with public funds, works, or public services subject to concession or administration. This law took effect on 21 April 2009. As part of the policy of transparency o f the MINFINand within the activities underway to implement the Law of Access to Public Information, the Public Information Unit was createdto receive and orient people seeking to obtain public information. The ministry web page, www.minfin.gob.gt, also provides entry to the System of Public Information Access (Sistema de Acceso a la Informaci6n Phblica-SAIP), which allows individualsto make requests on line. e) Strengtheningpublic financial administration and procurement Via Governmental Accord 394-2008, the Government approved a new organizational structure, functions and coordination mechanisms for MINFIN intendedto, among other aims, encompass the functions and responsibilities o f the Integrated Financial Administration System (Sistema Integrado de Administracibn Financiera-SIAF) and GUATECOMPRAS, the government procurement system. The new structure incorporates the Vice-Ministry o f Transparency, which will be in charge o f the Directorate o f Fiscal Transparency and Trusts. This new structure will make it possible to balance the administrative and functional responsibilities o f the MINFIN. Inparticular, the Vice-Ministry of Financial Administration is given its own responsibilities in its area o f operation, and is in charge o f the Technical Directorates o f the Budget, State Accounts, Public Credit and National Treasury. The Vice-Ministry o f Internal Administration and Systems Development is in charge of the administrative units, and as part of the systems development area incorporates the new Directorate o f Municipal Financial Administration Assistance. This new directorate constitutes the adequate institutional counterpart for overseeing the incorporation SIAF into all the municipalities o f the country. Inline with actions oriented to strengthenpublic financial administration, the MINFIN also approved the technical norms for the formulation o f the proposed 2010 budget and multiannual 2010-2012 budgets, which include provisions and technical indicators to initiate the implementation o f results-basedbudgeting in central government agencies. These norms have beenpublishedon the ministrywebsite and distributed to central government agencies for the formulation of these budgetproposals. 11. Expanding Opportunities for Vulnerable Groups To implement the Solidarity axis o f the Government program mentioned above, the Government o f Guatemala has established a coordination mechanism, the Social Cohesion Council. The council has the specific objectives o f increasing the impact o f social investment and establishing priorities based on criteria o f geography (municipalities with higher levels o f extreme poverty) and programs (most cost- effective options). To achieve these objectives, the Government has implementeda conditional cash transfer program, Mi Familia Progresa ("My Family Progresses"-MIFAPRO). The high priority placed on MIFAPRO has translated into strong call to action on the part of the involved ministries and agencies, and a demand for acceleratedimplementation. The program is comprehensive, and it is active inmunicipalities and localities with high levels of poverty and vulnerability as determinedby a poverty mapping. The first phase reaches 50 priority municipalities, and a total o f 125 o f the country's 333 municipalities are projected to be 52 covered after the program is fully rolled out, with the aim o f strengtheningand increasing eduction, health and nutrition services. As o f the last quarter o f 2008 MIFAPRO designed an information system to give it the technical and financial capabilities needed to administer the conditional cash transfer program. The system has four modules: a) census; b) beneficiary registry; c) tracking o f responsibilities; and d) account lists. These modules are periodically reviewed to adapt them to the practical necessities o f the program. This information system contains variables that allow it to act as an oversight and evaluation system covering, among other areas, responsibilities o f involved parties, updating the beneficiary lists, inscription and service tracking. Regarding external evaluation systems for MIFAPRO, the program evaluated the instruments designed for that purpose and assembledthe Operation Manual, which will serve as a guide to the relevant information flows. This manual has a section detailing the rules guidingprogram operation. To reduce the risk o f making unscheduled cash payments, MIFAPRO already has a bi-monthly payment calendar for 2009 which will ensurepayments proceed as planned. 111. Sustainableand Productive Growth The Government of Guatemala is convinced that the opening of more and better markets will only have benefits as long as the country continues improving its investment and business climate, as well as the appropriate infrastructure. A key objective of the Government program is to maintain disciplined and orderly public finances as a support to development and poverty reduction in the country, not compromising macroeconomic stability with high and unsustainable fiscal deficits. With this in mind, the Government intends to generate additional fiscal resources to finance a significant increase in public investment and, in particular, social spending. As part of this objective, the SAT has been modernizing customs administration. During 2007, an information tool known as the Work Flow Administrator (Gestor de Flujos de Trabajo, or SAQB'E in Maya) was developed to systematize customs adminstration, and it will be implemented in all customs offices inthe country. Thus far, SAQB'E has been implementedin three customs points: Puerto Barrios, Puerto Santo Tomas de Castilla and Express ACreo (this last located in the L a Aurora International Airport). Information about the system has been distributed to SAT personnel as well as other users o f the customs system via the publication"Modern Customs" that the SAT sends out periodically by email. These three customs points manage more than 30 percent o f the country's imports and exports. The implementation o f SAQB'E in Puerto Barrios began on 17 August 2007, and is currently applied to both cargo administration and customs office processes. The implementation o f SAQB'E in Puerto Santo Tomas de Castilla beganon 7 August 2008, and in Express ACreo on 13 March 2009. Inboth locations, the system applies to cargo administration and customs office processes. IV. Conclusion 53 As can be seen, the Government o f Guatemala is highly committed to promoting and implementing the actions necessary to achieve higher sustained growth, increase productive investment prioritized in the areas o f health, education and social protection, and strengthen the transparency and efficiency o f public spending. These actions are all oriented to increase the country's economic development and improve the quality o f life o f the Guatemalan population, inparticular the most vulnerable groups. In this context, the World Bank's financial support via the Second Programmatic Fiscal Policy and Institutional Development Loan for US$350 million is particularly relevant, and is part o f the financing strategy o f the national budget. In giving thanks for the continued support offered to us by the World Bank, Itake this opportunity to express my regards and esteem. Yours, Juan Albert0 Fuentes Knight (Minister o f Finance, Guatemala) 54 a a a a a a a il * 2 Z 0 a a ANNEX 4: IMFPUBLICINFORMATIONNOTICE April 23,2009, PressReleaseNo. 09/142 The Executive Board of the International Monetary Fund approved on April 22 an 18-month, SDR 630.6 million (about US$935 million, or 300 percent of quota) Stand-By Arrangement for Guatemala. The Guatemalan authorities intend to treat the arrangement as precautionary, meaning that they do not intend to draw on the Fund's resources unless the need arises. Guatemala has no immediate balance of payments need, and this program is part o f a comprehensive preventivestrategy to strengthenthe country's liquidity cushion inthe face o f an uncertain global environment, thereby enhancing the confidence of investors and market participants. Guatemala has made substantial progress in consolidating macroeconomic stability and implementing structural reforms. Adverse external conditions, however, are affecting economic activity and financial conditions. The Guatemalan authorities have taken a number of upfront measuresto mitigate the impact of the external shock and preserve macroeconomic stability. The program will support the authorities' policies and provide insurance against significant downside risks. Following the Executive Board discussion on Guatemala, Mr. Murilo Portugal, Deputy Managing Director andActing Chair, issuedthe following statement: "Guatemala has a strong track record of prudent macroeconomic policies and structural reforms, which has helped to solidify the economy in recent years. As in many countries in the region, however, the global crisis has weakened economic conditions. A more prolonged global recession could increase downside risks to Guatemala's outlook in 2009 and 2010. The authorities' economic program, supported by a Stand-by Arrangement with the Fund, which the authorities plan to treat as precautionary, is an appropriate response to mitigate these risks and preserve macroeconomic and financial stability. "The authorities' strategy entails a moderate fiscal expansion, continued efforts to anchor inflation at low levels inthe context ofthe inflation-targeting framework and a flexible exchange rate regime, a further strengthening of the financial sector, and the mobilization o f substantial external financing, including from the World Bank and the Inter-American Development Bank. This financing will boost the economy's foreign currency liquidity buffers, and provide protection against any larger-than-anticipated shocks to the balance o fpayments. "The Bank of Guatemala is cautiously easing the monetary policy stance, after succeeding in controlling inflationary pressures that surged in 2008. The authorities plan to strengthen their inflation-targeting fiamework further, with a view to achieving a medium-term inflationtarget of 4 percent (+/- 1%). They are committed to maintaining a flexible exchange rate to facilitate the adjustment to external shocks. "The authorities' fiscal program aims to provide some stimulus to the economy and protect the most vulnerable segment of the population. To achieve these goals, the 2009 budget envisages higher spendingon labor-intensive public infrastructure projects anda strengtheningo f the social safety net. This countercyclical fiscal policy is possible given the low level o f public debt, resultingfrom prudentfiscal policies pursuedinthe past. 59 "Guatemala's banking system is not exposed to risky structured financial products and has consolidated in recent years. The authorities are nonetheless taking measures to safeguard the liquidity and capital positions of banks through adequate liquidity-provisionarrangementsby the central bank and a gradual increase inprovisioning requirements. At the same time, continuous on-site supervision has beenput inplace to monitor developments closely, anticipating risks and corrective actions, if needed. During the program period, the Government plans to further strengthen financial sector policies by enhancing supervision and regulation and strengthening the framework for bankresolution," Mr.Portugal said. RecentEconomicDevelopments Real GDP growth is estimated to have slowed to 4 percent in 2008, from 6.3 percent in 2007. The decline has been driven by domestic demand, particularly investment, as external demand remainedrobust through most of 2008. Annual inflation continues to decline, from its peak of 14percent inmid-2008, to 9.4 percent by year-end, and further to 5 percent in March 2009. The decline in inflation has become firmly entrenched: various measures o f core inflation have declined consistently in the last quarter o f 2008; inflation in services and nontradables has moderated substantially; and inflation expectationsare decliningrapidly. The external current account narrowed to 4% percent of GDP in 2008, already signaling lower domestic absorption, helped by the reversal of the negative terms-of-trade shock from commodity prices inthe second half o f last year. Since the last quarter o f 2008, remittances have been declining, export growth has slowed and imports fell markedly. Private capital inflows have slowed, but nonetheless international reserves increasedto US$5 billion by end-March 2009 due to recent disbursementsofpublic external financing. The strength of the fiscal position was maintained during 2008, with the central government deficit declining to 1.7 percent o f GDP, despite a real decline intax revenue. The drop inrevenue hasbecomemore severe inearly 2009, due to cyclical and structural factors. ProgramSummary The Guatemalan authorities have been proactive in addressing the effects o f the global crisis through a comprehensive policy response. Their strategy has four key elements: A moderate fiscal stimulus to support domestic demand, financed with substantial external resources from multilaterals to minimize crowding out the private sector; A monetary policy focused on consolidating the decline ininflation inthe context of a flexible exchange-rateregimeto facilitate economic adjustment; Strengthening o f financial sector policies to increase the resilience of banks and enhance the bankingsector safety net andresolutionprocedures; A refocusing of public expenditures towards strengtheningsocial spendingand labor-intensive public works. To complement those efforts, Guatemala is now aiming at building a higher external liquidity cushion to reduce risks from suddenchanges inthe current and capital account. Fundsupport is a key element of the strategy to face these risks, not only through the contingent financing providedunder the proposed SBA, but also through the endorsement o f the authorities' program, which will helpmaintaininvestor confidence. 60 The authorities' social protection policy aims at enhancing current programs to offset the effect of the crisis on the most vulnerable segments of the population. Social spending will increase from 4.4 percent o f GDP in 2008 to 5.0 percent of GDP in 2009. To address extreme poverty, emphasis will be placed on four flagship government programs. A key conditional cash transfer program initiated in 2008 will be expanded aiming at reaching 500,000 families in 2009, with a cost of 0.4 percent o f GDP. 61 ANNEX 5: PUBLICAND EXTERNAL DEBTSUSTAINABILITY ANALYSIS A. Introduction Despite the recent adverseeffects generatedby the globaleconomic crisis, Guatemala's BB+ ratingg remains stablethough an increasein publicdebt is forecast in2009. Guatemala's public and external debts are among the lowest in Latin America as well as within the group of lower middle-income countries. However, Guatemala i s starting to feel the impact o f the crisis. GDP and tax revenues will contract this year, largely due to declining exports, tourism, and remittances, leading to expectations that the fiscal deficit will increase from I.7 percent o f GDP in2008 to 2.8 percent o f GDP in2009. Given the environment of effective suspension o f credit markets, there is a growing perception within the country that an increase in multilateral debt i s inevitable due especially to the need to maintain productive spending, the Government's continued commitment to protectingthe poor, and a well-established strategy of responsible debt management. Inthis context, it is useful to present a detailed fiscal and external debt sustainability analysis. This analysis is implemented in two distinct frameworks: one in which debt determinants are assumed to evolve in a deterministic manner, and another in which key variables are subject to stochastic shocks. The stochastic fiscal sustainability analysis is undertaken here inview of the rapidly changing and increasingly uncertain external environment, and its inevitable impact on Guatemala, a small open economy with close ties to the US. Figure A5.1: Public debt-to-GDP ratio in2008" 160% T 120% 80°h - - 40% -~ 300? "% 240/.22% 21% 21% 19% 19% 4% 0% 7 Source: EIU; Fitch Ratings, Global Development Finance, WorldBank; In Services. B. Baseline assumptions Baseline assumptions are presented in Table A5.1 below and are consistent with Tables 1 and 3 o f this document. Fitch ratings loSome ofthe numbersare projectionsand canbe revisedafter the conclusionofthis document. 62 Table A5.1: Key macro and externalbaselineassumptions Actual Projections 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 NominalGDP (billions ofdollars) 23960 27333 30264 34301 38956 37592 38360 40086 42476 45262 48295 RealGDP growth (%) 3.2 3.3 5.4 6.3 4.0 -0.5 1.4 3.5 4.0 4.0 4.0 GDP deflator inU.S. dollarterms (%) 9.8 7.8 4.5 6.8 6.4 -3.1 0.6 1.0 1.9 2.5 2.6 Nominal effective interestrate(YO) 5.0 5.1 5.3 5.3 4.5 4.1 4.1 5.2 6.7 6.8 6.8 Growthof exports (dollar terms, YO) 10.8 12.9 14.2 20.3 15.5 -13.7 5.9 7.0 7.3 7.7 8.0 Growth of imports(dollar terms, %) 16.2 14.1 15.0 16.7 8.6 -15.5 8.2 9.9 8.1 7.3 7.5 Net transfers 13.0 13.1 14.1 14.2 12.8 11.1 11.5 12.6 13.7 14.0 14.3 Net FDI 1.1 1.7 1.8 2.1 2.1 1.5 1.6 1.7 1.8 1.9 2.1 Nominal interest rate on public debt I/ 6.9 7.0 7.4 7.8 7.1 6.6 6.4 6.4 6.8 6.9 7.0 GDP deflator inlocalcurrency (YO) 6.1 5.6 5.0 6.9 8.5 5.7 4.7 4.4 4.8 4.9 4.9 Primarydeficit (in YO) -0.3 0.3 0.6 0.3 0.3 1.2 1.0 0.4 0.2 0.1 0.1 1/ Derived mthe average nomiml interestexpendituredividedby previousperioddebtstock. C.FiscalSustainabilityAnalysis Since 1998, the public debt-to-GDP ratio has been around 21 percent. The share o f foreign-currency denominated debt has been decreasing since 2003, but is still over 50 percent o f the total. Historical average of public foreign currency debt to GDP is about 15 percent whereas the domestic currency debt ratio is about 6 percent. 90 percent o f foreign debt is of the Central Government and 2 percent is o f the rest of the public sector. 63 FigureA5.2: Publicsector debt: evolution and decomposition Total public sector debt to GDP Foreignand domestic publicsector debt to GDP 25 I I 1998 '1999 2000 2001 2002 2003 2Ml4 2005 2W6 2007 2008 lforeigncurrencydebt Ddomesbcdebt Foreign Public Debt 2008 (Millions of USD) Rest of Public ntral mmnt 4,285.3 Source: Buncode GuatemalaandIMF BaselineResults Under baseline assumptions, Guatemala's public debt is sustainable. Even though we project an increase of the ratio from 2009 to 2014, all vulnerability indicators remain within prudent ratios (Table A5.2). In the baseline, total public debt increases to 28.3 percent of GDP by 2014 from 20.2 in 2008. Primary deficit-to-GDP ratio spikes in2009, but decreasesto 0.3 percent ofthe GDP in2014. 64 DeterministicStress Tests This section measures the robustness of baseline analysis by applying extreme shocks to key debt determinants and then observing the evolution of debt consistentwith these shocks. The shocks are applied to the following macroeconomic variables: GDP growth, interest rates and primary deficit. For all variables except the interest rate (to which a one standard deviation shock is applied), the magnitudes of the shocks are one-half standard deviations from the historical average. The extreme scenario applies a combination o f one-forth standarddeviations shocks to allthe listedvariables. Table A5.2: 'ublic Debt - BaselineMedii a-Term Projections Actual Projections 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Public sector debt/GDP 20.8 21.8 21.7 20.2 23.8 26.0 26.9 27.5 27.9 28.3 o/w external debt 15.8 14.0 13.4 12.1 14.2 15.7 15.7 15.6 15.1 14.8 Change inpublic sector debt/GDP -1.1 1.0 -0.1 -1.5 3.6 2.2 1.0 0.6 0.4 0.4 Identifieddebt-creating flows/GDP -0.4 0.0 -0.7 -0.7 2.6 2.1 0.9 0.3 0.3 -0.1 Primarydeficit/GDP 0.3 0.6 0.3 0.3 1.2 1.1 0.6 0.3 0.3 0.3 Public sector debt-to-revenue ratio 173.4 171.3 168.5 168.3 210.6 225.9 222.6 226.5 227.9 230.5 Even under a combination of economic shocks, public debt-to-GDP remains at sustainable levels. Results show that the public debt is most vulnerable the assumption of no improvement in the primary deficit. Under this scenario the debt-to-GDP ratio rises to 32.6 percent. For all other cases public debt ratio remains under 30 percent. (For detailed results please check Table A5.A inthe appendix). More specifically: Historical Averages: under the assumption that the key macroeconomic variables would evolve according to the historical average values, public debt indicators fall below the baseline scenario and total public debt reaches26.5percent of GDP by 2014. Constant primary deficit: under the extreme assumption of no policy change after 2009 (*1.e. a constant primary deficit o f 1.2 percent of GDP duringthe forecast period) the public debt would increase 12.4 percentage points reaching 32.6 o fGDP by 2014. Shock to primary balance: under the assumption of loose fiscal policy (a repeated shock to primary balance equivalent to 0.3 percentage points below historical averages) the public debt-to- GDP ratio increasesby 7.9 percentagepoints duringthe forecasting period, reaching 28.1 percent in2014. Shock to growth: a repeated shock to GDP growth o f half standard deviation below historical averages (a shock equivalent to 1.3 percentage points) increases the public debt by 8 percentage points between 2008 and 2014. Shock to Interest Rates: under tighter financial market conditions resulting in higher nominal interest rates (0.6 percentage points above historical averages), projected debt indicators for 2014 would be 1.1 lower than under the baseline scenario for public debt, reaching 27.2 percent. Combined shocks: the combination of lower output growth, worse financing conditions and looser fiscal policy (the previously defined shocks to GDP growth, interest rate and primary balance) would raise the public debt-to-GDP ratio by 8.1 percentagepoints, reaching 28.3 percent in2014. 65 FigureA5.3: Total public debt trajectory underdifferent stressscenarios(presents projectionsof TableA5.A inthe appendix) - (NetPublicDebt,in percent of GDP) 34.0- 32.0- -0-Baseline 30.0 +Historical 28.0-- ACostantprimary - balance 26.0 Interestrate (repeated) 6GDPgrowth 24.0- (repeated) -Primary balance Shock -CCombo 16.04 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: WE0and WorldBank staff calculations StochasticSimulations Stochasticsimulations confirmthat in the baselinescenario public debt remains sustainable. Figure A5.4 illustrates the result using 5000 interactions and under the assumption o f i.i.d shocks (independent and N(0,l)). Simulations have 2008 as the base year, with initial public debt to GDP ratio o f 20 percent, and use estimated elasticities between growth and the real effective exchange rate (REER), primary balance and interest rates. Figure A5.4 shows that by 2014, the debt ratio will remain below 50 percent with 97.5 percent confidence level and below 35 percent with 90 percent confidence level. FigureA5.4: Stochastic Simulationsof the PublicSector Debt I 4 , 010-15 I -Baseline 0-2.5 1 2008 2009 2010 2011 2012 2013 2014 i ~ Source: WorldBankstaff calculations . D. ExternalDebt SustainabilityAnalysis Guatemala'stotal external debt as well as its composition remained stable over the past few years. The most recent figures for Guatemala show that total outstanding external debt (public and private) is 35 percent o f GDP. This ratio increased by almost 10 percentage points in the last 10 years but has been fairly stable since the 2006 banking crisis. A large and increasing share of external debt is held by the private sector with no sovereign guarantees. Public and publicly guaranteed external debt currently 66 accounts for 32 percent o f the total external debt (and approximately 12 percent o f the country's GDP). Of total public and publicly guaranteed external debt around 24 percent is hold by multilateral and bilateral institutions. The remaining 75 percent is mainly held by commercial creditors and bonds accounts. Finally, more than 65 percent o f external debt matures in more than a year giving the country some time to overcome the external turmoil. The continuation and further deepening of the global crisis could undermineGuatemala'saccess to external finance. Guatemala's financial system is relatively closed and mostly dependent on internal resources for financing. This feature has protected the country from the immediate effects of the crisis. Nevertheless, there are other channels through which Guatemala external position can be affected. Remittances from abroad account for almost 12 percent o f the GDP and declined by 11 percent in February 2009 (year-on-year). External lines o f credit to the banking sector are increasingly expensive and more difficult to roll-over. Foreign direct investment, a significant source o f capital inflows, is expected to decline over the next two years as well. The decrease in external demand is also likely to affect exports. Total exports decreasedinthe last two months of 2008 when comparedto the same months in 2007. However, the decrease incommodities prices has led to a marked improvement in Guatemala's terms-of-trade -export growth decline will therefore be more than offset by a fall inthe imports bill. FigureA5.5: Total outstandingexternaldebt: evolution and decomposition. 40% 100% . ... .. .. ........". ..... ...... -.."...... ..... 30% 80% 20% 60% 40°h 10% 20% 0% 0% 2003 2004 2005 2006 2007 2008 2003 2004 2005 2006 2007 2008 Yo of GDP Private Public 100% Public and publiclyguaranteed 80% 60% 7% 40% 20% 0% 2003 2004 2005 2006 2007 2008 Short Term Long Term 0 fv!altilaterals ORicialBilaterals Commercial Others Source: IMF, WorldBank and CentralBank Baseline Results Under baseline assumptions, external debt is sustainable. As described in Table A5.2, the economic crisis will have a significant impact on the external debt in next 2 years. The forecasts show that total external debt-to-GDP ratio is expected to peak at about 39.7 percent in 2011 and decrease to approximately 38.6 percent in 2014. The public external debt as a ratio o f GDP follows a similar path reaching 14.2 percent in2010 and decreasing to less than 13 percent in 2014. Finally, the current account 67 deficit is projected to decrease as a proportion of GDP over the next five years, reaching external debt stabilizingvalues in2013 and 2014. Table A5.3: Total KternalDebt-Baselineil :dium-TermProjections Actual Projections 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Total externaldebt/GDP 34.5 35.9 36.7 35.3 36.9 38.3 39.7 39.7 39.2 38.6 olw public andpublicly guaranteed/GDP 13.1 13.1 12.4 11.2 13.1 14.2 13.9 13.7 13.0 12.9 olw private/GDP 21.4 22.8 24.3 24.1 23.8 24.1 25.8 26.1 26.2 25.7 Change inexternaldebt/GDP 1.0 1.4 0.8 -1.4 1.6 1.4 1.4 0.0 -0.5 -0.6 Identified netdebt-creatingflows -0.5 0.1 -1.2 -0.8 4.3 2.5 1.5 0.2 -0.2 -0.4 Currentaccount deficit* /GDP 3.0 3.4 3.5 3.3 3.0 3.4 3.0 1.8 1.7 1.6 Endogenousdebt/GDP dynamics -1.9 -1.5 -2.6 -2.0 2.8 0.7 0.3 0.3 0.1 0.1 Debt service/GDP 12.4 13.6 14.5 14.4 13.9 14.0 15.5 15.7 16.4 15.6 Debt servicelexports 77.1 82.4 82.7 80.7 84.8 83.1 90.2 89.7 92.7 87.1 Non-interestcurrentaccount deficit/GDPthat stabilizes debt ratio 2.0 2.0 2.7 4.8 1.4 2.0 1.6 1.7 2.1 2.2 * excludesinterestpayment Stress Tests The stress tests implemented in this section address uncertaintiesabout the duration and depth of the global economic crisis by considering two types of shocks: repeated and short term. Repeated shocks are small in size but are applied to the target variables for all five years in the forecast period simulating prolonged unfavorable conditions. On the other hand, short term shocks are larger but simulate a temporary worsening inexternal conditions -they hit only inthe first two forecasted years. Shocks to macroeconomic variables are first introduced into the baseline model one-by-one and then combined. The list ofkey variables includes GDP growth, exports growth, inflation, non-debt flows and the interested rate. Repeated shocks are a one-half standard'' deviation while short term shocks are a one standard deviation impulseto baseline values. The stress tests suggest that external debt is particularly vulnerable to a continuous decrease in non-debt flows. The overall debt exposition to repeated shocks is relative low. For most of the target variables the shocks shift the long term debt-to-GDP ratio to less than 45 percent. For few extreme shocks debt-to-GDP ratio reaches61 percent. (For detailed results please check Table A5.B inthe appendix). More specifically: 0 Shock to GDP growth: a repeated shock o f half standard deviation to GDP growth (equivalent to 0.65 percentage points fall per year) causes the external debt-to-GDP ratio increase 4.2 percentage points between 2008 and 2014, reaching39.5 inthe end of the period. Shock to exports growth: a repeated shock to exports (equivalent to 3.1 percentage points fall per year) increases debt-to-GDP ration by approximately 4.4 percentage points in the eight year period. Shock to financing conditions: a deterioration in financing conditions (increase in 2 percentage points the interest rate paid for new debt) have a similar effect on the external debt, increasing debt-to-GDP ration by 5.6 percentage points. I'Standarddeviationis calculatetaking as basevalues for the period 1999-2008 68 Shock to Inflation: a repeated shock of half standard deviation to Inflation (equivalent to 2.5 percentage points) produces a larger effect, risingthe debt-to-GDP almost 9.5 percentage points between2008and2014. Shock to non-debtflows: the largest individual effects is produced by a repeated shock to non- debt flows (equivalent to a reduction of 3.1 percentage points in net transfers-to-GDP ratio and 0.25 percentage points in net FDI-to-GDP ratio). In this scenario the growth rate o f the external debt remains hightowards the whole forecast period such that the total external debt-to-GDP ratio reaches60.7 percent in2014. Combination of shocks: a combination of repeated shocks o f one-forth standard deviation (including .33 percentage points fall in GDP growth, 1.6 percentage points fall inexports growth, 1.25 fall in inflation, 1.5 reduction in net transfers-to-GDP and 0.13 percentage points fall in net FDI-to-GDP ratio) also significantly increases the growth rate o f the external debt. In this extreme scenario the total external debt-to-GDP ratio grows 25.2 percentage points, reaching60.5 percent in2014. FigureA5.6: Total outstandingexternaldebt trajectoryunderdifferentstressscenarios repeated - shocks (presents projections ofTableA5.B inthe appendix) 60.0-I 55.0- -Histoncat A G D P growth 50.0- (repeated) -Exports (repeated) --bInflation(repeated) 45.0- A N o n d e b t flows (repeated) 40.0- *Combo 35.0- 30.04 2003 2004 2005 2006 2007 2006 2009 2010 2011 2012 2013 2014 Source: WE0and WorMBank staff calculations Vulnerability to non-debt flows and exchange rates persists when short term shocks are taken into consideration. The overall debt exposition to large short term debts shocks is even lower than in the previous case. For most scenarios debt-to-GDP ratio stabilizes in lessthan 43 percent, only 4.4 percentage points above the baseline forecast. In the most extreme scenario external debt-to-GDP ratio stabilizes around 60 percent in 2014. More specifically: Shock to GDPgrowth: a short term shock to GDP growth o f one standard deviation (equivalent to 1.3 percentage points fall per year) causes the external debt-to-GDP ratio increase 3.7 percentage points between 2008 and 2014, reaching 39 inthe end o fthe period. 0 Shock to exports growth: a short term shock to exports (equivalent to 6.1 percentage points fall per year) increases debt-to-GDP ration by approximately 6.8 percentage points in the eight year period. 0 Shock to Inflution: a short term shock to Inflation of one standard deviation (equivalent to 5 percentage points) rises the debt-to-GDP almost 7.4 percentage points between 2008 and 2014, reaching 42.7 in 2014. 69 Shock to non-debtflow: a short term shock to non-debt flows (equivalent to a reduction o f 6.3 percentage points in net transfers-to-GDP ratio and 0.5 percentage points in net FDI-to-GDP ratio) results in significant increase inthe external debt in the beginning o f the forecast period In this scenarioexternal debt-to-GDP ratio stabilizes around 52.8 percent in2014. Combination of shock: a combination of short term shocks of half standard deviation (including .65 percentagepoints fall inGDP growth, 3.15 percentage points fall in exports growth, 2.5 fall in inflation, 3.15 reduction in net transfers-to-GDP and 0.25 percentage points fall in net FDI-to- GDP ratio) also significantly increases the growth rate of the external debt. In this extreme scenario the total external debt-to-GDP ratio grows 24.2 percentage points, reaching 59.5 percent in2014. Figure A5.7: Total outstanding external debt trajectory under different stress scenarios short - term shocks (Dresents Droiections of Table A5.B in the aDDendix1 65.0 60.0 - El Baseline 55.0 Histoncal --t-GDP growth 50.0 -Exports - 45.0 --PInflation Nondebtflows 40.0 -0- Combo Finanang --,- . 2003 2004 2005 2006 2007 2006 2009 2010 2011 2012 2013 2014 wrce: WE0and WorldBank staff calculations 70 Auuendix Table A5.A: PublicDebtratiosundersensitivity tests lin YOof GDP) 2008 2009 2010 2011 2012 2013 2014 Baseline 20.2 23.8 26.0 26.9 27.5 27.9 28.3 Key variables are at their IO-year historical averages 20.2 23.9 24.7 25.2 25.7 26.1 26.5 Nopolicy change (constantprimary balance) 20.2 24.1 26.3 27.9 29.6 31.0 32.6 Real interest rate is at historical average plus permanent onestandard deviation 20.2 23.8 25.8 26.5 26.9 27.1 27.2 Real GDP growth is at historical average minuspermanent one-half standard deviation 20.2 23.8 25.8 26.7 27.3 27.7 28.2 Primary balance is at historical average minuspermanent one-half standard deviation 20.2 23.8 26.0 26.9 27.4 27.8 28.1 Combination of 1-3 usingone-quarter permanent standard deviationshock 20.2 23.8 26.0 26.9 27.5 27.9 28.3 Table A5.B: ExternalDebt ratiosunderstress tests 2008 2009 2010 2011 2012 2013 2014 Baseline 35.3 36.9 38.3 39.7 39.7 39.2 38.6 Key variables at their IO-year historical averages 35.3 33.3 33.1 34.2 35.7 37.1 38.5 Repeatedshock on GDP growth 35.3 37.0 38.5 40.1 40.3 40.0 39.5 Short-term shock on GDPgrowth 35.3 37.3 39.0 40.4 40.3 39.7 39.0 Repeatedshock on exports growth 35.3 36.9 39.3 40.7 40.8 40.3 39.7 Short-termshock on exports growth 35.3 38.1 41.6 43.1 43.2 42.7 42.1 Repeatedshock on inflation 35.3 37.8 40.2 42.8 43.9 44.4 44.8 Short-term shock on inflation 35.3 38.8 42.4 44.0 44.0 43.5 42.7 Repeatedshock on non-debt flows 35.3 40.5 45.6 50.8 54.6 57.7 60.7 Short-term shock on non-debt flows 35.3 43.7 52.4 54.1 54.1 53.6 52.8 Repeated combinedshocks 35.3 40.2 45.4 50.2 53.9 56.9 60.5 Short-term combinedshocks 35.3 48.4 59.0 60.8 60.9 60.3 59.5 Worsen infinancing conditions 35.3 37.2 38.9 40.7 41.2 41.1 40.9 71 ANNEX 6: FINANCIAL SECTORBACKGROUNDAND TRENDS Backround The Guatemalan financial sector was an important area of vulnerability for the Guatemalan economy in the late 1990s and early 2000/01, as a FSAP (Financial Sector Assessment Program), jointly conducted by the World Bank and IMFin 2000/2001, had documented. Most banks operated at the center of financial conglomerates that included a related, unregulated, off-shore bank catered exclusively to Guatemalan residents. Banks off-shore and off-balance operations were not reported; thus they were not regulated, and anecdotal information suggestedthat these operations amounted to the same volume as regulated operations. The credit boom o f the late 1990s had taken place in a context o f poor bankingsupervision and prudential regulation, and when the economy slowed down, a number o f banks experienced a sharp increase innon-performing loans (NPLs), which further compromised the soundness o f the financial sector. The FSAP hadwarned o f the possibility of a systemic crisis ifthese vulnerabilities were not addressedinthe short-term. The highcost of the interventionof three small weak banks and two financierasin 2001 convinced the Governmentof the need to strengthen financialsector regulations and supervision, resultingin the request for support from the IFIs. The Government intervention in 2001, paying off depositors in full, had an initial cost to the Central Bank of close to US$200 million. This convinced the Government o f the needto strengthen financial sector regulations and supervision, and o f introducing a bank resolution mechanism that did not involve the bailing out of depositors by the Central Bank. Concerned with the possibility of further bank failures, the Government requested support from the IFIs to elaborate a new legal and regulatory frameworks that would addressthe major shortcomings diagnosed by the FSAP. In 2001 and early 2002 the Guatemalan Congress approved a package of financial sector laws, preparedwith technical advice from the Bank, the IDB and IMF, addressing the main legal and regulatory shortcoming identified by the FSAF'. The authorities worked closely with the Bank, IMF and IDB inthe design o f the basic financial sector laws and worked hard for their approval by Congress. More specifically, this included the enactment o f four fundamental financial laws: (i)the Central Bank Law, (ii)the Monetary Law, (iii)the Banking and Financial Groups Law, and (iv) the Banking Supervision Law. The authorities were also active participants in the design o f the adjustment and technical assistance operations by the Bank, the FSAL and accompanying FSTAjointly presented to the Board for approval inJune 2002. The 2006 joint IMF-WB FSAP Update concludedthat, while the successfulresolutionof two banks (in late 2006 and early 2007) showed the significant progress made, there was still the need for further strengthening of the financial sector. Th e successful resolution o f Banco del Cafe S.A. (Bancafe) and Banco de Comercio S.A. showed the adequacy o f the new legal and institutional framework. However, the FSAP Update concluded that there i s still a need for significantly strengthening consolidated supervision, and for better risk-management practices by financial institutions. 72 Box A6.1: Progressinthe Guatemalanfinancialsafety net Guatemala's financial safety net, supported inits creation by a WB Adjustment Loan (FSAL) and accompanying TA loan (FSTA), consists of: (i) new bank regularizationhesolution mechanism, establishing a procedure o f a dealing with problem banks that consists o f agreeing on a regularization plan, ordering the suspension o f the bank's operation inthe case that the regularization plan is unsuccessful, and transferring the bank's deposits and an equivalent amount o f its assets to willing banks in the system. The residual assets and liabilities are transferred to a trust fund for their liquidation; (ii) newly established Deposit Insurance Fund(FOPA), which the insures deposits for up to 4~20,000(US$2,600) per individual or entity ina local bank or subsidiary o f a foreign bank. It is a fund administered by Banguat (the Central Bank) constituted by quotas paid by participating banks, returns on investments o f the fund, proceeds from liquidation o f banks and Government contributions. FOPA also received the equivalent in Quetzals o f US$73.5 million from the FSAL; (iii)the newly established Bank Capitalization Fund (FCB), which has the objective to support financially the process o f regularization and strengthening o f the national banking system, within the context o f processes o f bank mergers, acquisition o f assets, andprocesseso f exclusion o f assets and liabilities. Also, when strictly necessary it can support financially the FOPA. InOctober 2006 and inJanuary 2007, the operations of Banco del Caf6 S.A. (Bancafe) and Banco de Comercio S.A. were suspended, and FOPA was authorized to provide funds to the trusts constituted to exclude the assets of these banks, up to the amount o f the deposits covered by FOPA's guarantee (41,600.0 million for Bancaf6 and 4360.0 million for Banco de Comercio, 23.6 percent and 37.8 percent o f the total deposit obligation o f the two banks). These two bank resolutions are very significant. They are the first rapid resolution cases ever implemented with the new framework without going through liquidation. They put into practice the new resolution mechanism, and verified the resilience o f the new bank resolution framework. The resources provided by FOPA plus the total amount o f the excluded assets o f the suspendedbanksallowed for 100 percent coverage o f the deposits in both institutions. This mechanism allowed FOPA to utilize fewer resources (4564.6 million less) than it would have had to utilize to cover the promised guarantee, favoring its financial situation. The processeswere carried out ina rapid and orderly way, preservingthe stability o f the system. However, this experience highlighted the need to enhance the effectiveness and funding o f both FOPA and the FCB. Despite FOPA's subsequently recapitalization (through additional fiscal funds, an increase in premiums charged to banks, and additional secured funding form banks inthe system), there is a need to secure additional funding sources to support possible fiture bank resolutions. In January 2007, the FCB also provided financial assistance to FOPA for 4360.0 million, and to the three banks that participated in the process o f exclusion o f assets and liabilities o f Bancaf6 with 4138.4 million (subordinated debt to cover the increase in their respective minimum capital requirement due to the acquisition o f the business units that were incorporated in their balances). Since then, the FCB has also provided financial assistance in the order o f 4108.6 million to three banks to cover the minimum capital requirement, either related to the acquisition o f new business units or mergers with other banks. The failure o f these banks also highlighted some important vulnerabilities in the sector, and convinced the authorities o f the need to further strengthen risk-based, consolidated supervision o f financial conglomerates, and to create a financial crimes investigation unit. Since the failure o f these two banks, domestic financial markets have remained stable with no systemic runs. Since then the Bank has been assisting with the FTAL (closing on 06/30/2009) and the programmaticseries of DevelopmentPolicyLoans (DPLs) announced the 2005-2008 CAS. Inthe aftermath of the resolutions, the SIB and the Central Bank authorities requested further Bank assistance and the Minister of Finance requested an extension of the Closing Date of the FTAL and the reinstatement of US$2.0 million that had been cancelled earlier for budgetary reasons. It was agreed that the reinstated amounts would support efforts to advance the long term goal of transitioning to a risk-based supervision model and to enhance consolidated supervision of financial conglomerates, while also strengthening the supervision of AML/CTF activities, enhancing the financial safety net, and continuing with the modernization of the payments system. These efforts are expected to be continued beyond the closing date ofthe FSTA. 73 Evolution,status and imuactofthe internationalfinancialcrisis on the FinancialSector Guatemala's financial system is small compared with other countries in the regionand dominated by banks. Guatemala compares unfavorably with other countries in the region in terms o f domestic financing to the private sector (see Figure A6.1). The supervised system comprises o f banks (onshore and offshore); finance, insurance and bonding companies; foreign exchange houses; warehouses; and leasing, factoring and credit card companies. As o f January 2009, the banking sector accounted for about 84 percent o f the assets o f the financial system. Supervised non-banking sectors are small. Finance and insurance companies account only for 14 percent of the system's assets and the participation o f bonding companies, warehouses and exchange houses does not reach 1percent. The insurance and pension sectors are small and underdeveloped, the former heavily orientedtoward non-life insurance andthe latter largely public. There i s no equity market and the private debt market consists mainly o f short-term promissory notes, mostly issued by credit card companies and a few enterprises. The Government and the Central Bank are the primary bond issuers. In the unregulated sector, microfinance institutions have grown in recent years reaching an estimated total o f about 4 percent o f the banking system's credit portfolio. Close to 300 registered Savings and Credit Cooperatives are the most relevant microfinance institutions interms o f lending and provide a wide range of financial services like micro-savings, remittances payments, micro-insurance, and housing loans to mostly un-banked, moderate-income Guatemalans. FigureA6.1: Domesticcreditprovidedby bankingsector as percent of GDP Domesticcredit prowded by bankingsector (% of GDP) I 100% , 1 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Source: WDI&GDF The banking sector is mainly domestic and privately owned. The number o f onshore banks has dropped from 31 in 2002 (primarily through mergers and acquisitions'*) to 19 banks as o f January 2009. The four largest onshore banks hold about 73 percent of the system's assets13,with a moderate but rapidly increasing since 2006 Herfindahl-Hirschman concentration index for assets, credit portfolio and deposits. Inaddition, 7 banks operate as offshores and belongto financial conglomerates associated with onshore banks. The majority o f the 16 finance companies also belong to the local financial groups. Intotal there The banking crisis o f 2006-07, including the intervention o f Banco de Caf6 (the fourth largest bank at the time) and Banco de Comercio, further reinforcedthe trend. l3The four largest onshore banks are Banco Industrial, Banco G&T Continental, Banco de Desarrollo Rural and Banco Agromercantil de Guatemala. 74 are 10 financial conglomerates with Q134.4bn (US$17bn) o f assets. In terms o f ownership, although 7 onshore banks count with foreign participation, the main foreign bank is Citibank with a market share of about 7%, while Banco Azteca, a Mexican bank that initiated its operations in Guatemala in,2007, specializes in micro consumer loan operation^.'^ There are no majority state-owned banks inthe system, with the Government only holding a minority position in Banco de Desarrollo Rural (Banrural), an institution with about 18 percent o f the banking sector's assets that is dedicated to providing small short- term loans to farmers. Cr6dito Hipotechrio Nacional (CHN), an autonomous government entity that specializes in mortgage loans, has faced continuous difficulties since 2001, with losses reported for 2008 anda highNPL leveldespite several restructuringattempts. Table A6.1: Selected Banking Sector Indicators Dec-05 Dec-06 Dec-07 Dec-08 Jan-09 No of Banks LI 19 19 Balance Sheet (Q millions) Assets 88,679 106,698 118,393 130,778 133,33 1 Investments (net) 25,624 31,154 25,064 28,126 29,263 Liquidassets 13,534 16,741 18,078 19,1!n 20,403 Loans 43,560 51,515 68,984 74,826 74,886 NPLs 1,082 1,202 1,111 1,789 1,960 Provisions 951 1,135 1,172 1,309 1,361 Liabilities 81,251 ! n , O l l 107,504 117,350 120,07 1 Deposits 67,199 78,804 86,904 97,654 99,474 Capital 7,428 8,688 10,888 13,428 13,260 Primary capital 5,573 6,013 7,2 18 8,380 8,776 Note: Assets (US$ millions) 11,666 14,046 15,5 15 16,806 16,769 Assets o f5 largest banks (%Total) 61.4 71.O 77.8 79.1 79.0 Loans in US$ (% Total) 27.6 30.2 33.1 33.6 34.2 Income Statement (annualized) Interest income 5,594 6,O 43 10,245 11,075 12,7 13 Interest expense 2,090 2,329 4,111 4,453 5,043 Operating expenses 3,770 3,8 11 5,030 4,994 5,280 Pre-tax profit 1,387 1,6 13 2,229 2,684 3593 Net Income 1,128 1,293 1,834 2,188 3,300 Financial Indicators(%) Statutory Capital to Risk Weighted Assets 12.8 14.2 15.0 14.7 15.0 NPLRotal Loans 2.5 2.3 1.6 2.4 2.6 Provisions/NPLs 87.8 94.4 105.5 73.2 69.4 NPL-ProvisionsPrimary Capital 2.4 1.1 -0.8 5.7 6.8 ROE 15.2 15.1 16.9 16.3 24.9 ROA 1.3 1.2 1.6 1.7 2.5 Liquid assetflotal Assets 15.3 15.7 15.3 14.7 15.3 Source: SB Reported ratios of performance and solvency of banks have improved after the banking sector crises of 2001, butweaknessesremain. Financial sector legal and regulatory reforms implementedsince l4HSBC has been reported planning to begin operations in2009. 75 2000 have improved banks' solvency and resilience to market volatility. Official figures indicate that all banks in the system present capital to asset ratio over the statutory minimum o f 10 percent, with an average of 10.3 percent as o f December 2008 (in line with the other Central American countries ratio). The quality o f the banks' lending portfolios has improved with non performing loans (NPLs) as a percentage of total loans dropping from a system's average of 13.8 at end 2002 to 2.4 percent in December 2008. Bank profitability has also improved with an increase in the system's Return on Assets (ROA) from 0.6 at end-2002 to 1.7 percent in 2008, and for Return on Equity (ROE) from 10.7 to 16.3 percent inDecember 2008. However, weaknesses remain primarilythrough the low level o f provisioning for NPLs and possible capital adjustments that could weaken the capital to assets ratio thus implyinga lower than reported loss absorption capacity, and the dollarized portion o f the portfolio that is susceptible to exchange rate fluctuations due to non-dollar income generating clients. It should be noted however that the Monetary Board approved regulation in December 2008 to increase bank provisioning for NPLs. In addition, the 2006/2007 failure o f two banks, although successfully resolved, pointed to remaining vulnerabilities inthe sector and promptedthe financial authorities to strengthen the regulation of financial conglomerates and acceleratethe transitionto a risk-based consolidated supervision approach. The internationalfinancialcrisis hasprimarily impacted the Guatemalanfinancialsector througha squeeze in credit lines from international banks, and the Guatemalanauthorities have responded with a number of preventive measures. The largely domestic banking system o f Guatemala has been shielded from the external events, and direct subprime exposure was not an element of the banking sector. While secondround effects may include the impact o fthe economic slowdown, lower remittances and the recent depreciation o f the quetzal, the main impact has so far materialized as a drop in bank's lines of credit reportedly inthe order o f 25 percent, with the majority having been renegotiated with international banks albeit at less favorable terms. The main response by the Central Bank has been to: (i)ease the requirements on banks' accounting of reserves, in force since November 2008; (ii)established a temporary US-dollar fund facility for banks. This facility was initiated on November 2008 and was extended untilMarch 2009, but so far less than 35 percent o f the US$290m funds have been utilized by banks; (iii)cut its policy rate to 5.75 percent. This was the result of three distinct interventions, as the Central Bank cut its policy rate by 25bp in January, 50bp in February, 25bp in March, and 50bp in April following a slowdown ininflation. These decisions followed two consecutive years o f overshooting o fthe Central Bank's target and negative real interest rates in 2008, but the fall o f oil and commodity prices in late 2008, combined with falling domestic demand, resulted in a change in the Central Bank's policy stance. So far the policy rate cut has not translated to an adjustment in banks' lending interest rates, but there has been an impact on interbank rates; (iv) other measures, such as the utilization o f the 2005 introduced facility for liquidity in Quetzals, the withdrawal o f treasury bonds and the Central Bank deposit certificates heldby banks, increasedbank premiumsto the deposit insurance mechanism (FOPA). The SIB has also intensified supervision, with meetings among Central America Superintendents taking place on a monthly basis, and introduced regulationto increase bank provisioning for NPLs. Furthermore, the Congress approved Decree 64-2008, establishing a financial panic offence against false communications that may undermine the confidence o f clients, users, depositors or investors o f institutionsunder SIB supervision. 76 ANNEX 7: GUATEMALA AT A GLANCE Guatemala at a glance 4/28D9 7 LEdn LOU= Key Developnent Indicators America midb Guatemala 8 Caib. home Age dlrtributlon,2007 (lorn) Poprlation,mid+er(milions) 13.3 563 3,437 eo+ %face am(t-d sq km) 109 20,421 35,510 7074 Poprlafongiuvih(%) 2.5 1.2 1.0 Bo84 &banpopdrtion(% of told populrtim) 48 78 42 5054 4C-44 GNI(Atlasmethod,U Sbillicns) 32.9 3,118 6,485 x-34 GNIperc@i$ (Allasmetmd,Us$) 2,470 5,540 1.887 2024 GNIperqih(PPP, Hmtiorrd$) 4,440 9.320 4,544 IC-14 0-4 GDPgiuvih(%) 6.3 5.7 9.7 M 10 0 10 x1 W P percapitagmAh(%) 3.7 4.5 8.6 pnmt (most recentestimate 2000-2007) Pomelh/headwrntratioat$1,25aday(PPP,I) 8 Pomelh/headwrntratiort$2.Waday(PPP,Oh) 18 hder-5 mortally rate (per 1,000) Lifee x p m y a t tirh()em) 70 73 69 Idartmttdity(per1,OWliwbim0) 31 22 41 801 Childmalntrilim (W ofctildrenvder5) 18 5 25 Multliteracy,male(% dages 15andMer) 75 91 93 Adultliteracy,femde(%of ages 15adolder) 63 89 85 Grossprimay ermllmnt mde (%of w e g r q ) 118 120 112 Grosspimay ermllmntfemale(% d age guy) 109 116 109 Access to animprovedHBtersom(%of popdation) 95 91 88 Access to impromdsaitarionfacilities(%of populaicn) 86 78 54 NetAid flows 1980 1980 2000 2007 (US$rni//ionsj NBIODA adofficialaid 73 Pl 263 487 G r M ofGDPand GDP pacapita (%) T C3~domrs (inzm6): S w n 0 15 224 UribdStates 17 88 58 67 6 1 Jqa 3 5 67 39 Ad (% dGNI) 0 9 2 7 1.4 1.6 Adpercapi$(US$) 10 23 23 37 LOnpTerm EconomicTends 90 85 00 05 Ccosmaprices(m-4Wm e ) 107 41.0 7.3 11.4 W P implicitdeflar (mud%m e ) 100 40.5 6.8 6.9 -ODP -ODPprcqitn 1 0 4.5 7.8 7.7 Terms of Veda idex(2030= 1W) E x m e ma (mudamrage,localp rUS$) 1980-90 1960-20W 2000-07 (aveweannualgm4h %) Population.midyea(mi1ims) 7 0 8.9 11.2 13.3 2 4 2.3 2.5 GDP(US$millions) 7,079 7.650 19,289 34,a)l 0.8 4 2 3.7 (%Of GLPj p g ~ u l t l m 24 8 25.9 22.8 11.2 1 2 2 8 3 1 lnjstry 22 0 19.8 19.8 27.5 0 2 4 3 3 0 w a d * 166 15.1 13.2 18.4 00 2 8 2 9 senices 532 54.3 57.4 53.5 0 9 4 7 4 1 bbusehddfinalwnsmpfon axpendihre 78 9 83.6 83.9 87.7 11 4 2 4 1 Gam1gov'lfimlmnsunc4ionexpenditue 8 0 6.6 7.0 8.7 2 6 5 1 0 6 Gross cqitdfamation 159 13.6 17.8 20.7 -1 8 6 1 4 2 Exportsofgmds ad services 222 21.0 20.2 25.3 -1 8 6 1 2 1 Importsofgmdsad services 24 9 24.8 29.0 42.3 -1 7 9 2 34 Gross sauirgs 139 10.0 MJB Fig- inildicsrreforyerrsd~~anthosespwfied2007datairepreliMrrayi-dic&s&aaerrlavalable a M dataire fcr Po6 Developma Ecomics, DevelopmerlDrtaGrmp(DECDG) 77 Guatemala Balance of Payments and Trade 2000 2007 IGovernanceIndkators, 2000 and 2007 (US$ millions) Totalmerchandiseexports(fob) 3.085 5,196 Totalmerchandiseimports(ci9 5,171 i1,848 Voice andaccwnbbity Nettrade ingoods and services -1,705 5,968 Pobbcalstablity Currentaccountbalance -1,049 -1,723 ase%ofGDP 5.4 5.1 Workers' remittancesand compensdon of employees(receipts) 596 4,130 Reserves,includinggold 1.811 4,335 Central Government Finance (% of GDP) Currentrevenue(iffiluding grants) 10.4 12.9 Tax reverue 95 12.1 Currentexpenditue 8.5 9.5 Technology and Infrastructure 2000 2007 OverallsUplus/defirit -1.e -1.4 Pavedroads (YOof total) 34.5 Hghestmarginaltax rata(%) Fixedlineand mobilephone Individual 31 31 subscriben (per 100people) 14 65 Corporate 31 31 Hightechmlogy exports (% of maufachred exports) 7.9 3.1 External Debt and Resource Flows Environment (US%millions) Totaldebt outstandinganddisbmed 3.853 5,776 Agricultural Imd(%of landarea) 42 43 TotaldebtseMce 390 626 Forestarea (% of land area) 38.8 36.3 Debtrelief(HIPC, MDRI) - - Nationallypmtected areas (% of landarea) .. 23.4 Totaldebt (% of GDP) 20.0 17.0 Freshvaer resomes percapita (cu. meten) .. 8,592 Totaldebt service (% of exports) 8.4 5.5 Freshvaer withdrawal (% of internalresources) 1.8 Foreigndirectimstment(netitMows) 230 354 CO2 emissionsper capita(mt) 0.91 0.96 Porifolioequity (netinflows) 0 0 GDP per rnitof energy use Composltlonoftotalexternaldebt, 2006 (2005 PPP$ perkgof oil equivalent) 6.1 6.4 Energyuse per capita(kgof oil equivdent) 636 628 (US$ millions) IBRD Total debtoutstandingand disbursed 296 740 Disbursements 51 136 Principalrepayments 13 38 Interestpayments 21 37 IDA Totaldebt outstandingand disburrred Disbmements Private Sector Development 2000 2008 Totaldebt service Time reqtiredlo starta business(days) 28 IFC (fisca/ year) Cost to starta business (%of GNI percapita) -- 50.6 Totaldisbursedand outstandingporifolio 118 57 Time requiredto registerpmpelty (days) - 30 ofwtichIFCownaccount 84 46 Disbursementsfor IFC own account 21 0 Rankedas a majorconstraintlo business 2000 2007 Porifoiiosales, prepaymentsand (ohof managen swveyedwho agreed) repaymentsfor iFC ownaccount 9 52 Coinipbon ,, 80.0 Crime .. 80.4 MlGA Gmss exposm 18 101 Stockmarketcapitalization(YOof GDP) ######## Newg u m e e s 0 0 Bark capitalto asset ratio(%) 8.9 9.1 Note Figuresinitdics are for yeas otherthanthose specified 2007 dataare preliminary i-dicates datawe rot available -indicates ObseNatlonis not applicable DevelopmentEcoromics, DevelopmentDataGroup (DECDG) 78 MiHennium Development Goals Guatemala Wth selected targetsto achieve between 1990and 2015 (estimateclosestto dateshown, W- 2years) Goal 1:havethe ratesforextremepovaty andmalnubition I890 1995 zoo0 2007 Puveriyt-ed~r~oat$125a&y(PPP, %of popllabn) Puvertyhedccrnt r& at &nal povertyline(%of population) 57.9 562 S h i v e o f i ~ a m e o r c a ~ ~ ~ i o n t o U m p o w s t q ~ l e ( % ) 2.2 3.5 3.9 Prevdemof malmbition(%of chiktenunjer5) 20.3 Goal 2: ensurethat children we ablato completeprbnary schooling Primayschoolemllmalt(net.%) 85 94 Primaycompletionrate(% of relevintagegrap) 48 58 n 23 38 53 youm r i e ym(% d p o p west 524) Serarday schooledlment (gross.%) 73 77 79 Goal 3: dhinde gender disparity Ineducationa denpowerwomen Ratioofgirisbboysinpnmaymdserardayed~ion(%) E9 92 Womenernpbpd inUmmnagncdtvalS&Q (%of mrqnWnualemployment) 37 38 Prrpotkmof seats heldbywanen innationalpdment(%) 7 13 7 12 Goal 4: r d u w unda-5 mortalltybytwo-thirds 62 64 53 41 60 49 39 31 68 83 ea 95 Goal 5: reducematernalmortalitybythree-foutths M a dmortalityratio(modeledestima,p a 100,OWIM births) 290 B i b atteded by skilledhe4thstaff (%of total) 34 41 Comacepbveprevalem(%ofwommages 1549) 31 38 Goal 6: hdt a d beginto reversethespreadof HV/ADSand othermajordiseases Prevdenceof HIV (%of popllatlonages 1549) 0 8 0 8 lmldemdt h d o s i s (per1W,MOpeople) 90 87 83 79 Tubedcsis casesdetectedtrderDOTS (%) 43 50 56 Goal 7: hdvethe proportionof peoplewmwtsustdnableaccessto basicneeds Access to mimmvedwater s w c e (% of populatiffl) 79 85 91 95 Access to improvedsgntahmfacil8es(% dpopdabon) 58 68 78 86 Forestarsa(%oftotal la-dm a ) 43.8 38.6 36.3 NabonalMprotectadmas(%d btalIa-daea) 23.4 CO2 emsslons(metnctonsper cap&) 0.6 0.7 0.9 1.o GDPpamtofenergyuse (caDtmtZW5PPP $perkgofoil equdalt) 6.5 6.7 6.1 6.4 Goal 8: dwebp a globd partnershipfor devebpment Telephone miinlines(per100people) 21 2.9 6a 10.4 Mobilephonesubscribers(per100people) 0.0 0.3 7.6 76.0 Internetusers (per100people) 0.0 0.0 0.7 10.1 7 Pmond mpnm(per 100people) 0.3 12 2.1 !ducation indicators(%) leasles bnmunhation(%ofl-yearolds) ICThdcators(peclo0people) $03. x x x ) x x ) 2 x x y m o B &Primrynetmmlmrtralo -c-Rrdoofgirklo&oinpimay 8 semrdaryeducdlm Nste:Figues initalics~forprrsdherh~thosespecifiedirdcatesdatammtavailable. .. 4mD9 Dwdopmalt Ecomics,DewlopmerlDateGrwp(DECDG). 79 IBRD 33413R1 GUATEMALA 91°W 90°W 89°W 88°W SELECTED CITIES AND TOWNS DEPARTMENT CAPITALS NATIONAL CAPITAL M E X I C O RIVERS GUATEMALA PAN AMERICAN HIGHWAY MAIN ROADS 18°N RAILROADS 18°N DEPARTMENT BOUNDARIES Paxbán INTERNATIONAL BOUNDARIES 92°W Carmelita San Pedro P E T É N TikalTikal El Naranjo Melchor de Mencos L. Petén Itzá BELIZE 17°N 17°N Flores Usumacinta opán La Libertad M To M E X I C O Tuxtla Gutiérrez PasióSayaxché n Machaquilá Salinas Gulf San Luis of 16°N Cancuén Honduras 16°N cxáIn Sarstún Barillas Chiyú Modesto Lívingston Méndez HUEHUETENANGOHUEHUETENANGO ALTA VERAPAZ AL VERAPAZ Puerto nta Cruz Barrios Cahabón SaIZABAL IZABAL QUICHQUICHÉ QUICHÉ Mts. Sierra de Selegua El Estor Chajul Chamá Cahabón L. de Cobán Cobán Izabal Morales Huehuetenango Los Amates SAN Sierra Negro Polochic de MARCOS los Motagua BAJA VERAPAZ BAJA VERAPAZ Tajumulco TOTONICAPAN Santa Cruz Chuacús Salamá Salamá Z A C A P A 15°N (4220 m) Del Quiché Quiché EL EL San Marcos 15°N Totonicapán otonicapán Motagua Zacapa To PROGRESO PROGRESO To Tonalá S El Progresso Suchia i NQuetzaltenango GO e El Progreso Sololá Sololá GUATEMALA Chiquimula et UETZATLLT rENAr SOLOLÁ SOLOLÁ a TENANGO Chimaltenango CHIQUIMULA CHIQUIMULA QRetalhuleu MazatenangoL.Atitlan Jalapa SACATE- Antigua GUATEMALA Esquipulas HONDURAS M JALAPA JALAP Ocós a CHIMAL PEQUEZ d Guatemala RETALHULEU r e Cuilapa Jutiapa Champerico Escuintla SUCHITEPEQUEZ SANTA JUTIAPA JUTIAP ESCUINTLAESCUINTLA ROSA 14°N 14°N Sipacate San José EL SALVADOR EL SALVADOR Las Lisas 0 20 40 60 Kilometers To La Unión 0 10 20 30 40 50 Miles To La Unión This map was produced by the Map Design Unit of The World Bank. PACIFIC OCEAN The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, or any 13°N endorsement or acceptance of such boundaries. 13°N 92°W 91°W 90°W 89°W 88°W NOVEMBER 2006