Report No. 39807-NI Nicaragua Public Expenditure Review 2001­2006 March 20, 2008 Poverty Reduction and Economic Management Central America Department Latin America and the Caribbean Region Document of the World Bank Acknowledgments This report was prepared by a team led by Ulrich Lachler (LCSPE) and Amparo BalliviAn (LCSPP), as co-task-managers, and comprising Ed Bresnyan (RUTA), Rafael Cortez (LCSHD) Aline Coudouel (LCSHS), Tony James (LCSFT), Rodrigo Jarque (LCC2C), Christine Lao Pena (LCSHH), Fernando Lecaros (LCSFP), Julio Revilla (LCSPE), Jeffrey Rime (LCSPS), Ulrich Schoppmeyer (Kreditanstalt fir Wiederaufbau, Germany), Alexandria Valerio (LCSHE), and Manuel Vargas (LCOAA). The peer reviewers for his report are Jordi Prat (IMF) and Steve Webb (LCClA). The principal authors responsible for each sector addressed inthe PERare as follows: 0 Macroeconomic Analysis UlrichLachler 0 Debt Sustainability Julio Revilla 0 Education Alexandria Valerio 0 Health Christine Lao Penaand Rafael Cortez 0 Social Protection Aline Coudouel 0 Transport Tony James 0 Water & Sanitation Ulrich Schoppmeyer 0 Energy Fernando Lecaros 0 Agriculture/Rural Development EdBresnyan a Public Employment and Wages Amparo Ballivihn 0 Decentralization Jeff Rime 0 Public ExpenditureManagement Manuel Vargas 0 StatisticalAnnex Rodrigo Jarque A mission to coordinate the preparation of the report visited Nicaragua at the end o f November 2006 and another mission visited in mid-March 2007. The PER team would like to thank the Nicaraguan authorities for their cooperation in facilitating access to any data and information requested by the mission. Director, LCC2C: Jane Armitage Director, LCSPR: Ernest0 May Task Managers: UlrichLachler AmDaro Ballivihn NICARAGUA PUBLIC EXPENDITUREREVIEW 2007 PREFACE ........................................................................................................................................... i EXECUTIVE SUMMARY .................................................................................................................. ... 111 CHAPTER INTRODUCTION I. ........................................................................................................... 1 A. Country Context .................................................................................................................. 2 B. Two KeyDevelopment Issues............................................................................................. 5 C. Summary Outline of the PER.............................................................................................. 7 CHAPTER 11 OVERVIEW OF PUBLICSECTOR SPENDINGAND FISCAL . SUSTAINABILITY .............9 A. Overview o fthe Public Sector andthe Compositiono fPublic Spending........................... B. ThePatternofRecent FiscalAdjustments and SizeofGovernment ................................ 9 16 C. Fiscal Sustainabllity........................................................................................................... . . . D. MainConclusions .............................................................................................................. 20 24 CHAPTER 111 THE EFFICIENCY OFPUBLIC SPENDING1NNICARAGUA 27 A. Growth andPovertyReductionPerformance.................................................................... . ........................................ 27 B. The Level and Efficiency o fPublic Investment ................................................................ 28 D. TheEfficiency ofSocial Sector Spending......................................................................... C. The Level of Social Sector Spending ................................................................................ 36 40 E. Summary and Conclusions ................................................................................................ 48 CHAPTER Iv.PUBLIC SECTOREMPLOYMENT REMUNERATION POLICY AND .......................... 51 A. The LegalFramework ....................................................................................................... 52 B. Public Sector Employment................................................................................................ 53 C. Public Sector Remuneration.............................................................................................. 57 D. MainFindings andPolicy Options .................................................................................... 72 CHAPTER v.FISCALDECENTRALIZATIONNICARAGUA IN ........................................................ 77 A. Municipal Government Roles and Assigned Revenues (1987-2006) ............................... 78 B. The Budget Transfer Formula and Municipal Own-Revenues ......................................... 81 Municipal Expenditures..................................................................................................... 83 D. C. Accountability for Public Expenditure.............................................................................. 85 E. Redressing Imbalances: Current and Proposed Reform Actions....................................... 87 F. Concluding Considerations ................................................................................................ 92 CHAPTER IMPROVING VI . GOVERNANCE EXPENDITURE MANAGEMENT ................................................................ THROUGH REFORM 95 A. The Legal and Institutional Framework o fPublic FinancialManagement ....................... 95 B. Performance o f Systems. Processesand Institutions....................................................... 100 D. MainConclusions............................................................................................................ C. Reform Process................................................................................................................ 120 124 REFERENCES ............................................................................................................................... 129 Annexes Annex A. Technical Note on the Efficiency o fPublic Spending inNicaragua ......................... Annex B. Basic Parameter Assumptions Underlying the Fiscal Sustainability Analysis ..........133 143 Annex C. Reviewo f Public Spending on Education.................................................................. 145 Annex D. Reviewo fPublic Spendingon Health....................................................................... 161 Annex E. Reviewo fPublic Spendingon Social Protection....................................................... 177 Annex F. Review o fPublic Spending on Transport ................................................................... 185 Annex G. Review o fPublic Spendingon Water and Sanitation ................................................ 195 Annex H. Review o fPublic Spendingon Energy...................................................................... 203 209 Annex J. Budget Transfer Allocation byMunicipality, 2006-2007 .......................................... Annex I. Review o f Public Spending on Agriculture and Rural Development......................... 219 Annex K. Implementation Status o f CFAA Action Plan, January 2006 .................................... 223 Annex L. Model Outline for Sector ExpenditureReviews ........................................................ 229 Tables Table 1.1 Key Social Indicators. 2005 ........................................................................................... 2 Table 2.2 Nicaragua: Fiscal Balances o fthe Non-FinancialPublic Sector.................................. Table 2.1 Nicaragua: Financial Structure o f the National Public Sector Budget. 2007 .................9 Table 2.3 Nicaragua: Economic Composition o fCentral Government Expenditures .................11 12 Table 2.4 Nicaragua: Sector Composition o f Central Government Expenditures ....................... 14 Table 2.5 Nicaragua: Institutional Compositiono f Central Government Expenditures ..............16 Table 2.6 Central Government Revenues and Expenditures inLatin America & Caribbean ......17 22 Table 2.8 Nicaragua: Total Domestic Public Liabilities .............................................................. Table 2.7 NPV o fFuture Stream o f Public Revenues.................................................................. 23 Table 3.1 Relationbetween Growth Rates and Gross Fixed Capital Investment:l990-2005 .......28 Table 3.2 Nicaragua: Capital Expenditures o fthe Central Government, by Sector..................... 29 Table 3.3 InfrastructureSector Investment inLatin America: 1991-1998................................... 30 Table 3.4 Social Sector Spending inCentral and Latin America: 1990-2003 ............................. 37 Table 3.5 Public Spending on Primary Education in2005........................................................... 38 Table 3.6 Public Spending on Secondary Education in2005....................................................... 39 Table 3.7 Population, GDP and healthExpenditures in Central America, 2003 ......................... 40 Table 3.8 Rankingo fEfficiency Scores for Public Spending inEducationand Health.............. 41 Table 3.9 Distribution o f Government Education Subsidies byHouseholdExpenditure Quintile ............................................................................. 45 Table 3.10 Nicaragua: Health Expenditures, by Source; 2001-2004 ........................................... 46 Table 3.11 Shares o f Total health Spending by Function.............................................................. 46 Table 3.12 Health Outcomes and Outputs; 2001 and 2005 ........................................................... 47 Table 3.13 Main Social Protection Programs inthe Budget (executed budget; YOo f GDP)............. Table 4.1 Nicaragua: Public Sector Employees ........................................................................... 55 Table 4.2 The Central Government Wage Bill............................................................................. 58 Table 4.3 Salary Distribution inthe Public Sector ....................................................................... 58 Table 4.4 Public versus Private Sector Pay.................................................................................. 62 Table 4.5 Average Annual Remuneration. by Gender. 2002 ....................................................... 63 Table 4.6 Monthly Salaries inEducation. by Level and School Modality................................... 64 Table 4.7 Monthly Salaries inEducation. by Autonomous Centers ............................................ 64 Table 4.8 Monthly Salaries inEducation. DecentralizedMunicipalities ..................................... 64 Table 4.9 Monthly Teacher Salaries inCentral America ............................................................. 65 Table 4.10 Hourly Wages Rates inCentral America .................................................................... 66 67 Table 4.12 Health sector: Share o f Gross Wage Bill. by Type o f Service ................................... Table 4.11 Health Sector Remunerationand Wages .................................................................... 68 Table 4.13 Health Sector Professional Wages by Occupation..................................................... 68 Table 4.14 Average Doctors' Salaries inCentral America .......................................................... 69 Table 4.15 Physicians' Base Salaries Relative to Per Capita GDP .............................................. 69 Table 4.16 Consultants' Compensation by Financing Source (18 Institutions) ........................... 71 Table 4.17 Budgetary Lines Utilizedinthe Contracting o f Consultants...................................... 71 Table 4.18 Reference Table for Consultant Wages ...................................................................... 72 Table 4.19 Reference Salary Table. 2006..................................................................................... 75 Table 4.20 Basic Salary Table for the Ministry o f Health............................................................ 76 Table 5.1 Areas ofMunicipalResponsibility............................................................................... Table 5.2 Evolution o f Central Government Transfers to Municipalities. 2003-2007.................78 82 Table 5.3 Composition o f Total Municipal Current Revenues. 2005 .......................................... 82 Table 5.4 Municipal Current Revenue and BudgetTransfers. 2003-2007................................... 83 Table 5.6 Current Revenues. Municipal Categories & Budget Allocation Rules........................ Table 5.5 Share of Municipal Expenditure inTotal Public Expenditure. 2003-2006 ..................83 84 Table 5.7 Allocation o f Transfers According to Municipal ApprovedBudgets.......................... 84 Table 5.8 Utilization o f Budget Transfer According to Municipal Approved Capital Budgets.2004-2006 ....................................................................... 84 Table 5.9 MunicipalExpenditures by Category. 2004................................................................. 85 Table 5.10 Municipal Debtwith the INSS. byDepartment......................................................... 86 88 Table 5.12 Allocations for "Tax Collection Efficiency" 2007..................................................... Table 5.11 BudgetCuts to "Neutralize" Transfers. 2004-2007 ................................................... 90 Table 6.1 Deviation inExpenditure Budget Execution andVariance inComposition ofPrimaryExpenditure............................................................................................ 100 Table 6.2 Aggregate InternalRevenue Execution...................................................................... 101 Table 6.3 RecordedFloating Debt.............................................................................................. 101 Table 6.4 Legally EarmarkedFunds........................................................................................... 107 Table 6.5 In-year Expenditure BudgetModifications................................................................ 109 Figures 11 Figure2.2 Nicaragua: Evolutionof CentralGovernment Wage Bill........................................... Figure2.1 Nicaragua: Evolutiono fTotal Current Government Expenditures ............................ 13 Figure2.3 Total Central Government Expenditures, 1994-2006................................................. 14 Figure2.4 Measures o fGovernment Size: Expenditures and Revenues ofthe Non-Financial Public Sector ............................................................................. 19 Figure3.1 Nicaragua's Relative GrowthPerformance ................................................................ 27 Figure3.2 Per Capita GDP, Gross FixedCapital Formation and InfrastructureQuality Across Lower Middle Income Countries..................................................................... 32 Figure 4.1 Nicaragua's Economically Active and Inactive Population........................................ 54 Figure 4.2 Total EmpleadosPublicos........................................................................................... 54 Figure 4.3 Average IndividualSalary Gross Monthly C$............................................................ 59 Figure4.4 MHCP, TSR y RangosSalariales(en C$). Junio 2006............................................... 61 Figure 4.5 MECD. Numero de Funcionarios y Masa Salarial Bmta (en C$/Mes)....................... 61 Figure 4.6 Base Salaries ofHealth Care Providers Relative to Physicians' Salary ..................... 62 . Box 2.1 PensionSystem CoverageinNicaragua......................................................................... Boxes 25 Box 6.1 MainLaws and Regulations ofPublic Financial Management...................................... 95 Box 6.2 National Development Plan............................................................................................ 99 StatisticalAnnex Tables A.l.O Nicaragua: KeyMacroeconomic Indicators..................................................................... 233 A.l.1 Nicaragua: Ingresosdel Gobierno Central(en millones de Cordobas) ............................ 234 A.1.2 Nicaragua: Ingresosdel Gobierno Central (en porcentajedelPIB) ................................. 235 A.1.3a Nicaragua: Gasto Corriente del Gobierno Central por Institucion(en millones Cordobas) ........................................................................... 236 A 1.3bNicaragua: Gasto Capital delGobierno Central A.1.4 Nicaragua: Gasto Total del Gobierno Centralpor Institucion (en millones Cordobas) ...238 por Institucion (en millones Cordobas) ........................................................................... 237 A.1.6 Nicaragua: GastoTotal delGobierno Centralpor Institucion (en %PIB)....................... A.1.5 Nicaragua: GastoTotal delGobierno Central por Institucion (en % gastototal) ............239 240 A.1.7 Nicaragua: Balancedel Gobierno Central (en millones Cordobas).................................. 241 242 A.1.9 Nicaragua: Gasto del Gobierno Central por Sector (en % PIB) ....................................... A.1.8. Nicaragua: BalancedelGobierno Central (en %PIB) .................................................... 244 B.l NumberofPublic Sector Employees.byInstitution.......................................................... 245 B.2 Wage Bill. by Institution..................................................................................................... 246 B.3 Average GrossMonthly WageBill.byInstitution ............................................................. 247 B.4 Average IndividualSalary Gross Monthly ......................................................................... 248 NICARAGUA-PUBLICEXPENDITURE REVIEW PREFACE Public Expenditure Reviews (PERs) are core diagnostic studies periodically prepared by the World Bank to analyze public sector issues, with a focus on the efficiency and equity o f public resource allocation. This PER was undertaken at the request o f the Nicaraguan government administration under President Bolaiios, whose mandate ended in January 2007, and is mostly based on information up to 2006. Given that time horizon, its capacity to comment on the new programs that have been prepared or are being contemplated by the current government under President Ortega is limited. Furthermore, the analysis in this PER takes as its point o f departure the market-based and private sector-led development perspective that was broadly shared by the Bolafios administration and which was reflected in the poverty reduction strategy that was in effect at that time. This perspective differs in several important ways from the more social- oriented andpublic sector-led development perspective adopted by the current administration. In this context, the reader i s remindedthat the views expressed inthe PER are solely those o fWorld Bankstaff anddo notnecessarily reflectthe views or positions o fthe Nicaraguangovernment. The authorities are currently i s inthe process o f updating Nicaragua's poverty reduction strategy for the period 2008-2011, to be named the Plan Nacional de Desarrollo Humano (PNDH). The PNDH is expected to build on the longer term poverty reduction strategy presented earlier by placing greater emphasis on social development and inclusive growth. As indicated in several position papers presented in 2007; the Nicaraguan authorities are committed to maintaining continuity with certain key elements o f the earlier strategies that have been considered successful. These include (i) maintaining macroeconomic stability and ensuring public debt sustainability as prerequisites for reducing poverty, (ii)advancing on key social indicators toward meeting the Millennium Development Goals, (iii)diversifying the export base and leveragingregional free trade agreements inorder to increase access to external markets, and (iv) preserving a policy environment conducive to attracting more private investment, including from foreign sources. The authorities also have indicated a commitment to change certain elements o f the earlier poverty reduction strategy. The most important strategic changes include: 0 refocusing attention from the "cluster development strategy" that figured prominently in the earlier growth strategy and which i s viewed as favoring the larger, more established economic agents, towards supporting production by the poorest households and small & medium sized enterprises, including through increased access to credit for these sectors, L +These documents refer to: Gobiemo de Reconciliacion y Unidad Nacional, "Programa Economico-Financier0 2007-2010 (Agosto 2007) Nicaragua: Progress Report National Development Plan 2006 (Agosto, 2007), Gobiemo de Reconciliacion y UnidadNacional, Secretaria Tecnica del Poder Ciudadano (SETEC), "Nicaragua: ProgressReportNational Development Plan2006 (August 2007), and Gobiemo de Reconciliacion y Unidad Nacional, "Prioridades del Gobierno de Reconciliacion y Unidad Nacional Proceso en ConstruccionPermanente, (Agosto, 2007) 1 0 discontinuing the privatization agenda, which is viewed as not having worked well especially inthe electricity and social security sectors, and placing more emphasis on state intervention andoversight, 0 placing greater attention on promoting human development, instead o f compensatory polices and what i s perceived as too narrow a focus on eliminating extreme poverty, and 0 improving access to public services in health and education, in part by providing these services free o f charge to beneficiaries and in coordination with other line ministries. This last strategic change i s associated with a broader program reorientation away from the principle o f targeted interventions toward one that aims for greater universality. While some o f the recommendations offered in this report may require adaptation to these differences in development perspective, the most important fiscal challenges facing the Nicaraguanauthorities remain unchanged. This PERi s intendedto provide a timely reference in drawing attention to these challenges and inhelping to identify various opportunities for raising the impact ofpublic expenditures, independent o f the preferred development approach. 2 NICARAGUA-PUBLIC EXPENDITURE REVIEW Executive Summary 1. Nicaragua has made impressive progress since 2001 in reducing the overall fiscal deficit. A series o f internal and external shocks (hurricane Mitch, banking crisis, elections) reopened major fiscal gaps at the end o f the 199Os, which threatened to destabilize the economy. Since then, fiscal management has remained prudent in spite o f spending pressures, resulting in an improvement o fthe combined public sector balance (after grants) from a deficit o f 5.4 percent o f GDP in2002 to a surplus o f 0.2 percent in2006. Economic growth also recovered duringthis period, to average almost 4 percent, while inflation remained in single digit figures. This positive outcome was facilitated by a favorable external environment, characterized by rapid growth among Nicaragua's trading partners, a doubling o f remittance flows, and massive external debt relief. .. 11. The decline in the fiscal deficit was brought about entirely through increases in public revenues, which raises some concerns about political sustainability. In spite of substantial debt service relief (achieved through the HIPC and other initiatives), total NFPS expenditures as a share o f GDP now surpass the peak level reached in the immediate aftermath o f hurricane Mitch. Meanwhile, tax revenues have risen continuously, from 13 percent o f GDP in2001 to almost 18 percent in2006. This was madepossible through a series of tax reforms, followed by improvements in tax administration and a buoyant tax response to a growing economy. Recent cross-country research, however, suggests that fiscal adjustments that depend mainly on revenue increases are more difficult to sustain over time than those that depend on expenditure reductions. These concerns could be addressed through a more balanced approach when future adjustment needs emerge, combining revenue-raising measures with expenditure cuts innon-priority areas. iii. Nicaraguaexhibitsamoderate,butmanageable, riskofexperiencingdebtdistress, provided that sound macroeconomic policies continue to be applied. When all ongoing debt relief initiatives have been implemented, Nicaragua external debt, in net present value terms (NPV) declines to about 35 percent o f GDP. Nicaragua also has a highlevel o f domestic debt, however, with an NPV o f about 19 percent o f GDP at end-2006. This adds up to a combined public debt o f approximately 54 percent o f GDP, which i s sustainable ifNicaragua can continue to grow by at least 4 percent per annum, maintain a primary fiscal surplus near the levels achieved inrecent years and keep various fiscal pressures incheck. Key threats to fiscal stability inthe short runarethe risingfiscal transfers to the municipalitiesmandatedby Law 466 (without a coincident transfer o f spending responsibilities), growing pressures on public wages and the possibility o f an energy crisis. In the medium term, a major threat is posed by the actuarial deficit o fthe pension system. iv. Nicaragua's long run fiscal sustainability will depend closely on how the authorities deal with the actuarial deficit of the pension system. In2006, the pension system exhibited an actuarial deficit estimated at around 162 percent o f GDP. Ifthe system i s allowed to remain as is, then the present fiscal framework is clearly unsustainable, even with a 2 percent primary fiscal surplus. To sustain the resulting domestic debt (including pension liabilities), would require a 3 substantially larger primary fiscal surplus - on the order o f 6 percent ifGDP growth remains at 4 percent. This would be an extremely ambitious fiscal target, as well as an extremely inequitable one, considering that the beneficiaries o f the pension system generally do not comprise the poorer members o f societies. Fortunately, the pension system is not projected to generate cash deficits for a few more years, which gives adequate time to prepare an appropriate pension reform. Two other (though difficult to quantify) contingent fiscal liabilities that need to be taken account o f in assessing the risk o f debt distress are the liabilities originating from the current bank deposits guarantee inthe event o f new bank failures and from the finance ministry's open- ended capacity to issue new compensation bonds (BPIs) in response to new claims o f compensation for past confiscations. v. Nicaragua's somewhat lackluster growth performance raises questions about the effectiveness of public spending, particularly investment spending. Since the late 1 9 9 0 ~ ~ Nicaragua's per capita GDP growth has remained consistently below the average rate seen in other lower middle income countries worldwide, even though it exhibited similar shares o f public andprivate investment spending as this country group. Furthermore, the pace o f growth achieved inrecent years has not been sufficient to keep up the momentum inpoverty reduction, which has suffered a marked deceleration. The poor link between investment and growth in Nicaragua i s explained in part by the widespread misclassification o f public consumption spending as public investment. Also, earlier research (Nicaragua DPR 2004) had revealed that Nicaragua exhibited particular shortcomings in several key determinants o f growth, notably in public infrastructure development and human capital development (education attainment and health). These shortcomings point to possible inadequacies in the level and quality o f public spending inthese sectors. vi. The total amounts of public infrastructure spending and social spending in Nicaragua are broadly in line with the country's economic capacity, but there is much room to improve the quality of public spending. Nicaragua has been devoting a similar or higher share o f GDP on public infrastructure spending as other countries in Latin America, but its Infrastructure Quality index (based on the Global Competitiveness Report, 2006-07) ranks among the lowest inthe region and worldwide. Recent World Bank research on the efficiency o f social spending also suggests that Nicaragua is less efficient, on average, than other countries in the region. That is, Nicaragua's average efficiency scores derived by comparing social sector - outcomes and public social expenditures - consistently rank below the regional median score. vii. Various opportunities have been identifiedfor improvingthe quality and efficiency of publicexpenditures in key social and infrastructuresectors. These opportunities-some o f which seek to take advantage o fmarket forces and private initiative - are summarized next. 0 InTransport, important efficiency gains could be achieved by (i) shifting a higher share o f sector resources toward road maintenance, preferably through the road maintenance fund (FOMAV), using least-cost public bid contractual approaches, (ii)scaling up existing adoquinado programs in the expansion o f secondary roads, as a more cost-effective alternative to asphalt or gravel roads, (iii) adapting road designs to less costly standards appropriate to local conditions, and (iv) strengthening the institutional capacities o f MTI in the areas o f planning and programming, and o f FOMAV in the areas o f contracting and procurement procedures. 4 0In Water & Sanitation, important efficiency gains could be achieved by simultaneously allowing tariffs to adjust to cost recovery levels and improving the operating efficiency o f the water utility, while protecting the poor from price shocks in sector services. This may be achieved by (i) introducing a loss-reduction program in ENACAL, which could include a greater de-concentration o f operations, (ii)granting greater autonomy to INAA in setting tariffs based on long-run marginal costs, and (iii) revising the existing system o f subsidies to target them to the poor. Also, the introduction o f a hygiene education program inrural areas could significantly raise the impact o f sector infrastructure inreducing water-related diseases. 0InEnergy, it is necessary to step up the level oftotal sector investment. Given the limited fiscal capacity to increase public investment, this will require improving the investment climate facing private investors. Important measures that could help improve investor confidence inthe sector are (i) a lessening o f tensions with the private distribution company, identifying common ground for improving service, and (ii)a simplified electricity pricing structure (while re-considering the existing electricity consumptions subsidy with a view to targeting it more effectively to the poor). Since energy projects have long gestation periods, it will also be important to update existing studies for hydro-electric and geothermal projects (which are more efficient than the thermal plants that currently dominate electricity generation inNicaragua) to feed into a long-term sector expansion plan, givingpriority to the development o fnew projects within a regional context. 0In Education, sector outcomes could be significantly improved by (i)shifting a higher proportion o f sector resources toward early childhood development, pre-primary education and secondary education, (ii) introducing greater cost recovery at the university level, coupled with an expanded scholarship program exclusively targeted to poor students, (iii) improving the school autonomy program by revising its financing formula and strengthening monitoring and evaluation mechanisms, applying the lessons learned so far from the program's implementation, (iv) developing demand-side programs to reduce the direct and indirect costs that have proven to be barriers o f access to schooling for poor families, and (v) improving the quality o f education through better humanresource management. 0InHealth, major efficiency gains could be had by (i) increasing the proportion o f the sector budget devoted to preventive health care and health promotion, from the current share o f 7 percent to the regional average o f 30 percent (with INSS adopting a strong preventive health policy, since its current benefits do not include preventive exams), and (ii) improving the skills mix and allocation o f personnel, toward a higher proportion o f nurses and greater concentration inrural areas, away from Managua. Significant fiscal savings to finance greater spending on preventive health care and health promotion activities could be had by (i) revisingthe overly generous sector wage policy (more on this below), (ii) reducing the over- consumption o f health services, particularly in INSS, through the implementation o f regulation, audit and quality controls in the prescription o f pharmaceuticals and other health services, as well as by adopting different capitation payments for INSS that account for gender and age-related costs and risks, (iii)implementing a system o f targeted health subsidies, as an alternative to offering free health services for all, and (iv) introducing more efficient drugprocurementprocedures. 5 viii. Many of these opportunitiesfor improvingthe efficiencyof public spending also are available under a more social-oriented, public sector-led developmentapproach. As noted inthe Preface, the Ortega administration does not share the same development perspective as previous administrations and i s disinclined to apply discriminatory pricing policies in the provision o f public health and education services, as well as toward greater reliance on private and non-governmental group participation, or decentralization, in the provision o f certain public services (e.g., education, water & sanitation). This means that some o f the opportunities listed above for improving the quality and efficiency o f public services (e.g., improving the school autonomy program, de-concentrating ENACAL operations, or a better targeting o f health subsidies) are being ruled out. It does not, however, rule out the other opportunities that have been identified, in particular those seeking to strengthen public sector management, improve regulatory systems, create monitoring and evaluation mechanisms, streamline public procurement and enhance public planning capacities. Iffact, these measures become even more important inthe context o f a public sector-led development approach. Public Employment and Remuneration ix. The public sector budget payroll has been increasingas a share of GDP, posing a potential threat to macroeconomic stability. Although the total size o f public sector employment inNicaragua still represents a smaller share o f the population thaninother countries inthe region, the annual growthinpublic employment hasbeenexceeding the population growth rate since 2001 (2.4 percent per annum versus 1.9 percent). At the same time, average public sector salaries have been growing faster inreal terms than private sector salaries (at 3.7 percent p.a. versus -0.4 percent). The threat of macroeconomic destabilization became more acute in mid-2006, amidst growing pressures fiom public sector unions that succeeded in raising the minimum wage and in boosting the salaries o f health sector personnel, based on regional benchmark levels that bear little relation to Nicaragua's economic and fiscal capacity. x. Adequate framework legislation to govern public sector remuneration is urgently neededto ensure an orderly, transparentand efficientprocessofwage determinationin the public sector. The absenceo f such framework legislationis underminingthe authorities' efforts to manage public wage pressures in an orderly manner. Good framework legislation i s characterized by (i) coverage, encompassing all public sector agencies covered by the broad Civil Service Law, (ii) transparency (which i s enhanced by maintaining a simple wage structure built around a base salary, with few bonuses and no in-kindcompensation), (iii) principle o f the merit-based pay, where the remuneration system rewards good individual and team performance, subject to the prevailing fiscal constraints, (iv) non-discrimination, and (v) a responsiveness to market forces. A sensitivity to market forces i s very important for ensuringthat the public sector is neither over-paying its employees (and thus over-taxing the economy), nor allowing the quality o f its work-force to deteriorate. The adequacy o f public sector wages i s best gauged by the frequency o f labor turnover and quality o f applicants for different positions, as well as by carrying out periodic market surveys o f private sector wages in Nicaragua - not by comparing themto the ratespaidinother countries or to the prices o fparticular commodities. xi. The efficient implementation of this framework legislation would be enhanced through the introduction of a uniform Reference Salary Table (RST). The pace o f introduction may need to be gradual, however, and calibrated to conform with Nicaragua's fiscal limitations. (Prior to introducing the RST, it i s important to estimate the fiscal impact o f 6 alternative salary structures.). The RST will also need to be periodically revised and adapted to changing labor market conditions and relative scarcities o f different skills. xii. A key prior action needed for the efficient implementation of proper framework legislationand developmentof an RST is the creation of a centralized data base on public employment and remunerationthat covers the entire public sector. Article 8 o f the Civil Service Law provides a sufficient legal basis for requiring all public sector agencies to submit such information to the Ministry o f Finance. The status o f consultants (especially those consultants that are currently occupying permanent positions) and their contractual arrangements also require special attention in the implementation o f the framework legislation and RST; both may needsome adaptation to avoid fiscal problems. xiii. There is a need to undertake a teacher census to determinewith greater precision the geographicdistribution of teachers and their work hours and serve to informdecisions on the deployment of teachers (within urban areas and across ruraYurban areas). In the longer term, there is also a need to devise a better compensation policy for teachers within the framework legislation discussed above that includes more incentives to attract better teachers, encourage the upgrading o f unqualified teachers ("empricos") and reward good teaching performance. In seeking to link teacher compensation to teaching performance and results, it will be important to analyze the recent student assessment data (from 2006) with the objective of identifyingthe main factors associated with good teacher performance and results. The education sector accounts for 44 percent o f total central government employment, which means that the impact o f the proposed public wage framework legislation will largely hinge on a successful application inthis sector. Fiscal Decentralization xiv. Political decentralization presents, both, opportunities and fiscal challenges for poverty reduction. It can improve the efficiency o f resource allocation under the right circumstances, but it can also lead to fiscal imbalances or gaps inthe provision o f critical public services in the event that municipalities lack adequate institutional capacity. A commonly- accepted argument for decentralization is that by shifting the locus for government decision making closer to citizens, choices about the use o f public resources will be better aligned with locally-defined preferences. The experience to date in Nicaragua, however, indicates that municipal officials consider poverty reduction to be mostly a central government responsibility. In moving the decentralization agenda forward, a process of consultation and dialogue with mayors, AMUNIC, and civil society organizations will be critical to encourage a consensus around a vision for municipal governments as key protagonists in Nicaragua's development. Decentralization can encourage citizen-centered development that includes concerted efforts to ameliorate poverty. xv. Defining the proper roles for different levels of government needs to be at the forefront in designinga full-fledged decentralizationstrategy in Nicaragua. Over the last ten years, the polemics surrounding decentralization inNicaragua have focused primarily on the share o f national income to be transferred to municipalities. Less attention has been devoted to the appropriate roles o f each level o f government, or to an analysis o f the local government capacity required to carry out given tasks. For the decentralization process to advance in Nicaragua, producing a document o fthis nature should be the first order o f business. 7 xvi. The growth of public spending on current transfers is threatening to undermine fiscal stability. Central government spendingon current transfers increased by almost 2 percent o f GDP between 2004 and 2006, in part reflecting the increase in fiscal transfers to the municipalities mandated by Law 466 o f 2003. The growth in these fiscal transfers i s set to continue under the law untilthey reach 10percent o f total central government revenues by 2010. Since the law does not mandate a corresponding transfer o f expenditure responsibilities, central government expenditures are poised to increase by another 0.8 percent o f GDP over this period. Until 2006, the central government was able to "neutralize" these budget transfers by cutting capital expenditures in the areas that most closely overlap with municipal activities, and requiring the municipalities to co-finance the investment activities o f central government agencies (especially FISE and IDR) in the municipalities. This option for reducing expenditures i s more or less exhausted. It is, therefore, critically important to implement other corrective measures to neutralize the adverse fiscal consequences o f the increasing transfers. This could include raising taxes, reducing other central government expenditures o f lower priority and transferring additional expenditure responsibilities fiom the central government to the municipalities (alongside the additional revenue transfers). xvii. To address the fiscal imbalance triggered by the municipal transfers law, it may be necessary to revise the legal framework governing municipal responsibilities. When additional fiscal resources are transferred to the municipalities without an equal transfer o f expenditure responsibilities, there is a danger that increases in municipal spending on items o f low social priority will crowd out spending on items of higher social priority, as the central government is forced to make cuts in order to maintain fiscal balance. The framework that currently governs the assignation o f responsibilities to municipal governments dates from 1997, and needs to be reviewed in light o f the substantial increase in resources available to municipalities that has subsequently takenplace. xviii. As the activities to be carried out by local government are defined, it is critical to quantify their costs, as well as the administrative demands those roles place on central and local governments. In many decentralized government systems, for example, maintenance o f physical infrastructure in education and primary health care falls to local government; but that i s not presently the case inNicaragua. How much do those activities cost? How would (revised) municipal roles fit within the sector-specific service delivery models in Nicaragua? And how complex are the administrative demands (e.g., contracting, personnel management, oversight, accounting, etc.) for carrying out any o f these new mandates effectively? Public Expenditure Management xix. The PER has assessed Nicaragua's public financial management (PFM) performance, using an international framework o f reference that addresses seven critical dimensions: (i) credibility o f the budget, (ii)comprehensiveness and transparency, (iii) budget planning, (iv) predictability and control in budget execution, (v) accounting, recording and reporting, (vi) external scrutiny and audit, and (vii) donor practices that affect PFM. The assessment reveals that significant progress has been made since January 2004 in the implementation o f the 2003 CFAA Action Plan, but that some areas require further attention. Based on that assessment, the following measures are considered critical for scaling up ongoing efforts to reform and modernize public financial management (PFM). 8 xx. The comprehensivenessand transparency of fiscal information would be significantly increased by (i) enforcing compliance with the requirements o f Law 550 on preparation and publication o f execution reports for all budgets, as well as o f financial statements, (ii) revising the rules and their application vis-&vis current expenditures in investment projects, (iii) enforcing comprehensive publication o f procurement data through the State's Procurement and Public Contracts Integrated System (SICCE), (iv) expanding dissemination o f audit reports, and (v) enforcing compliance by decentralized entities (by function and territory) with the requirementso f Law 550 on provision o f information, while creating capacity in the MHCP to analyze that information and monitor aggregate fiscal risk. xxi. Budget planning would be strengthened through (i)increased budget flexibility by reducing the amount o f earmarking o f budget allocations (18.8 o f primary expenditures are currently earmarked), (ii) continued implementation o f the medium term budget framework, with an emphasis on the executing entities' capacity to prepare or refine costed sectoral strategic plans properly reconciled with the fiscal framework, (iii) better integration o f public investment a programming (PIP) into the medium term and annual budget formulation process, with due consideration to recurrent cost implications, and development o f SNIP'S monitoring and evaluation tools, and (iv) an increased performance orientation o f the budget under proper sequencing arrangements, including the accountability framework, the dimensions and scope o f indicators, andthe capacity to measure the marginal cost o f changes inperformance. xxii. The predictability and control in budget execution would be improved by (i) enforcing compliance with the timely recording o f expenditure commitments, e.g. through automatic links with the SICCE, (ii) streamlining the mechanism o f direct payments by the Treasury, through better coordination with the Central Bank, (iii) continuing the development o f the Civil Service Integrated System (SISEC) and the extension o f the Fiscal Payroll System (SNF) with a view o f developing a consolidated payroll system, which in turn should be subject to systematic audits, (iv) developing information to assess performance o f the Technical Internal Control Norms (NTCI) implementation, (v) building internal audit capacity, and (vi) increasing efficiency and transparency o f the procurement system through the development o f SICCE and the reform o f the legal and regulatory framework, inline with international good practice. xxiii. Accounting, recording and reporting functions would be enhanced by (i) supplementing budget execution reports with data on bank balances, first, and with financial statements based on accrual accounting later, and (ii) examiningwith greater detail and support the efforts o f the different sectors, mainly o f the Ministries o f Education and Health, to compile and process more information on the resources received (or not) allocated to service-delivery units (schools and health centers). xxiv. External scrutiny and auditing would be strengthened by (i) ensuring sustainability and continuous improvement o f the Controller General o f the Republic's (CGR) external audit reporting on budget execution reports and public sector financial statements, (ii)monitoring better the timely and thorough response to audit recommendations, and (iii) fostering access by the National Assembly to external audit reports, and the development o f mechanisms to their review, discussion and monitoring. xxv. The donor community in Nicaragua also has an important opportunity to help the Nicaragua authorities to strengthen overall public financial management by (i) aligning their assistance under the Joint Budget Financing Arrangement (JFA), (ii)ensuring the timely 9 provision o f projections and disbursements(and greater convergence between both), incash and in kind, and (iii)relying increasingly on national institutions and procedures in the implementation o f investment projects. In turn, the authorities may consider introducing elements into Law 550 to better balance their capacity to receive short-term grants (which have a modest fiscal impact), and the Legislature's right to approve budget modifications. xxvi. Concluding Summary. Nicaragua has come a long way since the beginning o f this decade in bringing its overall fiscal balances under control. This puts Nicaragua in a good position for combating poverty ina sustained manner. To maintain that position, however, it will need to overcome further challenges that threaten to undermine fiscal stability in the medium term, notably a rapidly growing public wage bill and fiscal transfers to the municipalities. Lookingbeyond macroeconomic stability, Nicaragua also needs to pick up the pace o f economic growth inorder to generate greater momentum inpoverty reduction. Inthis regard, the PER has identifiedvarious options for improving the quality o fpublic expenditures inkey areas relevant for economic growth. It also pointed out the most important measures needed to modernize public expenditure management and, thereby, facilitate the adjustments needed to improve the quality o fpublic spendingina cost-effective manner. It is hoped that these insights prove useful to the authorities intheir efforts to promote faster growth and poverty reductioninNicaragua. 10 CHAPTER I COUNTRY CONTEXT AND MAINFISCAL CHALLENGES 1.1 Public Expenditure Reviews (PERs) are core diagnostic studies periodically prepared by the World Bank to analyze public sector issues, with a focus on the efficiency and equity o f public resource allocation. This PER is being prepared as part o f a package o f economic and sector work for Nicaragua, which also includes a Poverty Assessment (PA), Institutional and Governance Review (IGR) andEnergy Sector Strategy Study. Its ultimate aim is to improve the effectiveness and transparency o f public resource allocation in a way that promotes economic growth and poverty reduction. 1.2 The PERwas undertaken at the request ofthe administration o f President Bolafios, whose mandate ended inJanuary 2007. The background work for this PER primarily consists of "desk studies" that review the evolution and impact o f public expenditures since the previous PERwas completed in 2001. It i s based on information up to the end o f 2006 and, therefore, does not evaluate any new programs that the current administration under President Ortega has been preparing or may be contemplating. Also, it takes as its point o f departure the market-based and private sector-led development perspective that was broadly shared by previous administrations, but not by the current one. Nevertheless, it is hoped that this PER may serve as a timely reference in drawing attention to some important fiscal challenges facing Nicaragua and in helping to identify various opportunities for raising the impact o f public expenditures, independent o f any particular development perspective. The PER is also meant to provide necessary analytical foundations for the Bank-supportedprogram inNicaragua, including a new series o f Poverty Reduction Support Credits (PRSCs) and associated technical assistance operations contemplated in the 2007 Country Partnership Strategy for Nicaragua. By the same token, the PER should serve to facilitate donor coordination, especially in the context o f joint budget support operations and sector-wide approaches. 1.3 The main audience o f the proposed PER are the Nicaraguan economic authorities, principally but not exclusively comprising the staffs o f the Ministry o f Finance and Public Credit (MHCP), the Technical Coordination Secretariat o f the Presidency (SECEP) and the Economic Commission o f the National Assembly. A second target audience i s the staff o f the World Bank and o f other donor agencies that participate in the Budget Support Group (BSG)' and are involved in the design and implementation o f PRSCs. Finally, the PER may prove useful to academics and other members o f civil society that have a stake in good governance and public sector management, such as the members o f the National Council on Economic and Social Planning (CONPES). 1.4 Several donor agencies have beenproposing to carry out separate expenditure reviews in specific sectors over the medium term.2 To avoid overlaps and duplication, the PER has maintained a narrow focus on a few important cross-cutting public finance issues, and aims for breadth, rather than depth, in discussing sector expenditure trends. This may provide a useful L 1. The Budget Support Group consists o f 9 bilateral and multilateral donors that are providing budgetary support to Nicaragua under a common framework. This framework is contained in a Joint Financial Agreement and a Performance Assessment Matrix that was signedbyparticipating donors in2005. 2. This includes IDA, which i s in the process of preparing a Social Sector Expenditure Review, scheduled for completion in2009. 11 backdrop for the sector reviews being contemplated by different donors. (Annex L presents a generic outline o f the main topics generally treated in sector expenditure reviews, which can serve as a model to promote a certain degree o f uniformity and consistency o f coverage across the separate sector reviews.) Depending on the response and interest o f the new authorities to this initial PER, a follow-up second volume may be considered next year, with more in-depth analyses o fpublic spending inspecific sectors. A. CountryContext 1.5 Nicaragua i s one o f the poorest countries in Latin America, with a per capita gross national income o f only US$ 980 in 2006 (Atlas method) and a total population o f 5.3 milli~n.~ According to the 2001 Living Standards Measurement Survey (LSMS), 46 percent o f the population livedbelow the national poverty line, while 15 percent livedinextreme poverty. This represented a significant decline in extreme poverty since 1993, but only a modest decline in terms o f overall poverty rates. Data from the 2005 LSMS indicate that there has been no significant change inthe incidence o fpoverty since 2001,but some hrtherreduction inthe depth o fp ~ v e r t y .Poverty is heavily concentrated inrural areas and associated with agricultural sector ~ activities, which still account for 12 percent o f GDP (excluding livestock and fisheries); a relatively largeproportion o fbyregional standards. 1.6 Nicaragua also has among the least advanced social indicators in Latin America, which broadly corresponds to the differences in per-capita income levels. It i s notable, however, that Nicaragua's health indicators are comparable to the averages observed across other lower-middle income economies, even though its average per-capita income is less thanhalfas large; Table 1.1 Table 1.1 Key SocialIndicators,2006 NIC CRI SLV GTM HND CA LAC Lower-Mid Ave. -. Ave. IncomeAve. GNI per capita (Atlas; US$) 980 4,990 2,590 2,610 1,200 2,767 4,767 1,918 Populationgrowth(annual rate) 1.9 1.8 1.8 2.4 2.3 2.0 1.3 0.9 Education Adult Literacy Rate (%) 77 95 81 69 80 80 90 89 Gross enrollment (%) Primary 112 110 113 114 113 112 118 113 Secondary 66 79 63 51 66 65 85 74 Health Life Expectancy at Birth(yrs) 70 79 71 68 69 71 73 71 Infant Mortality Rate (/1000) 30 11 33 32 31 27 26 31 U-5Childmalnutrition( %) 10 2 10 23 17 12 7 13 Source; World Bank, Development Economics LDB and WDI databases;. L 3. Nicaragua's population figures were revised downward after the 2005 census, which yielded a total estimated population o f 5.1 million, versus an earlier estimate o f 5.5 million. This resulted in an upward revision o f the country's GNIper capita for 2005, from US$910to US$950. 4. The findings from the 2005 LSMS indicate little change in poverty indicators: the overall national poverty headcount rate increased slightly, from 45.8 percent in2001 to 46.1 percent in2005, while the extreme poverty rate fell from 15.1percent to 14.9percent. Furthermore, the poverty gap also appears to have declined over this period 12 1.7 From a macroeconomic standpoint, Nicaragua has stood out since the 1980s in both regional and worldwide comparisons on account o f its extremely highfiscal and external deficits, which have routinely exceeded 10 and 30 percent o f GDP, respectively. These large imbalances were initially associated with a large accumulation o f external debt during the 1980s. Subsequently, when Nicaragua was no longer considered creditworthy for new lending on market terms, the macro-imbalances were sustained by large amounts o f foreign aid and accumulation o f debt arrears. As a result o f these imbalances, Nicaragua had become by the early 1990s one o f the most highly indebted countries in the world (with a total external debt almost reaching 400 percent o f GDP), one o f the top aid recipients, and one o f the most macro- economically unstable countries interms o f fluctuating GDP and aggregate consumption. 1.8 Nicaragua advanced significantly in stabilizing the economy during the 1990s, but a major fiscal gap was reopened by Humcane Mitch at the end o f 1998, a banking crisis that followed in 2000-01 and a relaxation o f fiscal control prior to the 2001 presidential elections. The banking crisis, inparticular, boosted Nicaragua's domestic public debt burden from around 20 percent o f GDP to over 30 percent. Since then, Nicaragua has succeeded in shrinking its fiscal and external deficits through greater fiscal discipline and tax reforms, the gradual reactivation o f economic activity and exports, and massive external debt relief, especially under the HIPC and MDFU initiative^.^ Nevertheless, the fiscal and external deficits still remain high by regional standards and a source o f concern to policymakers. (The combined public sector deficit, before grants, was over 6 percent o f GDP in2004, while the current account deficit was over 15 percent o f GDP.) Both gaps reflect the relatively large amount o f aid that Nicaragua continues to receive, coupled with a rapidly rising inflow o f private capital, most recently attracted by the improved trading opportunities offeredby CAFTA. Recent Economic Developments 1.9 After dropping to less than 1 percent in 2002, economic growth recovered to average around 4 percent in2004-2006; Table 1.2. An important source o f growth has been the increase inexports (including maquila), which have doubled since 2002 to reach an estimated US$1,800 million (or 33 percent o f GDP) in2006, while aggregate demand has been stimulated by a rapid growth o f private remittances, which more than doubled since 2002 to reach an estimated US$685 million in2006 (or 12 percent o f GDP). Imports also increased significantly duringthat period, driven in part by rising oil prices, which has had the result o f maintaining the current account deficit roughly the same in US-Dollar terms, but declining as a share o f GDP, and permittingthe accumulationofinternationalreserves above the targeted levels. 1.10 Fiscal management has been prudent in spite o f frequently contrary political pressures. This has led to the progressive reduction inthe combined public sector deficit, after grants, from -6.6 percent o f GDP in2001 to -0.6 percent in2006. As noted in Chapter 11, this decrease inthe deficit was mainly achieved through fiscal revenue growth, some improvement in the operating balances o f public enterprises and a significant decline in the operating losses o f the Central Bank. L 5. These developments have had the effect of reducing Nicaragua's total external public debt (innominal terms) to around 70 percent of GDP (or 35 percent inNPV terms) in2006. 13 1.11 Nicaragua's overall positive economic performance since 2002 was supported by a PRGF-arrangement approved in December 2002 and a series o f budget-support operations from the World Bank (PSAC, PRSC-I and 11) and other donors. Although progress under these arrangements has occasionally stalled, the authorities eventually succeeded in bringing the program back on track again. Accordingly, the World Bank disbursed the second tranche o f PRSC-1 in March 2006 and approved a one-tranche PRSC-2 in October 2006, while the IMF successfully concluded its Eleventh (and final) Review under the PRGF arrangement in December 2006.6 Table 1.2 Nicaragua: K e y Macroeconomic Indicators and Projections (In percent of GDP, unless indicated otherwise) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Rial GDP (% change) 3.0 0.8 2.5 5.3 4.3 3.7 3.8 4.0 4.5 5.0 InflationRate (eop CPI, %) 4.6 4.0 6.6 9.3 9.6 9.5 16.9 9.5 7.0 7.0 Real Effect. Exch. Rate (% change)* 2.6 2.8 3.9 0.5 -2.0 1.3 -1.0 -- -_ _- Savings and investment Investment 26.8 24.9 24.8 28.0 29.6 29.5 29.2 29.2 29.1 28.6 Public 7.4 5.0 5.4 6.7 6.9 5.8 6.9 7.8 8.0 7.9 Private 19.4 19.9 19.4 21.3 22.7 23.7 22.3 21.4 21.1 20.7 Savings 8.8 7.0 7.6 15.4 14.7 13.7 12.2 11.2 13.8 13.9 Public -0.2 -0.4 2.0 2.9 2.1 1.8 2.4 1.6 2.4 2.3 Private 9.0 7.4 5.6 12.5 12.6 11.9 9.8 9.6 11.4 11.6 Balance o f Payments Curent Account balance -19.4 -19.1 -18.3 -12.6 -14.9 -13.2 -17.3 -25.0 -24.0 -23.0 Gross Int. Reserves (US$mill.) 383 454 504 670 730 924 1,103 1,192 -- _ _ Memorandum Items Nominal GDP (C$ millions) 55,155 57,376 61,959 71,156 81,233 93,007 105,644 124,338 138,252 155,326 GDP (US$ millions) 4,103 4,026 4,102 4,465 4,855 5,264 5,726 6,419 6,787 7,262 Source: Banco Central de Nicaragua and I M F . Notes:* (+) denotes depreciation. **Merchandise exports and imports include maquila. ***Includes ALBA-related flows as of2007 1.12 Nicaragua's macroeconomic performance has remainedbroadly favorable during the first year o f the Ortega Administration, which has kept a tight rein on public finances and succeeded in negotiating a new PRGF program that was approved by the IMF Board in October 2007. Economic growth in2007 is estimated to have been close to the projected level (4.2 percent) and the primary and the overall fiscal balance outcomes for 2007 are estimated to be much better than projected, though partly on account o f an under-execution o f public investment projects. However, the inflation rate (Dec-to-Dec) turned out to be considerably higher than program projections (17 percent versus 7.3 percent). This last outcome i s mainly attributable to several external shocks, which included a category 5 Hurricane (Felix) in early September 2007, followed by an unusually wet rainy season andrapidly rising international prices o f basic grains and fuels, rather than to a weakeningpolicy stance. L 6. An IMFpress release issuedupon completion o f the Executive Board discussion on December 11, 2006 stated that, "Nicaragua's performance under the PRGF arrangement continues to be satisfactory, reflecting the authorities' prudent and pro-active management. Notwithstanding the challenging circumstances o f an election year, macroeconomic stability has beenmaintained. Growth has remained positive, inflation has begun to decline, and the overall external position has been strengthened. International reserves have remained stable and the decline in deposits experienced in the run up to the elections is being reversed. However, progress on structural reforms has been slow and fraught with political difficulty. 14 Macroeconomic Outlook and Key Fiscal Concerns 1.13 The country's macroeconomic prospects remain broadly favorable, though fraught with much uncertainty in light o f the possible slowdown o f the global economy and rising international fuel and food prices. Economic growth i s expected to maintain the 4 percent pace averaged by Nicaragua's economy over the last three years and gradually accelerate to 5 percent inthe mediumterm, buoyedby continuing export growth (favorable coffee prices and growing maquila production) and a favorable investment environment supported by CAFTA, as well as stabilizing oil prices. Inflation is projected to return to within single digits. This generally positive outlook i s conditioned on the continued adherence to a prudent fiscal policy ~tance.~ As indicated in Chapter I1(Section C) and the 2007 IDA-IMF debt sustainability analysis (DSA), Nicaragua's risk o f experiencing debt distress i s moderate, but manageable, provided that sound macroeconomic policies are applied. The HIPC and MDRIinitiatives have significantly reduced the risk o f debt distress,' but the high level o f domestic debt continues to pose a significant risk in the medium term. Reducing that debt and the associated probability of debt distress inthe medium and long-term will continue to require sound macroeconomic policies, among which fiscal discipline is key. 1.14 Several developments over the last years have threatened to undermine fiscal discipline, amongthem, 0 the passage o f the Municipal Transfers law in 2003, which mandates the transfer o f a growing share o f central government revenues to the municipalities without a corresponding transfer o f expenditure responsibilities, 0 growing pressures on public sector wages and salaries from the public sector unions (a strike by the healthworkers crippled the health system at the beginningo f 2006, resulting inanunbudgeted increaseinmedicalstaffsalaries), 0 increasing resistance to price adjustments in transport, electricity and other public services in the face of rising oil prices, which required increased subsidization or reductions inservice quality, andthe 0 gradual financial deterioration o f the pension system in the absence o f further reforms, which also would require increased subsidization by the central government or eventually trigger the system's collapse. These developments pose important challenges that the authorities will need to address in order for the positive outlook described above to fully materialize. B. Two Key DevelopmentIssues 1.15 The 2001NicaraguaPER drew attention to several broad issues that included the need for (i) fiscaladjustmenttorestorefiscalsustainability,withprimaryattentiontoexpenditure further cuts inthe short run and raising tax revenues in the medium term, (ii) achieving a better balance 'LTwo other major sources o f risk for the realization o f this positive macroeconomic scenario are a slowdown inthe US. and global economies, which emerged as a significant threat in late 2007, and a deteriorating investment climate on account o f continuing political tensions between the Executive and Legislative branches o f government. 8. A second commercial debt buy-back operation, which was concluded in 2007, should contribute to the normalization o f financial relations with international creditors and help reduce fiuther the probabilities o f fbture debt distress. 15 inthe composition ofpublic expenditures by removing the bias infavor of capital spending and giving more attention to operating and maintenance expenditures, (iii) gradually introducing a medium term expenditure framework to permit better expenditure planning and budgeting, (iv) designing mechanisms to improve donor coordination (including through sector wide approaches) inthe context o f a highaid dependence, (v) improving the mechanisms to track and target public funds designated for poverty reducing activities and, (vi) reviewing the justification for earmarking revenues and considering how it can be reduced. That PER served as analytical background for the PSAC and PRSC-I, which supported actions to address these reform needs, and the authorities have made significant progress in implementing its recommendations. While many o f these issues are still being addressed and continue to be relevant for Nicaragua, additional issues for public sector management have gained prominence in the last few years. These include a need to devote more attention to fiscal decentralization, and to human resource management and remuneration inthe public sector. 1.16 Fiscal Decentralization. The Fiscal Transfers Law approved in 2003 mandated the transfer o f 4 percent o f tax revenues to the municipalities in 2004. Furthermore, the law also mandated that the share o f revenues to be transferred i s to increase by at least 1 percent every year - provided that GDP grows by at least 1percent in the previous year - until it reaches at least 10 percent. While this law is welcomed by many who emphasize the merits o f greater decentralization inpublic decision-making, it also poses a sudden fiscal challenge for the central government, considering that previously the transfer share had generally averaged around 1 percent o f total central government budget, while the currently mandated revenue transfer has not been accompanied by any mandated expenditure transfers. 1.17 The Fiscal Transfers Law has been modified twice since its initial passage, and the authorities have passed executive decrees that sought to limit the fiscal impact o f the Law by reducing expenditures at the central level on items that the Municipal Law identifies as being a municipal responsibility. These corrective efforts, however, only partly succeeded in limiting the threat o f fiscal destabilization. This is in part because the authorities relied solely on expenditure cuts as a mitigating measure, without changing any laws to ensure long-term fiscal sustainability. Furthermore, various shortcomings o f the Municipal Law limit its capacity to serve as a framework for guiding the decentralization process. A meaninghl decentralization process requires new legislation that establishes unambiguously the expenditure responsibilities o f the municipalities, together with complementary measures that allow the municipalities to control all the inputs needed to produce services and the transfer o f enough resources and different funding mechanisms to allow municipal governments to discharge those responsibilities, finding a balance between national and local expenditure objectives. This issue is addressedinChapter V. 1.18 Public Sector Salaries and Staffing. Public sector wages and salaries have been increasing as a share o f GDP since the mid-1990s. Although the size o f the public wage bill still appears to be relatively modest by the standards o f some neighboring countries, its growth has been a source o f concern as a potential threat to macroeconomic stability. That concern was heightenedinmid-2006 with the passage o f an Education law that - untilit was amended - had threatened to raise total spending teacher salaries in an unsustainable manner. Related concerns are the high variation in public sector wages across entities and job categories within the public sector, and the lack o f a general wage and staffing policy framework inthe government. Though the National Congress approved a Civil Service Law in 2004 that was designed to address these 16 two concerns, implementation o f the Law has been slow, resulting in tense annual wage negotiations that often prove disruptive and lead to outcomes that often bear little relation to the country's economic capacity.' 1.19 Another consequence o f weaknesses in the existing civil service framework i s the excessive reliance on consultants, who are often paid under donor-financed projects that are registered as public investment. In addition to engendering an economic misclassification o f public expenditures, this practice also has contributed to (i)undermining the financial sustainability o f key public sector positions and even o f institutions themselves," (ii) widening existing wage disparities within agencies, with depressing consequences on staff morale, (iii) the wasting o f training resources on temporary staff, (iv) the emergence o fpotential contingent fiscal liabilities arising from consultants' rights to social benefits, and (v) decreasing the likelihood o f continuity o f projects and activities managed by consultants. These issues are addressed in Chapter N. C. SummaryOutlineof the PER 1.20 This PER updates the analysis contained in the 2001 PER with respect to several key issues that remain relevant today and which are described inparagraph 1.15, while also covering new ground interms o f analyzing the new challenges facing the authorities inthe areas o f fiscal decentralization and civil service reform. 1.21 Chapter I1 presents an overview o f public finances, reviewing the evolution o f total public revenues and expenditures, and discusses the nature o f the adjustment process that has taken place since 2001. It reviews the composition o f public expenditures, along economic, institutional and functional dimensions, and provides some cross-country comparisons to assess the overall size o f public spending in Nicaragua. This chapter also reviews the progress made since 2001 in restoring fiscal sustainability, and concludes by pointing out several key fiscal challenges facing the authorities inthe short and medium term. 1.22 Chapter I11picks up from the discussion in the 2004 Nicaragua Development Policy Review, focusing on the link between public expenditures and economic growth, and drawing particular attention to the public infrastructure, education and health sectors. It evaluates the quantity and quality o f public spending in Nicaragua, with summary assessments o f public spendingand sector performance in these three key sectors. (These summary assessmentsdraw on more extensive sector discussions contained in Annexes C through Io f the PER.). It also summarizes the main findings on the efficiency of public expenditures from recent cross-country comparative data compiled bythe World Bank. 1.23 Chapter IV focuses on the overall size and composition o fpublic employment, and on the structure o f remuneration. It discusses recent reforms to restructure and professionalize the civil L 9. For instance, public sector doctors went on strike in late 2005 to demand salaries comparable to those paid in other Central American countries, whose per-capita GDPs are all higher than Nicaragua's. The strike lasted more than six months and had a perceptible impact on the health indicators of the poorer segments of the population. It eventually resulted in the passage of legislation in December 2006 that gradually equates health sector salaries to a regional benchmark. 10. Recent cases include the Nicaraguan Municipal Support Institute (INIFOM) and the Agricultural Technology Institute (INTA), both of which rely on donor projects to cover their salary bills and which have had major difficulties infinancing salaries after closure o f such projects. 17 service inNicaragua. The size, structure and evolution o f the public wage bill are compared to that in other sectors and countries in the region. The chapter concludes with a set o f recommendations on further steps needed to modernize and streamline remuneration policy in Nicaragua's public sector. 1.24 Chapter V reviews the status and prospects o f fiscal decentralization inNicaragua. While much o f the impetus for decentralizing public expenditures has been political, there are also strong reasons for seeking to decentralize on the basis o f efficiency considerations. This chapter (i) keystepsinthedecentralizationprocesssince1987,particularlyasthoserelatetothe recounts assignment o f roles and resources, (ii)discusses the budget transfer rules from central to municipal governments, followed by an analysis o f municipal expenditures, (iii) scrutinizes the accountability mechanisms for municipal expenditures, and (iv) highlights key fiscal imbalances that undermine the present system, and current efforts underway to remedy those shortcomings. The chapter concludes with a series o fpolicy options andpotential areas o f World Bank support. 1.25 Chapter VI assesses the overall performance o f public financial management (PFM) institutions and systems in Nicaragua, based on an international framework o f reference that addresses seven critical dimensions: (i) credibility o f the budget; (ii) comprehensiveness and transparency; (iii) budget planning; (iv) predictability and control in budget execution; (v) accounting, recording and reporting; (vi) external scrutiny and audit; and (vii) donor practices that affect PFM." It also reviews the progress made in modernizing public expenditure management systems inthe period since the 2004 Country Financial Accountability Assessment (CFAA), spelling out the remaining obstacles in the way to improving public financial management andproviding strategic recommendations on how to move forward. Links to Other Economic and Sector Work 1.26 The 2001 PublicExpenditureReview has served as the startingpoint for tracking fiscal developments in Nicaragua since 2000. More recent core Economic & Sector Work on Nicaraguaprepared by the Bank includes the 2003 PovertyAssessment, the 2004 Development Policy Review, the 2004 Country Financial Accountability Assessment (CFAA), the 2004 Country Procurement Assessment Report (CPAR), and the 2004 Decentralization Policy Study. 1.27 In parallel to this PER, the Bank has also prepared a Poverty Assessment, an Institutional and Governance Review (IGR), and an Energy Strategy Study. The Poverty Assessment analyzes the results from the 2005 LSMS and reviews the poverty impact o f public expenditures. This PER, therefore, devotes less attention on the poverty implications and incidence o f public spending, and focuses more on aspects o f expenditure management and growth. Similarly, it focuses on the fiscal aspects relating to the energy sector, which has become another area o f vulnerability, rather than duplicating the work o f the Energy Strategy Study. L 11. This chapter i s based primarily on P F M performance measurement analytics undertaken through a partnership o f the Government o f Nicaragua with the BritishDepartment for International Development (DFID), the European Commission (EC), the Inter-American Development Bank, and the World Bank. The performance measurement framework was developedby the Public Expenditure and FinancialAccountability (PEFA) partnership. 18 CHAPTERI1 OVERVIEW OF PUBLIC SECTORSPENDINGAND FISCAL SUSTAINABILITY A. Overview of the Public Sector andthe Compositionof PublicSpending 2.1 At the national level, Nicaragua's public sector consists o f the central government (comprising 12 ministries, 3 powers o f the State and various subordinated agencies), over 50 decentralized institutions (including the social security institute, 10 public universities, and 2 regional governments and councils), 10 public enterprises and 4 public financial institutions. At the local level, Nicaragua i s divided into 152 municipalities, which are the most basic political administrative units. Between the local and national levels there i s an intermediate political administrative level consistingo f 15 departments and 2 autonomous regions on the Atlantic coast (RAAN and M A S ) . Incontrast to the Municipal governments, which are elected by popular vote every 4 years and have their own budget and legislative powers, the Departmental governors are appointed by the President o f the Republic (who is elected every 5 years) and serve as an extension o f the Executive branch o f the national government. The two autonomous regions represent a mix o f the departmental and municipal forms o f governmental organization: each is led by a regional Governor appointed by the President o f the Republic and by a regional Council whose members are elected bypopular vote every 4 years. Table 2.1 Nicaragua: FinancialStructureofthe NationalPublicSector Budget; 2007 I Domestic Resources ExternalResources % of OWn Budget Total Treasury Revenues Credits Grants Credits 24,156 64.3% 19,915 -- -3,125 4,017 3,349 7,845 20.9% 2,970 6,560 -1685 -- 3,961 10.5% -- 5,544 -1,584 ---- -_ 161 0.4% 161 -- -- -- -- 4,415 11.7% 137 3,5 14 -256 297 723 1,621 4.3% -- 1,793 -455 __ 283 1,687 4.5% 98 744 175 288 383 847 2.3% -- 865 -134 -- 116 169 0.4% 169 -- -- -- -- 37,593 100% 23,352 10,939 -5,200 4,314 4,188 %of projected GDP 35.7% 22.2% 10.4% -4.9% 1 4.1% 4.0% 2.2 The relative sizes o f the different entities comprising the national public sector are shown in Table 2.1, which is based on the 2007 draft budget that was sent to the National Assembly. By far the largest entity is the central government, which accounts for almost two-thirds o f the consolidated national public sector budget. The decentralized institutions account for another 21 percent o f the total budget, with the social security institute, INSS, alone responsible for half o f that amount. The public enterprises account for most o f the remaining public expenditures (11.7 percent), with the two largest entities being the electric utility (ENEL) and the water utility (ENACAL). About 80 percent o f total central government spending i s paid for with resources 19 from the treasury, while the remainder i s paid with foreign aid, either in the form o f grants or concessional credits. Except for INSS, the decentralized and autonomous institutions, as well as the regional governments, rely mostly on transfers from the central government to finance their expenditures. The public enterprises and public financial institutions, in contrast, primarily finance their expenditures through the sale o f services. 2.3 The 2007 draft budget also gives us an approximation o f the State's overall footprint on the economy. The economic size o f the national government i s estimated to be around 32 percent o f projected GDP (derived by netting out the central government transfers12 from the total consolidated budget inTable 2.1). Inaddition, the total spending by the municipalities, net o f the transfers received from the central government, is between 1 and 2 percent o f GDP. Finally, if we add the projected operating losses o f the central bank, plus the total spending by the public universities (net o f central government transfers), we arrive at a grand total o f around 35 percent o f GDP for the combined (national + local) public sector spending contemplated in the 2007 budget.13 Fiscal Balances of the Non-Financial Public Sector 2.4 Duringthe 1980s, Nicaragua developed a massive public debt and a highdependence o f foreign aid, both o f which were reflected in huge fiscal deficits compared to other countries in Latin America. By 1998, the government had largely succeeded inreducing its fiscal deficit to sustainable levels, through a combination o f structural reforms, austerity measures and debt relief. These efforts were largely undone by hurricane Mitch, with struck the region in October 1998 and reopened a large fiscal gap. The deficit of the non-financial public sector increased from under 2 percent o f GDP in 1998 to almost 9 percent in 2000, and was mainly financed through increases in foreign aid and concessional credits; Table 2.2. Although post-hurricane reconstruction activities and the associated aid flows hadbeen winding down by 2001, the fiscal deficit before grants continued to grow to almost 10percent o f GDP. This represented a primary deficit after grants o f -2.8 percent that was clearly unsustainable, forcing the incoming Bolaos administration to make drastic adjustments in 2002 to avoid a fiscal crisis. The deficit before grants has been declining gradually since 2002, yielding a primary fiscal surplus after grants. L 12. These transfers refer to the treasury resources that are financing expenditures by entities other than the central government. 13.These expenditure estimates for entities excluded from the national budget (universities, municipalities and Central Bank) are largely based on conjecture. Data on total spending by the public universities is not publicly available. Considering that the cost recovery practiced by the public universities continues to be very limited, however, total spending by that sector is not likely to diverge very much from the transfers received from the central government. With respect to municipal spending, the Bank's 2004 Policy Note o n `Municipal Decentralization in Nicaragua' indicates (pg. 8) that the total municipal spending financed from municipal revenues is roughly equivalent to the amount of municipal spending financed with central government transfers - which represent 1.2 percent o f GDP in2007 draft budget. The operating losses o f the Central Bank for 2007 are projected at 0.7 percent o f GDP inthe MediumTerm Expenditure framework that accompanies the 2007 draft budget. 20 Table 2.2 Nicaragua: FiscalBalancesof the Non-Financial Public Sector (Aspercent of GDP, unless indicated otherwise) 1998 1999 2000 2001 2002 2003 2004 2005 2006 Revenue 21.5 21.2 21.1 20.4 21.2 22.8 25.1 25.9 27.6 Of which: Taxes 15.1 14.8 14.5 13.4 14.2 15.9 16.5 17.4 17.8 Expenditure 23.2 28.1 30.0 30.0 26.3 28.9 30.1 30.2 31.3 Of which: Interest 3.2 3.3 3.6 3.8 2.9 3.1 2.1 1.9 1.8 Overall Balance before grants -1.7 -6.9 -8.9 -9.6 -5.1 -6.1 -5.0 -4.3 -3.7 after grants 0.5 -1.8 -4.4 -6.6 -1.9 -2.3 -1.3 -0.9 0.2 Primary Balance a. grants 3.7 1.5 -0.8 -2.8 1.0 0.8 0.8 1.o 2.0 Memo items: Primary Balance (Combined Public Sector) -2.8 -0.3 0.1 0.3 0.8 2.2 Nominal GDP (C$ million) 37,805 44,198 49,952 55,155 57,376 61,959 71,156 81,233 93,007 Source: Central Bank of Nicaragua and IMF. 2.5 The reduction o f the fiscal deficit was brought about entirely through increases in fiscal revenues, rather than a decline in expenditures. Although total expenditures exhibited a significant decline in 2002 and 2003, they have since then g o w n again as a percent o f GDP to surpass the levels reached in the immediate aftermath o f hurricane Mitch. In contrast, tax revenues rose continuously, from 13 percent o f GDP in2001 to almost 18 percent in2006. This increase was made possible through a series o f tax reforms, followed by improvements in tax administration and a buoyant tax response to a growing economy. Economic Composition of Central GovernmentExpenditures 2.6 The 2001 Figure 2.1 Nicaragua: Evolution of Total Central PER had noted that GovernmentExpenditures --- the GDP share o f II total central 30 l-------- government B 2 5 : total expenditures expenditures (3 20 * /- total minw interest remained u stable [ 0 15.'' remarkably 10 during the 1990s, 5 interest payments prior to hurricane Mitch, and was mainly influenced by the evolution o f Source: Statistical Annex Tables. interest payments on the public debt. Following hurricane Mitch, non-interest central government spending spiked up from under 15 percent o f GDP in 1996-98 to around 21 percent in 1999-2000, reflecting a surge of investment spendingassociated with reconstruction activities and increased aid inflows. 21 As the reconstruction surge subsided, non-interest spending declined temporarily. Since 2002, however, it has been drifting upward again, reaching 21 percent o f GDP in2006;14 Figure2.1. 2.7 The growth innon-interest central government spending after 2002 i s mainly attributable to an increase o f investment spendingand an increase incurrent transfers. The increase inpublic investment i s closely linkedto increases in foreign aid flows; Table 2.3. The increase in foreign aid, moreover, reflects the restoration o f macroeconomic discipline and adoption o f important structural reforms, which led to a new PRGF program with the IMF in 2003 and facilitated greater access to concessional credit^.'^ The increase in public investment spending after 2002 also coincided with the Bolaiios administration's renewed emphasis on investment inproductive activities under its National Development Plan (PND), which regarded the acceleration o f growth as the main ingredient for reducingpoverty. Table 2.3 Nicaragua EconomicCompositionof CentralGovernmentExpenditures - (Aspercent of GDP) 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Total Revenues 15.9 15.4 14.9 13.8 14.8 16.4 17.2 18.1 18.8 o/w Tax Revenues -_13.0 -- 14.6 14.3 13.9 13.6 12.6 13.4 15.1 15.7 16.8 17.4 Total Expenditures 17.4 17.8 17.8 22.9 21.9 20.5 20.4 24.1 22.4 22.6 22.7 Current Expenditures 11.4 11.9 12.4 12.2 12.4 13.1 13.8 15.5 12.8 13.0 15.5 Consumption 6.9 6.1 7.0 7.3 7.6 7.7 7.6 7.7 7.2 7.3 8.2 Wages & Salaries 3.7 3.8 4.4 4.5 4.6 4.9 5.1 5.3 4.9 4.9 5.2 Goods & Services 3.2 2.3 2.6 2.8 3.0 2.8 2.5 2.4 2.3 2.4 3.0 Interest 1.7 2.8 2.6 1.9 1.8 2.1 2.7 4.3 1.9 1.0 1.7 Internal 0.2 0.3 0.8 0.7 0.6 0.7 1.6 2.5 1.6 0.6 External 1.6 2.5 1.8 1.2 1.2 1.4 1.1 1.9 0.3 0.4 ---- Current Transfers 2.8 3.0 2.7 2.9 3.0 3.3 3.6 3.5 3.8 4.7 5.5 Capital Expenditures 6.0 5.9 5.4 10.7 9.5 7.4 6.6 8.6 9.6 9.5 7.3 o/w FixedInvestment 3.3 3.1 3.2 5.2 5.3 3.9 4.2 5.5 6.0 5.4 3.5 Capital Transfers 2.5 2.8 2.2 4.9 4.2 3.5 2.4 3.1 3.7 4.1 3.9 Overall Deficit (before grants) -4.4 -3.3 -1.9 -7.5 -7.0 -6.7 -5.6 -7.8 -5.3 -4.5 -3.9 Net Financing External Grants 4.1 2.6 0.0 4.4 3.3 3.5 3.7 5.3 2.8 3.8 3.8 Net External Financing 3.0 0.8 1.5 5.4 2.5 1.8 2.0 4.0 5.7 3.5 2.7 Net Domestic Financing -2.8 -0.1 0.4 -2.3 1.3 1.4 -0.1 -1.5 -3.2 -2.8 -2.6 Source: Ministerio de Hacienda y Credit0 Publico. Note: Figures representactual expenditures on a cash basis. 2.8 As shown in Table 2.4 below, the share o f total central government spending in the Infrastructure and Production sector has been stagnant since 2002, which suggests that most o f the increase in investment spending took place in other sectors. This i s corroborated by Nicaragua's somewhat modest growth performance during the last four years. Averaging 9 percent o f GDP during 2003-06, public investment in Nicaragua is about twice as high as in other countries in the region. At the same time, Nicaragua's per capita growth performance in recent years has not significantly exceeded the regional average, which suggests that either the large amount o f public investment has been displacing private investment or is not contributing to a faster accumulation of productive capital; see paras. 3.4-3.5. L 14. The jump in expenditures to over 24 percent of GDP in 2006 i s partly explained by the elections in 2006, which cost over 1percent o f GDP. 15. It is important to recognize inthis context that donor-financed public expenditures are generally recorded as capital expenditures, even though they may be financing current expenditures. 22 2.9 Consumption spending, on the other hand, has hardly changed since 2002, and while interest payments on the public external debt have declined significantly as a result of various debt relief initiatives since the mid-l990s, this was mostly offset by increased interest payments on the domestic public debt, increased current transfer payments and an upward drift in public salary expenditures as a share o f GDP; Figure 2.2. Most notable is the increase in transfer payments during the last two years, which is partly explained by the increase in central government transfers to the municipalities, as mandated by the L a w o f Municipal Transfers (Ley No. 466) that was passed in2004. Figure2.2: Nicaragua:Evolutionof CentralGovernmentWage Bill 6.0 I 60% 55% E 50% 0= E 45% E s 2.0 40% % m c 35% c g v, 1.o 30% S 25% Source: MHCP. 2.10 Even though the GDP share o f actual central government spending has been steadily drifting upward since 2001, the budgets presented to Congress have been exhibiting a declining trend, until 2006; Figure 2.3. Another noteworthy feature of the initial budgets presented to Congress each year is that they systematically under-estimate the budget execution: since 1992, actual central government expenditures have exceeded, o n average, the initial budget presented to Congress by 1percent o f GDP, and they have only fallen below the initial budget intwo years over that entire period, namely 2001 and 2002. l6 This pattern reveals continuing problems in public expenditure management, especially inthe area of budgeting. L 16. The prevalence o f budget earmarking (e.g., the public universities are constitutionally entitled to receive 6 percent of the total central government budget) generates an incentive to under-program the budget, and to take a very conservative approach by not including aid-financed project expenditures in the budget until the requisite financing has been secured. Untilrecently, the Executive could increase the budget during the course of the fiscal year without requiring immediate legislative approval if adequate sources of funding (loans and grants) became available, and approval could be obtained by means of retroactive amendments of the budget law; see Chapter VI, paras. 6.1 13-6.117. With the passage of the Financial Management and Budget Regime Management Law (No. 550) o f 2005, however, this practice is no longer permitted as legislative scrutiny o f any budget changes has been strengthened. 23 Figure 2.3: Total Central Government Expenditures; 1994-2006 (Budgetedversus Executed) 30% I 1 25% Actual * - 20% 15% - c - - - 10% I ' * - Budget I 5% 0% -5% Difference(actual budget) - - I Source: Ministerio de Hacienda y Credit0 Publico. Table 2.4 Nicaragua-Sector ComDositionof Central Government ExDenditures 1996 1997 1998 1999 2000 2001 2002 2003 2004 20051 2006b As percent of GDP Social Services 6.5 6.5 5.9 9.0 8.6 7.4 8.1 9.5 10.0 10.91 9.9 olw Education 2.8 3.1 3.0 3.9 3.8 3.6 3.9 4.2 4.0 4.7: 4.3 Health 2.6 2.4 2.2 3.2 3.1 2.8 2.9 3.3 3.0 3.41 3.0 Infrastructureand Production 3.5 4.2 4.7 6.8 5.9 4.8 3.6 3.8 4.4 4.01 4.3 Defense and Security 2.1 1.7 1.6 1.6 1.7 1.7 2.0 2.1 1.8 1.81 1.8 General Services 3.5 2.3 2.5 2.8 3.9 3.5 2.6 2.5 2.7 3.41 3.2 Others 0.0 0.3 0.2 0.6 0.0 0.9 1.0 1.4 1.5 1.31 1.6 Interest on Public Debt 1.7 2.8 2.6 1.9 1.8 2.1 2.7 4.3 2.0 1.21 1.8 TOTAL 17.4 17.8 17.6 22.8 21.9 20.3 20.0 23.6 22.4 22.61 22.6 As percent of Total Expenditures Social Services 37.6 36.3 33.5 39.3 39.3 36.2 40.4 40.3 44.6 48.21 43.8 olw Education 16.2 17.7 16.9 17.2 17.4 17.7 19.3 18.0 17.7 20.81 19.1 Health 14.7 13.4 12.4 14.1 14.2 13.8 14.5 13.9 13.3 15.0; 13.4 Infrastructureand Production 20.4 23.7 26.9 29.8 26.9 23.6 18.2 16.2 19.6 17.71 19.0 Defense and Security 11.8 9.6 9.1 7.2 7.8 8.2 10.0 8.7 8.1 8.0: 7.9 General Services 20.2 12.6 14.4 12.4 17.8 17.2 13.2 10.4 12.0 15.0: 14.3 Others 0.0 1.9 1.2 2.8 0.0 4.3 4.9 6.0 6.7 5.81 7.1 Interest on Public Debt 10.0 15.9 14.9 8.5 8.2 10.5 13.3 18.3 8.9 5.3; 7.8 24 Sector Composition of Central GovernmentExpenditures 2.11 The 2001 PER had noted a significant shift in the sector distribution o f central government expenditures after hurricane Mitch, with the social sectors accounting for almost two-thirds o f the total increase innon-interest expenditures and the Infrastructure and Production sectors accounting for the other third. Since 2001, social sector spending has continued to expand, both as a share o f GDP and as a share o f total central government expenditures; Table 2.4. In fact, the increase in total central government spending after 2001 is entirely accounted for by the increase in social sector spending. Close to one-half o f the total central government spending currently takes place in the social sectors. The shares o f public spending on the Infrastructure and Productive sectors, on the other hand, have reverted to their lower pre- hurricaneMitchlevels, and currently account for around 20 percent o ftotal spending. Institutional Composition of Central Government Expenditures 2.12 The largest central government institutions are the Ministries o f Health and Education, which together account for around 30 percent of total central government spending. The next largest institutions are the Ministries o f Governance (police) and o f Transport & Infrastructure, each o f which accounts for between 5 and 10percent o f total central government spending. It is also noteworthy that about one-third o f total central government spending i s in the form o f transfers to other institutions outside the central government. 2.13 The increase in transfers to other institutions represents the most important shift in the institutional composition o f central government spending since 2002. As shown in the next-to- last column o f Table 2.5, the share o f total central government spending devoted to transfers has increased by 33 percent between 2002 and 2006 Meanwhile, spending shares have declined in all central government institutions, except for the Ministry o f Economy, the Ministry o f the Family, the Attorney General's office, and the Supreme Electoral Council, which coordinatedthe 2006 Presidential elections. Except for the Electoral Council, these latter entities spend relatively little in absolute terms, however, and therefore have only played a limited role in influencing the overall composition o f central government expenditures. 2.14 The institutions that have been most influential in the growth o f central government expenditures since 2002 have been the Ministries o f Education and Health, as well as the decentralized institutions. As shown in the last column o f Table 2.5, total non-interest central government expenditures increasedby 2.73 percent o f GDP from 2002 to 2006. Ofthat increase, the Ministry o f Education contributed 0.43 percent o f GDP, and the Ministry o f Health contributed another 0.38 percent. Even though these two ministries experienced a decline in their shares o f total central government spending, they are mainly responsible among the central government agencies for the increase in public spending. The most important source o f increased public spending, however, has been the increase in transfers to decentralized and autonomous institutions outside o f the central government. Within that spending category, the transfers to the municipalities increased by 0.82 percent o f GDP, which represents the single most important source o f growth incentral government expenditures over that period. 25 Table 2.5 Nicaragua InstitutionalCompositionof CentralGovernmentExpenditures - (As percent of total central government expenditures) 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2 0 0 6 ~ ~ 2 0 0 2 % change absolute spending change in GDP as percent of Total CG expenditures (excluding debt service) share shares NationalAssembly 1.9 2.1 1.6 1.7 1.9 2.0 2.0 1.7 1.7 1.6 -16% -0.01 SupremeCourt 3.2 4.0 2.8 3.2 3.7 3.8 4.0 3.4 3.7 4.4 14% 0.21 SupremeElectoralCouncil 1.1 1.3 0.7 0.8 6.7 2.1 0.8 2.2 1.4 4.8 131% 0.61 Comptroller General 0.6 0.7 0.4 0.4 0.6 0.7 0.6 0.6 0.6 0.6 -14% 0.00 Office of the Presidency 3.7 2.3 4.7 3.1 2.2 2.4 1.8 1.4 1.3 1.4 -44% -0.15 Ministry of Governance 5.5 5.8 4.4 4.1 5.3 6.4 6.2 5.4 5.4 5.4 -16% -0.03 Ministry of External Relations 2.8 2.6 1.9 2.2 2.5 2.6 2.2 1.9 1.8 1.8 -30% -0.09 Ministry of Defense 6.0 4.9 3.4 3.4 3.7 4.9 4.4 3.6 3.3 3.4 -32% -0.18 Ministry of Finance 2.9 3.6 2.4 2.3 0.9 0.9 0.7 0.6 0.6 0.6 -34% -0.04 Ministry of Economy 0.7 1.6 0.7 0.8 0.9 1.1 1.4 1.4 1.4 1.8 63% 0.17 Ministry of Education 14.8 13.4 13.8 15.2 13.6 15.1 15.0 14.2 14.9 15.2 0% 0.43 Ministry ofAgriculture & For. 4.7 4.4 4.9 3.7 3.4 3.4 3.3 2.9 2.6 2.8 -18% -0.03 Ministryof Transport& Infrast. 9.7 13.1 15.9 14.3 12.1 9.3 8.7 9.2 8.2 4.6 -50% -0.70 Ministryof Health 16.0 14.6 15.3 18.5 15.3 16.5 16.8 14.7 15.3 16.1 -2% 0.38 Ministryof Labor 0.5 0.5 0.6 0.9 0.6 0.5 0.4 0.4 0.5 0.5 -5% 0.01 Ministryof Environment 2.5 2.6 1.7 2.4 1.9 1.7 1.8 2.3 1.6 1.5 -13% 0.00 Ministry ofthe Family 0.4 0.6 1.5 2.2 1.2 1.3 2.5 2.9 2.2 1.6 23% 0.09 MunicipalDevelopmentInstitute 1.1 1.3 3.7 3.3 1.4 1.1 1.0 1.1 0.9 0.0 -100% -0.19 Attorney General 0.3 0.3 0.2 0.2 0.2 0.1 0.2 0.1 0.1 0.2 18% 0.01 Other Institutions 21.8 20.2 19.2 17.3 22.0 23.9 26.2 29.9 32.6 31.7 33% 2.23 oiw IDR(PNDR) 4.0 4.5 5.6 5.6 4.6 3.1 2.9 2.7 3.0 2.6 -17% -0.03 FISE 0.8 0.8 -- 0.9 0.6 2.6 4.9 5.8 4.7 1.7 -36% -0.12 Transfersto Universities 5.9 6.2 4.5 4.9 5.8 6.7 6.6 5.2 5.4 6.5 -2% 0.14 Transfersto Municipalities 0.0 0.0 0.3 0.7 1.0 1.5 1.2 2.8 4.9 5.4 260% 0.82 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 0% 2.73 Source: Ministeriode Hacienday Credit0 Publico. Note:Total CG expendituresexclude debt service. B. The PatternofRecentFiscalAdjustmentsandSize of Government 2.15 The earlier discussion suggested that the fiscal adjustments and disciplined policies applied over the last 5 years, coupled with external support through the HIPC and MDRI initiatives, have brought the fiscal situation largely under control fkom a sustainability perspective. A s shown in Table 2.2, however, the fiscal deficit was reduced entirely through increases on the revenue side, without any significant reductions on the expenditure side. This pattern o f adjustment raises some concerns with respect to the permanence of past fiscal reforms. 2.16 A significant body of research on the link between the composition of fiscal adjustments and the likelihood o f successful fiscal reform has questioned the permanence o f fiscal adjustments that are mainly revenue based. Using a sample o f OECD countries, Alesina and Perotti (1995) find that successful adjustment^'^ have relied mostly on expenditure cuts (especially reductions intransfers and the public wage bill), while unsuccessful ones have mostly relied on tax increases. Using a somewhat different methodology, Von Hagen and Strauch (2001) arrive at a similar conclusion. They found that `unsuccessful consolidations have relied almost exclusively on increasing revenues, while successful ones put heavy emphasis on cutting L 17. Alesina and Perotti (1995) "Fiscal Expansions and Fiscal Adjustments inOECD Countries" define a successful adjustment as "a very tight fiscal stance in year t such that the gross debt/GDP ratio in year t+3 i s at least 5 percentage points of GDP lower than inyear t". 26 government spending'. In a similar vein, a "survival analysis'' applied to a sample o f 29 developing countries by Gupta et al. (2004) finds that a reallocation o f current expenditures to capital outlays tends to render fiscal adjustments more permanent, while large levels o f wages and salaries, transfers, and subsidies tend to have the opposite effect. Other studies, however, indicate that expenditure based adjustments are also not in themselves sufficient to maintain healthy public finances over the medium term; Gupta et a1 (2003).18 These research findings suggest that the Nicaraguan authorities must remain wary o f pressures to overturn previous fiscal reforms, and should seek to pursue a more balanced approach when new adjustment needs emerge, by combining revenue raising measures with expenditure cuts. countries in Central Table 2.6 America), while its CentralGovernmentRevenues andExpenditures total expenditure inLatinAmerica & the Caribbean level was very close Tax RevenuedGDP Total Expenditures to the regional 200012001 200312005 200012001 2003/2005 average; Table 2.6.19 Nicaragua 13.1% 15.8% 21.2% 22.4% On the basis of such CentralAmerica 3* 12.1% 13.1% 17.5% 17.8% regional LatinAmerica & Car. 14.9% 16.2% 22.4% 22.7% comp~sons, the Source: World Bank, Development Data Platform, LDB Database. Note: Central 2001 PER had America 3 refers to El Salvador, Guatemala, and Honduras . I s Nicaragua 's Public Sector Oversized? 2.18 By focusing entirely on revenue mobilization, recent fiscal adjustments have had the effect o f gradually expanding the size o fpublic expenditures. This raises the question o fwhether Nicaragua's public sector may have grown too large. Leaving aside for the moment considerations o f fiscal sustainability, there is little to go by in seeking to assess whether a L 18. Gupta, Sanjeev, E. Baldacci, B. Clements and E.Tiongsen (2003), "What Sustains Fiscal Consolidations in EmergingMarket Countries? (IMFWorking Paper No. 03/224). It is also important to keep inmindthat most o f the studies cited here have focused on emerging market and OECD economies, which typically have higher levels o f spending and taxation than low income counties such as Nicaragua. Extending this research to lower income countries is clearly called for. 19. In 2001, Nicaragua's national income accounts were still unrevised, reflecting a substantially undervalued GDP. As a result, the public expenditure and tax ratios based on the official figures were substantially higher than the regional averages. The PER'S recommendations were based instead o n adjusted figures that reflected an estimated GDP under-valuation o f 70 percent, which was subsequently borne out by the revised national income accounts that were published in2003. 27 country's public sector i s too large, too small or about right. National preferences for public versus private goods differ across countries, and this i s reflected in significant variations in the size o f public sectors. One way o f forming ajudgment about the appropriate size o f government i s through the use o f international comparisons, as done in the previous benchmarking comparison o f central government revenues and expenditures. The top panels o f Figure 2.4 present a similar comparison o f total public revenues and expenditures across various countries and country groupings2' as shares o f GDP, using a broader measure o f government, namely the Non-Financial Public Sector. Based on these figures, Nicaragua appears to have a somewhat larger public sector than the Central American average underboth measures o f government size, and incomparisonto the LatinAmerica average with respect to the expenditure-based measure. 2.19 These measures cannot be taken at face value, however, as there exists a positive and statistically significant relationship between the size o f the government and income levels across countries; shown in the middle panels o f Figure 2.4. Accordingly, the bottom panels in Figure 2.4 present the measures o f government size controlling for differences in per capita income levels. That is, they measure the size o f government as the difference between the actual size o f public sector revenues (or expenditures) and the size predicted by the income level o f that country. Based on these adjusted figures, Nicaragua continues to exhibit levels o f public spendingand revenues that are higher than the regional averages, but they do not stand out in a wider global comparison. L 20. The Latin American average is based on Argentina, Mexico, Chile, Peru, and Colombia. The average for Europe is based on Belgium, Denmark, Germany, Ireland, Italy, and Netherlands. 28 Figure 2.4: Measures of Government Size: Expenditures and Revenues of the Non-Financial Public Sector (% of GDP)*/ Public ExpendituredGDP PublicRevenuesIGDP j0 ............................... ......l....l^l.-.....- . 43.9l j 40 I 35 31 7 Cross-Country Relationship ExpendituredGDP RevenuedGDP ' 0 1 ! d '0000 20000 30000 40000 50000 6ObOO 0 10000 20000 30000 40000 50000 60000 GDP per sapits Actual - Predicted 15,-. ....................................... ,/ -.I I' .... .~.............. I - 5 d , d n , ~ z g ? k - ; : ; > ~ ~ r = " & ^ 4 - " ^ " ' s g- ? : ^ u . Note: */ Left hand side always refers to Expenditures and righthand side to Revenues. All numbers are for (2004). Source Own calculations bases on IMF's Article IV Staff Reports 29 C. FiscalSustainability TheEvolution of Nicaragua's Public Debt 2.20 Nicaragua has reduced its external debt substantially inrecent years. From beingone o f the most highly indebted countries in the world, with an external debt that almost reached 400 percent o f GDP in 1994, Nicaragua's external public debt in nominal terms i s currently around 84 percent o f GDP. This decline in the public external debt ratio was mainly due to the debt relief provided by the Paris Club and multilateral institutions, as well as increased fiscal discipline. Debt relief was provided through various mechanisms, including a commercial debt buy-back operation, bilateral debt relief, the Heavily Indebted Poor Countries (HIPC) Initiative and, most recently, the Multilateral Debt Relief Initiative (MDRI).21Total external debt reached US$4.5 billion in nominal terms at end-2006. O f that amount, about US$780 million i s scheduled to be forgiven by the IDB as its contribution under the MDRI. When all the debt relief has been awarded under these initiatives, the NPV o f external debt is projected to fall to about 35 percent o f GDP (HIPC methodology).22 23 2.21 Although Nicaragua succeeded in getting rid o f much o f its external public debt, it continues to be saddled with a significant domestic public debt. That debt originated mainly from two sources: 0 The largest source o f domestic debt are the Compensation Bonds ("Bonos de Pago de Indemnizacidn, BPIs) issued by the Ministry o f Finance since the early 1990s to settle the property disputes that emerged from the confiscations and land reforms carried out in the 1980s. They carry maturities o f 15 years andinterest rates o f 4.5 percent (on average). 0 The next largest source o f domestic debt are Central Bank negotiable bonds ("Certifcados Negociables de Inversidn, CENIS) issued with maturities o f up to three years and with market interest rates determined by a competitive biddingprocess. (Interest rates have varied with a recent range between 8 and 15 percent.) CENIS were created initially to mop up liquidity through open market operations, but the bulk o f them have served to rescue public banks that encountered financial difficulties in the 1990s and to assist in the resolution o f several failed private bank failures that were intervened during2000-01. L 21. Nicaragua reached the HIPC Decision Point in December 2000 and the HIPC Completion point in January 2004. The IMF and World Bank have beenproviding additional debt reliefunder the MDRIsince January 2006 and July 2006, respectively, while the IDB agreed to participate inthe MDRIinDecember 2006 22. The end-2006 estimate o fpublic external debt (US$4,527 million) includes debt forgiveness from the IMFand IDA of US$203 million and US$982million, respectively, during 2006 following the MDR Initiative. (It is important to note that these overall debt figures refer to actual debt levels to date, and not to the full-delivery scenario figure that would be observed if all the HIPC debt relief were fully delivered as of end-2006.) Adding the recently announced debt forgiveness by the IADB, public external debt at the end o f 2006 would be US$3,741 million (or about 70 percent o f GDP innominal terms and close to 35 percent o f GDP innet present value terms.) A fillHIPC debt relief delivery scenario, with all non-Paris Club creditors participating, would reduce the nominal debt below US$3 billion. 23. A second commercial debt buy-back operation, which was concluded successfully in 2007, will eliminate external debts on the order o f US$1.3 billion innominal terms. These commercial debts, however, mainly consist o f interest arrears and penalties that are not included inthe US$4.5 billionexternal nominal debt figure, as estimated by the Central Bank o f Nicaragua. Inother words, the elimination o fthis debt does not affect the official debt figures. 30 2.22 The domestic debt has fallen since 2003 as a result o f declining fiscal deficits that have permittedsubstitution o f more expensive domestic market debt with concessional external debt. Financingrequirements on domestic debt inthe next few years, however, are expected to remain large, as the original BPIs are beginningto fall due. 2.23 The domestic public debt i s dollar-indexed and currently estimated at around US$ 1.2 billion, or 23 percent o f GDP (and about 19percent o f GDP when expressed innet present value terms). This means that the NPV o f the total public debt (after HIPC and MDRI are fully implemented) remains close to 54 percent o f GDP, which i s still fairly large by developing country standards and remains a source o f fiscal vulnerability. Debt Sustainability 2.24 The question we turn to now is whether the fiscal adjustments carried out over the last five years, combined with the debt relief received, have left Nicaragua in a fiscally sustainable position. To address this question, we utilize a simple analytical model developed in the Nicaragua Development Policy Review (World Bank (2004))24. Broadly speaking, fiscal sustainability i s determined in this model by comparing the expected flow of future net public revenues to the flow o f future debt payments required to service the country's outstanding public debt. Ifthe present value o fthe future flow o fnet revenues exceeds the present value o fthe flow o f debt servicing requirements, then the government's fiscal policy stance and debt levels are said to be sustainable. Ifit falls short, they are not sustainable. 2.25 As a heavily indebtedpoor country, Nicaragua's capacity to borrow externally remains severely constrained, and mostly confined to official borrowing on concessional terms. Since concessional funding is limited, this means that the evolution o f Nicaragua's external debt since the early 1990s has been supply-determined by donors. For the sake o f simplicity, it is assumed that donors are prepared to continue extending concessional financing in an amount that maintains Nicaragua's total external debt constant in U S Dollar terms at current levels.25 With this assumption about donor behavior, attentioncan focus entirely on the domestic debt. 2.26 The present value o f the expected future flow o f public revenues (net o f debt service payments on the concessional external debt and expressed as a share o f GDP) can be derived as a function o f the average GDP growth rate and o f the primary fiscal balance, as shown in Table 2.7.26 The figure determinedfor a particular combination o f growth and fiscal surplus rates can then be compared to the net present value o f the expected flow o f debt servicing requirements (also net o f debt service payments owed on the external debt). Given that this debt was mostly contracted on market terms, the present value o f those debt service flows will be much closer to the nominal value o f the underlying stock o f debt than is the case with the external, concessional debt. Accordingly, each cell inTable 2.7 can be interpreted as the maximal amount o f domestic L 24. The model is presented inAnnex A o f the Nicaragua Development Policy Review (World Bank 2004). 25. One implication o f this assumption i s that the ratio o f the external debt stock to GDP declines gradually over time at a speed that depends entirely on the rate o f GDP growth. A less conservative assumption would have been to assume that the external debt stock increases at the same rate as the dollar inflation rate, which means that its real value inUS$ remains constant over time. As long as the rate o f growth o f the external debt stock does not exceed the rate o f growth of nominal GDP (Le., the joint growth rate o f inflation and real GDP), its projected trajectory i s considered sustainable. 26. See Annex B for a more detailed description on how the figures inTable 2.7 were calculated. 31 debt (expressed as a share o f GDP) that can be sustained under a given combination o f the primary fiscal surplus and real GDP growth. (Note fi-om these figures that higher rates of economic growth and higher primary fiscal surplus rates permit the public sector to sustain a higher domestic debt level.) Whether a particular combination of fiscal surplus and economic growth i s sustainable or not then depends on whether the actual net present value o f the domestic debt lies below or above the figure corresponding to these parameters inTable 2.7. Table 2.7: NPV of FutureStreamof PublicRevenues Basedonthe fiscal parametersvalues of 2006 (percent of GDP) RealGDPgrowth 1% 2% 3% 4% 5% 6% -42 -47 -54 -65 -82 -116 -28 -30 -34 -39 -47 -63 -14 -13 -13 -13 -12 -10 1 4 8 13 23 43 15 21 28 39 58 96 30 38 49 65 93 149 44 55 69 91 128 202 59 72 90 117 163 255 ------ 73 89 111 143 198 308 Note: * The future stream o f public revenues i s net of the external (concessional) debt service. Source: Estimations based on the model inAnnex A o f the World Bank (2004), Nicaragua: Development Policy Review. 2.27 The primary fiscal surplus for Nicaragua's combined public sector varied between 0 and 0.5 percent o f GDP during2003-2005, before increasingto 2.2 percent in2006. GDP growth, in turn, averaged almost 4 percent per annum during 2003-05. According to Table 2.7, a growth rate o f 4 percent together with a 0-primary fiscal surplus would sustain a domestic debt o f roughly 13 percent o f GDP. If the same growth rate is coupled with a primary surplus o f 2.0 percent, it could sustain a domestic debt o f 65 percent o f GDP. 27 2.28 Turningnow to the actual level o fNicaragua's domestic public debt, we noted earlier that the Net Present Value o f that debt was estimated at 19 percent o f 2006 GDP. Based on the figures inTable 2.7, this stock o f domestic debt could not be sustained with a primary surplus o f 0, but it is well below the maximal debt level that could be sustained with the 2 percent primary surplus achieved in2006. Other Public Liabilities 2.29 There are several additional public sector liabilities that also have to be taken into account in assessing a country's fiscal sustainability, even though they are not securitized. The most important o f these liabilities is the implicit debt associated with the actuarial deficit o f L 27. It i s worth pointing out that when this same exercise was carried out inthe 2004 DPR, the same growth rate o f 4 percent and fiscal surplus ratio o f 2 percent would only have been able to sustain a much lower maximum domestic debt level (equivalent to 40 percent o f GDP). The reason for this difference is that several other economic parameters have substantially improved during the intervening years, raising Nicaragua's debt sustaining capacity. The most important parameter improvement in this regard has been the decline in the estimated real domestic interest rate (from 10 to 8 percent), see Annex B. 32 Nicaragua's pension system. Table 2.8 presents various estimates o f the actuarial debt arising from the pension system under the alternative parameter reforms. Using an 8 percent discount rateY2*which coincides with the estimated real interest rate for domestically issued debt, the Net Present Value o f the pension system's actuarial deficit under the current parameter setting i s estimated at 162 percent o f GDP. A modest reform involving only a slight increase in contributions would reduce that contingent liability to 58 percent o f GDP, while a more ambitious reform that raises both the contribution rate and retirement age would reduce that deficit further o f 34 percent o f GDP. Of course, under a sufficiently drastic parametric reform the actuarial deficit could even bebrought down to zero.29 Nicaragua Total Domestic Public Liabilities(as ofNovember2006) - Table 2.8 NPV of Debt I n US$millions As % of GDP Domestic Debt 1,040 19% Bonos de Pago por Indemnizacion(BPI) 778 14% CENIS 209 4% Other 53 1Yo Actuarial Deficit of Social Security System (under alternativeparametric reforms) Option 1(no reform) 8,700 162% Option 2 (modest reform) 3,115 58Yo Option 3 (ambitious reform) 1,826 34% Option 4 (drastic reform) 0 0 Grand Total Option 1 181% Option 2 77% Option 3 53yo Option 4 19% Source: Nicaraguan Central Bank, Ministry o fFinance - Comision Tecnica Interinstitucional., and World Bank, Nicaragua Development Policy Review (2004) 2.30 From Table 2.8 we see that the long run sustainability o f the fiscal framework depends closely on how the authorities deal with the actuarial deficit o f the pension system. Ifthe current system i s allowed to remain unreformed, then the fiscal framework is clearly unsustainable, even with a 2 percent primary fiscal surplus. To sustain the resulting domestic debt (including pension liabilities), estimated at 182percent o f GDP, the primary fiscal surplus would have to be raisedto around 6 percent of GDP; assuming that GDP growth remains at 4 percent. Conversely, we can conclude from the figures in Tables 2.7 and 2.8, that the 2 percent primary surplus L 28. A real interest rate o f 8 percent may be considered high for discounting future streams with long horizons, such as those associated with pension systems. While using a lower interest rate raises the net present value o f the same future stream o f pension deficits (and hence the size o f the implicit public debt), it also enhances the economy's capacity to sustain debt under given fiscal parameters. The overall impact on sustainability, therefore, is difficult to assess without engaging ina more detailed analysis. 29. These estimates are comparable to the ones discussed by the HighLevel Commission for reform o f the pension system inNicaragua and the Inter-institutional Technical Committee. They have estimated that the actuarial deficit o f the pension system inN P V terms could reach as high as four times the size o f GDP if the current system remains unchanged to as low as no deficit at all with a very drastic parametric reform is introduced. See, "Proyecciones Financieras de Reformas de Pensiones" Comision Tecnica Interinstitucional, Nicaragua, Ministry o f Finance, June 2006, and "Carta - Escenario de Reforma a1 Sistema de Pensiones" Nicaragua, Ministry o f Finance, November 2006. 33 reached in 2006 is only sustainable with a pension reform on the order o f Option 3. Under Option 3, the total domestic debt i s reduced to 53 percent o f GDP, which i s comfortably below the maximal domestic debt ratio (65 percent) that can be sustained with a 2 percent fiscal surplus and 4 percent growth. Fortunately, the pension system is not projected to generate cash deficits for a few more years, which gives adequatetime to prepare an appropriate pensionreform. 2.31 In addition to the liabilities associated with the pension system, there are also other contingent liabilities that need to be taken account o f in assessing the risk o f debt distress. One potential fiscal liability originates inthe financial sector and is related to the de-jure and de-facto government guarantee o f deposits in the event o f a bank failure. Although it appears that prudential regulations and the institutional capacity o f the Superintendency of Banks to detect imprudentbehavior have been strengthenedthroughprevious financial sector reforms, the risk o f another bank crisis cannot be ignored as long as the government maintains a legal or even moral responsibility to bail out depositors inthe event o f a crisis. 2.32 Finally, another important, but difficult to quantify, contingent fiscal liabilityrefers to the government's open-ended capacity to issue BPIs inresponse to new claims o f compensation for past confiscations. There is a danger that the ability to issue BPIs offers a seemingly easy way out inresolvingproperty conflicts that the judiciary i s unable or unwilling to handle. D. MainConclusions 2.33 The preceding review finds that Nicaragua has made impressive progress since 2001 in reducing its overall fiscal deficit. The decline o f that deficit, however, was brought about entirely through increases in public revenues, which raises some concerns with respect to the future permanence o f past fiscal reforms. To address those concerns, and considering the relative evolution o f public revenues and expenditures in recent years, the authorities may wish to consider a more balanced approach when future adjustment needs emerge, by combining revenue-raising measureswith expenditure cuts. 2.34 A debt sustainability analysis found that Nicaragua's combined public debt o f approximately 54 percent o f GDP appears sustainable as long as the country continues to grow at the average rate achieved inrecent years and maintain positive fiscal surpluses on the order o f 1 to 2 percent. This result coincides with the finding that emerged from the joint IDA-IMF debt sustainability analysis carried out in August 2007, indicating that Nicaragua exhibits a moderate, but manageable, risk of experiencing debt distress, provided that sound macroeconomic policies continue to be applied. Nevertheless, Nicaragua still remains vulnerable to destabilization from various potential developments that could undermine fiscal discipline. The most important threats in the short run were identified as the rising fiscal transfers to the municipalities mandated by Law 466, growing pressures on public wages, and the possibility o f an energy crisis. 2.35 In the long run, Nicaragua's fiscal sustainability will also depend closely on how the authorities deal with the actuarial deficit o f the pension system, which is currently at an unsustainable level. To render the implicit debt associated with the pension system sustainable would require a substantially larger primary fiscal surplus - on the order o f 6 percent, if GDP growth remains at 4 percent. This would be an extremely ambitious fiscal target, as well as an 34 extremely inequitable one, considering that the beneficiaries of the pension system generally do not comprise the poorer members of societies (see Box 2.1). Fortunately, the pension system is not projected to generate cash deficits for a few more years, which gives adequate time to prepare appropriate pension reforms that would reduce the actuarial deficit in a socially equitable manner to a fiscally sustainable level. Box 2.1 PensionSystem Coverage inNicaragua Nicaragua exhibits very high levels o f labor market informality - about 65.7 percent (using small and micro enterprises as the marker o f informality) or 82.8 percent (usingthe lack of contribution to the social security system as a marker of informality) of the economically active population. (Source: Estela Monroy 2006). Accordingly, the share o f the populationthat i s eligible for pensionbenefits i s very small. Nicaragua ranks 4th lowest in a sample o f 15 Latin American countries in terms of the percentage of the population covered by the pension system (only Bolivia, Paraguay and Peru have lower coverage). According to the 2005 LSMS, only 13.5 percent o f the population over 60 years o f age report receiving benefits from the pension system. Another notable characteristic o f the pension system in Nicaragua is the great disparity in coverage across rural-urban areas, income quintiles, occupations and education attainment levels. As indicated in the Figure below, it i s the richest population quintiles, most educated, urbanpopulationthat benefit most from pension system. Not the rural, agriculture-based segments o f the population, where most poverty i s concentrated. The coverage of health insurance provided through INSS exhibits identical disparities ncoverage; see 2005 NicaraguaPoverty Assessment. INSS Coverage Rates; 2001 60 I-- 50 40 30 Source: RofmnandLucchetti(2006)- from LSMS2001. 35 36 CHAPTERI11 THE EFFICIENCY OF PUBLICSPENDINGINNICARAGUA A. Growth andPovertyReductionPerformance 3.1 Nicaragua's growth performance since the mid-1990s has been reasonably good by regional standards, but somewhat lackluster incomparison to developing countries elsewhere. In fact, except for 1998-99, Nicaragua's per capita GDP growth has remained consistently below the average rate exhibited by all lower middle income countries worldwide; Figure 3.1. Furthermore, the pace o f growth achieved in recent years has not been sufficient to keep up the momentum inpoverty reduction, which has exhibited a marked deceleration since the end o f the 1990s: following a steady decline in the extreme poverty headcount ratio from 19 percent in 1993 to 15 percent in 2001, the latest Living Standard Measurement Survey (LSMS) in 2005 only revealed an insignificant change vis-&vis 2001. Figure3.1: Nicaragua'sRelativeGrowthPerformance Vis-a-vis Latin America & the Caribbean Vis-a-vis all Lower Middle Income Countries 10, I 10 , 1 5 5 -E 8m O 8 0 -5 P -5 g -10 3g -20 -15I -10 -15 Source: World Bank, World Development Indicators. Notes: The graphs present the difference between Nicaragua's per capita GDP growth rate and the average rates in LAC, or in all Lower Middle Income Countries. The underlying figures on GDPper capita are based onpurchasingpower parity (PPP). 3.2 A decomposition o f per capita GDP growth into the rate o f capital accumulation and the rate o f productivity growth can offer some insights for understanding the pattern o f growth. The findings from such a growth decomposition analysis were reported in the 2004 Nicaragua Development Policy Review (DPR), which concluded that Nicaragua's difficulties in achieving fast sustained growth were attributable partly to insufficient rates o f capital accumulation, but more importantly to insufficient productivity growth, which i s largely related to the quality o f investment. The 2004 DPR also had pointed out that Nicaragua exhibited particular shortcomings in several o f the key determinants o f growth, namely in education attainment, public infrastructure, financial sector development and g~vernance.~' L 30. These key determinants o f growth were identified in a cross-country study by Loayza, Norman, Pablo Fajnzylber and Cesar Calderon (2006) "Economic Growth in Latin America and the Caribbean." (World Bank , Latin America and the Caribbean Region), which provided the analytic underpinning for the DPR. 37 3.3 These findings draw attention to the quantity and quality o f public investment, both in humanand physical capital, which contributes to the accumulation o f the country's total capital stock. This chapter seeks to assess whether Nicaragua's public sector is devoting an adequate amount o f resources toward aggregate investment, as well as toward the key sectors (education and infrastructure) identified as critical for raising economic growth in Nicaragua. The second issue addressed i s the quality o f these investments. The objective o f this assessment i s to determine whether the shortfalls in development outcomes are mainly due to insufficient public spending inparticular areas or to shortcomings inthe efficiency o fpublic spending. B. The LevelandEfficiency ofPublicInvestment 3.4 Nicaragua appears to devote a much higher share o f its GDP toward gross fixed capital formation (GFCF) than the average inLatin America; Table 3.1. This difference relative to other Latin American countries i s mainly attributable to a significantly higher rate o fpublic investment spending. While the share o f private investment i s roughly the same inNicaragua as in the rest o f Latin America, the share o f public investment i s more than double the regional average. In this regard, Nicaragua resembles other lower middle income economies. Admittedly, public and private investment ratios have been significantly higher inthe fast growing East Asia region, but the similarity to the ratios exhibited by other lower middle income economies suggests that Nicaragua's relatively modest growth rate i s not primarily attributable to insufficient public investment or the crowding out o fprivate investment. I aspercent of GDP !TotalGFCF 23.94 i 19.13 i 26.15 i ; 32.44 ! i Public GFCF 7.44 I I I I 3.00 I 9.69 I 14.38 !AverageICOR* 7.65 I 5.27 i 4.98 i 3.96 ij ;TotalGFCF/GDP 0.57 0.21 I 0.78 0.57 !Private GFCF/GDP 0.54 0.08 0.78 0.31 !Public GFCF/GDP II -0.19 I 0.15 -0.29 0.23 3.5 Where Nicaragua does stand out i s with respect to the productivity of total investment, as measured by the average Incremental Capital Output Ratio (ICOR). While the average ICORs observed in Latin America and other lower middle income economies are not too far apart from the average value observed in East Asia, Nicaragua's ICOR i s nearly twice as large. That is, somehow the investments undertaken inNicaragua are much less efficient interms of generating or eliminating obstacles to growth than those undertaken in the other countries. One possible 38 explanation is that Nicaragua i s not directing its public investments toward the most productive activities. In this regard, it i s notable that Nicaragua exhibits a negative correlation between public investment and economic growth, which contrasts with the positive correlation observed for East Asia, as well as with the positive correlation between private investment and economic growth exhibited everywhere. Other lower middle income economies exhibit a similar correlation pattern as Nicaragua, however, indicating that this factor may not have been the most critical for explaining the differences in economic growth. Another, more compelling explanation for the difference in average ICORs is that Nicaragua's overall public investment figures are grossly over-estimated. 3.6 As indicated in Table 3.2, over 40 percent o f total public spending in the social sectors was classified as capital spending during 2003-05. It i s hard to imagine such a high proportion o f capital spending in these service-delivering sectors. Furthermore, the capital spending reported for the social sectors accounted for almost half o f the total central government investment expenditures. This suggests that either current expenditures are being mis-classified as capital expenditures or the public sector i s at risk o f investing far beyond its capacity to maintain and operate the accumulated capital. This would explain the high average ICOR rates observed earlier, as the high reported public investment rates are either not contributing to the growth o f the total capital stock or the capital stock is not being adequately maintained and operated. Table 3.2 Nicaragua: CapitalExpendituresof the CentralGovernment, by Sector 2000 2001 2002 2003 2004 2005 2006 Sector Investment as % of Total Public Investment Expenditures Social Sectors 45% 28% 40% 47% 47% 49% 38% Infrastructure & Prod. 51% 53% 46% 39% 41% 37% 45% Defense and Police 1% 1% 2% 1Yo 1% 1% 1Yo General Services 3% 5% 3% 3yo 2% 6% 4% Other 0% 13% 9% 11% 9% 6% 12% ................................................................................................................ Total 100% 100% 100% 100% 100% 100% 100% Sector Investment as % of Total Sector Public Expenditures Social Sectors 43% 29% 33% 42% 46% 43% 28% Infrastructure & Prod. 87% 84% 83% 86% 90% 88% 78% Defense and Police 6% 6% 6% 6% 7% 7% 4% General Services 13% 11% 8% 9% 6% 17% 9% Other na 99% 49% 57% 58% 48% 53% ................................................................................................................ Total 42% 37% 32% 36% 43% 42% 32% memo item: Netforeign grantshedits as % of Total Public Capital Expenditures 62% 69% 85% 92% 56% 47% 55% Source: Statistical Annex Tables. Figures for 2006 are preliminary 3.7 The misclassification o f current as capital expenditures arguably is responsible for most o f the over-reporting o f public investment levels, especially inthe social sectors. To begin, it is important to keep in mind that Nicaragua is one o f the most aid-dependent countries in the region. As indicated in Table 3.2, net foreign inflows since 2000 have averaged around two- 39 thirds o f total public capital spending.31 Furthermore, as a rule, public expenditures that are explicitly linked to these inflows are automatically classified as capital expenditures, independent o f the true economic use o f those funds.32 This pattern o f expenditure misclassification i s expected to eventually change with the introduction o f sector-wide approaches and the increasing recourse to budget-support funding. 3.8 The Infrastructure and Production sector also exhibits a high proportion o f investment spending,with over 75 percent o ftotal spending classified as capital expenditures. About halfof total spending in this sector (the Production part) consists o f public support to agriculture, environment and rural development activities, which are highly dependent on aid and largely involve the delivery o f public services. The ratio o f investment to total public spending reported for those sub-sector activities, averaging 88 percent during 2002-2004, therefore also appears to be heavily distorted by the misclassification o f current as capital expenditures. The other half o f total spending in this sector (the Infrastructure part), however, is dominated by the transport sector, which by its very nature involves much higher proportions o f investment spending than the other, more service oriented sectors. That is, the investment figures reported for infrastructure spending are more indicative o f the true amount o f investments taking place. Therefore, to the extent that the reported infrastructure investment figures appear unusually high, they would more likely be reflecting true imbalances between investment and recurrent spending, rather than a misclassification o f expenditures. Table 3.3 Infrastructure Sector InvestmentinLatin America; 1991-1998 Total Public Infrastructure I Transport Infrastructure j Water Infrastructure Total Public Private j Total Public Private/Total Public Private in percent of GDP Argentina 1.7 0.5 1.2 0.4 0.2 0.2 0.1 0.1 0.1 Bolivia 6.9 2.8 4.1 2.2 1.8 0.4 0.7 0.1 0.6 Brazil 2.2 1.1 1.1 0.2 0.1 0.1 0.2 0.2 0.0 Chile 4.3 1.5 2.7 1.2 1.o 0.3 0.3 0.3 0.1 Colombia 5.1 3.9 2.2 1.o 0.9 0.1 0.5 0.5 0.0 Ecuador 4.5 3.4 1.o 0.6 0.5 0.1 0.8 0.8 0.0 Mexico 1.8 0.9 0.9 0.8 0.3 0.6 0.2 0.2 0.0 PeN 1.4 0.4 0.9 0.2 0.1 0.0 0.0 0.0 0.0 Venezuela 1.O 0.1 0.8 0.1 0.1 0.0 0.0 0.0 0.0 Averse________________________________________---------,1.6 3.2 1.7 ________________________________________---. 0.7 0.5 0.2 ______________________________________ 0.3 0.2 0.1 Nicaraeua na 3.4 na ! 1.6 1.6 0.0 0.8 0.8 0.0 Source: World Bank, ProjectDatabaseon InfrastructureInvestmentin LAC, Office ofthe ChiefEconomistfor Latin America & the Caribbean. Datarefers to investmentsin roads, railways, electricity/gas, water andtelecoms. Data for Nicaraguarefersto capital spending over the period 2002-05 and is estimatedon the basis ofinformation in the PER statisticalannex and governmentbudget. L 31. Not all o f these inflows are used to finance capital spending. A significant portion also has been provided in the form o f budget support and substitutes for domestic financing o f the deficit. Even so, sector-specific external grants and credits represent almost 100 percent of the total capital budget in education and around 68 percent in health. 32. The reasons for such a rule are well known: on one hand, most donors traditionally have insisted on restricting their development aid to investment activities on the grounds that financing recurrent spending leads to unsustainable outcomes. O n the other hand, the national authorities generally have no choice but to record aid- financed project expenditures as investment expenditures, given the finite time horizon and limited commitment o f fimds associated withthese projects. 40 Has Nicaragua been spending enough on Public Infrastructure? 3.9 Nicaragua's public sector invests a significantly higher share o f GDP in public infrastructure than the Latin America average; Table 3.3. Even though Nicaragua privatized the public telecommunication enterprise and much o f the electricity sector, and no longer has a railway, its total public infrastructure investment ratio i s over twice the regional average. While reliable figures are not readily available on private investment, Nicaragua's public investment in these sectors exceeds the combined public and private investment observed inmost o f the other countries over the previous decade. In the transport and water & sanitation sub-sectors, Nicaragua's investment ratios represent an even greater multiple o f the regional averages. Nicaragua's GDP share o f public investment in the water & sanitation sector, for example, is about 4 times the regional average. 3.10 The preceding finding suggests that Nicaragua's public sector has not been investing too little in public infrastructure, or at least not in the transport and the water & sanitation sectors. On the other hand, Nicaragua also has a greater public infrastructure deficit than the average in Latin America, and so should be investing more. Inthat regard, Nicaragua is comparable to the other HIPC country (Bolivia) that is represented inTable 3.3. Also, this conclusion needs to take into consideration that not all o f the total public investment reported for these sectors constitutes true investment expenditures, but maybe disguised current expenditures. The absence o f data on private investment expenditures in some o f these sectors adds to the difficulty in assessing the adequacy o f total investment spending. Although the private sector is not significantly involved in the transport and water sectors (except in terms of road maintenance activities), it is very closely involved in the electricity and telecommunications sectors. The telecommunications sector appears to be expanding in a satisfactory manner. In energy, however, the growth in effective installed generation capacity has fallen behind the growth o f electricity demand since 2001,reflecting inadequate investment levels; see Annex H. TheEfficiency of Public Infrastructure Spending 3.11 In spite of what appears overall to be a significant level of investment in public infrastructure, Nicaragua's infrastructure quality indicators are among the lowest worldwide. According to the infrastructure quality index o f the World Economic Forum's 2006/2007 Global Competitiveness Index, Nicaragua ranks 10IStout o f a total o f 125 countries; that is, in the bottom quartile. 3.12 Nicaragua's relatively poor performance in this area i s inpart associated with its overall lower level o f development, as measured by per capita GDP. Even after taking into account differences in the level o f per capita income, however, Nicaragua continues to exhibit a level o f infrastructure quality that is below the norm for countries with similar income levels; top panel o f Figure 3.2. Furthermore, Nicaragua's shortfall in infrastructure quality is particularly pronounced after accounting for differences in gross fixed capital formation as a share o f GDP; lower panel o f Figure 3.2. While its ratio o f gross fixed capital formation (averaged over 2001- 05) ranked in the top quartile o f the distribution o f these ratios among lower middle income countries, its infrastructure quality index ranks inthe lowest quartile. These findings suggest that the quality o f investment inNicaragua exhibits significant deficiencies, both in terms o f helping 41 to generate economic growth and in terms o f providing adequate infrastructure services. The next three sections present summary reviews o f the transport, water & sanitation, and electricity sectors in Nicaragua, with the purpose o f identifying the main sources o f deficiencies in each sector. Figure3.2. Per Capita GDP, Gross FixedCapitalFormationand InfrastructureQuality across Lower MiddleIncomeCountries I i!E: 5.00 3.50 3.00 2.50 2.00 1.50 - 1.oo 0.50 0.00 0 2000 4000 6000 aooo per capita GDP (constant 2000 Int'lS) .. .... . ~ ...-.. 5.0 , 2.E 0 4.5 - 4.0 I. dE 3.5 I I. 3.0-->-- - B. 30a 2.0 2.5 rnI I I 1.5 g8 U L 1.0 Nicaragua - 0.5 0.0 , , , 0 10 20 30 40 50 Gross FixedCapital Formation(%of GDP) Source: Lopez-Claros et a1 (2006), The Global Competitiveness Report 2006-2007, and World Bank, World DevelopmentIndicators. This figure is basedon data for 49 lower middle income countries. Summary Review of Public Expenditures in Transport 3.13 Recent Sector Performance. Nicaragua's road network had deteriorated to the point where only about 12 percent o f the network was in good condition in the early 1990s. By the end o f 1999, this proportion had risen to 19 percent, in spite o f the setback produced by humcane Mitch, and reached 20 percent in 2006. This outcome was achieved with annual budgetary allocations to the transport ministry (MTI) o f around 2.0 percent o f GDP, (or around 10-15 percent o f total central government expenditures). In 2005 and 2006, however, MTIs budget execution declined significantly, below the level considered adequate for a country at Nicaragua's stage o f development and recovery; see Annex F. 42 3.14 Nicaragua's overall road sector performance is considered adequate from a resource allocation viewpoint. Noteworthy improvements in this regard are (i) the increasing reliance on a road maintenance fund (FOMAV) to maintain the most trafficked roads, and (ii) an increasing reliance on adoquines (cement paving blocks) as a cost-effective alternative to gravel-surfaced roads, especially for rural traffic.33 Although the ratio o f sector recurrent to capital expenditures has been unusually low over the last decade, this has been reflecting a focus on reconstruction needs and is not expected to continue. Road improvements are now selected largely on the basis o f their economic justification (usingthe World Bank's HDMmodel), providing further comfort in that allocations are being made on an efficient basis. Concerning the other transport sub- sectors, most transport services for roads, ports and airports in Nicaragua are concessioned, or owned and operated by the private sector, and have modest direct fiscal implication^.^^ 3.15 Key Sector Challenges. In spite o f the improvements observed over the last decade, Nicaragua still exhibits the lowest road infrastructure quality indicators inCentral America. The increased regional competitiveness that is expected to emerge with CAFTA heightens the urgency to address this infrastructure deficit. The challenge is how to close the infrastructure deficit withinthe constraints o f a limited fiscal budget. 3.16 Measures to Improve Allocative and eerational Efficiency. To meet the challenge o f closing Nicaragua's infrastructure deficit in the road sector, it i s important to prevent MTIs budget from declining below the average levels in 2001-2005. In the roads sub-sector, which presents the greatest infrastructure deficit, the volumes o f traffic are generally not large enough to render viable the private provision o f infrastructure. Closing this infrastructure gap, therefore, will continue to depend mainly on public sector provision. Before contemplating any increases inMTI's budget, however, it is necessary to reverse MTI's recent declines inbudget execution. Inaddition, the following measureswouldhelpto raisethe impact ofpublic expenditures. Greater reliance on adoquinadoprograms. Given the success o f the trunk road rehabilitation program so far, the next order o f priority i s to improve the grid o f secondary and major rural roads (the distributor network) that link to the trunk roads and serve the productive zones. The scaling up o f existing adoquinado programs represents a cost-effective alternative to asphalt or gravel paving o froads, especially for the secondary network. 0 Emphasizing road maintenance. It i s essential that the rehabilitated roads are not left to deteriorate (as in the past) and once again allowed to become bottlenecks. A comprehensive maintenance program, including guaranteed funding arrangements via F O M A V and the use o f least-cost public bid contractual approaches for works implementation, are an indispensable part o fthe strategy to increase paved road coverage. Adapting road design to local conditions. There has been a growing tendency to design roads to meet excessively high administrative standards (e.g. insisting that all collector roads must L 33. The reliance on adoquines has contributed to an increase in technical efficiency by minimizing the consumption of economic resources in its construction and maintenance. Road users also realize increased savings over the gravel-surfaced alternative. In most low traffic volume situations, gravelling has long been the preferred option for surfacing when upgrading earth roads because it is less costly than asphalt. However, Nicaragua i s ahead o f many countries in addressing the paradox o f improving low traffic volume by using the non-traditional adoquinado option, which provides an all-weather service quality similar to asphalt but has a lower life-cycle cost than gravel. 34. While anecdotal evidence suggests that operational efficiency vanes highly across these sub-sectors, the PER has not reviewedthese other sectors insufficient depth to emit an opinion. 43 be 7 meters wide) rather than adhere to less costly standards that are appropriate for the prevailing traffic volumes and likely growth rates. Clarzfiing and strengthening sub-sector institutional arrangements: While its institutional capacities have improved, MTI i s still affected by overall weaknesses in planning and programming. There i s a need to develop MTI's basic capacity to carry out road condition inventories, to fully install the Pavement Management system, to seek least cost solutions to technical and engineeringproblems associated with road and bridge maintenance, as well as to help foster the development o f the local consulting and contracting industries. Furthermore, the FOMAV needs appropriate technical assistance, particularly in contracting and procurement procedures so that it can develop the capacity eventually to manage the maintenance o f the entire core road network. For overall sustainability and efficient road management, fbrther analytical work is needed to identify the appropriate roles and responsibilities o f the key players (both at central and local level, and including INIFOM, IDRandthe municipalities) andto promote synergies while avoiding a duplication o fefforts Improving urban mobility by restructuring public transportation services and developing improved mass transit corridor management in Managua. This could be designed as part o f an integrated bus routes development andimproved traffic demand management program. Summary Review of PublicExpenditures in Water & Sanitation 3.17 Recent Sector Performance. Public investment in water and sanitation, which averaged 0.75 percent o f GDP during 2002-06, is highby regional standards. Sector outcomes have been mixed, however: while access to sanitation improved, access to water has stagnated and effective water & sanitation use has gone down; Table 4 in Annex G. Two factors are primarily responsible for the uneven impact o f sector investments. First, the identification o f sector investments has been flawed. Decisions on expenditurepriorities have been basically driven by emergency and political considerations, very rudimentary planning by ENACAL and FISE, and donor offers o f grants and concessionary loan financing. The second important factor refers to the poor performance o f the sector's main public operator. ENACAL has been a loss-making public enterprise, whose financial situation has deteriorated to the verge o f illiquidity during 2003-2006, due to a high percentage (56 percent) o f unaccounted-for water (half o f which may be due to illegal connections), low labor productivity (7.6 employees per 1000 water connections), and low collection and micro metering rates that clearly lag behind regional standards. Also, a dramatic increase inthe energy bill, combined with a tariff freeze (innominal Cordoba terms) that has been in place since 2003, has resulted in cost-coverage ratios between 0.69 and 0.86 that explain the negative operating cash flows since then. 3.18 Kev Sector Challenge: Achieving 100 percent coverage in water and 95 percent coverage in Sanitation by 2015 are two important MDGs highlighted in Nicaragua's poverty reduction strategy. They are also critical for achieving the country's health-related MDGs. The key challenge facing Nicaragua is to expand service coverage indicators without significantly expanding the sector budget. 3.19 Measures to Improve Allocative and Operational Efficiencv. To meet this sector challenge, Nicaragua needs to significantly improve the efficiency o f sector expenditures and sector management. The water and sanitation sector strategy developed by the sector policymaking agency, CONAPAS, provides a good starting point for addressing the problems 44 that currently constrain the sector, and the basis for a more systematic planning process. Important measures that would help to improve sector performance and efficiency are listed below: Planning: Designating a policy body (such as CONAPAS) with sufficient political weight and institutional capacity is an important first step for improving sector planning. As long as the sector strategy i s operational and has adequate political backing, a Sector Wide approach would be the preferredmode o f cooperation for donors. Regulation: Giving INAA full autonomy in tariff setting could improve cost-coverage ratios. Interms ofpolitical timing, the Government/ENACAL may first need to improve efficiency and service before adjusting tariffs - although there i s never a perfect time for tariff increases. Also, I N A A ' s power o f supervision needs to be strengthened by systematically linking any subsidies from the general budget to improvementsinperformance indicators, to be defined in the concession contract between ENACAL and INAA. Subsidization. The current system o f sector subsidies needs to be reviewed and possibly revised inorder to target the direct and indirect subsidies more effectively to the poor. Urban areas: Improving the service quality and efficiency o f ENACAL is one o f the most ' urgent priorities inthe sector. Important opportunities for reducing ENACAL's losses exist in the commercial area (through the reduction o f non-technical losses, and increase o f metering and collections), as well as in terms o f reducing personnel and energy cost. A greater de- concentration o f ENACAL's operations also i s an alternative that could be considered, balancing economies o f scale and proximity to clients. The Matagalpa-Jinotega experience with de-concentrated service provisionmay offer useful lessons inthis regard. Rural areas: FISE has developed considerable experience in local development and in cooperating with municipalities and communities in the sustainable operation o f water systems, which leaves it well placed to assume a leadresponsibility for the rural sub-sector, in collaboration with municipal governments (in a supportive role) and the rural water communities (CAPS), whose legal status needs to be secured so that they can manage and operate their systems more effectively. Integrated approach to sanitation: Hygienic behavior is critical for improving health outcomes, particularly inrural areas. As access to water and sanitation infrastructure expands, a hygiene education program could significantly leverage the impact o f this infrastructure in reducingwater-related diseases. Summary Review of Public Expenditures in Energy 3.20 Recent Sector Performance. Public spending on electricity infrastructure has been modest, as most new generation capacity over the last decade has been provided by the private sector. There has been commendable progress in expanding access, with Nicaragua's electrification coverage increasing from 47 percent in 2001 to 54 percent in 2005, in good measure due to the operation o f the National Electric Industry Development Fund (FODIEN). However, little progress has been made in diversifying power generation away from petroleum and distribution losses (28 percent) continue to be the highest, by far, in the region. Most importantly, there has been little new investment in electricity generation, so the power reserve 45 margin has fallen to 6 percent o f total average demand, once again resulting in system-wide blackouts and power rationing. While the recent installation o f additional generation capacity with Venezuelan assistance offers a short-run remedy to this problem, additional actions are neededto ensure a long-run solution to the sector's shortcomings. 3.21 Key Sector Challenges: As inthe case o f transport, Nicaragua lags far behind the other countries in the region in access to electricity, putting the country at a strong competitive disadvantage in the context o f CAFTA. The main challenge in the short to medium term i s to secure sufficient generation capacity to eliminate blackouts and accommodate the anticipated growth in energy demand. The longer term challenge is to expand electrification rates to levels comparable to other countries in the region. In view o f the massive infrastructure investments needed to achieve these targets, and the limited fiscal resources, meeting this challenge will require significant private sector participation. 3.22 Measures to Improve Allocative and Operational Efficiency. To meet these challenges the recent Energy Sector Policy Note prepared by the World Bank focuses attention on the need to (i) the confrontation with the private distribution company and seek a common ground defkse for improving service, with the ultimate aim o f re-establishing investor confidence and encouraging sector investments, (ii) simplify the electricity pricing structure (and abiding by it), while re-considering the existing electricity consumption subsidy, which represents the largest single fiscal cost emerging from the sector, but may not be reaching the poorest households, (iii) extend electricity service by strengthening the rural electrification fund, FODIEN, and (iv) update existing studies for hydro-electric and geothermal projects to feed into a long-term sector expansionplan, givingpriority to developingnew projects within a regional context. C. The Level of Social Sector Spending 3.23 Overall public social spending has represented a somewhat lower share o f GDP in Nicaragua than in most other countries in Latin America; Table 3.4. That difference in public spending, however, mainly reflects lower spending on social protection, especially pensions. In education and health - which are more indicative o f investments in human capital - Nicaragua spends roughly the same as other countries inthe region, both as a share o f GDP and as a share o f total public spending. The distribution o f public spending within each sub-sector, however, exhibits significant variations, both inhealth and ineducation, as discussed below. Has Nicaragua been spending enough on Education? 3.24 The aggregate social spendingmeasures in Table 3.4 only give a partial sense o f whether Nicaragua i s investing an appropriate amount in education. Since Nicaragua has a higher proportion o f school age children than the regional average, it would have to spend more than the average to provide the same amount o f education services per child. Table 3.5 and 3.6 provide adjusted measures o f the public expenditure effort that goes into primary and secondary education inLatinAmerica, taking into account the respective differences innet enrollment rates and inthe school-age populations. 46 Table 3.4: SocialSector Spendingin Central and Latin America; 1990-2003 as % of GDP As % of TotalPublicExpenditures 1990/91 1994/95 1998/99 2002/03 1990/91 1994/95 1998/99 2002/03 Total Public Social Sector Spending CostaRica 15.7 16.0 16.6 18.9 na na 63.6 64.5 El Salvador na na na 7.1 na na na 35.9 Guatemala 3.3 4.0 6.0 6.5 29.5 41.4 44.9 50.0 Honduras 7.9 7.8 7.5 13.0 36.4 32.0 31.4 51.8 Nicaragua 6.6 7.1 7.6 8.8 34.0 39.9 37.1 40.0 Panama 16.3 17.3 16.5 17.5 40.2 43.5 45.5 45.4 LACAverage 9.3 10.6 11.9 12.0 40.5 44.0 46.8 44.1 Public Spending on Education Nicaragua 2.6 2.8 3.4 4.1 13 15.8 16.7 18.5 LACAverage 2.9 3.4 3.9 4.3 13.9 15.2 15.9 16.7 Public Spending on Health Nicaragua 2.8 2.8 2.7 3.0 14.0 15.8 13.3 13.5 LACAveraKe 2.3 2.5 2.6 2.7 9.8 10.0 10.1 9.9 Source: CEPAL, Panorama Social de America Latina, 2006. 3.25 These tables indicate that Nicaragua is making a similar expenditure effort in primary education as other countries in the L A C region on average. At the secondary level, however, Nicaragua's public expenditure effort i s little more than half the regional average, suggesting an important public spending shortfall inthat area.35 3.26 In contrast to secondary level education spending, Nicaragua appears to be spending much more per student at the tertiary level than other countries inthe region. Almost one-third o f the 4.1 percent o f GDP devoted to education spending in Nicaragua is spent at the tertiary level. This translates into an estimated public expenditure o f a little more than US$l,OOO per student.36This per-student transfer represents over 100percent o fper capita GDP, or roughly 10 times the amount spent on each primary student and 8 times the amount spent per secondary student. It is also about 3 times higher in per-capita GDP terms than the amount spent per tertiary student in the rest o f Latin America, which averages 36 percent o f per capita GDP (World Bank, Edstats). L 35. These preliminary conclusions should also take into account differences inprivate sector involvement at each level. In Nicaragua, around 15 percent o f primary students and 28 percent o f secondary students are enrolled in private institutions (World Bank, EDStats). These ratios, however, are fairly close to the average ratios inthe other countries o f the regional sample. 36. This estimate ofper-student spending i s based on a sample o f universities (WAN-Managua, UCA and UNA), which account for approximately one-half o f the central government transfer to the universities; JUDENIC, "Investigacidnsobre 10s Fondos Asignados a las Universidadesdel Presupuesto General de la Republica." 47 Table 3.5: PublicSpendingon PrimaryEducationin 2005 Public Expenditure Net Primary Primary Age on Primary EnrollementRate Population Adjusted Expenditure Effort as % o f GDP p.c. ("/.I as%ofTotalPop. = 1*2*3 Index L A C = 100 (1) (2) (3) Argentina 10.9 98.8 10.8 1.2 93 Bolivia 16.4 95.2 15.5 2.4 193 Brasil 10.8 92.9 7.5 0.8 60 Chile 12.9 84.8 11.2 1.2 98 Colombia 16.7 83.2 10.8 1.5 120 Costa Rica 17.1 90.4 12.4 1.9 153 Dominican Republic 5.0 86.0 12.8 0.6 44 Ecuador 3.2 97.7 13.3 0.4 33 El Salvador 9.4 92.3 13.7 1.2 95 Guatemala 4.7 93.0 16.3 0.7 57 Jamaica 12.6 90.6 12.4 1.4 113 Mexico 16.0 97.8 13.2 2.1 165 Nicaragua 9.1 87.9 16.0 1.3 102 Panama 9.9 98.2 12.2 1.2 95 Paraguay 12.6 89.3 15.2 1.7 131 Peru 6.4 97.1 13.5 0.8 67 Trinidad & Tobago 16.0 92.2 10.9 1.6 128 Uruguay 6.5 90.4 9.8 0.6 46 L A C Average 10.9 92.1 12.6 1.3 100 Source:A. Morduchowicz& L. Duro (2007),CEPAL. Based on figures for 2005 or most recent 48 Table 3.6: PublicSpending on Secondary Educationin2005 Public Expenditure Net Secondary Secondary Age on Secondary Enrollement Rate Population Adjusted Expenditure Effort as YOof GDP p.c. (%I as%ofTotalPop. = 1*2*3 Index LAC = 100 (1) (2) (3) Argentina 14.3 79.1 10.8 1.2 134 Bolivia 13.0 73.6 14.4 1.4 151 Brasil 11.2 75.7 13.4 1.1 I24 Chile 14.3 80.8 11.5 1.3 145 Colombia 16.0 54.9 12.6 1.1 121 Costa Rica 17.2 52.7 10.7 1.o 106 DominicanRepublic 1.3 49.3 13.3 0.1 9 Ecuador 6.1 52.2 12.8 0.4 45 El Salvador 9.0 48.1 13.0 0.6 62 Guatemala 3.7 33.7 12.2 0.2 17 Jamaica 21.9 79.2 10.7 1.9 203 Mexico 17.3 63.8 12.9 1.4 156 Nicaragua 10.7 40.7 12.3 0.5 59 Panama 12.6 63.7 11.9 1.o 104 Paraguay 14.1 51.1 14.4 1.O 114 Peru 8.7 68.8 10.9 0.7 71 Trinidad & Tobago 17.2 71.9 9.2 1.1 124 Uruguay 7.2 73.2 9.6 0.5 55 LAC Average 12.0 61.8 12.0 0.9 100 Source: A. Morduchowicz & L. Duro (2007),CEPAL. Based on figures for 2005 or most recent. Has Nicaragua been spending enough on Health? 3.27 The Central American countries, except for Guatemala, display a uniform pattern in overall health spending, ranging between 7.1 and 8.1 percent o f GDP; Table 3.7. The distribution between private and public spending, however, exhibits considerably more variation. Costa Rica and Panama rely primarily on the public sector to provide health services. (These are also the two richest countries in the region, with the most comprehensive social security systems.) The other countries inthe region, including Nicaragua, exhibit a more evenly balanced distribution of health spending3' Nicaragua's total amount of per-capita spending on health L 37. The higher reliance on private health spending among the poorer countries in the region, of course, raises questions about equitable access to health care services. 49 (US$208 in2003) i s considerably lower than the regional average (US$363), but still well above the US$80 in spending that i s considered the minimum necessary to sustain an adequately working health system.38 Based on these findings, it does not appear that Nicaragua's public sector i s spending too little on public health. Table 3.7 Population, GDP, andHealthExpendituresinCentralAmerica, 2003 Totalhealth Of which, 1 Averageper Per capita Public expenditures Public Private 1 capita health Expenditureson Spending Spending ! expenditures health As percent of GDP (in International US$,2003) Costa Rica 7.3 5.8 1.5 616 486 ElSalvador 8.1 3.7 4.4 378 174 Guatemala 5.4 2.1 3.3 235 93 I IIiI Honduras 7.1 4.0 3.1 184 104 Nicaragua 7.7 3.7 4.0 208 101 Panama 7.6 5.0 2.6 555 368 Average 7.2 4.0 3.2 1/i 363 221 Source: WHO Core Indicators, 2006. Public health expenditure includes both recurrent and capital spending from government (central and local) budgets, external borrowings and grants (including donations from international agencies and nongovernmental organizations), and social (or compulsory) health insurance funds. D. The Efficiencyof Social Sector Spending Some Cross-country Evidence 3.28 A general assessment o f the efficiency o f social expenditures in Nicaragua can be obtained from recent research at the World Bank on the measurement o f efficiency in public spending across c~untries.~'This work involves the construction o f empirically-derived world production possibilities frontiers, relating the amounts o f public spending inparticular sectors to various outcome indicators in each sector. Inthis context, efficiency is measured as the distance between a country's actual combination o f public spending and sector outcomes in each sector and an efficiency frontier. This distance to the frontier can be measured, alternatively, in terms o f the amount o fpublic spendingmade ingenerating a particular output, or interms o fthe output generated for a particular level o f public spending. Inboth cases, the index measuring efficiency is constructed in a way that countries on the frontier exhibit an index o f 1.0 and less efficient countries exhibit an index that i s between0 and 1. See Annex A for details. L 38. A study by Evans et al. (2006) estimated the efficiency o f the health system o f 191 countries by comparing levels of health outcomes and health inputs (health expenditure per capita and education level). The study finds that it is difficult for systems to be efficient with annual healthper capita expenditures lower than US$80. 39. Herrera, Santiago and Gaobo Pang (2005), "Efficiency of Public Spending in Developing Countries: An Efficiency Frontier Approach", World Bank working paper, May. 50 ble 3.8: RankingofEfficiency Scoresfor Pub1 :Spending inEducationand Health Average Efficiency Scores in Education Average Efficiency Scores in Health Input-oriented Output-oriented Input-oriented Output-oriented Uruguay 0.97 Uruguay 0.97 Trin. & Tob. 0.89 Chile 0.98 DominicanRep. 0.80 Argentina 0.75 Chile 0.88 Mexico 0.96 Guatemala 0.70 Barbados 0.72 Mexico 0.79 Trin. & Tob. 0.95 El Salvador 0.66 Panama 0.70 Dominican Rep. 0.78 Panama 0.95 Chile 0.63 Chile 0.67 Guatemala 0.71 Uruguay 0.94 Peru 0.62 Mexico 0.67 Peru 0.71 Barbados 0.94 Trin. & Tob. 0.62 Trin. & Tob. 0.67 Jamaica 0.70 Jamaica 0.94 Argentina 0.61 Peru 0.66 Ecuador 0.69 Costa Rica 0.93 Brasil 0.60 Brad 0.66 Brasil 0.69 ElSalvador 0.93 Mexico 0.57 Jamaica 0.63 Honduras 0.68 Honduras 0.92 Sample median Paraguay 0.68 Argentina 0.9 1 Paraguay 0.52 Paraguay 0.61 Costa Rica 0.67 Peru 0.9 1 Colombia 0.52 Dominican Rep. 0.61 Sample median Panama 0.52 Guyana 0.61 Venezuela 0.66 Nicaragua 0.90 Nicaragua 0.52 Bolivia 0.60 El Salvador 0.66 Brasil 0.90 Guyana 0.5 1 Colombia 0.58 Nicaragua 0.65 Ecuador 0.88 Bolivia 0.50 CostaRica 0.56 Haiti 0.65 Guyana 0.87 Honduras 0.50 ElSalvador 0.55 Bolivia 0.63 Colombia 0.86 CostaRica 0.49 Honduras 0.53 Colombia 0.62 Dominican Rep. 0.85 Jamaica 0.44 Nicaragua 0.47 Guyana 0.60 Paraguay 0.84 Barbados 0.36 Guatemala 0.47 Barbados 0.58 Venezuela 0.84 Ecuador na Ecuador na Panama 0.55 Guatemala 0.81 Venezuela na Haiti na Uruguay 0.55 Bolivia 0.75 Haiti na Venezuela na Argentina 0.50 Haiti 0.57 Yource:Annex A. 3.29 Table 3.8 compares the average efficiency scores for public spending on education and health in the Latin American region, based on data from 1996-2002. It indicates that the efficiency o f public spending in Nicaragua is among the lowest in the region. Nicaragua's efficiency scores fall below the median, both for the input-oriented as well as output-oriented measures, and for education spending as well as for health spending (albeit somewhat less pronouncedinthe latter case). 3.30 These findings suggest that there is significant room for improving the efficiency o f public social spendinginNicaragua. One way to gauge the potential room for achieving greater efficiency i s by comparing Nicaragua's efficiency scores to the scores achieved by countries ranked at the 75th percentile o f the regional and world-wide distribution o f efficiency scores. Such a comparison suggests that Nicaragua could achieve fiscal savings on the order o f 13 to 21 percent in education spending, and o f around 9 percent in health spending, by adopting the practices o f countries that are operating closer to the efficiency frontier. The same analysis, using output oriented measures, suggest that Nicaragua could raise outcome indicators by around 50 percent in education and 5 percent in health by adopting those practices while maintaining overall spendingthe same. 40 L 40. See Table 3 inAnnex A. The comparisonwith countries at the 75thpercentile of the distribution of efficiency scores appearsreasonable as a benchmarkfor most developing countries. While it looks beyond a simple average, it i s not as ambitious as seeking a position on the efficiency frontier. Ifpositions on the efficiency frontier were taken 51 Summary Review of Public Expenditures in Education 3.31 Recent Evolution o f Education Expenditures. Since the late 1990s, there has been a marked upward trend in education expenditures, from 3.6 percent o f GDP in 2001 to 4.9 percent o f GDP in 2005. About two-thirds o f the total expenditure on education i s allocated to the education ministry for pre-university education, a figure that has been constant for a decade. Excluding transfers to the universities, the bulk o f education resources are devoted to primary education (77 percent), followed by secondary education (13 percent) and adult education (5 percent). Overall, per student spending i s highest at the primary level (US$ 128) followed by secondary education (US$ 48) and pre-school education (US$ 20). External resources (grants and credits) finance around 30 percent o f total education spending. Most o f these external funds have been earmarked for primary education and for centrally executed activities and programs. Overall the rate o f budget execution in the sector i s high, averaging over 90 percent for public resources and grant financing. 3.32 The total teaching force increased by approximately 5,000 positions between 2002 and 2004, or approximately 11 percent. Teacher salaries also increased over the same time frame, although the average teacher salary (2.4 times GDP per capita) remains below the target benchmark o f 3.5 times GDP per capita established under the EFA FTI indicative framework. An in-depth study is required to determine a more effective teacher compensation and deployment policy that takes into account teacher performance and promotes greater teacher accountabilitytowards results. 3.33 Kev Sector Developments. Among the most noteworthy sector developments since 2001 are the passage o f the Education Participation Law (Law 413) and approval o f the Education for All -Fast Track Initiative (EFA-FTI). The Ortega administration has embraced the EFA FTI- which disbursed US$ 7 million for 2004-2005 and i s projected to yield another US$ 10 million for 2006-2007 - but has expressed concerns with aspects o f the autonomy program, particularly with the financial transfers provided to the schools. As a result, all financial transfers to the schools were stopped for the academic year beginning in 2007, pending a final decision by the education ministry on how to proceed. Another major development under the Ortega administration has been the abolition o f school fees and voluntary contributions. Both are discussed next. 3.34 Decentralized School Management. The school autonomy program started as a pilot in 1993, with the participation o f 20 large, urban secondary schools on a volunteer basis. In 1995, the model was extended to primary schools with special adaptations inrural areas, and by 1997, a total o f 3,950 schools were participating inthe autonomy program. The autonomy program was institutionalized with the Education Participation Law passed in 2002, along with internal regulations for its implementation. By 2006, a total o f 4,997 primary schools (or 58 percent o f the total) and 501 secondary schools (or 40 percent o f the total), enrolling almost 1 million students, were operating under the Participation program. A key feature o f the autonomous program i s the decentralization o f decision making and financial resources directly to the schools using a per-capita financing formula. as benchmarks, the potential fiscal savings would increase to 48 percent ineducation and 35 percent inhealth, while potential outcome gains would increase to over 100percent ineducation, and 11percent inhealth. 52 3.35 A brief assessment o fthe autonomy model yields a series o f important findings. Positive aspects include the empowerment o f parents, students and teachers in planning and decision making and better education indicators when compared to traditional schools, especially interms o f lower repetition rates, fewer unqualified teachers and higher student test results in some subjects. Negative aspects include higher student-teacher ratios. Since 2006, the Ministry has been studying some o f the adverse effects caused with the financing formula used to determine the size o f the financial transfer to each school. Initial findings indicate that the formula, which i s anchored on enrollment, appears to have led to an over-statement o f school enrollment levels. In 2006 the Ministry revised the formula, on a transitional basis pending an in-depth assessment o f the formula and consultations on options to strengthen it. 3.36 School fees and voluntary contributions. The Ortega Administration feels that many potential students were excluded from attending school by the fees and voluntary contributions that had been previously charged. While the decision to abolish these fees is an important step forward in removing possible barriers to school enrollment or continued attendance, it i s also important to recognize that concomitant allocations must be forthcoming to offset forgone revenue, which previously served to cover important operational expenses. Similarly, it is also important to recognize that the school fees and contributions only constitutedpart o f the overall costs o f schooling. Many other important costs (e.g., related to uniforms, shoes, materials, meals) have not been reduced and have been found to have an equal if not greater incidence on enrollment and retention, particularly among the poor. 3.37 Evolution o f Sector Outcomes. While the funds channeled to education have increased since 2001, sector outcomes exhibit a mixed performance. Overall access, internal efficiency and primary drop out indicators show improvements, but secondary drop out rates, teacher quality and studentlteacher ratios inpublic school exhibit little change or deteri~ration.~~ Access. Net enrollment rates increased inall levels between 2000 and 2005: from 31.8 to 41.7 percent inpreschool education, from 84.1 to 91.9 percent inprimary education and from 36.8 to 44.3 percent insecondary education. In2005 the official age at entry inthe first grade was also reduced from 7 years to 6 years to promote an earlier entrance into the formal school system. Inrural areas, however, only 54 percent were inthe appropriate age bracket. Infact, a third o f first graders were 9 years or older. Internal EfJiciency. Progress has been steady since 2001, but slow. Repetition rates have remained high and virtually unchanged since 2001. However, the proportion o f students that complete primary education in the allotted time for the cycle (6 years), increased from 36 percent in2001 and 41 percent in2006; most notably inrural areas, where the proportion rose from 23 percent in2001 and 31percent in2006.42 41. Unfortunately, there i s no time series data available at this point to assess the evolution o f student performance. The national student assessment carried out in 2002 showed that most students in the 3rd and 6th grades achieved basic levels o f proficiency in Spanish and Mathematics, with students inprivate schools generally exhibiting a margin o f 10 to 12 percentage points above public school students. An analysis o f teacher profile factors and their impact on student performance indicated that only about half o f the teachers feel well prepared to teach concepts related to mathematics. Results from a national assessment in2006 are forthcoming. 42. Improvements in the primary completion rate are hampered by school desertion, grade repetition and the fact that many students simply fail to register for the next school year. This last phenomenon is most prominent in the transition from first to second grade. 53 0 Drop out rates. Drop out rate at the primary level remain very high, particularly inthe early grades o f the cycle, but have been declining. The average annual drop out rate in grade 1 for 2000 through 2005 was 17.5 percent compared to 20 percent 1990-2000. Since 2005 there has been a marked improvement in lowering the drop out rates in grade 2 and beyond. The immediate challenge remains in grade 1 which i s an exit point for many students. Improvements in reducing drop outs at the secondary level have been negligible or non- existent. 43 0 Teacher quality. At the primary education level, the percentage o f unqualified teachers increased slightly, from 25.8 percent44 in 2002 to 26.3 percent in 2004. At the secondary level, the increase was fairly substantial, from 37 percent to 51 percent. An in-depth study on the situation o f teacher qualification level inthe education system inNicaragua found that the highest proportion o f unqualified primary school teachers was registered in StateMunicipal, non-autonomous schools (40 percent) while autonomous schools had the lowest proportion (19 percent). At the secondary level, the proportion o f unqualified teachers i s above 50 percent, irrespective o f type o f school establishment. The proportion o f unqualified teachers remains dangerously highandwarrants immediate action. 0 Student/Teacher ratio. The number o f students per teacher exhibits a declining trend for the education system overall, falling from 33.6 students per teacher in 2002 to 31.5 in 2004. However, this decline is due entirely to the fall instudent teacher ratios at private institutions. Inpublic institutions, the student-teacher ratio has increased, reaching 36.3 inprimary and 39.7 insecondary (versus private school ratios of 24.7 and 23.1). 3.38 Measures to Raise the Impact o f EducationSpending. Nicaragua will need to continue its efforts to increase access andimprove the quality o fprimary education, particularly inrural areas and among vulnerable population groups to ensure that it achieves the MDG o f universal completion o f primary education by 2015.45 In addition, as the primary education system expands, it i s important to increase investments inother levels o f the system, most notably early childhood development, pre-school and secondary education. Since substantial additional fiscal resources are not available in the short to medium term (nor are the required expenditures to reach strategic milestones inthose levels well defined), it is necessary to rely on efficiency gains in the sector to generate the fiscal savings needed to finance additional spending in early childhood and secondary education. L 43. Findings from recent household surveys point to monetary problems as the most important constraint related to highdrop out rates for primaryschool aged children, especially students livinginextremely poor households inrural areas. For the secondary school aged population, the main constraints are financial, work activities and lack o f interest in schooling opportunities. 44. Radiografia del empirismo docente, JR Laguna, Diciembre, 2005 - Estadistica Escolar 2000-2005, MECD. 45. Of particular importance in this context is the need to eliminate the bottlenecks that inhibit the supply o f education services inthe Atlantic Coast, where the disparity inindicators i s most acute 54 3.39 Tracking Sector Expenditures. To ensure adequate resource flows to the sector, it is important to (i) monitor closely the implementation o f poverty focused programs in the context o f the Poverty Reduction Strategy, (ii) develop a medium-term cost and financing framework that incorporates the poverty-focusedprogram along with targets for additional spending in early childhood development, preschool and secondary education, (iii) identifypotential fiscal savings through intra-sector resource reallocations. One potentially large source o f fiscal savings is the transfers provided to the universities. fi This subsidy is generous,both Table3.9: Distributionof GovernmentEducation SubsidiesbyHouseholdExpenditureQuintfle(in%) relative to the transfers receivedby other Education year Quintiles (QI=poorest) students in the education system and to Level Q1 42 Q3 Q!__--______________ Q5 the transfers provided in the other Primary 1993 16 21 22 22 19 countries in the region. Since most o f 1998 23 24 23 19 10 the beneficiaries o f these transfers do Secondary 1993 4 15 27 23 32 not belong to the poorest quintiles inthe University 1993 1998 6 15 24 30 25 0 5 24 71 country (see Table 3.9), a strategy based 1998 1 2 14 21 62 on greater cost recovery efforts by the Source: World Bank, Edstats,basedon LSMS 1993 & 1998. universities, coupled with scholarship programs targeted to poor students, could prove viable and would reap significant gains across the sector. 3.40 Improving Sector Administration and Management. For the process o f decentralization to move forward more effectively, it will be important to evaluate the lessons learned from the accumulated experience with the Education Participation Law, including the autonomy program with a view to strengthening parts that may not be responding to the current context and changing conditions. It i s particularly important to review the school financing formula and strengthen monitoring and evaluation mechanisms at the school level to generate timely informationwith respect to their finances and outcomes. 3.41 Improving Access and Quality. To improve access and retention it will be crucial to develop or reinstate a demand-side program aimed at reducing the direct and indirect costs o f schooling for children and young people from extremely poor households for whom these schooling costs are a major barrier to enrollment or retention. Moreover, it will also be important to revisit successful and cost-effective early childhood programs that have been implementedas pilots over the years to target children from vulnerable families to improve their nutrition status, cognitive development and school readiness. 3.42 Improving Personnel Management. To improve the quality o f education it is imperative to develop a human resource strategy with particular emphasis on raising the profile o f the teaching profession and improving the quality o f teacher education programs. In developing such a strategy, urgent attention needs to be devoted to the transformation o f pre-service teacher education programs, the introduction o f effective in-service programs to upgrade the existing stock o f unqualified teachers within a short period of time, the design o f an efficient teaching support system to promote better teacher performance, and a reformed teacher remuneration framework that links wages to performance; see Chapter N. 55 Summary Review of Public Expenditures in Health 3.43 Recent Evolution o f Health Sector Expenditures. National public health expenditures grew by 22.5 percent in constant terms, from US$ 315 million in 2001 to US$ 386 million in 2004; Table 3.10. This represents an increase o f 12.5 percent,inper capita terms over this period, from US$63 per person in 2001 to US$72 in 2004.46 As a share o f GDP, health spending increased from 6.8 percent o f GDP in 2001 to 8 percent in 2004. Households accounted for around 41 percent o f total health spending during this period, while the Ministry o f Health accounted for 36 percent and N S S for 17 percent. While MOH's per capita spending (net o f IHSS affiliates) was US$ 28, INSS spent US$ 176 per affiliate and US$ 135 per beneficiary. INSS has muchhigherper capita expenditures (3.9 times to 5.8 times) than the M O H ~ Institution 2001 2002 2003 2004 2001 2002 2003 2004 In constant 2006 US$millions I As percent of Grand Total Public Sector 169.8 180.2 212.3 213.7 I 53.9 52.4 56.6 55.3 Central Government 115.0 129.6 155.6 149.9 I 36.5 37.7 41.5 38.8 Ministry o f Health 101.1 119.8 143.3 137.6 32.1 34.8 38.2 35.6 Other Ministries 13.9 9.8 12.3 12.3 4.4 2.9 3.3 3.2 mss* 54.8 50.6 56.6 63.9 1I 11I 17.4 14.7 15.1 16.5 Private Sector 145.1 163.6 162.7 172.5 46.1 47.6 43.4 44.7 Households 132.6 156.2 144.3 158.9 42.1 45.4 38.5 41.1 Other (incl. insurance &NGOs) 12.5 7.4 18.4 13.6 1 4.0 2.2 4.9 3.6 GRANDTOTAL 314.9 343.8 375.0 386.3 100 100 100 100 Sources: MOH, DGPD, NHA. *INSS expenditure in2001 include US$ 1.6 million spent by PES. 3.44 Composition o f Health Spending. Medical inputs and curative services comprise the lion's share o f total health expenditures (a combined share o f 84 percent in2002 and 77 percent in 2003), while the combined shares of preventive services, training and research are significantly lower at 10 percent in 2002 and 14'6 percent in 2003; 3* Table 3.11 * costs comprise the majority o f M O H recurrent Shares of Total Health S endingby Function (in %) costs, increasing their share from 57 percent in Average 2002l2003 2004 to 60 percent in 2006. In contrast, the Curative 37.4 PreventivesemiceS 7.8 share o f Non- Personnel Services declined Medical inputs 43.3 from 16 percent to 15 percent, with the share Training and Research 4.5 o f drugs decreasing the most - from 19 percent Administration 5.1 in2004 to 15percent in2006. Others 2.1 Total 100 Sources: MOH, NHA. L 46. Nicaragua keeps a good system of National Health Accounts (NHA) but the most recently published figures only extend until 2003. This section uses 2004 unpublished NHA data and other sources, updating some o f the informationup to 2006. 56 3.45 Evolution o f Key Health Outcomes. Since 2001, Nicaragua has made gradual, but steady, progress ina number o f key health indicators; Table 3.12. Infant and child mortality rates and chronic malnutrition have declined. Maternal mortality rates based on MOH data also decreased from 2001 to 2005, but these are mainly facility-based data and not from nationally representative surveys. The available data for percentage o f attended births by skilled health personnel (a proxy to measure MMR) i s from 2000 at 67 percent. As for other maternal health indicators, prenatal coverage increased slightly but more progress was made in terms o f institutional births. However, family planning coverage declined significantly. Moreover although BCG coverage increased, the coverage rates for polio, DPT, and MMR vaccinations decreased. Table 3.12: HealthOutcomesand Outputs, 2001 and 2005 Key Performance Indicators 2001 2005 Infant mortality rate (per 1,000 live births) 35a 30b Under five mortality (per 1,000 live births) 40a 37b Chronic malnutrition (children <5 years of age) 20.2a 18.1c(2004) Maternal mortality rate (per 100,000) 107.2d 86.5d Institutionalbirths ("A) 50.6 58 Prenatalcare coverage (%) 70.2 71.6 Familyplanning coverage ("A) 24.5 12.9 One year old children who receivedBCGvaccine 98 102 One year old children who receivedpolio vaccine 92.6 86.7 One year old children who receivedDPT (Diphtheria, Pertussis, and Tetanus) vaccine 92 86.2 One year old children who receivedMMR (measles, mumps,rubella) vaccine 101.6 96.3 Sources: aENDESA2001; bWDR2006, `SEVIN 2004, dMOHstatistics (INS 2004-2008 document) .Note: the 2000 MOH MMR estimate of 87.6 deaths per 100,000 is muchlower than the WHO Core indicator estimate of 230 per 100,000 3.46 The Relative Efficiency o f Health Spending. The increase inhealth spending appears to have resulted in improvements in a number o f indicators. However, some indicators such as coverage rates for family planning and immunization coverage rates declined, which may be reflecting the low spending on preventive care. Relative to other countries with similar PPP per capita health expenditures, Nicaragua appears to have a lower child stunting rate (20) than Bolivia (27), Ecuador (26), Honduras (25), and Peru(25), but higher than Venezuela (13). Also, Nicaragua has a higher under-5 mortality rate (38) than Ecuador (26) Peru (29), Honduras (32), and Venezuela (19). 3.47 Nicaragua could achieve efficiency gains in health spending through the following intra- sectoral resource reallocations: 0 Increasing the focus on and budget allocated to cost effective preventive health care and health promotion (PHHP) measures especially for poor, disadvantaged segments o f the population. The 2004 expenditure share o f preventive services o f about 7 percent i s very low-especially when compared to the regional average of 30 percent. Investment in health promotiodIEC i s also essential because 30 percent o f the population (LSMS 2005) resort to self-medication, which can pose healthrisks ifdone inappropriately. 0 Improving the mix and allocation o fpersonnel. Nicaragua has more doctors but fewer nurses compared to its level o f development (GDP per capita). Despite having a relatively high number of physicians, about 50 percent o f the physicians live and work in Managua (Dussault and Franceschini, 2003). Nicaragua deploys social workers on long-term 57 assignments based on each region's risks and needs; this strategy could be extended to health care workers (WB 2007) 3.48 To generate the fiscal savings that would permit shifting more resources toward preventive health care and promotion, as well as toward neededhuman resources such as nurses and auxiliary/PHC workers, the Government could improve operational efficiency through the following measures: 0 Revising sector wage policies. The recent legislation to equate sector salaries with those prevailing in the Region poses a major fiscal threat, considering that Nicaragua's per capita income i s the lowest in the region. At least the legislation needs to be amended so that it refers to an equalization o fwages interms o fper capita GDP, instead o f inabsolute levels. 0 TargetinP health subsidies. The intentto establish free health services for all is laudable, but not affordable from a fiscal viewpoint. To render it fiscally viable, it is necessary to target this subsidyto the poor and neediest segments o f the population, with the idea o f eventually establishing a fixed fee scheme with well specified exemptions. 0 Reducing the over-consumption o f health services. INSS seems to over-consume services, such as drugs with no epidemiologicaljustification4' . This presents a need to regulate, audit, and implement quality controls in the prescription o f pharmaceuticals in the Empresas Medicas Previsionales (EMPS). A strong primary health care and preventive policy is also needed because IHSS benefits currently exclude preventive exams. The Government could establish different capitation payments that account for cost and risk by age and gender, and that include cost- and overuse- containment strategies. 0 Improving drug procurement. A study found that the average price o f a list o f 35 generic medicines in Nicaragua was 10 times higher than the price paid by an IDB project in Argentina (Meerhoff, 2004a). Also, while the public drug and medical supply agency (CIPS) provides subsidizedfree drugs, only 45 percent o f the population has access to these drugs, and the rest face very high prices for non-generic drugs. The Government could consider establishing a drug-purchasing and distributing agency or look into the Ecuador experience where the MOHnegotiates the prices with its providers, while the local health centers decide the amount and kind o f medicines they need, and buy directly from the provider o f their choice, based on previously agreedprices between the providers and the MOH. Summary Review of Public Expenditures on Social Protection 3.49 Unlike education or health, social protection is generally not defined as its own sector, but rather as a sub-sector or "strategy" within the various traditional sectors making up an economy. Since it cuts across sectors and is integrated into a wide variety o f types o f programs and projects, it i s often difficult to identify how much o f the budget is specific to social protection. Social protection programs and activities are typically undertaken by a myriad o f actors, often within their regular operations, which are not included in the sector expenditure totals reported here. For instance, the Ministry o f Education might have a program o f L 47. Consumption o f medication ranges from 9.8 drugs per year per beneficiary for 12 small EMPs (average size o f 2,212 members), to 24.3 drugs per year per beneficiary for the two largest EMPs (average size o f 34,154 members). Consumptionby region also varies significantly. 58 scholarships for poor, high-achieving students, which could be considered a social protection program. Similarly, many municipalities runprograms that are not covered inthis analysis. 3.50 Evolution of Public Spending in Social Protection. Table 3.13 presents the budget executed by the core social protection programs since 1991. The main institutions in this sub- sector are the Ministry o f the Family (MIFAM) and the Social Emergency Investment Fund (FISE), as well as the now-defunct Social Action Secretariat (SAS) and Social Emergency Fund (FES) managed under the Presidency during the 1990s. The National Social Security Institute (INSS), a co-financier o f health and pension benefits for its affiliates, occupied a large share o f the sub-sector budget in the early 1 9 9 0 but much o f its current financing takes place outside o f ~ ~ the central government budget.48 Table 3.13: Main Social ProtectionPrograms in the Budget (executed budget; % o f GDP) 1991 1995 2000 2001 2002 2003 2004 2005 Presidency (SAS and FES) 0.00% 0.60% 0.27% n/a 0.04% 0.03% 0.03% 0.04% Ministry o f Labor (w/o INATEC) 0.15% 0.05% 0.09% 0.05% 0.05% 0.05% 0.04% 0.03% Ministry o f the Family 0.00% 0.00% 0.42% 0.22% 0.22% 0.49% 0.58% 0.30% Social Emergency Invest. Fund(FISE) 0.00% 0.09% 0.13% 0.12% 0.46% 0.95% 1.18% 0.62% National Social Security Institute (INSS) 0.38% 0.04% 0.01% 0.00% 0.00% 0.00% 0.00% 0.00% TOTAL 0.54% 0.79% 0.91% 0.38% 0.77% 1.52% 1.84% 0.98% 3.51 The sub-sector's share o f the budget is low, typically fluctuating around 1 percent o f GDP. Expenditures on social protection programs exhibit a rather erratic pattern - with large fluctuations in the total amounts devoted to the various programs and institutions, and large fluctuations inthe share o f specific programs and institutions inthe total. Even fi-om one year to the next, changes can be dramatic - for instance, the sector experienced a reduction by almost 50 percent between 2004 and 2005. These fluctuations are partly linked to emergency relief operations, but, more generally, reflect a lack o f planning and budgeting capacity for social protection programs. Similarly, the actual execution o f programs can depart significantly from the planned budgets, especially in the case o f FISE. Although the variability seems to have decreased over the years, differences still persist with, for instance, FISE executing 1.65 times its planned expenditurein2004. 3.52 One o f the challenges o f social protection is that it typically requires counter-cyclical funding - larger resources are neededin times o f lower economic growth and/or disasters. At the same time, however, social protection programs typically involve lower fixed costs (e.g. salaries) than other ministries (e.g. health or education) and hence face less resistance to budget cuts. This last aspect makes the sector a primecandidate for large cuts or shifts intimes of fiscal consolidation. It is also a sector where governments typically attempt to develop flagship programs that are strongly identified with a particular administration and hence have lower chances o fbeingcontinued after political transitions. L 48Since 1994, the Nicaraguan Social Security Institute (INSS) has had a surplus and has not been a burden on the budget. This might be related to the efforts inincreasing the number o f insured workers - from 200,000 in 1993 to 430,000 in2006. However, the current system has a significant actuarial deficit (estimated at C$ 271,573 millions). As a result, the Government is studying alternative options for reform. The initial reform proposal presented by the HighCommission for the Reform o f the Pension system (which adjusted the contribution rate, the age o f pension, and the indexation o f benefits) still involves a deficit starting in2040 and reaching up to 6 percent o f GDP by 2065. The Inter-institutional Technical Commission is currently studying alternative scenarios 59 3.53 The notably erratic execution o f many programs in the social protection area is partly linked to a high dependency on external sources o f funding for these programs. For instance, in the case o f the Ministry o f the Family, the share o f external financing in total capital expenditures averaged 88 percent in2003-2004. Eventhough this share was programmedto fall to 75 percent in 2007, it still signals a high dependency on external funding that renders sub- sector spending vulnerable to program disruptions and to highstaff turnover, both o f which limit their effectiveness and sustainability. 3.54 Evolution of Key Sector Outcome Indicators. Progress in poverty reduction has been disappointing. In spite o f steady, though modest, declines in poverty rates during the 1990s, poverty remains highand social indicators weak inNicaragua (headcount o f 46.2 percent for the poor and 14.9 percent for the extremely poor in2005). Nicaragua has experienced a reduction in inequality (Gini from 50.4 in 1993 to 41.0 in 2005) over the past decade, associated with a reduction in the depth o f poverty. However, the number o f poor has not declined. Poverty and vulnerability also are reflected in poor nutrition outcomes, where the pace o f improvement slowed down and 21.5 percent o f children under 5 are chronically malnourished in2005. 3.55 Poverty i s particularly acute in rural areas and the Atlantic coast region. In addition, the poor in Nicaragua exhibit a relatively high vulnerability linked to the frequency o f covariate shocks, including natural disasters, commodity price shocks and household-level shocks, in particular health and labor-related shocks. 3.56 Assessment of Efficiency The disappointing human development results described earlier occurred in spite o f a growing GDP per capita and substantial public spendingon poverty reduction programs broadly defined. This suggests that much o f this spending has been inefficient. One o f the most critical issues noted in the area o f social protection is the low level o f allocational efficiency, partly linked to the fragmentation o f programs across and within sectors, the duplication o f efforts, and the overlap o f programs. MINSA and the Ministryo f the Family, for example, both manage early childhood development and nutrition programs that are similar in nature and use the same protocols, but are not coordinated. Overlaps and lack of coordination are also common within institutions and agencies. For instance, the operations o f the Red de Proteccidn Social and o f PAININ, both in the Ministry o f the Family, were not coordinated and ledto duplication inspecific areas o f implementation. 3.57 Another critical issue is the poor quality o f services and outcomes. Most programs are o f a "pilot" nature, covering very small groups in the country. This raises two issues in terms o f effectiveness o f public expenditure - the targeting o f these programs could often be improved with larger-scale interventions, and the resulting services provided to different communities vary largely across the country, limitingthe horizontal equity o f the programs. Eventhough individual social protectionprograms are generally well targeted, their fragmentation resulted inoverall low coverage. The social protection services also suffer limitations in terms o f quality, partly due to erratic financing and uncertainty surrounding their continuity (which prevents the establishment o f strong, effective structures with a skilled and stable workforce). Inaddition, the efficiency o f social protection programs depends by nature on complementary investments in health, education, and other sectors, such as rural development, water, or credit. 3.58 The other critical issue for social protection programs in Nicaragua is their limited operational efficiency. This i s attributable to fluctuations in financing, variability in the costbenefits o f different programs and large overhead costs o f central activities, partly as a result 60 o fprogram fragmentation (Some efforts have beenmade to reduce these costs, particularly inthe Ministry of the Family, which has reorganized to centralize some of the financial management and procurement activities for all its programs (GON, 2006)), introduce sector-wide monitoring and evaluation mechanisms, and address human resource bottlenecks. 3.59 Greater planning and coordination o f social protection programs, and o f social programs ingeneral, are key ingredients for raising their impacts. Key actions that could help to improve program coordination and effectiveness are presented below: Proa-am Consolidation. Program consolidation could start with a few programs, and gradually integrate projects and programs in a coherent way, avoiding overlaps between agencies and filling gaps, while eliminating interventions with little demonstrated impact. The social cabinet can play a key role inthis effort. Strengthened analvtical foundations. Develop a sector map that includes an inventory o f existing programs and services provided in the country (public, private, civil society) and identifies gaps in the supply o f services. An analysis o f targeting mechanisms, and o f the strengths and weaknesses o f selected programs, would also be useful. Strategic Planning and Monitoring. Strengthened strategic planning mechanisms and M&E systems are needed to improve coordination and program designs, and would contribute toward the development o f a sector-wide approach. Unified and integrated mechanisms would provide a better basis for programmatic support by international partners, which, in turn, couldhelp to reduce fragmentation andduplicationofprograms. Regional Coordination. Stronger mechanisms are needed to centrally coordinate the allocation o f programs across geographic zones. This would result in improved targeting o f resources, and greater synergies between programs. Local Coordination. There exist opportunities to consolidate earlier efforts to foster local coordination of projects. This could include developing mechanisms to harmonize eligibility criteria for households/individuals, mechanisms to propose a unique window for social services, and mechanisms to provide accompaniment to families and individuals in accessing services. E. SummaryandConclusions 3.60 The previous chapter had concluded that the overall size o fpublic spending inNicaragua does not stand out as particularly large or small in regional and worldwide comparisons with countries at similar levels o f development. This chapter found that Nicaragua's total public spending in key areas that are closely linked to growth and social development - namely public infrastructure investment, education and health - also does not appear to be significantly out o f line from the averages spent by other countries across the region. Nevertheless, Nicaragua's performance falls short in terms o f certain important outcomes, such as per capita GDP growth, the quality o f public infrastructure, and various education and health indicators. This suggests that while the total volume o f public spending in Nicaragua may be adequate, the intra-sector composition and quality o f public spending exhibit deficiencies that manifest themselves in a low efficiency o fpublic spending. 3.61 The preceding review identified various opportunities for improving the quality and efficiency o f public expenditures in key sectors. These opportunities, which are summarized 61 below, mainly involve intra-sector resource shifts, rather than the development o f new programs that require new sources o f financing. InTransport, important efficiency gains could be had by (i) shifting a higher share o f sector resources toward road maintenance, preferably through FOMAV, using least-cost public bid contractual approaches, (ii)scaling up existing adopinado programs in the expansion o f secondary roads, as a more cost-effective alternative to asphalt or gravel roads, (iii) adapting road designs to less costly standards appropriate to local conditions, and (iv) strengthening the institutional capacities o f MTI inthe areas o f planning and programming, and o f F O M A V in the areas o f contracting and procurement procedures. InWater & Sanitation, important efficiency gains could be had by simultaneously allowing tariffs to adjust to cost recovery levels and improving the operating efficiency o f the water utility, while protectingthe poor from prices shocks insector services. This may be achieved by (i) introducing a loss-reduction program in ENACAL, including through a greater de- concentration o f operations, (ii) grantinggreater autonomy to INAA insetting tariffs based on long-run marginal costs, and (iii) revising the existing system o f subsidies to target them to the poor. Also, the introduction o f a hygiene education program in rural areas could significantly raise the impact o f sector infrastructure inreducingwater-related diseases. InEnergy, it is necessary to step up the level of total sector investment. This is best done, however, by creating a more stable policy environment for private investors, especially by (i) dehsing the current confrontation with the private distribution company and seeking a common ground for improving service, and (ii) simplifying the electricity pricing structure (while re-considering the existing electricity consumptions subsidy with a view to targeting it more effectively to the poor). Since energy projects have long gestation periods, it will also be important to update existing studies for hydro-electric and geothermal projects (which are more efficient than the thermal plants that currently dominate electricity generation in Nicaragua) to feed into a long-term sector expansion plan, givingpriority to the development o fnew projects within a regional context. In Education, sector outcomes could be significantly improved by (i)shifting a higher proportion o f sector resources toward early childhood development, pre-primary education and secondary education, (ii) introducing greater cost recovery at the university level, coupled with an expanded scholarship program exclusively targeted to poor students, (iii) improving the school autonomy program by revising its financing formula and strengthening monitoring and evaluation mechanisms, (iv) developing demand-side programs to reduce the direct and indirect costs that have proven to be barriers o f access to schooling for poor families, and (v) improving the quality o f education through better human resource management. InHealth, major efficiency gains could be had by (i) increasing the proportion o f the sector budget devoted to preventive health care and health promotion, from the current share o f 7 percent to the regional average o f 30 percent (with INSS adopting a strong preventive health policy, since its current benefits do not include preventive exams), and (ii) improving the skills mix and allocation o f personnel, toward a higher proportion o f nurses and greater concentration inrural areas, away from Managua. Significant fiscal savings to finance greater spending on preventive health care and health promotion activities could be had by (i) revising the overly generous sector wage policy, (ii) reducing the over-consumption o f health services, particularly in INSS, through the implementation o f regulation, audit and quality 62 controls in the prescription o f pharmaceuticals and other health services, as well as by adopting different capitation payments for INSS that account for gender and age-related costs and risks, (iii) implementing a system o f targeted health subsidies, as an alternative to offering free health services for all, and (iv) introducing more efficient drugprocurement procedures. 63 64 CHAPTERIV PUBLIC SECTOREMPLOYMENT AND REMUNERATIONPOLICY 4.1 The public sector budget payroll has been increasing as a share o f GDP since the mid- 1990s, posing a potential threat to macroeconomic stability. That threat became more acute in mid-2006, amidst growing pressures from public sector unions. Meanwhile, the absence o f adequate framework legislation on public sector remuneration has undermined the authorities' capacity to ensure that the process o f public wage determination takes place in an orderly, transparent and efficient manner. Nicaragua's legislation on public sector employment i s fairly recent and only partially implemented. As a result, staffing and remuneration decisions leave ample room for discretion, the public wage structure exhibits a large, unsystematic dispersion that i s not reflective o f labor market conditions, and employment instability is more the rule than the exception, all o f which lead to disruption and inefficiency in government services. In key areas, these weaknesses are compensated by the extensive use o f long-term consultants occupying civil service positions. Often these consultants are paid directly by foreign donors, and their compensation can be quite high compared to domestically-financed employees, further eroding staffmorale and conspiring against institution-building efforts. 4.2 A lack o f systematic data collection on public employment and remuneration has contributed to discretionary decision-making, raising an additional obstacle to rational policy formulation. The three principal official sources o f data - the Directorate o f Public Employment (DGFP), the Directorate ofthe Budget (DGP) andthe National Social Security Institute (INSS) - have differing coverage and different data for the same public institutions for any given year.49 The budget payroll includes only about 40 percent o f public sector employees. Further, remunerationis hidden innumerous budget categories so that, depending on the definition used, the level canbe up to 40 percent higher thanthe budget line corresponding to salaries alone. 4.3 This chapter seeks to develop a better understanding o f the overall size and composition o f public employment, and on the structure o f remuneration, pointing out important shortcomings and their implications for the fiscal budget and public sector management. It discusses recent reforms to restructure and professionalize the civil service in Nicaragua and concludes by outlining the elements o f an efficient, transparent and equitable remuneration policy framework that could help to ensure a more orderly public wage determination process and reduce the threat o f fiscal indiscipline. L 49. The data used in this report corresponds to the years up to 2006 and does not include the recent changes to government structure introduced by the Government of President Ortega in early 2007. The data are mostly taken from the data base of the National Directorate o f Public Function and the computerized SIGFA systemand cited in Nogales (2006). The data differs from that cited IMF, 2006, which was taken from INSS records. 65 A. The Legal Framework 4.4 The legal framework governing public employment and remuneration in Nicaragua is givenbythe following pieces o f legislation: e Labor Code (Codigo del Trabajo) - Law No. 185 o f October 30, 1996. e Civil Service Law (Ley del Servicio Civil y Carrera Administrativa) Law No. 476 o f December 11,2003 e Civil Service Regulations (Reglamento de la Ley del Servicio Civil) - Decree No. 87- 2004 o fAugust 6,2004 e Law o fAcquired Rights (Ley de Derechos Laborales Adquiridos) - Law No. 516 o f January 17,2005. e Law on HiringProfessional and Technical Services (Ley que Regula la Contratacion de Servicios Profesionales y tecnicos Nicaraguenses) - Law No. 505 o f January 26,2005. e Law on Leveling Salaries o f Doctors (Ley de Equiparacion de Salarios a Nivel Centroamericano de 10s Medicos y Odontologos que laboranpara el sector Publico de Nicaragua) - Law No. 608 o f February7,2007 4.5 The Labor Code i s the principal legislation governing labor relations inNicaragua and i s applicable to public sector employees. Some o f the precepts o f this Code would be highly desirable ifindeedthey were followed, such as those that guarantee employment stability subject to performance and equal promotion opportunities, as well as those mandating equal salary for equal work, without discrimination on grounds o fpolitical or religious affiliation, gender, race or other human characteristics (see section C). Some o f its other precepts, however, threaten to raise fiscal costs, most notably those relatedto social benefits. 4.6 The Civil Service Law is the principal piece o f legislation governing the relations o f the State as an employer and public employees. It is the newest legislation o f its kindin the region5' and, although its regulations were approved only a year after the Law was passed, its implementation only started in 2006 and is incipient (section B). The potential fiscal cost o f full implementation o f the Law has been raised as a reason for its slow implementation. However, legally there i s no direct fiscal cost o f implementing the Law. 4.7 The Law o f Acquired Rights has potentially important fiscal consequences. Although the law did not initially aim to cover consultants, it has been interpreted to apply to consultant contracts as well interms o f extending the social benefits afforded by the Labor Code and other legislation to short-term consultants. Legal recourse to this law has been taken by several consultants whose contracts expired, and all rulings have been in favor o f the consultants. This i s so even though Article 6 o f Law 505 - which was published afterwards - explicitly indicates that consultant contracts do not generate a legal labor relationship. To achieve clarity in this matter, it would be useful to have an estimate o f the potential fiscal cost o f this Law and a legal opinion from the Attorney General about the Law's applicability to consultant contracts financed with domestic or foreign resources. L 50. The oldest i s El Salvador's, which dates back to 1961 and the second most recent is Panama's, which dates back to 1994 (see Iacoviello, 2006). 66 4.8 Law 505 i s applicable to consultant contracts financed with foreign aid. It establishes that Nicaraguan nationals are to be given preference over foreigners at the same level o f qualification. This law i s little known and scarcely implemented. 4.9 The Law mandating a leveling o f the salaries o f public sector doctors to the Central American average emerged fiom a six-month doctors' strike in early 2006. It establishes that all public sector doctors and dentists must have their salaries raised to the Central American average level over five years. The fiscal cost o f implementing this law has been estimated at C$550 million (about US$ 30 million) per year. Furthermore, its implementation would send a very negative message to the rest o f the public sector, which could also demand a similar treatment. 4.10 Finally, early inits government mandate, the Administration o f Daniel Ortega has passed a new law to cap the salaries o f the highest-ranking government officials. This law i s based on a similar law that was passedin2005, but later declared unconstitutional by the Supreme Court on the grounds that the law only applied to a subset o f Nicaraguan citizens rather than to everybody in Nicaragua." Given that the appeal to the Supreme Court was brought by employees o f autonomous agencies, the new law limits its coverage to the central government and decentralized agencies. The law limits the salary o f the President o f the Republic to US$ 3,200 permonth andestablishes that nopublic sector employee covered bythe Law can earn more than this limit. Its implementation would represent savings o f around C$ 11 million (about US$ 600,000) per year to the Nicaraguan treasury. While in principle the measure is desirable from the viewpoint o f reducing the dispersion o f wages (see section C), it would have been advisable to include it as part o f more general legislation on public sector wage policies; which i s currently lacking. B. PublicSector Employment Size, Growth and Compositionof Public Sector Employment 4.11 The public sector in Nicaragua i s not a particularly large employer. In 2005, the Nicaraguan public sector employed around 126,000 people, which represented less than 2.5 of the total population, 5.7 percent o f the economically active population and 16.6 percent o f total formal sector employment; Figure4.1. Central government employment, in turn, represents 1.9 percent o f the total population inNicaragua, which is below the L A C average o f 2.5 percent. 4.12 The current number o f public sector employees is about the same as it was in 1991, following the huge contraction o f the public sector that took place at that time; Figure4.2. Since the early 2000's, however, the number o f public sector employees has grown steadily by 2.4 percent per year, which is faster than the general population growth o f 1.7 percent. L 51. The approval o f this Law (No. 505) was part o f the political breakdown between the Executive and the Legislative in 2005. The National Assembly passed it, but the presidency refused to send it for publication, so its publication was ordered by the President of the National Assembly, a legal but highly unusual procedure. Its declaration of unconstitutionality had probably more to do with the political pact that broke the deadlock than the actual motivation stated inthe Supreme Court sentence. 67 Figure 4.1 Nicaragua's EconomicallyActive and InactivePopulation Public Sector (126,376) Formal (762,658) Private Sector Economically Active Population Sub -Employed Population (2,203,394) (661,790) (5,142,098) Informal Inactive (1,318,242) Unemployed Population (1 22,466) Others Source: INEC, 2005 TOTAL EUPLWOS PUBLICOS I I ..I" 1.11 1988 1990 1992 1994 19% 1898 MW 2002 m4 MOB MOB Source: Nogales, 2006. 4.13 Public employment growth has been largest inthe decentralized institutions (4.6 percent) and local governments (10.5 percent).52 This means that monitoring the decentralized institutions, especially universities, and local governments i s becoming increasingly important for understanding the fiscal pressures associated with public employment growth. It also focuses attention on the need to develop a centralized data base on the number o f employees and their remuneration. The rapid growth in employment at the local governnient level, moreover, draws attention to the process o f decentralization, and especially on the need to devolve expenditure responsibilities -including employment - from the center to local government, to avoid overlaps and an excessive fiscal burden. 4.14 O f the total number o f public sector employees in 2006, about 77 percent work in the central g~vernment.~~f that amount, 95 percent work in five sectors: education (which O accounts for 44.4 percent), health (24 percent), defense (12.2 percent), police (11.3 percent) and L 52. It has also been relatively large at public financial institutions, but this i s mostly due to hiring of survey personnel at the Central Bank and these institutions have a relatively low weight in the total, so this is less o f a concern. 53. These include the legislative, judicial and electoral powers, the Comptrollers Office, the Attorney General's Office and 12 ministries. 68 justice (3.3 percent); Statistical Annex Table B.I. These five institutions also comprise 87.5 percent of the central government wage bill. This means that (i) by and large, the Nicaraguan government deploys its human and financial resources in core government services, rather than inactivities that compete with the private sector, and that (ii) concerns about fiscal pressure any arising from the growth in the public sector wage bill will need to pay special attention to the education and health sectors, which together account for more than two-thirds o f central government employment. Table 4.1 NICARAGUA: PUBLICSECTOREMPLOYEES TOTAL PUBLICSECTOR 110,104 111,649 108,904 110,285 117,013 119,356 126,376 2.3% CWRAL GOVWNMW 91,158 91,749 88,114 88,177 93,584 93,622 96,854 1.0% STATEFOWEFS 3,584 3,976 4,060 4,473 4,683 69% MWlSTRlES 84.530 83.815 89.153 88.838 91.821 2.1% DECBCTRALQEDINSTKUTIONS 9,409 9,853 10,148 10,619 11,116 12,103 12,294 4.6% olw UNNEFSITIES 3,993 4,053 4,551 6.8% R83LICFlNANClAL I N S T ~ l O N S 859 979 986 1,021 970 988 1,468 9.3% MUNICIPALANDLOCAL GOVWNMWS 8,678 9,068 9,656 10,468 11,343 12,643 15,760 10.5% Gender Equity 4.15 There are no official records o f gender decomposition o f public sector employment and the only survey information i s fairly outdated. A study commissioned by the Vice-presidency and the MHCP in 2003 covering 12 public sector institutions and covering 24,260 positions, found that two-thirds o f employees were women.54This proportion varied according to the level o f the positions. Women accounted for 49 percent at the highest level ("sewicio directivo "), 74 percent at the middle level ("sewicio ejecutivo"), and 64 percent at the lowest level ("sewicio opevativo"). Based on the 2001 household survey, the Economic Commission for LatinAmerica (ECLAC) calculates that 9.8 percent o f all male wage-earners inurban areas work in the public sector, which i s lower than the overall share of urban wage-earners working in the public sector (11.9 percent). Conversely, the equivalent percentage for females is 14.7 percent. This would point towards a bias in favor o f females inpublic sector employment. Human Resources Management Policies 4.16 Policy attention to human resources management is weak and needs to be strengthened. The most important piece o f legislation on the subject - the Civil Service Law - is very new and its implementation has been slow. Although the Law is applicable to the entire public sector (with few exceptions), and covers the large majority o f public sector employee^,^^ its main operational implication so far has been the incorporation o f employees into the administrative career. The Law i s potentially applicable to 45 public sector institutions, but those that have their L 54. Lopez Hislop, Javier ,2003. 55. Exempt from the Law are employees o f public enterprises, public universities, armed forces personnel and high authorities, which include: officials elected dlrectly or indirectly, and officials legally named either by Congress' ruling directive, by the President, by the Supreme Court or by the Supreme Electoral Council. 69 own career streams approved by law (interior, defense, foreign service and education) are exempt from the Law's provisions regardingthe administrative career. Potentially around 59,000 public sector employees,56or about 47 percent o f the total 126,000 public sector employees are subject to incorporation into the administrative career. The process o f incorporation requires the description o fjob positions ineach public institution, including a categorization into one o f three groups (operational, executive, director), and the definition o f requisites to occupy each post. Once this process i s completed, each public employee occupying a position i s checked against the requisites and, if he/she fulfills them, is "accredited" to occupy the p~sition.~'Newly hired employees must fulfill the requisites for each post. As o f end 2006, only 4,307 employees had been incorporated to the administrative career. The incorporation process has been limited mostly to non-professional positions. This further weakens the possibility o f attaining the objectives o f the Civil Service Law, which i s to guarantee a core cadre o f public servants with adequate professional qualifications that i s competitively paid and remains stable across political transitions. 4.17 One reason for the slow implementation of the Law has been the concerns about its fiscal cost. However, the implementation o f the Civil Service Law per se has no perceptible fiscal cost. A common misperception is to confuse the implementation o f the Civil Service Law with the application o f the Reference Salary Table (RST, see section C), which i s not even mentioned inthe Law or its regulations. Because public sector employees are subject to the provisions of the Labor Code and because the Code establishes that workers' salaries cannot be reduced, the implementation o f the reference table only permits upwards adjustments. However, the fiscal cost o f applying the RST as it currently stands has not been calculated, so the magnitude o f the potential fiscal impact is unknown. The second source o f concern is that many professional positions are occupied by consultants (see section E), whose remunerations are above the Reference Salary Table. The fiscal cost o f incorporating these consultants into the administrative career path and adjusting their salaries to the RST (as suggested by article 119 o f Law 476), has not been calculated either. 4.18 Inspite of these concerns, there is much room for implementing the basic principles of the Civil Service Law more aggressively, but some amendments are also needed. To begin, the Law contains many desirable provisions that are not related to salaries and hence have no fiscal implications. This could be achieved by differentiating the duties and obligations o f belonging to an administrative career and those o f being a civil servant. Currently the only distinction in the law between the two i s that civil servants include temporary workers (less than 12 months), project personnel and "trusted" collaborators o f the current government. The Law makes no distinction between the guarantee to job stability afforded to civil servants and to administrative career personnel.58This i s a major drawback o f the Law, which needs to be modified in order to L 56. This is taken from Statistical Annex Table B.l, by subtracting from the total number o f public sector employees, those that work in the four sectors that have their own administrative careers, except administrative employment in those sectors, and university employees. The actual number would be lower, since elected officials should also be subtracted, but this information is not available.. 57. There are 3 ways to be "accredited": i)direct, when the person fulfills all requirements for the position, ii)by equivalency, when the person can compensate an inferior academic level with more years o fjob experience, and iii) by labor experience, applicable only to operational and executive posts, and when the person compensates lack o f academic background with at least 10years' experience in similar posts. 58. According to article 37 of the Law, the only difference in rights o f civil servants and o f administrative career personnel is that the later are entitled to training opportunities and canparticipate inpromotionprocesses. 70 provide appropriate motivations to public servants. Only those employees that have been accredited or recruited into a position according to Law 476 and its regulations, and hence fblfill the position's requirements, should have guaranteedjob stability and training opportunities. This could go a long way towards avoiding discretionary and politically-motivated human resource decisions, with no fiscal implication whatsoever. 4.19 There i s also a large loophole in the law, as Article 77 exempts those sectors that have their own career laws from the administrative career path. Since the procedures for competitive hiringfollowing a definition o f duties and requirements for each post are applicable only to the administrative career, the most important results aimed for by the law -namely the professionalization o f public employment and the shielding o f civil servants from the political process - are lost. Infact, an easy way to escape the discipline intended by the law i s to have a sector-specific career, as the health sector and the association o f municipalities are trying to do. While it seems reasonable for each sector to have a different employment structure and corresponding salary scale adapted to sector-specific tasks, the provisions o f the Civil Service Law regarding the principles for hiring and promoting personnel should be applicable to all public sector employees. C. PublicSector Remuneration Size and evolution ofpublic sector wage bill 4.20 According to the IMF Government Finance Statistics, total employment compensation during 2002-04 averaged around 30 percent o f total public expenditures inNicaragua, which is about the same as the L A C average o f 29.6 percent. This overall wage bill represents 6.1 percent o f GDP in Nicaragua, versus an average o f 6.6 percent in the rest o f LAC. 59 However, the accuracy and comparability o f these figures are questionable. One reason is that the coverage o f the budget payroll is incomplete: o f the 126,000 persons working in the public sector in 2005, only 51,500 (or about 40 percent) are included in the budget payroll. The budget payroll excludes non-centralgovernment institutions (see paragraph 4.14), and also excludes about 9,091 members o f the armed forces, about 32,970 teachers working in autonomous schools, 8,000 policemen and the diplomatic corps. Employment compensation in decentralized institutions, local governments and public financial institutions i s captured within the budget line corresponding to "transfers." IMF Staff have calculated that Nicaragua's overall public sector wage bill could be as high as 7 percent o f GDP when all these items are taken into consideration.60 4.21 The growth o f the wage and non-wage bill i s an issue o f concern for several reasons. As shown in Table 4.2, the wage bill has been increasing as a share o f GDP in recent years. This upward trend has been compounded by recent union activity pressuring for wage increases, especially in the two largest sectors - education and health. A strike by the health workers crippled the health system at the beginning o f 2006, resulting in an unbudgeted increase in medical staff salaries. Later in the year, the National Assembly passed an Education Law that - L 59. The LAC average is based on a sample o f 17 countries, using figures from the IMF, Government Finance Statistics on "compensation o f employees as % o f expense" as reported inthe World Bank, WDI database, 2006. 60. IMF(2006), "Staff Report for the Eleventh Review Underthe PRGF Program". 71 untilit was amended -hadthreatened to raise total spendingteacher salaries inan unsustainable manner. Early in 2007 a law on salaries o f public sector health professionals was approved, mandating that salaries o f these staff be equated to the Central American average within five years. The fiscal cost o f this law has been estimated bythe Ministry o f Finance and Public Credit (MHCP) to be around US$ 30 million (C$ 550 million). Further, this law sets a precedent for similar demands from other sectors and poses a clear threat to fiscal stability. The largest source o f employment growth has been the decentralized institutions and local governments, which are applying hrther pressure on the budget and may bemore difficult to bringunder control. Table 4.2: The CentralGovernmentWage Bill 2002 2003 2004 2005 2006 WAGE BILL(C$ millions, current) 2,510 2,697 3,177 3,907 4,583 GDP (C$ millions, current) 57,376 61,959 71,661 82,162 94,318 Wage as '30of GDP 4.4% 4.4% 4.4% 4.8% 4.9% Total EXPENDITURES 12,967 14,003 16,195 18,979 23,108 Wage as % of total expenditures 19.4% 19.3% 19.6% 20.6% 19.8% Source: Wage bill (Statistical Annex Tables based on data from DGFP); GDP and Expenditures (IMF, 2006Article IVConsultation report, basedon data fromMHCP andBCN) Table 4.3 Salary Distributioninthe Public Sector No. of workers Wage Bill Average Wage YOof workers YOof wage bill (C$per month) (C$per month) 98,548 305,775,820 3,103 99.35% 88.19% 695 40,942,133 58,910 0.065% 11.81% Total 346,697,953 100% 100% Source: Table 4.3 cited inReine (2006). 4.22 There is a large disparity in the distribution o f the overall salary bill across employment categories. In 2003, a minuscule proportion o f central government employees (0.065 percent) captured 11.81 percent o fthe total wage bill; Table 4.3. 4.23 Another source o f concern is the extensive reliance on non-wage compensation, which generates serious inequities and additional fiscal pressures. For example, the wage andnon-wage bills inthe 2006 central government budget add up to a total o f C$ 6,052 million,61or 6.4 percent o f GDP. In some cases, such as the health sector, the total remuneration bill can be up to 260 percent higher than the salary bill. These non-salary benefits are mostly the result o f political bargaining by labor unions, resulting in collective agreements that provide various types o f compensation, like bonuses, meals, eye glasses, more overtime, and larger trip allowances. While these non-wage benefits may reduce the dispersion o f total compensation within a public institution, they increase inequities between institutions and create perverse incentives both to individuals and to transparent humanresources management. 4.24 The preceding findings allow us to conclude that, i)the rapid growth o f overall labor compensation i s a source o f fiscal concern, ii)there is a need to have a centralized data base o f public sector remuneration, including all forms o f compensation, in order to make informed L 61. See Nogales (2006), p. 53. 72 policy decisions,62 iii)there i s a need to simplify the remuneration concepts to make policy decisions that are equitable for all public sector employees, and iv) the principles o f equity and professionalization included in Law No. 476 point towards individualized salary increases based on merit and the avoidance o f across-the-board salary increases through collective union agreements. Figure4.3 AVERAGE INDIVIDUALSALARY GROSS MONTHLY C$ Source: Nogales (2006) Public sector salaries Salary dispersion betweenpublic sel for institutions 4.25 Public sector salaries exhibit large disparities across public institutions; Figure 4.3. For example, in June 2006, the average salary in the four State Powers, plus the Comptroller's and Attorney General's Office, is C$ 12,088 per month, or almost four times larger than the average salary in the 12 line ministries, which is C$ 3,202 per month. Also, the average salary paid in the National Assembly i s 857 percent o f the average salary over all ministries, in the Comptroller's Office it i s 379 percent, and inthe Supreme Court it i s 313 percent. Ifwe take the highest paid public institution (the National Assembly) in relation to the lowest (Ministry o f Defense), the relation o f average salaries was more than 10 to 1. A similar ratio is found with L 62. The SISEC (Sistema de Infonnaciondel Servicio Civil), created by article 32 could be a starting point, but it would needto be complemented with data ofpublic servants not covered by the Civil Service Law. 73 respect to the average salary inthe Ministryo f Education.63O f course, these simple ratios can be misleading, since the proportion o f skilled to unskilled public officials differs from one institution to another, but they are still indicative o f wide disparities. The differences between ministries can also be quite large. For instance, in 2006, the average salary at the Ministry o f Industry and Commerce was 4.5 times larger than the average salary o f the Ministry o f Defense or o f the Ministry o f Education. As Nogales (2006) states, the incentive i s not to be trained, gain experience and be promoted, but rather to have the political connections necessary to be employed at a high-payingpublic institution. Salary dispersion withinpublic sector institutions 4.26 Salary dispersion within institutions can also be quite large. While the lack o f a centralized data base prevents the analysis o f all institutions from this dimension, we have information on two ministries - Finance and Education - shown in Figures 8.4 and 8.5 respectively. Figure 4.4 exposes several distortions inthe MHCP. First, the relative difference between the lowest and the highest salary within categories varies widely from one category to the next. For instance, incategory 13, the maximum salary is 7.5 larger than the lowest, while in category 16 the difference i s only 1.6 times. Second, the average salary barely changes in the first nine categories, while it follows an exponential trend inthe last eight categories. Third, the average salary in a lower category can be higher than the average salary ina higher category, e.g. the average salary in category 13 i s higher than incategories 14 and 15 and equal to the average salary incategory 16. Ingeneral, there is no reasonable pattern either inthe minimum-maximum ranges within categories, nor in the minimum, maximum and average salaries between categories. 4.27 Inthe EducationMinistrythe distortions are similar: little variation inaverage salaries up to category ten and exponential growth thereafter, wide differences between minimum and maximum salaries across categories, and average salaries higher for lower categories. These distortions are o f great concern in this ministry, given that it employs over 44 percent o f all central government employees. 4.28 A final issue to be considered in assessing individual salaries is the number o f hours worked. Untilrecently, the normal work schedule inthe public sector was from 7 am to 2 pm. In some cases, such as the education sector, employees may work only four hours a day.64 Hence, the above levels o f remuneration may be considerably larger if assessed on a per-hour basis. For this reason, it is recommended that the data base o f public sector employment and remuneration include this information. L 63. The comparison with education i s probably more relevant, since the military and the police receive in-kind remuneration inthe form o f food, uniforms and housing. 64. During the 2006 health strike the press reported that most public sector doctors complemented their regular salaries with private practice for a fee and that often these private consultations took place in government premises and usedpublic sector assets. 74 Figure 4.4 MINISTER10 HACIENDAY CREDITOPUBLICO JUNIO 2006: -- TSRY RANGOSSALARlALES (C5) 50,000 ~ 1 45,000 ' ' 40,000 35,000 1 30,000 I 25,000 20,000 15,000 10,000 5,000 17 16 15 14 13 12 11 I O 9 8 7 6 5 4 3 2 0 Source; Nogales (2006) Figure 4.5 MECD: NUMERO DE FUNCIONARIOS Y MASASALARIAL BRUTA (C$/MES) SALARIO BRUT0 C I I M E S # FUNCIONARIOS 6,000 5,500 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 i 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 I ~ 75 TheReference Salary Table 4.29 In2005, the Government adopted a Reference Salary Table (RST) with the objective of imposing greater discipline and order in the structure o f public sector salaries.65 It i s the implementation o f this table that has fiscal implications and not, as is often claimed, the implementation o f the Civil Service Law. In fact, the Civil Service Law has only a few articles referring to public sector remuneration,66 and the regulations to the law do not add significant guidance. 4.30 The implementation o fthe RST is desirable because it would impose discipline and apply the principles for public sector remuneration adopted in Law 476. But its legal grounding i s weak, which has led most public sector institutions to resist its implementation. Moreover, because o f its fragile legal underpinnings, the universe o f institutions that are potentially subject to the RST remains unclear. Comparisons with theprivate sector 4.31 The application o f the principle o f competitiveness adopted by Law 476 requires information on private sector remuneration for positions similar to those in the private sector. Yet, the public authorities responsible for determining public sector remuneration do not collect this information systematically. Table 4.4 shows average salaries for the period 2001-2005. This data, taken from INSS, show that average salaries in the public sector have recently surpassed those inthe private sector, showing higher rates o f increase. Table 4.4 Public versus Private Sector Pav AVERAGE 2002 2,775.6 3,150.7 211.3 4.1% 3.7% 88.1%) AVERAGE 2003 3,079.6 3,320.1 222.5 5.4% 0.1% 92.8%) AVERAGE 2004 3,344.5 3,481.0 241.3 0.1% -3.3% 96.1%) AVERAGE 2005 3,857.6 3,735.0 264.5 5.2% -2.1% 103.3%) 4.32 These data must be used with caution, however, given the incentives o f the private sector to understate the wages reportedto the INSS. Nevertheless, other sources o f data reveal a similar pattern. PriceWaterhouseCoopers, which conducts an annual salary survey inthe private sector, found the simple average salary in the private sector in 2005 to be C$ 3,584 per monthY6'while data publishedby the Central Bank o f Nicaragua reveal that the average public sector salary in August 2005 was C$ 3,776.68 These data show orders o fmagnitude similar to those inTable 4.4 and also point to a lower average salary in the private sector. Other sources o f data69show L 65. See Table 4.19. 66. Article 30, which indicates that remuneration should be based on principles o f equality, equity and competitiveness; Articles 100 to 103 on the types of remuneration; and Articles 117 and 118011considerations regarding the implementation of remunerationpolicy 67. PriceWatherhouseCoopers, 2006. 68. Banco Central de Nicaragua, 2005 69. By contrast, IMF(2006), paragraph 10cites muchlarger public sector wage levels. 76 significantly different orders o f magnitudes for average public sector wages, indicating still larger public-private wage differentials. In any case, average wage comparisons must take into account the education and skills requiredfor different positions. It can be argued that the private sector occupies a significantly larger proportion o f low skill workers. All this points to the need to undertake a rigorous data collection effort, identifying clearly the number o f hours worked, skill requirements and specification o f the remuneration concepts included in each indicator (base salary, 13thmonth, compensation in kind, and the like). The RST needs to be adjusted, takinginto account this information, as well as the overall fiscal envelope. Gender equity 4.33 As in the case o f employment levels, there are no official records o f gender decomposition o f average remuneration. But some information regarding average income o f the economically active population, by gender, can shed some light. Based on the 2001 household survey, the Economic Commission for Latin America (ECLAC) calculates that the mean income o fpublic sector workers inurban areas was 4.5 times the per capita poverty line. For male public urban workers the mean income Was 5.8 times Table4.5 AverageAnnualRemuneration, by the per capitapoverty line, while for females it was 3.3 times the per capital poverty line. Assuming that the main source of income for wage-earners is wage earnings, this would point towards a bias infavor o fmales inpublic Directive 61,230 sector remuneration. This conclusion i s also Source: Lopez (2003). supported by the study by Lopez (2003) on twelve public sector institutions, which finds that the average remuneration for males is higher than for females at all levels, with the differences becomingup to 30 percent higher infavor o fmales at the highest levels (Table 4.5). Needfor Public Sector Remuneration Framework Legislation 4.34 The above findings point to a clear need for adopting an official policy on remuneration inthepublic sector, grounded ina nationallaw, and implementing its enforcement mechanisms. Such legislation i s best based on the concepts already approved in the Civil Service Law, and expanded with provisions pertaining to (i) institutional coverage o f the policy, which should be as wide as possible, (ii) rules for initial pay upon hire and pay increases, with the later based solely on merit, (iii)limits on the dispersion o f wages between and within public sector institutions, (iv) non-salary remuneration, which should be kept to a minimum, (v) consultants' remuneration(see section D), and (vi) reporting obligations. Remuneration in the Education Sector 4.35 The education sector is the largest employer in the public sector. It comprised about 43,000 employees in mid-2006 (about 44 percent o f total central government employment) and accounted for 32 percent o f the central government wage bill. Tables 4.6, 4.7, and 4.8, show the average monthly wages by type o f education employees and school modality. Several conclusions can be drawn from these tables: 77 The average wage for primary teachers i s about the same in autonomous and centralized schools, but much lower indecentralized municipalities The average wage for secondary school teachers i s highest in centralized schools and lowest indecentralized municipalities Among teaching positions, teachers' training attracts the highest salary The average growth rate o f average salaries has been highest in autonomous schools (22 percent), followed by centralized schools (13 percent) and decentralized municipalities (9 percent) Table 4.6. Monthly Salaries in Education, by level and school modality (C$per month) Table 4.7 Table 4.8 Special Education 78 4.36 Simple comparisons o f monthly salaries for teachers and non-teachers can be very misleading, among other because teachers tend to work fewer hours than non-teachers (and so often have more than one job) and generally have longer vacations. A recent study by CEPAL7' indicates that, on average, Nicaraguanteachers earn about the same monthly salary (expressed in purchasing power parity terms) as their L A C counterparts; Table 4.9. 71 Since Nicaragua is a substantially poorer country than the average Latin American country, however, Nicaraguan teacher monthly salaries are substantially higher in terms o f per capita GDP than the Latin and Central American regional averages. (That is, the average annual teacher salary inNicaragua is equivalent to 324 percent o f per capita GDP, compared to regional averages o f 240 and 255 percent.) By this criterion, Nicaraguanteachers appear to be paid quite well. Table 4.9: Monthly Teacher Salaries in CentralAmerica iTeachermonthly I I I I !Monthly Average / 2005 per i salary as % o f the average monthly! Teacher Salary capitaGDP salary of: I 1 I I I iisalary as %ofper I capita^^^* Professionals & Salaried I 2000 US$ PPP I iIiAll Workers I Technicians Professionals i Costa Rica 1,268 8697 175% i 147% 87% 85% i ElSalvador ii 885 4629 ii 229% 182% 93% 92% Guatemala 752 4034 224% Ii 137% 73% 80% i Honduras Nk.?EE _________ i______________________ ii 936 2998 i 865 ------------.I------- 1 3208 I 324% 133% 71% 93% I _____________ jI________________________________________--------------- 375% 270% 82% 81% i Regional !verages 1i I Central America 941 4,713 240% 174% 81% 86% LatinAmerica ii 858 4,044 255% 11 126% 64% 74% Source: A. Morduchowicz& L.Duro (2007), CEPAL @age21) andWorldBank,World Development Indicators.Notes:The wage figures for CostaRica refer to 2005, for El SalvadorandGuatemala to 2004, for Hondurasto 2003, and for Nicaraguato 2001. Average annual wages are calculatedas the average monthlywage times 12 and do not take into account non-wageremuneration. 4.37 Nicaraguan teachers also tend to work substantially longer hours than teachers in most other L A C countries, however, which partly explains their comparatively high salaries; Table 4.10. Whereas the average teacher in Latin America works only 32.3 hours per week, Nicaraguan teachers average 41 hours o f work. This translates into a correspondingly lower hourly wage rate, with Nicaraguan teachers earning an hourly wage of 4.9 Dollars (in constant 2000 PPP terms), while the other teachers inthe region average over 6 Dollars. By this criterion, Nicaraguan workers appear to be paid relatively poorly. However, this comparison is also misleading because it does not take into account differences inproductivity and skill levels. To the extent that cross-country differences in per-capita GDP reflect differences in labor productivity, the shortfall inNicaraguan teacher wages ($4.9 vs. $6.2) i s approximately equal to the shortfall in per capita GDP ($3,208 vs $4,044). That is, after adjusting for differences in national productivity levels, Nicaragua's teachers appear to be paid a comparable wage rate to what other teachers inthe region receive.72 L 70. Morduchowitz, Alejandro and Luisa Duro (2007), "La inversion educativa en America Latina y el Caribe: Demandas de financiamiento y asignacion de recursos (Buenos Aires, CEPAL), 71. See also Hermani-Limarino, Werner, (2006), "Are Teachers Well Paid Latin America and the Caribbean?: Relative Wage Structure o f Returns o f Teachers", in Emiliana Vegas, ed. (2006), Incentives to I m r o v e Teaching, (Washington, D.C; World Bank), Figures 3.1 and 3.2. 72. Public sector teachers and health workers in Nicaragua like to compare their salaries with those paid in Honduras. Indeed, the average monthly salary o f school teachers inHonduras is significantly higher. This is not an 79 4.38 Arguably, a more appropriate way o f assessing the adequacy o f teacher remuneration is through intra-country comparisons with other workers and professions. Table 4.9 indicates that the average Nicaraguanteacher salary i s 33 percent higher than the average salary receivedby all workers in Nicaragua, but only represents 71 percent o f the average salary received by private sector professionals and technical staff and 93 percent o f the average remuneration o f salaried professionals in the private sector. It turns out, however, that teachers in Nicaragua (as almost everywhere else in LAC) tend to put in less time than the overall average hours worked in the private sector (41.0 hours per week vs. 48.8 hours), but marginally more hours than other salaried professionals inthe private sector; Table 4.10. On an hourly basis, Nicaraguan teachers earn proportionately more than all private sector workers (59 percent more according to Table 4.10), but they earn 26 percent less than other professionals and technicians, and 10 percent less when compared to all other salaried professionals inNicaragua.73 Table4.10. HourlyWage Ratesin CentralAmerica 1jAverageHours worked 1 Average iTeacher wage rate as %o f the average wage] per month* 1j Monthly hours hourly rate of: II I I Teachers I I workedby 1j teacherwage j I Teachers all non- versus rate (2000 US$IAll Workers Professionals & Salaried j I Teachers I all non-Teachers j I PPP) I Technicians Professionals I tI CostaRica 40.3 46.5 I 87% 7.3 170% 104% 95% El Salvador 1i 32.7 45.1 73% 6.3 1: 251% 120% 109% ij Guatemala j 31.3 46.2 Ij 68% jjj 5.6 I 202% 101% 94% j Honduras 34.5 49.2 I 70% I 6.3 385% 110% 106% Nicaragua i: 41.0 48.8 i 84% i 4.9 Ij 159% 74% 90% I:: Regional Averages ;! I I I CentralAmerica 36.0 47.2 76% 6.1 228% 101% 98% Latin America ii 32.3 44.7 Ii 72% Ij 6.2 Ii 174% 86% 96% Source: A. Morduchowicz& L.Duro (2007), CEPAL @age21-23) andWorld Bank, WorldDevelopmentIndicators.Notes:the average hours workedper monthdoes not take into accountdifferencesinvacationtime, which tends to be longerfor teachers. 4.39 The differences inaverage wage rates paid to Nicaraguan teachers vis-a-vis professionals inthe private sector are conceivably due to differences in productive endowments or of other socio-economic factors. Such differences are taken into account in the study by Hernani- Limarino (2006), who estimates conditional wage differentials by regressing hourly pay on productive endowments (education, years o f experience), socioeconomic factors (sex, age, place o f residence) and a teacher's dummy. The study concludes that after these differences are taken into account, teachers in most o f the countries in the region receive higher wage rates than non- teachers. Nicaragua is an exception, with teachers receiving a lower average wage than non- teachers. The magnitude o f this conditional wage difference, however, i s very sensitive to the appropriate comparison, considering that Honduras represents a statistical outlier, with one o f the highest average hourly teacher wage rates in LAC - and the absolute highest when expressed as a share o f per capita GDP. 73. These result are broadly consistent with the findings o f Hennani-Limarino (2006, Table 3.5), who reported that the hourly earnings o fNicaraguan teachers are, on average, 44 percent higher than those o f all other workers, but 66 percent lower than those of workers who have at least a secondary education and 68 percent lower than those of workers inoffice, technical or professional occupations, regardless o f educational level. 80 choice o f the comparison Finally, these results may also be biased by the presence o f unobserved heter~geneity.~~ 4.40 In any case, the preceding findings as they pertain to Nicaragua are based on the wage structure that prevailed in2001. Between 2001 and 2006, the average wage of teachers has been growing by an average o f 13.3 percent per annum, while the average national wage has only been growing by 10.7 percent. This difference in wage growth rates has reduced the average wage differential by around 12 percent below what it may havebeen five years ago. 4.41 So, are Nicaragua's teachers being adequately paid? Much rests on the answer to this question, considering that the quality of education is strongly influenced by the quality o f teachers, and the quality of teachers, inturn, i s largely determinedby the persons attracted to and retained in the teaching profession, and the performance incentives that they face. As indicated by Hermani-Limarino (2006), relative wage rates play an important role inteacher recruitment, performance and retention. The preceding review suggests that Nicaraguan teachers may be receiving an average wage rate that i s somewhat less than that received by similarly qualified private sector employees. This observation in itself does not suffice to make a compelling case for raising teacher remuneration levels. It does, however, suggest the need to maintain an open mindtoward possible wage adjustments ifwarranted byoverall labor market condition^.^^ Inthe event that such adjustments are warranted, it i s important to consider teachers' remuneration as a whole, and look beyond the wage alone. The reluctance to contemplate wage adjustments has frequently led to strikes that are eventually resolved through adjustments in non-wage benefits. Such non-wage benefits have an equally negative fiscal impact, but are not conducive to increased efficiency because they do not rewardindividual effort.77 2002 2003 2004 2005 2006 2007 Employment Remuneration 826,393,475 899,318,126 937,226,977 1,243,456,865 1,411,673,011 1,703,700,000 Wage Bill 612,736,254 667,744,987 708,552,884 971,148,074 1,151,626,713 Growth Remuneration I 9%1 4%1 33%1 14%1 21% GrowthWage Bill 9%1 6%1 37%1 19%1 Remuneration in the Health Sector 4.42 In 2006, the health ministry employed 23,241 people, or 24 percent of total central government employment, making it the second largest public sector employer after education. The social security institute, INSS, employed an additional 1,214 people. More than two-thirds o f the sector's employees are female. In2006 the wage bill o f the sector amounted to C$ 1,152 million (US$ 65 million) or 25.3 percent o f the total wage bill o f the central government, while total sector employment remunerationwas C$ 1,412 million (US$ 82 million) in2006. L 74. Hemani-Limarino (2006, table 3.6) 75. That is to say that teachers may not be a random simple o f workers whose decisions to teach are mainly based on wage differentials. If teachers constitute a special group that is attracted to the profession by non-monetary rewards, the labor market would be effectively segmented into two markets (one for teachers and the other for non- teachers), which do not necessarily clear at the same wage rate. 76. Some important indicators o f overall labor market conditions that are most relevant inthis context are the skill set o f individuals applying for teaching positions and the rates o f labor turnover among teaching staff. 77. According to Nogales (2006) the 2006 teachers' strike has cost C$41 million inbonuses. 81 4.43 Wage and total compensation have grown considerably in the past two years (Table 4.1l), with the health sector wage bill almost doubling since 2002. However, the share o f the gross Table 4.12 Health Sector: Share of wage bill assigned to health services is only 63 Gross Wage Bill,by Type of Service percent, with the remainder going to various types o f Health Services 63% Management 15% managerial, administrative and service jobs (Table Administration 3% 4.12). Technical 6% General Services 12% 4.44 The salary structure o f the Health Ministry Production 1% (MINSA) does not exhibit a clear, rational pattern; Training 0% Table 4.20: 0 Ofthe 22 salary levels inthe MINSA, the structure o fthe first 14 levels isbasically flat. 0 Subsequently, the salary dispersion becomes very large: the basic salary inthe highest level (level 22) i s 43 times higher thanthe basic salary inlevel 1. 0 Within the 22 salary levels there are 12 sub-classifications, and these sub-classifications within a salary level imply ahigher salary thanthe basic salary o f several levels above. 0 This salary table i s not very meaningful because the gross salary is composed o f fixed and variable salaries (with variable salaries comprising 45 percent of the total wage bill in 2006). Only 187 employees out ofthe total 21,365 didnot earn a variable salary. Source: Nogales (2006) 4.45 Within the expenditures for health service professionals there is also a lot o f variation, reflecting the highvariety o f skills required inhealth services. Table 4.13 shows the evolution o f average salaries for doctors and nurses o f different specializations. It indicates that sector salaries have grown by an even larger margin than either the wage bill or total compensation at the overall ministerial level. 82 4.46 Table 4.14 shows that Nicaraguan doctors working inthe public sector indeed earn less in absolute terms than their Central American counterparts. As noted earlier, however, this i s not an appropriate comparison, given that the overall income and productivity levels across these countries are very different. Table 4.14 Average doctors' salaries inCentral America (US$ per month) Nicaragua ElSalvador Honduras Costa Rica Guatemala Panamh General Doctor 408 969 1,203 740 472 1,025 Specialist 584 1,211 1,404 762 828 1,338 Resident 241 969 338 740 789 1,025 Source: Morales et. al. (2006) from data from ECLAC and WHO. Central American countries, except Honduras, whose Table 4.15: indicator is well outside the regional norm (Table 4.15). Physician,s Base Salaries Relative to In other words, there is no economic or social per Ca2ita GDP Nicaragua 489% justification for seeking to mandate the equalization o f EI Salvador 477% sector salaries to the regional averages. Guatemala 455% Honduras 1,638% 4.48 There i s a large variation in doctors and nurses Source: World Bank (2007), "Key Issues.", Figure 1.44 Figure 4.6 Base Salaries of Health Care ProvidersRelativeto Physicians' Salary 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Physicians Nurses Technicians Auxiliaries 1OEl Salvador UGuatemaia HHondurar DNicaragua I Source: World Bank (2007), Key Issues inCentral America HealthReforms. 4.49 Aside from levels and differences in base salaries, in the health sector it is particularly important to look at (i) variable wages and (ii) non-wage benefits. The issue o f variable salaries in the sector deserves careful analysis and revision. Variable salaries include bonuses for abnormal working conditions, salary complements, double turns, night shifts, recognition for years o f experience or academic record, and others. Some o f these items (like wage premiums for years o f experience or academic record) can be reflected inthe basic salary structure, together with the criteria for receiving the premiums. The more important problem is the large number o f 83 employees that are eligible for these benefits. It i s unclear, for example, why 16,670 employees (or 71 percent o f the total) are reportedly working under abnormal conditions, what justifies giving salary supplements to 5,079 employees, and why 5,560 employees are doing double shifts. 4.50 Health employees also receive non-wage compensation from collective agreements. The latest such agreement was signed in2006, following the health employees strike. The fiscal cost o f implementing it in 2007 has been estimated at C$ 150 million.'* Almost 40 percent o f that cost is related to clothing, footwear and protective equipment (which does not really qualify as employment compensation). A small percentage i s assigned to scholarships for employees' children, and 60 percent i s merely "other benefits" whose composition is not known. Moreover, the procedures for assigning those benefits to individual workers are also not known. 4.51 Regarding comparability with wages in the private sector, there i s virtually no information. The only available data comes from the PriceWaterhouseCooper's survey o fprivate sector pay, which includes only two health positions ("health project supervisor" and "health promoter"). It finds that the total remunerationlevels for these positions in2006 were C$ 36,000 (US$ 2,081) and C$ 28,133 (US$ 1,596) per month, respectively. These figures are not comparable with those in Tables 4.13 and 4.14, because they include overall compensation and not just wages. As in the case of education, the DGFP needs to conduct an in-depth survey o f salary levels in the Nicaraguan private health care market, without which the principle of competitiveness approved inLaw 476 would carry little weight. 4.52 Unlike the education sector, there is no data on the number ofhours worked that would permit ascertaining the hourly wage rate. Nogales (2006) indicates that specialized doctors work an average o f four hours a day. Numerous press reports duringthe last health strike have pointed out that public sector doctors generally work less than full time, and that they also attend private clients during that time - for private gain - using the assets o f the public sector. This i s an issue that needs further research and appropriate regulation. 4.53 There is some information linking overall public health expenditures to efficiency," but little that links remuneration in the Nicaraguan public health system with efficiency. Previous analyses, however, have drawn two conclusions that are nevertheless important for human resources management in the sector: (i) the need to assign more humanresources to preventive care vis-a-vis curative care and (ii) need to assign human resources geographically according the to need and risk areas; see para. 3.47. Consultants 4.54 Number and Cost of Consultants. The use o f individual consultants in the Nicaraguan public sector is extensive, mirroring the country's dependence on foreign aid. While many o f these consultants are assigned tasks o f a temporary nature that require a specialized expertise proper o f consultants, many others perform tasks o f a more permanent nature that should normally be assigned to civil servants. Many consultants are financed through external grans and credits, and their earnings undermine any attempts to impose discipline and provide adequate incentives to public sector employees. L 78. See Morales et. al. (2006), table 17. 79. See World Bank (2007, section 2.D) and Chapter 111. 84 4.55 Since there is no centralized registry and the budget does not provide precise information, the exact number o f consultants i s unknown. An estimate by the DGFP calculated the total number o f consultants financed by six international agencies (up to May 2005) to be 771, with a yearly expenditure o f about US$15 million (Table 4.16).80 Table 4.16 I R l A Y C E YO.COhS. % SALARYIMOYTH `/o m MAX AVERAGE SPANISHCOOPERATION 21 3% 10,573 1 Yo 95.81 6,131,33 503 48 WORLD BANK 498 65% 883,628 71% 101,56 10,000,OO 1,774 35 CABEI 14 2Yo 10,830 1% 200,oo 1,500,oo 773.56 IDB I54 20% 228,653 18% 150,OO 6,000,OO 1,484 76 EUROPEAN UNION 20 3Yo 33,977 3% 74.85 4,839,26 1.698 84 OTHER 64 8Yo 72,720 6% 10000 4,251.50 1,136 24 4.56 Taking information from the Budget, which includes both domestic and foreign sources o f financing, Nogales (2006) calculates that about 30 million dollars is spent on consultants. However, this calculation includes temporaries, which are not the main source o f public pay distortions. A similar calculation, based on individual consultants included in the public investment program (Table 4.17), shows that about US$ 28 million were spent on consultants in 2006,81but this Figure4.does not discriminatebetween short and long term consultants. Table 4.17 BUDGETARYLINES UTILIZED IN THE CONTRACTINGOF CONSULTANTS IUS$) Contracted Personnel for Advisory / Consultations 8,123,402 16,197,555 28,189,628 Studies, research and factibility of the projects 1,909,503 10,337,765 17,782,175 Technical advisory and refunds for studies 14,885,085 11,971,639 19,308,837 4.57 Based on the above, it is roughly estimated that the Nicaraguan government spends between US$ 20 and 30 million annually on individual consultants that perform permanent jobs. This represents 10percent o f the public sector wage bill. Based on the average salaries paid by the six donors included inTable 4.16, the total number of consultants working inthe Nicaraguan public sector i s between 1,350 and 2,000. Remuneration 4.58 Consultants' salaries are generally larger than the average public sector salary, and roughly similar to the remunerationo f high-level government employees. They also exhibit wide dispersion. Usingbudget figures, Nogales (2006) compared average consultants' remunerationto L 80. This i s roughly o f the same order o f magnitude as calculations done by the World Bank in the context o f the 2004 CPPR, which found that around 10 million dollars were spent annually in Bank-financed individual consultants. 81. But this figure could be considerably higher if one assumes that the code lines "Studies research and feasibility projects" (PIP code 241) or "Studies and Technical assistance" (PIP code 243) also include some individual consultants performingpermanentjobs. 85 average public sector wages, and found the former to be about six times larger. Considering that consultants' generally possess higher qualifications than the average public sector employee and are more comparable to top government officials, their average remuneration does not seem exaggerated (although they maybe in some isolatedcases). 4.59 To introduce greater discipline in the employment and remuneration of consultants, the MHCP issued two directives, in 2005 and early 2006.82 The first o f these introduced a remunerationtable to be applied to all consultants performing "line positions" (Table 4.18). The second clarified some o f the concepts that remainedvague inthe first. 4.60 This effort needs to be pursued in Table 4.18 several directions. First, some concepts I REFERENCETABLE WAGE CONSULTANT WAGES I included in these directives must be FEES co,wuxll+ ~ ~ ~ O ~ ~ l ~ A r lDllhIYUMjMkX1HUAf o ~ S clarified; notably what i s a ``he DIRECTI\ES m c r m 3,600 ,,@CII position." This is easily resolved by PRINCIPALTECHNICALADVISER 2,800 4,250 resorting to concepts already included in COORDINATORA 2,350 3,600 COORDINATORB the Civil Service Law. Second, the 1,900 2,950 EXECUTIVES OFFICIALA 1,450 2,300 requirement to inform the DGFP about OFFICIALB 1,100 1,750 all consultants' contracts and contract ANALYST 750 1,200 extensions needs to be enforced OPERATIVES SUPPORTA 400 650 SUPPORTB 350 450 D. MainFindingsandPolicyOptions 4.61 There is no complete, comprehensive and up-to-date data base on public sector employment and remunerationlevels. Furthermore, the budget payroll does not accurately reflect the fiscal risks associated with employment remuneration, because o f (i) large amount of the non-wage employment compensation, linked mostly to collective agreements, (ii) employment compensation inpublic institutions inside and outside the central government that is not included in the budget payroll (but is embedded instead in budget lines related to transfers), and (iii) employment compensation in public institutions registered in the capital budget. These shortcomings render it extremely difficult to monitor adequately the evolution o f public employment and remuneration, as needed for maintaining fiscal control. 4.62 The size o f public sector employment as a proportion o f Nicaragua's total population is somewhat below the average observed in other countries in Latin America and the Caribbean. One concern, however, pertains to the growth o f the public sector wage bill in recent years, which i s attributable, both, to increases in employment and in public wages. Most o f the public L 82. Memorandum MHCP-DM-E-23 196a-11-05 of November 29, 2005 and MHCP-DM-1-23 196b-02-06 o f February 10,2006. 86 employment growth has come from decentralized institutions (particularly universities) and local governments. At the same time, public sector salaries have been growing faster than private sector salaries, posing risks to fiscal sustainability. 4.63 The two largest public sector employers -the education and health sectors - raise the most concerns from a fiscal viewpoint. Salaries inboth sectors have increased rapidly inthe past few years, exceeding the average growth o f salaries at the national level. While some o f the indicators discussed earlier (paras. 4.36-4.41) suggest that the wage rates paid in the education sector may be on the low side, others suggest that teachers are paid quite well under prevailing market conditions and considering their average skill levels. Moreover, it appears that the average skill level o f the current teacher corps inNicaragua is very low, especially since so many of them are untrained ("empiricos").83 Under these circumstances, the fundamental challenge for humanresource management inthe sector is not to identifythe appropriate (or market) wage for the current, relatively untrained set o f teachers (except in a short-run context, when new wage contracts are being negotiated with the teachers union), but rather to identify the wage rate that would be required to attract and retain a set o f teachers with the desired teaching skills. It i s probably safe to say that the wages currently paid to teachers inNicaragua are far below the level that would be required to attract the type o f teachers that the country needs inorder to provide an education o f significantly higher quality. The challenge facing the Nicaraguan authorities, then, is getting from the current status quo o f low-paid and low-skilled teachers to the desired position o fbetter-paid, higher-skilled teachers. 4.64 Meeting this challenge will require implementing a carefully designed human resource strategy for the sector that encompasses, among other, a new wage policy, a better teacher training system and curriculum reforms. Even though the current wage rates paid in the sector may be inadequate from the viewpoint o f providing proper staff recruitment, performance and retention incentives, however, adjustments must be considered carefully within a medium term cost and financing framework for the education sector, while being mindful o f the overall government budget constraint. In particular, it would not be fiscally prudent to apply a wage policy based on the wages paid in other countries with vastly different per capita income and labor productivity levels, and operatingunder different labor market conditions. 4.65 Average salaries incentral government institutions are extremely dispersed both between and within institutions. This also applies to consultants' salaries, which account for around 10 percent o f the total public sector wage bill. Their average salaries are high compared to the overall average public sector salary, but similar to those paid in the higher echelons o f public employment. In both cases, the structure o f salaries often does not exhibit a rational pattern, either interms o fmerit, skills endowment or proper work incentives. 4.66 The recent evolution and structure o f public wages in large part reflect the absence o f adequate public wage framework legislation. Furthermore, recent efforts to regulate consultant salaries have been undermined by lack o f enforcement. As a consequence, public sector remuneration levels follow ad-hoc decision-making, are not transparent, and result in inequities that ultimately hamper the process o f civil service professionalization. L 83See World Bank, 2007, Poverty Assessment, paragraph 2.37. In 2005, the proportion of Nicaraguan teachers considered untrained ("empiricos") was 24 percent at the primary level and around 50 percent at the secondary level. This proportions were found to be higher than inother developing countries, even after accounting for differences in per capita income levels. 87 4.67 In order to ensure an orderly, transparent and efficient determination o f wages in the public sector, adequate framework legislationi s urgently needed. A good framework legislation i s characterized by the following key elements: 0 Broad coverage the framework legislation covers all public sector agencies; the same as the - Civil Service Law. 0 Transparency - the level o f remuneration i s built around a base salary, where bonuses are only applied inexceptional circumstances and in-kindcompensation is eliminated. Merit-based pay - the remuneration policy rewards good individual and team performance, subject to the prevailing fiscal constraints. 0 Non-discrimination - the pay policy does not discriminate across gender, ethnic or religious lines. 0 Market-responsiveness - the structure o f salaries reflects the relative market demand and supply for the different skills required inthe public sector labor force, thereby ensuring that the public sector is neither over-paying its employees, nor allowing the quality o f its work- force to deteriorate. The adequacy o f the pay structure can be gauged by the frequency o f labor turnover and quality o f applicants for different positions, as well as by carrying out periodic market surveys. Incontrast, basing the pay structure on the wage rates paid inother countries (as was recently done for health sector employees), or indexing it to particular commodities (such as the canasta bcisica), would not be consistent with the principle o f market responsiveness. The implementation o f framework legislation containing these principles is best achieved with the introduction o f a uniform Reference Salary Table throughout the entire public sector. The pace o f introduction may need to be gradual, however, depending on fiscal limitations. Also, the RST would need to be periodically revised and adapted to changing labor market conditions and relative scarcities o f different skills. 4.68 An efficient implementation o f the propose framework legislation also will depend on several prior actions by the DGFP: Creation o f a centralized data base on public employment and remuneration, covering the entire public sector. Article 8 o f the Civil Service Law provides a sufficient legal basis for requiring all public sector agencies to submit such information to the Ministryo f Finance. By enforcing this article, the Ministry o f Finance should be able to compile a reasonably comprehensive data base within a period o f six months. After collecting the data on individual salaries throughout the public sector (including consultants) and on the pay structure for comparable positions in the private sectors, it is necessary to estimate the fiscal impact o f alternative salary structures, to ensure that the implementation o f a particular RST does not lead to fiscal distress and, therefore becomes inoperable. With particular reference to consultants, it is important to enforce directives on information sharing o f consultant's contracts, amending and complementing the directives, as needed, to clarify coverage and concepts, raise its legal status and implement enforcement mechanisms. Inthis context, it is crucial to calculate the fiscal implications ofapplyingthe law o facquired rights to all consultants that are currently occupying permanent positions. It may be necessary to revise the legal and regulatory framework governing wages to permit the applicationo f the RST to consultants ina fiscally viable manner. 88 4.69 With particular regard to the education sector, there is a need to undertake a teacher census to determine with greater precision the geographic distribution o f teachers and the prevalence o f "ghost" teachers. This would serve as an instrument to inform decisions on the deployment o f teachers (within urban areas and across ruralhrban areas). In the longer term, there i s a need to devise a better compensation policy that includes more incentives to encourage the upgrading o f unqualified teachers ("empricos") and reward good teaching performance. (Ideally, a teacher licensing and program certification system that is linked to results is something to strive for, but may be premature for Nicaragua at this point.) In seeking to link teacher compensation to teaching performance and results, it will be important to analyze the recent student assessment data (from 2006) with the objective o f identifying the main factors (such as education profile, experience, wage rate) associated with good teacher performance and results. (The last student assessment carried out in 2002 had revealed, for example, that half o f the teachers felt ill-prepared to teach mathematics.) 4.70 Finally, the adoption o f a time-bound action plan for the incorporationof all public sector employees into the administrative career, as envisaged by the Civil Service Law, would greatly enhance the process o fprofessionalizingthe public labor force. DIRECTIVO 38,760 xx 31,604 XIX 25,770 23 XVIII 21,013 23 XVII 17,133 23 XVI 13.969 23 xv 11,391 23 XIV 9,287 23 XI11 7,572 23 EJECUTIVO XI1 6,174 19 X I 5,203 19 X 4,384 19 I X 3,695 19 VI11 3.1 14 19 VI1 2,625 19 OPERATIVO V I 2,211 15 V 1.928 15 Iv I 1.682 I 15 I11 1,467 15 I1 1,279 15 I 1.013 89 NGrnerode trabajadores consalario Moda 76 1,874 785 510 1,084 1.390 4,847 1,236 141 457 2,089 199 59 49 755 100 207 1,323 283 220 282 451 145 5 37 6 97 14 127 31 0 12 8 2 18.901 Source: Morales et. al. (2006) from fiscal payroll data. 90 CHAPTER V FISCAL DECENTRALIZATION INNICARAGUA 5.1 The Nicaraguan state traditionally has been highly centralized. That tradition continues to hold sway today. Yet, over the last 20 years the country has moved, in fits and starts, against that structural legacy and toward a more decentralized political model, enabling locally-elected municipal governments to play a larger role in setting priorities and delivering services in selected policy arenas. This can be a good thing, insofar as it permits choices about public resources to become better aligned with locally defined preferences - the classic justification for greater decentralization. It can also lead to problems interms o f fiscal imbalances or gaps inthe provision o f critical public services in the event that municipalities lack adequate institutional capacity. 5.2 The 1987 Constitution marked a key point o f departure, enshrining for the first time the principle o f "municipal autonomy" in Nicaragua. Since that time, and particularly since 1995, the government has undertaken a number o f legislative and regulatory measures to expand the authority andcapacity of municipal governments. Generally, however, those government actions have been ad hoc and piecemeal. They have not been part o f a well-articulated strategy providing a roadmap for the decentralization process. 5.3 Presently, the country faces several challenges - financial, political and administrative - concerning the respective roles and capacities o f the central government and municipalities. To move the decentralization process forward, there i s rough agreement among many government officials and external observers that an authoritative decentralization strategy document is needed, with entry points, a sequence o f action steps, andresponsible actors plainly specified, all consistent with a clear description o f the aims o f the decentralization process in Nicaragua. Several issues will have to be balanced in devising and implementing such a program. These include the need for a common set o f rules versus recognition o f sharply divergent municipal conditions, the need for capacity buildingvs. the ability to realize it, and the appropriate balance between central government directives and municipal autonomy. Most importantly, steps must be taken to maintain the nation's overall fiscal balance inthe face o f growing budget allocations to municipalities. 5.4 This Chapter seeks to contribute to that broader discussion by identifying specific problems, explaining them, and then arguing that the solutions lie in certain directions. It does not pretend to offer single, first-best technical solutions, as effective solutions in this area demand a modicum of political consensus, and untilthe nature o f that consensus becomes clear, various alternative approaches are viable. 5.5 The chapter is organized in six sections: the first recounts key steps in the decentralization process since 1987, particularly as those relate to the assignment o f roles and resources. Next, the budget transfer rules from central to municipal governments are discussed in detail, followed by an analysis of municipal expenditures. Then, the accountability mechanisms for municipal expenditures are scrutinized. Having described Nicaragua's decentralization arrangements, the next section highlights key fiscal imbalances that undermine 91 the present system, and current efforts underway to remedy those shortcomings. The chapter concludes with recommendations and potential areas o f World Bank support. A. MunicipalGovernmentRoles & Assigned Revenues (1987-2006) Municipal Roles 5.6 Nicaragua's 1987 Constitution declared the importance o f municipal autonomy and founded municipal governments elected via universal Regarding their competencies, Article 177 set out the broad principle that municipal governments are responsible ("tienen competencia") for maters relating to the socio-economic development o f their territory. The following year the National Assembly attempted to give legal effect to that provision by defining municipal government responsibilitiesina Municipalities Law (Law No40). 5.7 Gomez Sabaini and Geffner (2006) observe that the roles named in the Municipalities Law, including revisions in 1997 (Law No261), can usefully be arranged in three categories: service provision, regulatory functions, and promotion activities (see Table 5.1p5 In addition, municipal competencies are one o f three types: exclusive to municipal government ((`compentencias propias"), concurrent with the national government ("concurrentes"), or delegated roles ("deZegados") which the national government transfers to municipalities, along with resources for their execution. Table 5.1 Areas of MunicipalResponsibility Service provision Regulatory functions Promotional activities Garbage collection and solid Hygiene and sanitation Construction and waste disposal maintenance o f health centers Water, sewage and electricity Public transportation, transport terminals Emergency response committees Drainage Cattle brands, transport routes Hygiene andpreventive health campaigns Markets, public washing facilities Cemeteries Culture, sports and recreation Public ornamentation and Land use, urban and rural development Tourism displays planning, compliance with construction regulations Construct and maintain streets, Environment and natural resources Human rights sidewalks, parks and plazas Municipal roads and bridges River ports Street signs and signals Civil registry Note: This Table includes the most prominent responsibilities, but i s not exhaustive. Source: Sabaini and Geffner (2006), from Municipalities Law No40/261. L 84. The 1987 Ley de Autonomia de las Regiones de la Costa Atlantica established the Autonomous Regions o f the Atlantic North (RAAN) and Atlantic South (RAAS) as an intermediate level o f government. (For administrative purposes, the national territory is divided into 15 departments.) The first local government elections took place in 1996. 85. Law No261 (1997), "Reformas e Incorporaciones a la Ley 40 de Municipios," in Art. 7 lists a series o f competencias. See also Decree No52-97 and Decree No34-2000. 92 5.8 Unfortunately, Law No40 and its revisions do not provide a plain, unambiguous statement o f the roles and related expenditure responsibilities o f different levels o f government. Rather, they leave ample room for differing interpretations regarding what the discharge o f each "competency" entails. (What does it mean for municipal governments to "promote" health centers?) In addition, there are several sectors where the responsibilities of municipal governments, line ministries and autonomous agencies overlap in confusing ways. In the roads sector, for instance, the tasks assigned to municipal governments readily overlap with national projects and/or the activities o f foreign donor agencies. Verkooijen (2006) refers to conversations with officials o f the Nicaraguan Institute for Municipal Development (Instituto Nicaragiiense de Fomento Municipal -INIFOM) inwhich these officials themselves expressed a sense o f confusion regarding exactly what each municipality is meant to do. At times those ambiguities have led to inaction, while at other times they produce an inefficient duplication o f efforts as municipal officials press claims for resources to fulfill the same responsibilities that other public sector actors are engaged in.86 5.9 As government officials and other interested parties in Nicaragua consider reassigning roles between levels o f government, there are certain decentralization principles that need to be taken into account. "Assignment o fpublic services to local or regional governments can be based on considerations such as economies o f scale, economies o f scope (appropriate bundling o f public services to improve efficiency through information and coordination economies and enhanced accountability through voter participation and cost recovery), cost-benefit spillovers, proximity to beneficiaries, consumer preferences, and flexibility in budgetary choices on composition o f public pend ding."^' More broadly, the principle o f subsidiarity provides a common standard: roles should be assigned to the lowest level o f government consistent with the geographic area that internalizes the benefits and costs o f decision making for a particular public service.88 Municipal Revenues 5.10 The 1995 constitutional reforms built on the principle o f local government autonomy, mandating that the central government assign sufficient national budget resources for Nicaragua's municipalities to develop their competencies. Also, in recognition o f the inherent differences inresource endowments across municipalities, Nicaragua's poorer municipalities are to receive a disproportionate share o f the overall budget transfer. The constitutional changes did not specify, however, an amount or share o fthe budgetthat should be transferred. L 86. Shared and sometimes overlapping roles between organizations or levels of government are commonplace throughout the world. Yet, where resources are desperately scarce, as in Nicaragua, there is a greater need to minimize these overlaps - and the potential confusion they provoke. The analyses of Verkooijen (2006) and Sabaini Geffner (2006) each highlight the inefficiencies and confusion between government actors that the existing legislation enables inNicaragua. 87. Jennie Litvack and Jessica Seddon, eds., "Decentralization Briefing Notes." WBI Working Papers. World Bank Institute, p. 20. 88. For further discussion o f factors that should be weighed in considering the appropriate assignment of public functions, see http://wwwl .worldbank.org/wbiep/decentralization/modulel/topicO1qrinter.htm. 93 5.11 "Municipal autonomy" inNicaragua does not include authority to enact local taxes or set rates. These are solely determined by the central g~vernment.~~ On the heels o f the 1995 retain) the property tax (Impuesto de Bienes Inmuebles - IBI).9 constitutional reform, the central government assigned to munici8alities the right to collect (and Two years later, the Aleman Administration (1996-2001) expanded the tax base for the Municipal Income Tax (Impuesto Municipal sobre Ingresos - MI),but the IMI tax rate was reduced from 2.0 percent to 1.5 percent as o f January 1998, and to 1.0 percent from January 2000.91 5.12 The IBIand IMI- as well as lesser revenues from municipal services and licensing fees - provide a basis for municipalities to generate their own revenues. However, neither the original Municipalities Law nor its 1997 version assigned resources to municipalities. Only in the aftermath o f Hurricane Mitch in 1998 were funds totaling just less than 1 percent o f the national budget transferred to municipalities for reconstruction works. The 1995 promise o f a budget transfer - sufficient for municipal governments to exercise their assigned faculties - remained unrealized. 5.13 The watershed moment for municipal finances inNicaragua occurred in 2003 when the National Assembly approved (and President Bolaiios signed) the Budget Transfers to Municipalities Law (BTML).92Beginningin2004, 4 percent o f the central government revenue anticipated in the annual budget law would be transferred to municipalities. The Law further stipulated that the share o f tax revenues to be transferred would increase by at least 0.5 percent per annum (provided GDP increased by at least l%), and reach 10percent o f revenues in2010. For the first time, Nicaragua's municipalities were assigned a sizeable and relatively stable flow o f resources. (Notably, however, municipal governments themselves are not responsible for generating these resources locally.) 5.14 For the central government the fiscal implications o f the BTML were alarming from the start. The B o l ~ o sAdministration (2002-2006) agreed with the World Bank and IMF to "neutralize" the fiscal effect o f the transfers by making equivalent cuts in spending elsewhere in the national budget. However, in October 2004, the National Assembly revised the timetable and amounts set forth inthe BTML: the transfer was to be 6 percent o f national revenues in2005 and 2006, and then rise directly to 10percent from 2007 5.15 In November 2005, President Bolafios proposed legislation to freeze transfers at 6 percent o f national tax revenues, arguing that the responsibilities residing with municipal governments did not justify additional resources. The ensuing political contest between the Presidentand the legislature resulted inthe transfer rule ineffect today: transfers are to increase by 1percent per annum untilreaching 10percent in2010.94 L 89. Articles 115 and 138 o fthe Constitution declare that the creation o f taxes ("tributos") and approval of user fees (contained in the Planes de Arbitrio) is an exclusive authority o f the legislative branch. Likewise, Law No376 (article 11) prohibits under any circumstances the creation o fnew municipal tax. 90. Decreto 3-95, La Gaceta No21 del 31 Enero 1995. The E31i s 1% o f the property tax base, which is 80% o f the market value or the value inthe property registry. 91. LawNO257 92. Ley de Transferencias Presupuestarias a 10s Municipios de Nicaragua (No466), L a Gaceta No157, Agosto 2003. 93. Law No504 (2004) 94. Law No571 repealed Law No504 and reformed Law No466 (Art.5). 94 B. The BudgetTransfer FormulaandMunicipalOwn-Revenues 5.16 The BTML defines the rules for the distribution o f national revenues among Nicaragua's municipalities. Of the total resources for distribution, the Municipality o f Managua is a case apart, receiving a fixed 2.5 percent o f the total. For the remaining 97.5 percent, the allocation i s determined by four factors. Two o f these factors refer to the condition o f the municipality (population and fiscal equity). The remaining two are measures o f municipal government performance (efficiency in tax collection, and budget execution o f the transfer from the previous year).95 The four criteria are described ingreater detail below. Each receives an equal weight in calculating the overall transfer award. Population (25 percent). A per capita amount is transferred to each municipality in accord with its population, as determined by the National Statistics and Census Institute (FiscalEquity N C ) . (25 percent). The potential tax income o f each municipality is estimated. Next, that per-capita potential is compared to the national per capita average. Municipalities below the national average are to be awarded an amount to bringthem up to the national average, thereby "leveling the playing field" between municipalities. (In practice, the transfer exceeds what i s required simply for equalization because o f the 25 percent weig11ting.1~~ Tax collectionefficiency (25 percent). This performance measure compares the amount that each municipality collects inproperty tax (IBI)against its potential BI,as suggested by the municipal tax base. (For municipalities inthe Atlantic Regions a complement o f taxes is assessed rather than the IBI,given that large land holdings by communal Indian goups severely limit the revenue-generating potential o f the IBIinthese regions.) Execution of transfers (25 percent). This indicator is measured as the share o f the previous year's transfer that was executed (spent) on budget-approved projects or activities. 5.17 Transfers to municipalities in 2003 (prior to the BTML) totaled C$156 million. The estimate for 2007 is C$1,278 million, an increase o f 719 percent since 2003. Two factors explain this growth. First, the revenue share allocated to municipalities has increased from 4 percent to 7 percent in accordance with the schedule approved in the BTML. Second, central govemment tax revenues have grown over this period (see Table 5.2). Tax revenues as a share o f GDP increased inNicaragua by more than 3.5 percentage points from 2001 to 2004, reaching 16.9 percent o f GDP.97 L 95. If actual central govemment revenues exceed (or fail to meet) projections, then the Ministry o f Finance (Ministerio de Hacienda y Credit0 Publico - MHCP) must increase (or reduce) the transfer amount assigned to each municipality inthe course o fbudget execution. 96. Lacayo (2006) calculates that in2006 the amount o f money required to bring all municipalities to the national average was equal to 11 percent o f the total amount for distribution in transfers under L a w No466. However, the distribution formula assigns 25 percent o f the total to this criterion. T h i s result appears to disadvantage municipalities that are only slightly above the national average. 97. International Monetary Fund(2006) 95 Table 5.2 Evolution of Central Government Transfers to Municipalities, 2003-2007 Year Central Increase in Share of Total Munic. Total Transfers Transfers Government Income Income Transfers ifIncome were attributable to Income relative to Transferred to (millions of 2003 increase in share of (millions of 2003 Munic. Cordobas) (millions of Income Cbrdobas) W) (%) Cbrdobas) Transferred (millions of Cbrdobas) 2003 9,378.30 -- 1.7 156.00 156.00 0.00 2004 11,206.30 19.5 4.0 448.25 375.13 73.12 2005 13,505.00 44.0 6.0 810.30 562.70 247.60 2006" 16,020.70 70.8 6.0 961.20 562.70 398.50 2007b 18,257.10 94.7 7.0 1,278.00 656.48 621.52 Note: a/ Budgeted; b/ Projected Source: Moncada (2006), compiled with data from PGR and INIFOM. 5.18 H o w important is the budget transfer as a source o f municipal government revenues? In addition to this transfer, municipal current revenues include the MI,IBI, and municipal service fees and licensing fees.98 In 2005, the transfers mandated by the BTML accounted for only 12 percent o f total municipal current revenues (see Table 5.3). Have the growing budget transfers curbed own-revenue collection bymunicipal governments? This does not appear to be the case.99 Since 2004 when the BTML came into effect, municipal own-revenue collection has increased each year. The cumulative increase in own current revenues from 2004 to 2006 was 90 percent.100 Table 5.3 Compositionof TotalMunicipalCurrentRevenues,2005 Category Percent of total Municipal income tax (IMI) (sales and services) 46% Property tax (IBI) 13% Transfers Law 12% Municipal service fees 11% Licenses and school fees 9% Other 9% Total 100% Source: Compiledby author from data presentedinMoncada (2006); calculated from INIFOM andMHCP data. 5.19 These aggregate statistics mask important differences, however, between the dozen largest municipalities in Nicaragua and the rest. The Municipality o f Managua alone accounts for more than half o f total own-source municipal revenues. Thus, while transfers represented only 12 percent o f total municipal revenues in2005, for 30 municipalities the transfers that year accounted for more than 50 percent o f revenues."' Once Managua i s excluded, overall statistics L 98. Examples o f service fees include registration o f cattle brands, buildingpermits, market rents, civil registration fees, garbage collection and street cleaning. 99. The existing evidence i s insufficient to support a firm conclusion, as it would be necessary to estimate the counterfactual: H o w much own-revenue would municipal governments have collected in the absence o f the budget transfers from central government? 100. Moncada (2006), calculated with data from INIFOM and MHCP. 101. INIFOM(2004) 96 reveal a growing municipal financial dependence on central government budget transfers. As Table 5.4 shows, these transfers as a share o f municipal current revenues (excluding Managua) grew from 32 percent in2003 to 108percent (projected for 2007). Table 5.4 Municipal CurrentRevenue and Budget Transfers, 2003-2007 (excludingManagua) Year MunicipalCurrent Revenue, BudgetTransfers, BIA excludingManagua excludingManagua (millionsof Cbrdobas) (millionsof C6rdobas) A B 2003 490.1 156.0 32 2004 575.5 387.7 67 2005 717.9 770.3 107 2006" 1,063.7 913.8 86 2007b 1,127.5 1,214.9 108 Note: a/ Budget; bl Projection Source: Moncada (2006), compiled with data from PGR and INIFOM. C. MunicipalExpenditures 5.20 The share of total public expenditure budgeted and executed by subnational government i s one important measure o f decentralization. By that metric, as Table 5.5 shows, decentralization clearly has advanced in Nicaragua: the share o f total public expenditure by municipalities has grown from 8 percent in 2003 to 14 percent in 2006. As a share o f capital expenditure, the increase has been even more dramatic: from 13 percent to 22 percent over the same period. 5.21 The allocation of Table 5.5 Share ofMunicipal ExpenditureinTotal Public municipal revenues between Expenditure, 2003-2006 recurrent and capital Expenditure 2003 2004 2005 2006 expenditures i s controlled by Recurrent 5 7 8 8 Capital the central government. The 13 14 15 22 Total 8 10 11 14 Municipal Budget Lawlo* Source: Moncada (2006), from INIFOM and MHCP. establishes eight separate municipal categories (A-H) in accordance with their annual own current revenue. The greater a municipality's own revenue, the greater the share o f its budget transfer that must be assigned to investment expenditure (see Table 5.6). 5.22 Municipalities can use capital transfers as counterpart funding for investment projects or for training public sector personnel. However, capital transfers cannot be allocated to recurrent expenditures. Nor can annual transfers be used as a contractual guarantee for payment or for financial investments. Overall, the share o f transfers devoted to capital expenditure (according to approved municipal budgets) grew from 72 percent in 2004 to 75 percent in 2006 (see Table 5.7). L 102. Law No376 (2001), modifiedby Law No444 (2002). 97 Table 5.6 CurrentRevenues,MunicipalCategories& Budget AllocationRules Category Criteria: Current Annual Revenue Assignment of transfer funds Min. invest- (in cordobas) Investment Recurrent ment as YOof (min.) (max.) total revenue A 150,000,000 (Municipality ofManagua) 90 10 40 B > 10,000,000 & 5 50,000,000 80 20 30 C > 6,000,000 & 5 10,000,000 80 20 20 D >2,500,000 & 5 6,000,000 80 20 20 E > 1,000,000 &5 2,500,000 70 30 10 F >750.000& 5 1,000,000 70 30 10 G >400,000 & 5 750,000 60 40 10 H 5 400,000 60 40 10 Source: Ley del RegimenPresupuestario Municipal. Table 5.7 Allocation of Transfers accordingto MunicipalApprovedBudgets 2004 2005 2006 millions US$ Yo millions US$ % millions US$ YO CaDital 18.45 71.9 38.64 75.1 40.58 74.8 Recurrent 7.20 28.1 12.82 24.9 13.68 25.2 Total 25.65 100.0 51.46 100.0 54.26 100.0 Source: Verkooijen (2006); basedon TRANSMUNI data. Table5.8 UtilizationofBudget TransferAccording to MunicipalApproved CapitalBudgets, 2004-2006 2004 2005 2006 Rank in millions YOof total millions YOof total millions YOof total 2004 & of C$ transfer of C$ transfer of C$ transfer (2006)" Streets, bridges, pedestrian 177.09 60.4% 331.31 51.8% 380.19 54.1% 1(1) lanes, rural roads & highways Sports, comm./cultural ctrs 32.64 11.1% 50.35 7.9% 63.41 9.0% 2 (2) Markets 7.19 2.5% 18.45 2.9% 52.09 7.4% 9 (3) Water and sanitation 8.17 2.8% 28.31 4.4% 33.37 4.8% 7 (4) Rural Electrif. & Lighting 6.43 2.2% 11.37 1.8% 33.01 4.7% 10(5) Housing 8.49 2.9% 31.13 4.9% 24.06 3.4% 6 (6) Municipal Strengthening 9.42 3.2% 37.52 5.9% 17.31 2.5% 5 (7) Drainage 4.32 1.5% 7.19 1.1% 15.88 2.3% 11(8) Municipal Offices 10.06 3.4% 16.18 2.5% 13.25 1.9% 4 (9) Machinery and equipment 1.20 0.4% 55.15 8.6% 11.60 1.7% 14 (10) Latrines 11.45 3.9% 8.80 1.4% 9.74 1.4% 13 (11) Security 0.11 0.0% 0.51 0.1% 9.39 1.3% 16 (12) Healthposts and centers 0.18 0.1% 2.86 0.5% 4.5 1 0.6% 17 (13) Education 3.98 1.4% 17.59 2.8% 3.90 0.6% 13 (14) Cemeteries 7.48 2.6% 4.86 0.8% 0.78 0.1% 8 (15) Telecommunications 0.61 0.2% 0.81 0.1% 0.38 0.1% 15 (16) Environment and agriculture 3.11 1.1% 4.59 0.7% 0.36 0.1% 12 (17) Other 1.23 0.4% 2.21 0.4% 6.86 1.O% d a Insufficient Information 0.16 0.1% 9.37 1.5% 22.08 3.1% d a Total 293.32 100% 638.56 100% 702.17 100% Note: * Rankings added by the author. Source: Verkooijen (2006); based on TRANSMUNI data. 98 5.23 Article 12 o f the Budget Transfers Law states that transfers "preferentially" should be used to fulfill the municipal competencies listed in Article 7 of the Municipalities Law (see Table 5.1 above). That instruction affords considerable latitude to municipal governments. In practice, as Table 5.8 shows, building and/or maintenance o f roads, highways, and related infrastructure consistently absorb over half o f the capital transfer. This expenditure category i s five times larger than any other. Meanwhile, water and sanitation expenditure - a typical local government responsibility- accounts for less than 5 percent o fthe transfer. 5.24 As for recurrent expenditures, the largest cost item, as anticipated, is personnel. According to data from the Nicaraguan Institute for Municipal Development (Instituto Nicaragiiense de Fomento Municipal - INIFOM), in 2004 wages and salaries accounted for approximately 60 percent o f recurrent expenditures (see Table 5.9). Meanwhile, Moncada (2006) calculates that for 2004-2006 the wage bill as a share o f recurrent expenditure was roughly 70 percent. There is womsome evidence that local government employment may have increased by more than a third between 2000 and 2005.'03 However, the fiscal impact is not entirely clear. Wages and salaries as a share o f recurrent transfers evidently have not increased from 2004-2006.'04 Table 5.9 Municipal Expendituresby Category,2004 A B C D E F G H Total (millions of cordobas) Total expenditure 821.4 629.7 171.0 284.1 415.8 112.7 85.2 71.2 2,591.1 Current dxpenditure 338.1 244.7 85.0 107.0 118.6 33.3 28.8 23.2 978.8 Wages & salaries 176.2 160.7 53.9 61.0 70.9 19.6 16.1 14.9 573.3 Products & services 106.2 60.5 18.9 29.9 29.9 9.3 7.1 5.4 267.3 Transfers & donatn. 55.7 3.9 1.3 3.3 2.7 0.6 0.8 0.4 68.7 Other 0.0 19.6 11.0 12.9 15.1 3.7 4.8 2.5 69.5 Capital Expenditure 43.3 385.0 86.0 177.0 297.1 79.4 56.4 48.0 1,612.3 Physicalinvestment 329.0 353.9 79.8 166.0 268.6 73.3 53.5 40.0 1,364.1 Socialinvestments 0.0 30.1 6.0 10.2 18.3 6.0 2.5 3.1 76.3 Other 154.3 1.o 0.1 0.9 10.2 0.0 0.4 4.9 171.9 Source: Sabainiand Geffner (2006), basedon INIFOMdata. D. Accountabilityfor PublicExpenditure 5.25 A number o f reporting requirements are embedded in the nationally-defined rules for municipal transfers and budget formulation and execution. Mayors and municipal councils are obliged by the BTML, as well as the Municipal Budget Law, to report on their annual budget execution to the Ministry o f Finance and Public Credit (Ministerio de Hacienda y Crkdito Publico - MHCP) and the Contraloria General de la Republica (CGR), as well as to INIFOM. Submission o f these reports i s a precondition for a municipality to receive a budget transfer for the subsequent year. Article 10 o f the BTML stipulates that by February 15 o f each year municipal governments must sendthe following documents to the MHCP: a) Municipal budget, approved by the Municipal Council b) Executiono fthe previous year's budget L 103. Gil-Diaz (2006), sectionIV. 104. Moncada(2006) 99 Physical and financial execution o f the PIM Planfor use o fthe coming year's financial transfer Documentation o f special bank account that will be usedto administer the transfer Verification from the Municipal Council that the projects to be financed by the transfers are part o fthe PIM, deliveredto the National System o f Public Investment (Sistema Nacional de Inversi6.n Pziblica - SNIP), and duly approved and included inthe Municipal Budget. Recurrent transfers are transmitted to municipalities inmonthly installments. Following the first two transfers, municipal governments must report on their budget execution o f the previous trimester, demonstrating execution o f at least 65 percent o f those transfers. 5.27 Capital expenditure transfers are allocated in three annual installments (40 percent, 40 percent and 20 percent) at the end o f March, June and September, respectively. Each transfer is contingent, however, on the municipal government submitting to the MHCP a physical-financial report concerningthe projects executed duringthe previous term. 5.28 From this analysis, it is evident that shortcomings infinancial accountability result not Table 5.10 MunicipalDebtwiththe INSS, from a dearth o f reporting requirements, but ByDepartment, as ofMarch31,2006 rather from weak data systems and accounting Department C6rdobas Boaco 355,303 practices. The vast majority o f municipalities Carazo 1,002,145 maintain only cash flow accounting. Most use a Chinandega 2,387,551 schedule o f accounts (plan de cuentas) different Chontales 200,265 from that o f the central government. Frequently Esteli 430,003 the categorization o f expenditure is undisciplined Granada 3,484,086 Jinotega 150,688 -often with recurrent expenditures classified as capital outlay^."^ Leon 602,308 And external audits are not Madriz 171,544 regularly conducted. Plus, there are a myriad o f Managua 138,201,456 financial management data systems in use at the Masaya 30,095 municipal level in Nicaragua. A USAID study Matagalpa 4,973,280 identifiedat least nine.lo6 Nueva Segovia 1,673,401 M A N 1,128,947 5.29 At present there is no detailed accounting M ASari Juan S 31307,359 o f municipal debt. Yet analysis o f a sample o f 293,171 Rivas 311.169 municipalities conducted in 2006 revealed that Total 158,702;77 1 these debts are significant. In2006 the municipal Source: INSS debt owed to the Nicaragua Social Security Institute (Instituto Nacional de Seguridad Social - INSS) alone was equal to roughly 16 percent of the total transfers under the Budget Transfers Law (see Table 5.10).'07 A proper accounting o f municipal debt should also include arrears to L 105. Moncada (2006), analyzing 2005 accounts information from the Office of Municipal Finances and the MHCP, describes as commonplace the use o f the wrong codes and missing documentation, numbers that should match and do not. 106. Casals & Associates, USAID 2004, "Modulo de Asistencia Tkcnica (TAM) Sistemas Integrados de Administracion financiera (SIAF's) en 17 Municipios de Centroamerica." 107. Municipalities are required by law to retain 6.25 percent from the salary o f their employees and send 15 percent of their wage billto the INSS. Many municipalities have beenlate inmaking these payments, accruing debts 100 suppliers and other public entities, including utilities. After estimating overall municipal debt Gil-Diaz (2006) concludes that a significant number o fmunicipalities - though it was impossible to specify with precision, as consolidated debt is not registered by all municipalities - are effectively bankrupt."* 5.30 The Fiscal Decentralization Unit, created in 2005, and the MHCP are stimulating improvements in municipal accounting and improving the tracking and transparency o f municipal expenditures o f budget transfers. The System o f Municipal Transfers (Sistema de Transferencias Municipales - TRANSMUNI) registers online the use o f municipal transfers in a database managed by MHCP.lo9 The next phase, TRANSMUNI 11, i s presently under implementation. It i s intendedto incorporate full municipal budgets, consolidate accounts and link them with SIGFA to produce overall accounts on public sector expenditure. Unfortunately, tracking the quality o fmunicipal expenditure i s still a more remote goal. E. RedressingImbalances:CurrentandProposedReformActions TheStrugglefor Fiscal Neutrality 5.3 1 When expenditure responsibilities are devolved to lower levels of government, experience suggests that maintaining fiscal responsibility can be a difficult challenge. Where the costs o f taxation to finance transfers are largely borne by citizens outside the municipality receiving the transfer - as inNicaragua- the common impulse for municipal officials is to press for larger transfers, not for fiscal restraint. The MHCP, however, must be concerned with the country's overall fiscal balance. 5.32 The budget transfers mandated by the B T M L obviously represent a large additional outlay for the national treasury. To avoid a dramatic fiscal shortfall, the central government has sought to reduce other budget expenditures to "neutralize" the adverse fiscal effect o f the transfers. The MHCP calculates that the government has reached 97 percent o f the target agreed with the World Bank and IMF for neutralizing the municipal transfers. The percentage o f government taxes assigned to municipal transfers has increased since 2004 in accordance with the BTML schedule (6 percent in2005 and 2006, and 7 percent in2007). Meanwhile, according to the PRGF-supported program agreed with the IMF, the share o f transfers that must be neutralized has grown over time (33 percent in 2005; 66 percent in 2006; and 100 percent in 2007 and succeeding years). To calculate compliance, the MHCP position is that the higher percentages for neutralizing transfers apply only to the marginal increase in the overall transfer amount from one year to the next. The lower percentages continue to apply to the transfer amounts inthose respective years (see Table 5.1 1). with the INSS. Gil-Diaz (2006) identifies 90 municipalities with debts owed to the INSS. However, due to data limitations the study could not identify the age o f the debt. 108. The Municipal Budget Regime Law ( N O376) establishes that municipalities can contract medium and long- term debt only with their total debt service payments are less than 20 percent o f their annual current revenues (Art. 21). 109. Municipalities can submit their reports either electronically through the TRANSMUNI website or they can submit a physical report that is received by the MHCP inManagua. 101 Table 5.11 Budget Cuts to "Neutralize" Transfers, 2004-2007 Year Share of Total Munic. Percent of transfer MHCP Maximum B-A Income Transfers to be "neutralized" interpretation of interpretation of Transferred to (millions of inaccordance with budget cuts budget cuts Munic. c6rdobas) IMFagreement requiredto required under ("/I ("/.) "neutralize" IMFagreement transfers (millions of (millions of C6rdobas) c6rdobas) B A 2004 4.0 448.25 0 0.00 0.00 0.00 2005 6.0 810.30 33 267.40 267.40 0.00 2006a 6.0 961.20 66 366.99 634.39 267.40 2007b 7.0 1,278.00 100 683.79 1,278.00 594.21 Note: a/ Budgeted; b/ Projected Source: Data from Table 5.2 and calculated by the author. 5.33 Where has the MHCP identified these cuts? Ideally, financial transfers to municipalities would be neutralized by transferring equivalent service responsibilities from the central government to municipalities, and then reducing the central government budget accordingly. Indeed, ifthe allocative efficiency o flocal government expenditure is truly superior to that o f the central government, then entrusting local government with these expenditures will produce a higher social return. To date, however, the statutory responsibilities o f municipal governments have not increased commensurately with the fiscal transfers o f the BTML.'lo 5.34 From 2004 to 2006, the MHCP was roughly able to "neutralize" budget transfers to municipalities by making budget cuts to capital expenditure in those areas that most closely overlap with municipal activity. For instance, in 2005, the largest share o f funds in municipal capital budgets (44 percent) arrived via transfers from other central government institutions - particularly the Emergency Social Investment Fund(Fondo de Inversidn Social de Emergencia - FISE), INIFOM, the Rural Development Institute (Instituto de Desarrollo Rural - IDR), the Ministry o f Environment and Natural Resources (Ministerio Ambiental y Recursos Naturales - MARENA), and the Ministry o f Transport and Infrastructure (Ministerio de Transportes y Infraestructura - MTI). l1 National budget funding for these institutions has been cut significantly, and will have to be reduced still further inthe years ahead as the size o f the budget transfer to municipalities reaches 10 percent in 2010. Both FISE and IDR now require a degree o f co-financing o f investment projects with local governments, and increased municipal co- financing could reduce central government outlays while maintaining overall public investment levels - provided these projects are highly demanded by municipal governments. However, these options for reducing expenditure cannot fully neutralize the growing fiscal cost o f the BTML. 5.35 MHCP officials concede that for 2008 it will be necessary to reduce expenditure at the national level through a clear definition o f municipal (and national) roles. One step in this direction i s the draft legislation to reform the Municipalities Law (Law No40). The proposed L 110. The position defended by AMUNIC today is that when transfers to municipalities reach 10 percent o f central government revenues that will merely be sufficient for municipal governments to satisfy the roles assigned to them in the Municipalities Law, as revised in 1997 (Law No40/261). There are significant ambiguities regarding the assignment o f responsibilities inthe Municipalities Law. However, in 2002 (the year before the Transfers Law was approved) the budget demand by municipalities for 2003 was for 4 percent o f central government revenues. 111. Meanwhile, the Budget Transfer Law accounted for 41 percent o f municipal capital budgets. See Moncada (2006). 102 revisions include sharper definitions for "exclusive," "concurrent", and "delegated" competencies. Inaddition, functional responsibilities are defined with greater precision, and are explicitly assigned to one o f the three competency categories. As an illustration, the revised text covering municipal responsibility for electricity provision, in the section on "competencias propias," would read: Design and construct electrical distribution grids, provided the cost o f construction, repair, or extension i s not greater than four years o fprojectedbudget transfers to the municipality.''2 As o f June 2007, this legislation has not yet been presented to the National Assembly for consideration. 5.36 A more powerful step to achieve fiscal neutrality would be to balance (growing) budget transfers with new municipal responsibilities for public service provision. However, the present draft legislation to reform the Municipal Law does not include a new assignment of responsibilitiesto municipal governments. The political and legislative hurdles to do so present a daunting challenge, as the Budget Transfers Law itselfprovides that assigning new functions to municipalities shouldbe accompanied by an additional assignment o fresources. Simplijkation and Improvement of theBudget Transfers Law 5.37 The formula to calculate each municipality's share o f the overall budget transfer has four elements: population, fiscal equity, tax collection efficiency, and municipal execution o f transfer funds (described in section B above). D o these factors optimize the incentives for municipal governments to deliver services effectively, with a focus on poverty reduction? Are these factors, and the means for measuring them, perceived as legitimate by local government officials? The answer to bothquestions appears to be a qualified "no." 5.38 The BTML seeks to provide each municipality with sufficient resources to promote the socio-economic development o f its territory. Distributing part o f the transfer according to municipal population is uncontroversial, inprinciple. However, municipal officials have raised serious questions about the reliability o f the 2005 INEC census data. Among a group o f 30 mayors surveyed by INIFOM, nearly halftook issue with the population data.' l3 5.39 Municipalities with less income potential receive a disproportionate share o f the national transfer; but the distribution formula does not include a measure o f poverty. In practice, the "fiscal equity" criterion i s a partial proxy for poverty. Yet it i s very difficult to measure. INIFOM contracted with the Boston Institute o f Developing Economies to develop a Model for Determining the Municipal Tax Potential (Modelo de Determinacidn del Potencial Tributario Municipal - MDPTM). The resulting MDPTM includes socio-economic, labor, and fiscal modules, demanding detailed data on changes inpopulation, labor force, labor migration, as well as municipal revenues and expenditures. However, consultants quickly encountered data L 112. Diseiiar y construir redes de distribucion de energia electrica, siempre y cuando el costo de la construccion, reparacion o ampliacion de estas no sea mayor a1 monto proyectado equivalente a cuatro aiios de transferencias presupuestarias que percibe el Municipio. 113. INIFOM. Informe Final sobre Experiencia y Aplicacion de la Ley 466 de Transferencias Municipales en el 2004, preparado por CINASE: Centro de Investigacion y Asesona Socioeconomica, Bajo contrato UNCDF-GTZ, version Junio 2005. 103 limitations when attempting to apply this methodology, and thus a simplified methodology has been applied to date.'14 Still, the complexity o f measuring Municipal Tax Potential is nearly impenetrable to all but those who apply the formula, leading a perception among some mayors that the "fiscal equity" criterion i s unjust.'l5 5.40 Incontrast, the budget execution criterion is simple to measure. However, the incentive this factor creates is troublesome from a poverty-reduction perspective. The measure captures only whether or not money i s spent. Neither this indictor nor any other in the distribution formula addresses what the money buys or the quality o f that expenditure. It is often difficult (and relatively expensive) to measure the quality o f expenditure. However, it is important to avoid creating an incentive that prompts municipalities to spend badly inthe interest o f spending quickly - thereby ensuring the maximum possible transfer in the following year for "budget execution."' l6 5.41 Inpractice, almost all municipalities are receivingroughly the same amount for "budget execution,'' whether they have greater resource endowments and capacity (i.e., municipalities in categories B & C) or are among the least developed in the country (Le., categories G & H). In 2007, the standard deviation o f the monetary award for "budget execution'' to Nicaragua's 152 municipalities (excluding Managua) i s 0.20, by far the smallest standard deviation o f the four factors inthe distribution formula (see Annex A). 5.42 Like the budget execution measure, tax collection efficiency i s a criterion included inthe distribution formula to spur improved government performance. In 2005, IBIcollections were 13 percent o f total municipal revenues (see Table 5.3 above). Yet the potential revenues from this tax are muchhigher, comparable to the revenues earned from the IMI(46 percent ofcurrent revenues in 2005). During field visits conducted in 2005 for a donor-financed study on the effectiveness o f General Budget Support to Nicaragua, municipal leaders freely admitted that there was a gross under-registration of landholdings (Gasparini, et. al. 2006). Several municipalities visitedby the research team didnot collect any rural property tax. 5.43 Given this broad-based underperformance Table 5.12 Allocations for "Tax in collecting local taxes, encouraging improved IBI Collection Efficiency," 2007 collection i s certainly a worthwhile objective. Municipality Group Group Average (millions of c6rdobasb Additionally, increasing the weight o f a tax B 2.18 collection indicator within the distribution formula C 2.93 could demonstrate to local citizens how their D 2.62 payment o f taxes draws additional resources to the E 2.16 municipality. There are, however, important F 1.89 G 1.16 concerns about the specific design and consequences H 0.91 o f this indicator that need to be addressed. In2005, Source: Own calculations using 2007 budget nearly half o f the 30 mayors surveyed by INLFOM proposal data; Annex XX. L 114. Jiron Z. (2005). 115. INIFOM. Informe Final sobre Experiencia y Aplicacion de la Ley 466 de Transferencias Municipales en el 2004, preparado por CINASE: Centro de Investigacion y Asesoria Socioeconomica, Bajo contrato UNCDF-GTZ, version Junio 2005. 116. The budget execution indicator may disadvantage those municipalities with the least capacity to execute expenditures well, which i s to say the poorest municipalities. 104 criticized the measure o f tax collection efficiency, criticizing the quality o f the data inthe taxable property registry.' l7 Moreover, as applied in 2007, this distribution factor rewards relatively well-off municipalities more than it does Nicaragua's poorer ones. In descending order from municipal category C through H, municipal governments receive progressively less, on average, for "tax collection efficiency" (see Table 5.12). What accounts for this outcome? Is it the (lesser) capacity o f the smaller municipal governments? How can the tax registries be improved? Further analysis is needed to determine steps appropriate to redress this outcome. 5.44 The B T M L established an institutional mechanism to consider improvements to the allocation formula. Article 14 states that a Budget Transfers Commission (Comisidn de Transferencias Municipales - CTM) should revisit the formula every two years. The C T M is composed o f five voting members: 1) President o fINIFOM 2) President o fthe Association o f Municipalities o fNicaragua (Asociacidn de Municipios de Nicaragua -AMSJNIC) 3) President o f the Municipal Association o f the Caribbean Coast (Asociacidn de Municipios de la Costa Caribe-AMURACAN) 4) SNP Director 5) President o fthe National Assembly's Municipal Affairs Commission. Inaddition to these voting members, a CGR delegate sits on the CTM, and all meetings of the Commissionmustbe attended by a delegate o fthe MHCP. Addressing Institutional Capacity 5.45 The growing share o f municipal government expenditure within the public sector (see Table 5.5 above) raises the stakes for improving the capacity o f municipal institutions, particularly in accounting and audit. The Nicaraguan Institute for Municipal Development (INIFOM) was established in the early 1990s to provide technical assistance support to municipalities, including for accounting systems."* However, INIFOM was charged with a diverse mandate, including support for citizen participation, harmonizing actions by other state institutions and coordinating development projects with external cooperation. INIFOM also got involved inproject financing. Moving forward, it may be important for INIFOM to refocus its limited resources on a more narrow set o f priorities. Budget and tax administration would be good candidates for intensive support to municipalities. 5.46 Nicaragua's Fiscal Decentralization Unitplays an important and growing role intracking municipal expenditures and supporting municipal governments to improve their accounting practices. With the MHCP, the Fiscal DecentralizationUnit has implemented TRANSMUNI, an internet-based database that represents an important advance in accounting for municipal expenditures with national government transfers. TRANSMUNI I1 represents an additional L 117. INIFOM. Informe Final sobre Experiencia y Aplicacion de la Ley 466 de Transferencias Municipales en el 2004, preparado por CINASE: Centro de Investigacion y Asesoria Socioeconomica, Bajo contrato UNCDF-GTZ, version Junio 2005. 118. Ley 347; InstituteNicaragiiense de Foment0 Municipal. 105 advance to organize comprehensive data on municipal budgets, and allow for national consolidation o f accounts. To institutionalize and strengthen the role o f the Fiscal Decentralization Unit it would be worthwhile to consider linking this Unit organically to the MHCP as a Directorate. Municipal debt 5.47 Additional analysis is needed to quantify municipal debts and diagnose their sources. To contain any increase in debt obligations the proposed reform to the Municipalities Law is a useful step, as the changes would also assert greater control over municipal debt. For example, Article 82 o fthe revised law would read: 0 All public credit operations o f short, medium, and longterm that the Municipal Government wishes to undertake shall comply with the norms, procedures and requirements established inLaw No477 ... and its regulations.. . Accordingly, in general, the procedures for contractingdebt shall be the following: o Short-term debt shall be approvedbythe MunicipalCouncil andmay only finance expenditures included inthe Municipal Budget o fthe year in which the debt i s contracted. o Medium- andlong-term debt, as well as bondissues, shall be approved by the Ministryo fFinance and Public Credit andthe Central Bank, in conformity with Articles 20 and 21 ofthe MunicipalBudgetRegime Law, and shallonlyfinancethe provisionof publicgoods that correspondto exclusive municipalfunctions("competencias propias").' * (Emphasis added) F. ConcludingConsiderations 5.48 Over the last ten years the polemics surrounding decentralization in Nicaragua have focused primarily on the share o f national income to be transferred to municipalities. Less attention has beendevoted to the appropriate roles o f each level o f government, or to an analysis o f the local government capacity required to carry out given tasks. These issues ought to be at the forefront indesigninga full-fledged decentralization strategy inNicaragua. L 119. Toda operation de credit0 publico de corto, mediano y largo plazo que desee tramitar el Gobierno Municipal debera sujetarse a las normas, procedimientos y requisitos establecidos en la Ley No477 "Ley General de Deuda Publica" y su Reglamento, publicados en L a Gaceta, Diario Oficial No236 y No21 del 12 de diciembre de 2003 y 30 de enero de 2004, respectivamente. Por lo tanto, en lo general, 10s tramites para la contratacion de deuda seran 10s siguientes: a. Las deudas de corto plazo seran aprobadas por el Concejo Municipal y solamente podran financiar gastos cuyo pago este previsto en el Presupuesto Municipal del afio correspondiente a1que se contratan. b. Las deudas de mediano y largo plazo, asi como la emisionde titulos valores, de confonnidad con lo preceptuado en 10s articulos 20 y 21 de la Ley de Regimen Presupuestario Municipal, seran aprobadas por e l Ministerio de Hacienda y Credit0 Publico y el Banco Central y solamente podran financiar la provision de bienes publicos municipales de las competencias propias. 106 5.49 In its 2005 National Development Plan (NDP), the government pledged to design a "national strategy for decentralization linked to the broader process o f institutional reform and modernization." A year later, following a period o f consultations, the government partially fulfilled that commitment by publishing "Decentralization in Action: National Decentralization Strategy for Local Development."'20 However, that document is limited to providing a set o f guiding principles and goals. It is not a strategic document enumerating the specific services subject to decentralization, the processes to be followed, with a timetable, detailed financing, and action steps for specific actors - including line ministries, autonomous agencies, non- governmental organizations, and municipal bodies. For the decentralization process to advance inNicaragua, producing a strategy with all of these characteristics should be the first order o f business. 5.50 Fiscal issues must be a central topic o f concern in the new strategy. International experience demonstrates that without macroeconomic balance, central governments tend to cut back their transfers to municipalities, in spite o f any statutory share o f national income promised for distribution, though sometimes not before encountering major fiscal distress. Transfers to municipal government are increasing sharply in Nicaragua. Yet the responsibilities presently assigned to municipal government date from 1997. The fundamental challenge is to balance the accepted responsibilities o f municipal governments with the funding they receive, and thereby relieve the fiscal strain on the central government treasury. The recent NDP accepts that it is necessary to review the Municipalities Law to make the transfers fiscally sustainable, assigning responsibilities for municipal expenditure equivalent to the resources transferred, thereby permitting a reduction in the National Budget for central government spending on matters that are the clear competence o fmunicipalities.'21 5.51 As Nicaraguans consider which activities should most appropriately be carried out by local government, it i s critical to quantify their costs, as well as the administrative demands those roles place on central and local governments. For instance, in many decentralized government systems maintenance o f physical infrastructure ineducation and primary health care falls to local government; but that i s not presently the case inNicaragua. How much do those activities cost? How would (revised) municipal roles fit within the sector-specific service delivery models in Nicaragua? And how complex are the administrative demands (e.g., contracting, personnel management, oversight, accounting, etc.) for carrying out any o f these new mandates effectively? 5.52 Assigning roles to municipalities in Nicaragua is made more challenging by the country's tremendous territorial diversity. Managua accounts for nearly 20 percent o f the country's population, with a population density o f almost 4,000 hab/ km2. Meanwhile, municipalities in Category F average fewer than 15 hab/ km2.These statistics underscore the dramatically diverse demands for public services across Nicaragua's municipalities, and their sharply different capacities. Naturally, this diversity has important implications for the technical assistance and training required to support weaker municipalities to develop their administrative, technical, and financial capacities. In addition, this diversity suggests flexible arrangements for service delivery should be considered. That flexibility i s already reflected in the Municipalities L 120. "Descentralizacion en Accion: Estrategia Nacional de Descentralizacion para el Desarrollo Local (ENDDL)"; and Decreto No. 45-2006: "Politica Nacional de Descentralizacion Orientada a1Desarrollo Local" Cjulio 2006). 121. The Joint Financing Arrangement of the donor-supported Partnership for General Budget Support also requires the executive to ensure fiscal neutrality by transfemng new expenditure responsibilities to local government inline with the increaseinthe volume offiscal transfers to municipalities. 107 Law, but is underutilized. Law No40 (Art.9) provides that Municipal governments may contract with other government actors to provide services assigned to municipalities; and they may celebrate contracts or sign concessions to carry out services, while continuing their normative and oversight rolls.'22 5.53 A commonly-accepted argument for decentralization is that by shifting the locus for government decision making closer to citizens, choices about the use o f public resources will be better aligned with locally-defined preferences. Inmoving the decentralization agenda forward, a process o f consultation and dialogue with mayors, AMUNIC, and civil society organizations will be critical to encourage a consensus around a vision for municipal governments as key protagonists in Nicaragua's development. Decentralization can encourage citizen-centered development that includes concerted efforts to ameliorate poverty.123 5.54 There are several areas where the World Bank and bi-lateral donors may be able to provide support for Nicaragua's ongoing decentralization process, should the government consider that support opportune. These areas include: (i) sharing international experience as the Ortega administration considers a detailed decentralization program, and comparative advantage o f each level o f government; (ii) carrying out costing exercises for specific competencies; (iii) benchmarking o f municipal capacities; and (iv) supportingprograms to enhance the capability o f municipal governments to record, control and evaluate their expenditures. L 122. Law No40 (Article 9): Ene l ejercicio de su cornpetencia, 10s Municipios podran: a) Contratar con otras instituciones del Estado la prestacion de servicios que por su naturaleza puedan ser realizados por ellas de una mejor forma, observando su correcta ejecucion; b) Celebrar contratos uotorgar concesiones previa licitacion con personas naturales ojuridicas, de caracter privado, para la ejecucion de funciones o administracion de establecimientos o bienes que posea a cualquier titulo, sin menoscabo de ejercer sus facultades normativas y de control. En ambos casos, 10s contratos y concesiones deberan ser otorgados de conformidad con la Ley de Contrataciones del Estado, Municipalidades y Entes Descentralizados, ser ratificados por el Concejo Municipal y asegurar la calidad y equidad en la prestacion del servicio. 123. Gasparini et. al. (2006) found there was no strong desire among the municipal officials they interviewed to assume new responsibilities in key sectors - such as basic education and primary health care - that can have the greatest impact on poverty reduction. 108 CHAPTER V I IMPROVING GOVERNANCE THROUGH PUBLICEXPENDITURE MANAGEMENT REFORM 6.1 This chapter assesses the overall performance o f public financial management (PFM) institutions and systems in Nicaragua, based on an international framework o f reference. It begins with an overview o f the legal and institutional framework for public financial management in Nicaragua, and concludes with a review o f the progress made since 2004 in modernizing the PFM systems and discussion o fthe most important shortcomings that remain. A. The Legal and InstitutionalFramework of Public FinancialManagement 6.2 The legal instruments o f public financial management are set forth primarily in the laws and regulations listed inBox 6.1. The legal framework was strengthened in a significant manner when the Financial Management and Budget Regime Law (Law 550 o f August o f 2005, as amended) came into effect. Law 550 governs the PFM system and procedures related to the formulation, approval, implementation, control, evaluation and execution of the PGR and o f the budgets o fthe public sector entities. Box 6.1 MainLaws andRegulationsof Public FinancialManagement The Political Constitution o f 1987 (amended in 1995 and in 2000), in its Articles 112-115, sets forth the responsibilities o f the executive and legislative powers regarding the budget process and the creation o f taxes. In its Articles 154-157 establishes the Office o f the Controller General o f the Republic as the entity that governs the control system o fpublic administration. The Financial Management and Budget Regime Management Law (Law 550 o f 2005, as amended by Law 565 o f 2005), governs the public financial management system andnational budgets. Each annual Law o f the General Budget for the Republic (PGR) specifies the revenue and expenditure budgets (and the precise modifications that the National Assembly has included inthe bill submitted by the executive power), the financing o f the deficit, and some specific rules that apply to the year inquestion. The Ministry o f Finance and Public Credit (MHCP) issued every year Rules and Procedures o f Budget Implementation and Control, with detailed instructions for the implementing entities. The State's Public Contracting Law (Law 323 o f 2000, as amended by L a w 349 o f 2000) sets forth the system o fprocurement and public contracts. The Public Debt General Law (Law 477 o f 2003) regulates public indebtedness and guarantees. The Organic Law o f the Office o f the Controller General of the Republic and the Government Control System (Decree 625 o f 1980, as amended by Law 361 o f 2000) governs governmental audit and internal controls. The CGR issued Technical Internal Control Norms (NTCI) in2004. The Law on Organization, Competencies and Procedures o f the Executive Power (Law 290 o f 1998) governs the organizational framework o f the executive power. The Law on Budget Transfers to Municipalities (Law 466 o f 2003) sets forth the levels and the formula o f transfers from the PGR to the local governments. The Law on the Municipal Budget System (Law 376 o f 2001) contains the budget rules for the municipalities. 109 6.3 Institutional framework. Pursuant to the Constitution, the President o f the Republic formulates the Annual Bill o f Law o f the PGR, which must be submitted to the National Assembly to be discussed and approved. The Assembly can modify the Bill o f Law, but cannot create any extraordinary ex enditure if not by law and by means o f creating and fixing the resources to finance them.I2' The Assembly must be informed o f the execution o f the Annual Law o f the PGR. 6.4 Under the same Constitution, the budgets of autonomous and government entities and State-owned enterprises are included in the Annual Law o f the PGR for information purposes. The budgets o f entities decentralized by function, enterprises and financial institutions o f the State, and other autonomous entities, are formulated, approved and executed according to their own laws. However, Law 550 introduced information requirements to the mentioned entities on their budgets, modifications and execution, with compliance linked to the receipt o f transfers financed bythe PGR. 6.5 Municipalities (the country's political administrative division basic units) enjoy political, administrative and financial autonomy. Their financial management i s governed mainly by the Law on the Municipal Budget System (Law 376 o f 2001), which establishes that the Major is responsible for drafting the Municipal Budget, and the approval thereof is entrusted to the Municipal Council. On the other hand, Law 550 sets forth information requirements similar to the other entities that do not form direct part o fthe PGR (see precedingparagraph). 6.6 The governing body o f the country's public financial management system is the Ministry of Finance and Public Credit (MHCP), and to this end, it has four normative directorates for each o f the subsystems: budget, treasury, public credit and government accounting. As such, the MHCP is in charge o f implementing the financial management system in public sector institutions, formulating the budget policy and the annual laws o f the PGR, preparing rules and procedures to execute andcontrol the budget, and issuingexecution reports o f the PGR, amongst other responsibilities. Likewise, the MHCP governs the public procurement system. 6.7 According to Law 550, the MHCP is in charge o f coordinating the annual budget formulation and the medium-term programming o f public investments, with the cooperation o f public sector entities and o f the National Public Investment System (SNIP). The SNIP encompasses the entities, mles and procedures for the formulation, implementation and evaluation o f the public investment program (PIP) and maintenance o f the investment project portfolio. According to Presidential Decree 61 o f 2001, the Office o f the Technical Secretary to the Presidency (SETEC) is the agency in charge o f management, communication and coordination o f the SNIP, and to this end, it has the support o f the Public InvestmentUnit (UP) and an inter-institutional Investment Technical Committee (CTI).'25 SETEC i s in charge o f L 124. As with other laws, the President has the power to veto, partially or totally, the Annual Law o f the PGR approved by the Assembly, but the Assembly can reject the veto with the minimum vote o f half plus one o f the deputies. 125. The CTI is formed by representatives o f SETEC, the Central Bank o f Nicaragua (BCN), MHCP and the Secretariat o f Economic Affairs and Cooperation o f the Ministry o f Foreign Affairs (MINREX). It has the following responsibilities: (i) to assess the consistency o f projects proposed to the Budget by public institutions, against the projections on revenues and expenditures, and the anticipated availability of external resources; (ii) to ratify and/or modify the technical recommendation issued by the specialists o f the UIP and submit to the consideration o f SETEC the proposal o f the annual and multi-annual Public Investment Program; (iii) to review reports o f physical and financial monitoring o f projects under implementation; and (iv) to recommend intermediate and ex post evaluations for selected groups ofprojects and report them to SETEC. 110 submittingthe annual PIP to the economic cabinet and to the MHCP (to be incorporatedinto the PGR). 6.8 Inaccordance with the Constitution, the Office ofthe Controller General ofthe Republic (CGR) i s the autonomous agency that governs the system to control public management and to scrutinize Cfiscalizar) the goods and resources o f the State.'26 Its scope o f operation comprises all the public sector. Some o f its functions are the performance o f external audits (financial, compliance, operational, integral and special audits); evaluation o f internal audits; establishing rules o f internal control; setting liabilities (responsabilidades) o f an administrative (due to breaches to the legal provisions) and civil (due to economic loss) nature, as well as criminal allegations; approving exceptions to mechanisms o f the Public Contracting Law; and the reception andverification o f asset declarations under the IntegrityLaw (Law 438 o f 2002). 6.9 The "National System o f Participation and Agreement" provides mechanisms for government, civil society, private sector and the international community dialogue to define goals and priorities o f public policies, laws and strategic development plans. This system is structured in three territorial levels (municipal, departmental and national) and in four areas o f governance (political-administrative, technical-executive, participation and agreement, and coordination o f c~operation).'~~ Inconnectionto the subject-matter ofthis report, the Economic and Social PlanningCouncil (CONPES) has particular significance within the system. 6.10 The CONPES i s a consultative forum foreseen by the Constitution to support the President o f the Republic in the drafting o f economic and social plans. The President himself presides over the Council, which in turn is formed by re resentatives o f civil, labor, entrepreneurial, guild, community and municipal organizations. Amongst its functions, the CONPES makes recommendations on the bill o f the Annual Law o f the PGR, the investment process and public expenditure. It should be mentioned that the time span for the CONPES to review the budget before it is submitted to the Assembly has been very limited and, when it has made recommendations, these recommendations in general have not been implemented by the executive power or by the National Assembly.'29 The executive, in turn, has questioned the feasibility o f implementing said recommendations. Even so, the existing institutional mechanism that allows for the described communications i s a positive attribute o f the system o f participation. 6.11 Financial Manazement System. The Nicaraguan system i s based on normative centralization and operational decentralization, with integration o f the system components. The subsystems regulated under Law 550 are those on budget, treasury, public credit and government accounting. The "correlated systems" linked to the financial management system are those regarding contract management, civil service and administrative career, administration o f goods, andthe SNIP. L 126. The CGR is managedby a Superior Council o f five members, elected by the National Assembly for a term o f 5 years. 127. Government o f the Republic ofNicaragua (2005). 128. InJanuary o f2006, approximately 75 representatives formedthe CONPES. 129. CISAS (2005). 111 6.12 For the purposes described, the main facilitating instrument has been the Financial Management and Auditing Integrated System (SIGFA)'30~hi~hconstitutes the information system for processing transactions o f the budget cycle and all correlated factors (rules, processes, training, technological platform, reports, etc.). SIGFA enhances budget management at different levels: (i)it contributes to fiscal discipline by providing timely information on the implementation o f the budget, and establishing limits to the level o f expenditures, according to budget and cash programming; (ii)it increases operational efficiency by streamlining and standardizing processes; (3) it supports internal and external controls through safeguard processes and audit trails; and (iv) it contributes to transparency by allowing the timely publication o fbudget execution and other fiscal reports. 6.13 However, the potential o f the benefits mentioned above depends upon the coverage o f the system or its linkages with other systems inplace. To this effect, SIGFA permits recording o f all revenues and expenditures o f the PGR, but at the level o f individual transactions it basically covers the central administration. The transfers from the PGR to other entities o f the public sector are made mostly through other systems o f execution, treasury and accounting. And the coverage o f correlated systems (procurement, civil service and others) is even smaller. As it i s normal in the implementation o f information systems, the extension o f the coverage (both in technical modules and institutions) i s supposed to happen gradually, and the MHCP i s moving in that direction. 6.14 National Development Plan. In 2005, the Government o f Nicaragua presented the National Development Plan 2006-2010,13' as a second generation Poverty Reduction Strategy Paper (PRSP). The PND is based on the PRSP, but highlights economic activities and the increase o f employment, whereas the PRSP focused more in the measures to improve social indicators. 6.15 The PND focuses on four strategic areas: (i)economic growth to reduce poverty; (ii) development o f human capital and social protection; (iii)productive, social and public infrastructure; and (iv) governance and State reform. The PND is formulated within a medium- term macro framework where sensible economic policies, including fiscal discipline, would aid in supporting an improvement of the key indicators: growth would reach an annual average of 4.3 percent in the period 2005-09, whereas inflation would gradually decrease approximately 3 percent per year. The PND is the product o f an extensive consultation at local and sector levels, described by the Government as a participatory formulation process. 6.16 The donors have expressed their support to the PND, and have made important gains in harmonizing external assistance. This progress includes the signature with the Government o f Nicaragua in May o f 2005, o f the Joint Financing Arrangement (JFA) to Support the General Budget,13* which includes a Performance Assessment Matrix (PAM) with detailed commitments made by the Government inconnectionto policies and indicators consistent with the PND. L 130. The SIGFA integrates budget formulation units (SIGFAFOR), of budget expenditures implementation (SIEP), of fiscal payroll (SNF), of revenues budget implementation (SIER), of accounting (SICO) and o f treasury (SITE). The automatic links with other systems are still being developed: procurement and state contracting (SICCE), civil service (SISEC), properties ofthe public sector (SIBE), public debt (SIGADE) andpublic investment (SNIP). 131. Governmentofthe Republic o fNicaragua(2005). 132. The Budget Support Group (BSG) that subscribed the JFA is formed by Germany, Finland, Norway, The Netherlands, DFID, Sweden, Switzerland, the EuropeanCommissionandthe World Bank. 112 6.17 Under the area o f governance and State reform, the PND foresees the continuation o f improvements in public financial management (PFM), including mechanisms to implement and monitor poverty reduction expenditure. The specific strengthening areas were classified under: (i) financial management; (ii) formulation, implementation and monitoring o f fiscal policies; (iii) technical management o f the Government; and (iv) planning and participatory monitoring o f public policies (see Box 6.2). 6.18 The incoming authorities have indicated that they are determined to take ownership o f the reform and development agenda, and would like to see a more focused and feasible policy/actions matrix agreed upon for performance monitoring. Inthis context, they are planning to review and revise the longer term development strategies identified in the National Development Plan in order to better reflect the new administration's development priorities. These revisions will bereflected inthe next PRSPProgress Report. Box 6.2 National Development Plan Herein are the main reforms contained in the National Development Plan for the period 2006-2010 that relate directly to public sector financial management. To strengthen financial management:i)to consolidate and extend the integrated financial management system throughout all levels o f the Government, including universities, autonomous entities, decentralized entities and State-owned enterprises; ii)to channel and register all funds from donors to public sector entities in the Single Treasury Account (CUT), in coordination with the signatory agencies o f the Government o f Nicaragua and providers o f external assistance; and iii)the standard procurement and contracting documents will be used by all agencies o fthe central Government, 42 municipalities, 16 autonomous agencies and other institutions. To strengthenthe formulation, implementationand monitoring of fiscal policies:i)to review pension reformto reduce fiscal impact; ii)to reformthe legal framework for parametric aspects of the social security system; iii)toapproveandkeepineffect(a)aTaxCodeprovidingforasystemoffinesandpenalties,andspecificpowersto obtain and manage third-party information and (b) a Customs L a w consistent with the Tax Code and the Central American Customs Code (UAC); iv) to approve and regulate the Administrative Career Law o f the revenue and customs directorates (DGI and DGA) consistent with the Civil Service Law, and to set forth a new customs technological system, including outsourcing, equipment and communications; v) to approve the Financial Management Law according to good international practices; vi) to enact legal framework to prevent excessive fiscal deficits, the adoption o f stable fiscal policies and the international accounting standards o f the public sector through this law andrelatedlaws; andvii) gradual formulation o fthe medium-termbudget framework. To improve the productivity of the technical executive management of the Government: i)to implement the Civil Service, incorporating 5,000 employees in 2007 to the Administrative Career based o n transparent procedures; ii)to update Law 290 in order to provide the Executive Branch a more expeditious and fimctional organization, according to the PND. To strengthenthe planningand participatorymonitoringof publicpolicieswith the following actions: i)improving the coordination amongst providers ofexternal assistance; ii)strengthening the National Public Investment System; iii)strengthening and disseminating the system to evaluate and monitor public policies; iv) strengthening coordination capacities on communication and civic participation; and v) strengthening Departmental and Territorial Cabinets, increasing their decision-making powers. Source: Government o f the Republic o fNicaragua (2005). 6.19 Allocation of resources. Nicaragua has made progress in the implementation o f its poverty reduction strategy (PRSP).*33 Since adoption o f the PRSP in 2001, central government expenditure inpoverty reduction increased from 10.4 percent o f GDP in2002 to 12.3 percent o f L 133. IMFand World Bank (2006). 113 GDPin2004 and 2005. Eventhoughprogress has been made, it seems that budgetprogramming needs to get in line with the goals o f the PND. Recent efforts to establish a medium-term expenditure framework and to improve the harmonization o f external assistance go in that direction. Futurerefinement o f the medium-termfiscal policy framework should help to improve the connections between budgetprogramming and PND goals. However, these efforts are limited due to significant earmarked budget allocations (see Section B), which, if not reduced, could limit the scope for improvementsinthe targetingo fprograms to reliefpoverty. B. Performanceof Systems, Processes andInstitutions 6.20 This section assesses the essential elements o f the public financial management (PFM) system, based on an international framework o f reference that addresses seven dimensions: i) credibility o f the budget; (ii) comprehensiveness and transparency; (iii) planning; (iv) budget predictability and control in budget execution; (v) accounting, recording and reporting; (vi) external scrutiny and audit; and (vii) donor practices that affect PFM.'34 Credibility of the Budget 6.2 1 Some parameters may indicatewhether the budget is realistic enough and implementedas planned. To that effect, this section focuses on four indicators: (i) aggregate expenditure out-turn, (ii)composition ofexpenditure out-tum, (iii)aggregate revenue out-turn, and (iv) stock of payment arrears. 6.22 Expenditures. The Table 6.1: DeviationinExpenditureBudgetExecutionand capacity to implement the Variance inCompositionofPrimaryExpenditure (percentage o fthe expenditureoriginally budgeted) budgeted expenditures within 2003 2004 2005 the total amounts originally Total expenditure deviation 9.2 1.9 16.2 anticipated i s a key factor in Deviationinprimary expenditure, net o f 4.1 5.2 10.2 the capacity o f the projects (a) government to maintain fiscal Absolute variance incomposition (b) 5.0 6.4 10.4 discipline. As shown inTable Difference (b)-(a) 0.9 1.2 0.2 6.1, recent performance in Source: Own estimates. based o n MHCP. this regard has been reasonable: o f the three years reviewed, only in 2005 did the primary expenditure (not including projects with external financing) exceed the initial budget over 10 percent. In terms o f total expenditures, the deviations are generally greater, which is explained bythe over-execution o frevenues derivedfrom taxes (as explainedhereinbelow) and from loans and grants.'35 6.23 Composition of expenditures. Credibility o f the budget can also be assessedby the extent to which the entities receive the resources initially planned. As shown in Table 6.1, in none o f L 134. This assessment is based primarily on PFM performance measurement analytics undertaken through a partnership of the Government of Nicaragua with the BritishDepartment for International Development (DFID), the European Commission (EC), the Inter-American Development Bank, and the World Bank. The performance measurement framework was developed by the Public Expenditure and Financial Accountability (PEFA) partnership. 135. In 2004, the deviation in total expenditure was smaller than the deviation in primary expenditure (net of projects) due to the significant reduction ininterest spending when the HIPC completion point was reached. 114 the three years revieweddidthe variance incomposition ofprimary e~penditureexceed a total ' ~ ~ deviation o f over 2 percent. This basically means that, setting aside the effect o f deviations from the total expenditure that affects all entities, the latter do not show significant changes in execution o ftheir expenditures with respect to the amounts originally allocated. 6.24 Revenues. The comparison between budgeted and executed receipts may give a general indication on the quality o f revenue planning. As can be seen in Table 6.2, recent performance has been good interms o f availability of funding: innone o f the three years reviewed did actual internal collections fall below the budgeted amounts. On the other hand, it is clear that the forecasts have been consistently conservative, which may point at weaknesses inthe preparation ofthe projections reflected inthe revenue budget.'37 Table 6.2 Aggregate InternalRevenue Execution (percentage ofthe revenue originally budgeted) 2003 2004 2005 Tax revenues 105.8 109.9 110.9 Non-tax revenues 120.7 168.5 98.6 Total 106.8 113.2 109.9 Source: Own estimates, based on MHCP. 6.25 Payment arrears. The identification and control o f payment arrears has great importance, because they can constitute a form o f non-transparent financing that would affect credibility in budget information -and the cost o f doing businesses with the government-. As shown in Table 6.3, the levels o f floating debt recorded at the closing o f three recent fiscal years are minimal (less than 1 percent of total expenditure^),'^' and it is inferred that payment arrears would be even less. However, it must be noted that: (i) subsidiary records o f accounts payable with age no profiles are produced; and (ii) transfers and subsidies o f the PGR to other entities o f the public sector are recorded simultaneously as accrued and paid when the transfers are made (as opposed to when the expenditures financed bythe transfers are actually incurred). Table 6.3 RecordedFloatingDebt (percentage of accrued expenditure) 2003 2004 2005 Accrued disbursements not Daid 0.1 0.3 0.3 at the closing o f the fiscal year Source: MHCP. 6.26 Conclusions. I n order for the budget to be a tool for policy implementation, it is necessary that it is realistic and implemented aspassed. 6.27 From2003-2005, expenditure execution usually exceeded the amounts budgeted, posing a fiscal discipline risk. However, this risk did not materialize because the over-execution o f L 136. The variance in composition o f primary expenditure (net o f projects) i s calculated as the absolute weighted average deviation between the executed and original budgets, as percentage o f the latter, o n the basis o f the administrative classification (20 budget entities). 137. Anecdotal reference points to the perverse incentive created by the high level o f earmarked funds estimated as percentage o f the budget (see Chapter I). 138. Also, Law 550 imposes a maximum limit to floating debt, equivalent to 5 percent o f current revenues from January to November o f the fiscal year. 115 expenditures corresponded mainly to domestic revenues, grants and concessional loans that also exceeded budget forecasts. Evenwhen inboth cases budget credibility was affected, it should be noted that their effects were distributed in a relatively uniform manner among the different implementingentities, and there areno significant concerns onpayment arrears. 6.28 The credibility o f the budget i s a critical feature o f the ability o f the government to control fiscal discipline and prevent shortcomings in the financing o f sectoral budgets. It is expected that with the recent enactment o f the Financial Management and Budget Regime Law (Law 550), which sets forth strict limits to budget modifications, budget outcomes will increase the reliability o f the budget as policy tool. Comprehensivenessand Transparency 6.29 This section examines budget comprehensiveness and the oversight o f aggregate fiscal risk, as well as public access to fiscal and budget information. 6.30 Budget Classification. A strong classification system is required for meaningful public expenditure monitoring. The system used in Nicaragua for formulation, execution and reporting is based in four main budget classifications: administrative (institutional), economic (per type o f expenditure), per source o f financing, and pr~grarnmatic.'~~The classification system can produce information that approximates international standards, e.g., the programs have certain similarityto functional groups under GFSM/COFOG.'40 6.31 As is well known, a main issue in the application o f the system is the incorporation o f expenditures o f a current nature into investment projects classified fully as capital expenditures. Inthis subject matter, the rules andtheir applicationarebeingrevised. 6.32 Budget Documentation. In order for the legislative branch to execute its functions o f oversight and approval, budget documentation should allow a comprehensive vision o f fiscal projections, budgetproposals and the outcomes o f preceding years. Law 550 establishes that the following budget documentation is to be submittedto the National Assembly: (i) the bill o f law, including general provisions, the revenue budget, the expenditure budget and the annexes thereto; (ii) the introductory message to the bill o f law, including the list o f objectives, estimates, statistics, macroeconomic context, projections, assumptions and other information used to preparethe budget; and (iii) medium-termbudgetframework. the 6.33 Apart from the detailed information on revenues and expenditures, some selective characteristics o fthe budget documentation are described herein:I4' macroeconomic assumptions include inter alia estimates o f growth, inflation and . exchange rate; the estimate on fiscal deficit describes the anticipated composition o f its financing; but not the details on debt stock and financial assets; L 139. The classifications also allow for aggregation by general fimctions and other specific purposes, e.g., expenditures related to the poverty reduction strategy. 140. For purposes o f this report, the international standard for classification systems is the Government Finance Statistics Manual (GFSM) issued by the IMF, which incorporates the Classification o f the Functions o f Government (COFOG) supported by the UN.InNicaragua, fiscal statistics are basedon GFSM 1986. 141. The list makes reference to budget documentation per se, on the basis of the 2006 budget. As i s usual invery country, the MHCP manages additional information to prepare the budget. 116 . even though it i s not part o f the budget documentation per se, the information on budget outturn o f the preceding period i s available through the respective execution report; conversely, the budget documentation does not include budget figures for the . current year (modified or estimated) in the sameformat as the proposal; summarized budget data on revenue and expenditure, for the current (estimated) and . prior years, i s included for the main classifications used. the budget implications o f main new policies are discussed, albeit in a very general manner. 6.34 Coverage of government overations. Fiscal information (understood as the budget, the execution reports and the financial statements) should include all budget and extra-budget activities to allow a complete picture o f public revenues, expenditures and financing. To this effect, Law 550 requires an extensive coverage o fbudget documentation, which must include the General Budget for the Republic (the PGR includes the three branches o f government and the constitutional entities) and the budgets o f decentralized entities, enterprises and financial institutions o f the State, and other autonomous agencies dependent upon the PGR. The documentation meets to a great extent with this provision, with some exception^.'^^ 6.35 However, the annual budget execution report for 2005 covered only the PGR (including transfers to other entities, but not in their revenues).143 And, as noted later in the chapter, the public sector financial statements have not been issued yet. On the other hand, budgets and execution reports do include ample information on projects financed by providers o f external assistance, even though it is possible that some minor grants still escape the system.'44 6.36 Intergovernmental fiscal relations. Even though this report focuses on the financial management o f the central government, it i s worth analyzing three critical elements o f intergovernmental fiscal relations: the transparency o f rules for the horizontal allocation among sub-national governments o f transfers from the central government, the timeliness o f provision o f information to local governments for their planning processes, and the gathering o f budget data to allow the preparation o f consolidated fiscal information for the general government. As explained below, the Nicaraguan system performs inadequately in all three aspects; see also para. 9.26. 6.37 First, while the Law on Budget Transfers to Municipalities (Law No. 466 o f 2003) provides for a formula to distribute the annual transfer to municipalities, the formula is knownto be too complex, and no significant efforts have been made to disclose better its application for L 142. An outstanding absence inthe 2006 budget documentation is that o f the budgets for universities and centers o f higher technical education. The transfers from the PGR to these entities represented 4.3% o f the consolidated expenditure budget o f the public sector in 2006, but since there i s no information available o n their own revenues, the percentage that escapes from the budget documentation cannot be measured accurately. 143. According to the budget documentation o f 2006, revenues of decentralized entities by function and other autonomous agencies (except universities) -that are not transfers from the central government- amount to C$4,877 million (most of them corresponding to contributions to the Nicaraguan Social Security Institute), i.e. approximately 23 percent o f central government revenues. 144. For purposes o f this report, the concept o f in-kindgrants -which comprise assistance granted through direct administration by the cooperating agencies or by agreement between these agencies and non-government organizations (NG0s)- i s not covered inthis section. 117 the benefit o f oversight from civil society and the beneficiaries themselves. On the other hand, the law does not devolve to municipalities the expenditure responsibilities consistent with the increase o f revenue that the same law sets forth. Therefore, a situation has arisen where, notwithstanding the existence o f the formula, the central government continues to implement local expenditures with an unclear division o fre~ponsibilities.'~~ 6.38 Second, the information on transfers to municipalities i s made available to them on October the 15th o f every year, date on which the PGR i s submitted to the National Assembly. However, since this date coincides with that o f submitting sub-national budgets to Municipal Councils, local governments are not able to introduce modifications at this stage. 6.39 Finally, Law 550 introduces requirements for the municipalities to provide data on their budgets and execution to the MHCP through the Nicaraguan Institute o f Municipal Development (INIFOM), in order to allow general government budget consolidation. But the latter has not been carried out. It should be noted, though, that the 2007 budget norms link transfers to municipalities to previous reporting on execution through a compilation platform (TRANSMUNI). 6.40 Oversight of aggregate fiscal risk. Ingeneral, the central government should monitor and take timely actions regarding the fiscal risks with national implications that could arise from the activities o f sub-national governments, autonomous government agencies andpublic enterprises. Inthis area, recent legislation (Law 550) imposes information requirements for quarterly and annual budget execution, as well as annual financial statements, to decentralized agencies, state- owned enterprises, other autonomous agencies dependent upon the PGR, andmunicipalities. The implementation o f mechanisms to facilitate compliance with these requirements is underway, albeit not yet reaching the point where overall fiscal position and risks are consolidated and monitored systematically. 6.41 Public access to key fiscal information. Law 550 requires that the general and sector budgets, as well as the monitoring reports should be put at the disposition o f citizens through information and communication media available, at the latest fifteen days after their issuance. An important medium that has been recently used by the MHCP to disseminate such information i s the Citizen Access Portal k), where the budget documentation, the in-year execution reports and the annual execution reports o f the PGR are published. Notwithstanding o f these advances, some critical information i s not yet easily available to the public. 6.42 To start with, the public sector financial statements have not been published yet. Second, the Office o f the Controller General (CGR) has not yet finalized an audit on the PGR execution report. Third, the information on tender processes and public contracting is fragmented, with each public institution handling award data without necessarily or obligatorily communicating them to the ContractingDirectorateo fthe MHCP, which makes it difficult for the public to have access to the pertinent information. This situation is being gradually addressed through the State's Procurement and Public Contracts Integrated System (SICCE). Finally, the information on resources available to primary service units i s scarce and uneven amongst different sectors, although certain aggregated informationi s available at the central level. L 145. See a detailed discussion o f this subject inWorld Bank and IMF (2004). 118 6.43 Conclusions. Comprehensiveness of budget is necessary to ensure that all activities and operations of governments are takingplace within the government fiscal policy framework, and are subject to adequate budget management and reporting arrangements. Transparency is an important element that enables external scrutiny of government policies and programs and their implementation. 6.44 The budget information inNicaragua i s ample, based on a good classification system,'46 and has a comprehensive institutional coverage as far as the budget document per se i s concerned. But that is not the case with the execution reports which, up to now, include only the General Budget o f the Republic (PGR) and not the execution o f revenues from the rest o f the central government. At the same time, public access to information is limited due to the absence o f certain key information (financial statements, audit reports, reports o f resources received by service-delivery units, and comprehensive publication o f procurement and contracting processes). Likewise, the limited transparency o f the fiscal decentralization system and the difficulty o f monitoring the aggregate fiscal risk o f the public sector are areas in need o f improvement. 6.45 The ability o f the government to control aggregate fiscal discipline o f the public sector could be affected if fiscal neutrality o f transfers to municipalities is not attained, and if the mechanisms to compile and consolidate all public finances are not implemented. On the other hand, the scrutiny on the government's financial management -a key element to improve the strategic allocation and operational efficiency o f the use o f funds- is limited in view o f the absence inthe public domain o fthe aforementioned key information. 6.46 In the short term, improvements can be expected with the preparation of execution reports for all budgets and of financial statements (both are requirements stipulated by Law 550), the revision o f rules and their application vis-a-vis current expenditures in investment projects, the implementation o f transparency inprocurement through the State's Procurement and Public Contracts Integrated System (SICCE), and the publication o f customized financial information on resources received andused by service-delivery units, particularly inthe education and health sectors. To the extent that decentralized entities (by function and territory) comply with the requirements o f Law 550 on provision o f information, the monitoring o f aggregate fiscal risk will be facilitated, although the creation o f capacity in the MHCP to carry out this task may possibly take more time. Finally, it i s well known that subjecting further decentralization progress to a framework o f fiscal neutrality i s both critical and urgent. Budget Planning 6.47 This section discusses the process o f budget formulation, based on two principles: (i) an orderly and effective participation in the formulation process by the implementing entities and the pertinent authorities impacts the extent to which the budget will reflect macroeconomic, fiscal and sector policies; and (ii)due to its multi-annual implications, decisions on expenditure policy should be inline with the medium-term availability o fresources and sector strategies. 6.48 Annual budget formulation. The MHCP prepares a clear annual calendar that is generally observed by the entities. According to the schedule, and as required by Law 550, the MHCP distributes the budget policy to the implementing entities by May 30 o f each year, allowing the entities at least six weeks to prepare their preliminarybudget drafts. The budget policy includes L 146. Albeit not convergent with GFSM2001. 119 the ceilings approved by the Cabinet. The formulation process is duly regulated, allowing adequate participation by the sectoral entities, even though flexibility i s limited basically to the capital budget. With the more rigorous process for budget modifications (addressed later in this report) introduced by Law 550, the implementing entities that were accustomed to simpler mechanisms to modify their budgets during the year, found themselves in need to strengthen significantly their budget formulation capacity. 6.49 According to Law 550, the National Assembly should receive the bill o f annual law o f the PGRby October 15 o f each year, and has until December 15 to consider and approve it - with or without modifications. As with other laws, the executive has the capacity to veto, either totally or partially, the amendments proposed by the legi~lature.'~'In case the budget i s not approved within the legal schedule, the project submittedbythe executive takes effect untilthe budget law for the fiscal year is approved. For the three years reviewed (2004-2006), the Assembly approved the budget in a timely fashion, but for fiscal year 2005 it was enacted after the beginning o f the fiscal year due to the veto introduced by the President on the basis o f fiscal risk concerns. 6.50 Multi-year ,vers,vective. Law 550 introduced the Medium-Term Budget Framework (MPMP), which must contain at least an estimate o f revenues, expenditures, physical and production goals, program o f public investments, programming o f external disbursements, loans andgrants, evolution o fpublic debt, and a description ofbudget policies andcriteria that support the MPMP. 6.51 The budget documentation o f 2006 included the MPMP for the first time, as part o f a strategy that reasonably anticipated its development by stages. Thus, the Medium-Term Fiscal Framework (MFMP) and the MPMP were prepared using projections o f main aggregates as basis, against Medium-Term Sector Expenditure Framework (MGSMP) that started with three pilot institutions (ministries o f education, health and transport) for the 2006 budget and was extended to other entities that form part o f the PGR for the 2007 budget. The same Law 550 provides for transitional arrangements to gradually implement the MPMP throughout three years after the law entered into force, i.e. until2008. 6.52 The MFMP, which in turn i s founded on the Economic and Financial Program (PEFPRGF), includes the projections o f fiscal aggregates based on macro categories o f receipts and payments. The systematic links between the MFMP and the annual budgets cannot be assessed yet due to the recent implementation o fthe instrument. 6.53 The MGSMP includes current and capital expenditures for the entities that form part o f the PGR, and the aggregates are consistent with those o f the MFMP. However, there is little evidence, e.g. in costed sectoral strategies, as to the process o f policy assessment and reconciliation between the top-down and bottom-up multi-year planning. Still, it i s worth mentioning that certain costing exercises have been developed (e.g., in education and health care), which -subject to continuous quality enhancement- will provide greater support to the MGSMP. 6.54 As noted in the previous chapter, important progress has been made in the institutionalization o f the Investment Technical Committee functions and o f the National Public Investment System (SNIP), which currently has an ample coverage in the central administration. The Public Investment Program (PIP) is part o f the MPMP, and recent years have witnessed L 147. See footnote No. 1. 120 significantly increasing compliance in securing ex-ante technical approvals from the Public Investment Unit (UP),as well as inrecording public investment projects inthe official portfolio (banco). And, in line with the development o f the MPMP, investment decisions are slowly but increasingly made inthe context o f sectoral strategies. 6.55 Conversely, the analyses and documentation o f implications o f the PIP on future recurrent expenditures are still incipient. The same can be said with regards to the internal capacity to monitor and evaluate PIP implementation, a function performed primarily by providers o f external assistance with regards to their financed activities. 6.56 "Results-based budgeting". In the context o f implementation o f Law 550, more formal attempts havebeenmade to project and include inbudget documentation goals and indicators per program financed by the budget, with an emphasis ineducation, health and transport sectors. As is normal in the introduction o f this type o f instruments, the first set o f indicators deal fundamentally with figures on coverage. As in the case o f medium-term budgeting, the first efforts are worthy but a natural progressionis envisioned and required. 6.57 The set o f indicators by program could progressively reach a customized, yet manageable, mix o f dimensions (e.g., effectiveness, efficiency, quality) and scopes (e.g., process, outputs, outcomes). Similarly, the sophistication o f cost accounting systems to calculate unit standards and measure the marginal cost o f changes in performance could be gradually built. Credibility o f the new practices should rely on a formal program monitoring process that informs budget ceilings and allocations for upcoming years. Inthe longer term, introduction of incentives documented inperformance agreements is an option to be considered. 6.58 Earmarked fundina. Inevitably, efforts to enhance budget planning and programming are restricted by earmarked allocations mandated by the Constitution and laws. As part o f the total expenditure, at least 6 percent must be allocated to public universities and 4 percent to the Supreme Court o f Justice. And as part o f the revenues, 6 percent was allocated in 2006 to municipalities, a figure that according to current legislationmust increase at least 0.5 percent per year until reaching 10 per~ent).'~'There are other minor mandated allocations, as well as miscellaneous fees and charges (rentas con destino especifco) that the entities can claim for their own use. Altogether, legally earmarked funds can amount to around 19 percent o f primary expenditures (Table 6.4). Table 6.4: Legally Earmarked Funds (percentage of primary expenditures) 2006 Budget Universities 6.1 Municipal transfers 4.9 Supreme Court o fJustice 4.0 Other legal allocations 1.1 Entities' "own funds" 2.7 Total 18.8 Source: (2006 budget documentation). 6.59 Conclusions. A policy-based budgeting process enables the government to plan the use of resources in line with itsfiscal policy and national strategy. L 148. The finds allocated to universities have shown to favor mostly the non-poor, while the funds allocated to municipalities are not fiscally neutral (IMF and World Bank, 2006). 121 6.60 The annual formulation o f the budget is made in an orderly fashion, with due participation o f the implementing entities, notwithstanding the small margin -because o f earmarked funds and "fixed" expenditures- for flexibility. Institutionalization o f the national public investment system (SNIP) i s growing, particularly at the pre-investment assessment stage, but monitoring and evaluation remain weak. As for the medium term budget framework, the steps are recent but relevant. The framework has a clear legal basis, and the MHCP has an adequatestrategy inplace to implement this new instrument instages.*49 6.61 In the short to medium term, the capacity to prepare or refine costed sectoral strategic plans needs to be developed for reconciliation o f the top-down and bottom-up multi-year budget planning. The public investment program (PIP) should be based on those plans, with due consideration to recurrent cost implications. Once they are comprehensively implemented, the elements that compose the medium term framework, i.e. the fiscal framework and the sectoral expenditure framework, will reduce fiscal risks and provide informative elements that will increase the quality andconsistency o f decisions on the strategic allocation o f resources. 6.62 The effort to incorporate results elements inthe budgetingprocess is incipient and limited by budget rigidities. Basic goals and budget indicators have been developed, but the accountability framework has not. Enhancements to the dimensions and scope o f indicators, and to the capacity to measure the marginal cost o f changes inperformance, should be progressively built. 6.63 As is expected from such a significant overhaul o f the budget system, which should be gradually implemented over the medium and long term, there are capacity gaps in executing entities and in the MHCP that need to be addressed. And, inevitably, any effort to modernize budget planning and programming will be limitedto the extent that significant legally earmarked budgetallocations remain. Predictability and control in budget execution 6.64 This section analyzes selective elements o f the budget execution systems, with an emphasis on management o ftreasury and debt, and internal controls. 6.65 Availability of funds for expenditures. Planning, monitoring and management o f cash flows and balances are essential to support budget execution and prevent unnecessary financing costs. The Treasury Directorate o f the MHCP prepares an annual flow o f funds that comprises funds from the Treasury and external resources for budget support. The flow o f funds is updated on a quarterly basis on the basis o f information provided by the tax collection, public credit and budget entities, and on a weekly basis according to the flow observed. These processes are, however, kept in information systems parallel to the Integrated Financial Management System (implementationo f SIGFA's financial programming module has been long overdue). 6.66 In relation to the certainty on availability of funds to implementing entities, the first parameter i s the PGR, which sets forth the maximum limits to be spent per agency, source o f financing, and personnel expenditures. Expenditures cannot be executed in absence o f budget credits, which in turn are subject to quotas o f quarterly commitments and o f monthly accruals. These quotas affect the levels o f program, subprogram, project, group o f expenditure, and source o f financing, and are incorporated into SIGFA as soon as they are approved by the Budget Directorateo fthe MHCP. L 149. MHCP (2005). 122 6.67 While the quarterly commitment quotas provide a reasonable certainty to entities to implement their expenditures, in practice their reliability could be affected by some operating problems in the issuance o f payments. The main problem affects investment projects with accounts in foreign currency, because: (i)the mechanism o f direct payment (i.e., from the Treasury to the supplier) i s executed "manually" between the Treasury and the Central Bank (BCN), resulting in transaction processing times significantly greater than other types o f payment; and (ii) the alternative mechanism o f payments through rotating hnds is limited to a global 5 percent o f the budget for certain lines o f expenditure, and a maximum o f C$20,000 per individual payment. Inprinciple, the global limit for payments through rotating funds is sound, as long as it is complemented by a functional system o f direct payments. But if the latter fails, there will necessarily be delays that affect the flexibility o f the entities to execute. 6.68 On the other hand, insectors such as education andhealth that execute a large numbers o f small payments to or through service units spread across the country, the flow o f fund model is inneedofcustomizationinorder to better the balancebetweenefficiency andcontrol. 6.69 The modifications to the budget during the year are additional factors that can affect the availability o f funds for execution. Duringthe review period, modifications at the aggregate level have been significant (see Table 6.5), but these have increased -not diminished- the expenditure. As noted earlier, the increments were a consequence o f internal revenues that exceeded the amount budgeted (see Table 6.2 above) and o f automatic budget additions for under loans and grants for Therefore, the budget modifications, at least until 2005, did not bear a negative impact on the funds available for the entities (see Table 6.1 above). Table 6.5 In-year ExpenditureBudgetModifications (inpercentageofthe total budget) 2003 2004 2005 PGR:Total, net 17.1 11.1 24.5 Source: Own estimates, based on MHCP. 6.70 Cash management, debt and guarantee records. Law 550 sets forth the principle o f centralizationo frevenues and expenditures on the basis o f the Treasury Accounts System, which includes the Single Treasury Account (CUT), collection, payment and "mixed" accounts (external grants and loans). Operation o f the system allows estimating and consolidating most central government cash balances on a daily excluding rotating funds. The latter can be calculated periodically through the ImplementingUnits Integrated System (SIUE) or the Project Financial Management Integrated System (SIGFAPRO), but these processes are not run on a daily basis and not all the entities use the SIUE. 6.71 The quality o f records and reports i s key to assure proper budgeting and timely payments o f debt service. In Nicaragua, the responsibility to maintain public debt databases is shared by MHCP's Directorate o f Public Credit (central government internal debt) and the B C N (external L 150. These automatic additions are no longer allowed since the enactment o f Law 550. 151. Inthe context o f its reviews, the CGR has identified some "own funds" (rentas con destino especifico) that collecting entities have not recorded and transfened on a timely basis. 123 debt).'52 MHCP records are seemingly complete for the central government, but not for public enterprises and municipalities. The MHCP and the B C Njointly issue comprehensive information on a quarterly and annual basis -), usually within the next quarter following the period reported. This information includes internal and external debt, composition per debtor and creditor and per instrument and maturity, debt service, emissions and disbursements, and solvency indicators. 6.72 The legal framework to contract public debt and issue guarantees is clearly defined inthe Public Debt General Law (Law 447 o f 2003), which, inter alia, demands the annual preparation o f the Public Debt Policy (Presidential Decree). The Policy is prepared by the MHCP on the basis o f the Economic and Financial Program (PEF), and establishes the maximum limits for annual contracting and net debt, the general concessional terms for external loans, the maximum rate allowed for internal loans, and the maximum amount o f contingent liabilities (guarantees) to be subscribed. According to the Law, contracting o f debt and issuance o f guarantees are valid only with the authorization o f the MHCP, even though the permanent registry o f guarantees i s still to be implemented. 6.73 Pavroll controls. MHCP's Directorate o f Public Administration (Funcidn Publica) administers the Fiscal Payroll System (SNF), which allows direct and timely linkages between the payroll and the personnel database. The latter is fed by each government entity, which inturn keeps the individual files. The authority to introduce changes in the databases i s limited to authorized officers o f each entity, and the SNF keeps a logbook o f said changes. 6.74 However, in early 2006 the SNF covered only about halfo fpublic servants (some 52,000 employees o f 27 institutions). The rest o f the payroll is managed through unconnected individual systems that prevent, for example, to know with accuracy and timeliness the total number o f public servants and to have a general overview o f payroll preparation practices. Likewise, no payroll-specific audits are conducted systematically -when made, these are performed on an ad hoc basis ineach entity.'53 6.75 Procurement controls.'54 The State's Public Contracting Law (Law 323 o f 2000, as amended) promotes competitive processes, establishes ceilings for three types o f tenders (public, by registration, and restricted) and for the use o f quotations, and describes the exception mechanisms. However, there is currently no information system that permits gathering and producing aggregate data on the number and amount o f processes under each o f the cited methods. The recent worthy introduction o f the Public Procurement and Contracting System (SICCE) aims at, among other objectives, filling the cited gap. 6.76 The Office of the Controller General (CGR) authorizes the exceptions to the established procedures. The exceptions are presumably made according to the law ("for reasons o f urgency, safety or other reasons o f public interest", by means o f ajustified petition). The CGR publishes L 152. The BCN keeps it database in the Debt Management Financial and Analysis System (DMFASEIGADE) developed by UNCTAD. The MHCP uses its own system, and partially the DFMAS. Reports are shared between the two entities. 153. In the context of its budget reviews, the CGR has identified certain deficiencies inpersonnel management, such as supplemental financing with donor funding to staff on fiscal payroll, and weaknesses inmanagement o f paid leave and staff loans. 154. This report covers only some selective aspects o f government procurement management, a subject that is broadly analyzed inthe Country Procurement Assessment Report (CPAR). 124 monthly summaries o f the approved exceptions (www.cgr. aob.ni), but not o f the correlated justifications.'" 6.77 With respect to the complaint mechanisms available to bidders, the Law sets forth three administrative instances: (i) recourse o f clarification before the Tender Committee;'s6 (ii) recourse o f impugnation before the Reviewing C~mmittee;"~and (iii) recourse for annulment before the CGR.'58 6.78 In the legal front, there is a plan -but to no concrete outcome yet- to submit to the National Assembly a project for a modem law o fpublic sector administrative contracting, which would bringthe framework closer to international practice. 6.79 Other internal controls. As for the effectiveness o f controls to commit expenditures, Law 550 provides for the "committed expenditure" step. Accordingly, SIGFA procedures require the recording o f this stage prior to the payment. However, it is known that in practice the implementing entities record the commitment and accrual stages concurrently, which could affect Treasury's cash programming and could lead to delays for expenditures that are not recorded by the institutions until the payments are ready to be made. Therefore, the commitment control system is only partially effective. 6.80 Interms ofthe overallinternal control framework, inDecember2004 the CGRissued the Technical Internal Control Norms (NTCI) and proceeded with their induction in2005 through a series o f training events. The N T C I are based on international practice (COS0 framework) and thus emphasize risk management. The entities had until June 2006 to design their pertinent systems o f internal control, according to the NTCI. The CGR is in the process o f certifying implementation (about 60 certifications were issuedin2006). 6.81 Given the recent introduction o f the NTCIs, there is no data yet to assess the general level o funderstanding, compliance and cost-effectiveness o fthe internal control rules andprocedures. 6.82 Internal audit. The Organic Law o f the CGR and the Government Control System (Decree 625 o f 1980, as amended) determines the obligation o f public sector entities to have internal audit units (UAI). In accordance with the law, the UAI is in charge o f ex-post examination o f financial or administrative transactions as a service to the superior authority of the entity, to which it reports. However, internal auditors can only be dismissed with the authorization o f the CGR, which receives copies o f the UAIreports. Their independence is also granted, at least according to the law, in terms o f the unrestricted access to documentation and the prohibition to participateinadministrative processes. L 155. The CGR must receive copy o f contracts exceeding C$500,000 for review (the ceiling for purchases by quotation is o f C$lOO,OOO, and thus, not all contracts by tender are submitted to the CGR). In 2005, the CGR received 699 contracts. That same year, 202 applications for exception o f procedures were approved. 156. The recourse for clarification could unnecessarily delay the procurement process, if it is based o n trivial arguments to affect the competition. 157. The Reviewing Committee i s presided over by a representative of the MHCP, and formed additionally by the third-ranking officer of the contracting entity, and a representative o f the Office o f the Attorney General o f the Republic (PGR). 158. According to the time periods established by Law, a complaint that goes throughout all administrative instances would take about 46 days. 125 6.83 The UAIs are subject to the technical and scrutiny o f the CGR, which receives copies o f their work plans and reports. The entity administrators are bound to adopt in a timely fashion the corrective measures indicatedinthe internal audit reports. 6.84 The legal framework i s generally adequate, but actual perfomance i s heterogeneous across the different institutions. Inthe absence o f statistical data, anecdotal reference points that most UAIs do not comply fully with professional norms and devote most time to special studies, as opposed to systematic reviews.16' There i s no system to monitor internal audit recommendations, but it is presumed that administrations observe the most important matters, although not necessarily ina timely and comprehensive fashion. 6.85 Conclusions: Predictable and controlled budget execution is necessary to enable effective management of policy andprogram implementation. 6.86 There are strengths, especially in terms o f fiscal discipline, in the centralization o f treasury balances through the Single Treasury Account (CUT), as well as in the controls for contracting and recording public debt, albeit further enhancements are possible. In other areas there is more room for improvement. 6.87 Compliance with the timely recording o f expenditure commitments, e.g. through automatic links with the SICCE, needs to be ensured. Similarly, the mechanism o f direct payments by the Treasury should be improved, requiringbetter coordination between the MHCP and the Central Bank. The development o f the Civil Service Integrated System (SISEC) and the extension o f the Fiscal Payroll System (SNF) should continue with the purpose o f developing a consolidated payroll system, which in turn should be subject to systematic audits. The implementation o fthe Technical Internal Control Norms (NTCI) needs to be complementedwith information systems that assess their performance. Finally, internal audits require greater professionalization, more systematic risk-based approaches, greater dissemination and better follow-up to its reports. 6.88 The procurement processes and correlated statistics will be more transparent and efficient through the ongoing development o f the SICCE. There i s also a need, though, to reform procurement legislation (a draft is already available) in line with international practice. Specific areas for improvement include bidders' registration, guarantees, price adjustment, confidentiality o f bids, bid evaluation and award, bidder's access to review o f procurement decisions, responsive and responsible bidder, suspension o f bidders, procurement o f consulting services, sanctions regime, and options for procurement consolidation strategies (e.g. contratos marco). 6.89 Evidently, weaknesses ininternal controls may diminish the operational efficiency inthe use o f resources and create opportunities for corrupt practices, abuse and waste. Likewise, weaknesses in the controls o f commitments and payments may generate fiscal risks. Further attention to systems, processes and controls for budget execution are therefore necessary to ensure greater operational efficiency, fiscal discipline and transparency. L 159. Internal auditors must comply with the Government AuditingNorms (NAGUN) and, complementarily, with the International Standards for the Professional Practice o f Internal Auditing (ISPPIA) issued by the Institute o f Internal Auditors. 160. For the purposes o f this report, systematic reviews are those that address significant aspects of: reliability and integrity inoperational and financial information; effectiveness and efficiency o f operations; safeguarding o f assets; and compliance with laws, regulations and contracts. 126 Accounting, recording and reporting 6.90 This section discusses the record keeping, preparation and issuance o f government financial information for managerial and scrutiny purposes. 6.91 Account reconciliation. The frequent and timely reconciliation o f data from different sources i s fundamental for the reliability o f financial reports. Bank reconciliations for the accounts managed by the Treasury are made on a daily basis, with the support o f SIGFA automatic processes. Monthly reconciliation reports are also produced. However, the automation o f account statement uploading i s still pending, as is the reconciliation o f rotating funds, which mustbereconciledbythe implementing entities. No aggregate information is kept on the state o f reconciliations of the rotating funds. 6.92 Resources received by service delivew units. Monitoring o f these resources, for example, the amounts received by health care centers and schools in cash and in kind, is important to validate whether the financial management systems effectively support the delivery o f public services. The Ministry o f Health keeps central databases on funds in cash received and used by its decocentrated units. So does the Ministry o f Education with respect to schools, although the information i s generally less complete and o f poorer quality. Resources in kind or provided by NGOs to service delivery units are rarely tracked. It must be mentioned, however, that an effort is made by the local Public Investment Technical Units to monitor investments programmed in SNIP. 6.93 Hence, there are various systems in operation, but these do not yet gather complete data on the resources received by service delivery units. Moreover, the available information is not compiled and analyzed inperiodicalreports. 6.94 In-year budnet reports. Timely and periodical information on budget execution is essential for the MHCP to supervise fiscal performance and for the implementing entities to manage their budget. Inthis sense, Law 550 provides for adequate mechanisms: the entities that conform the PGRmust recordthe execution o f their budgets inthe financial management system and according to the rules set forth by the MHCP, whereas decentralized and autonomous entities must submit their quarterly execution reports to the MHCP thirty days after the end o f each quarter at the latest, for consolidationpurposes. 6.95 Inpractice, with SIGFA's platform, budget execution reports can be generated on "real time" for internal use. Among other features, these reports: (i) allow direct comparison to the classifications o f the approved PGR; (ii) cover all items o f the PGR (but not the detailed use o f transfers, as noted previously); and (iii) distinguishbetween the stages o f commitment, accrual and payment. Public reports are prepared on a quarterly basis duringthe thirty days following the end o f each quarter. The main concern on the quality o f the information, as mentioned before, is the usual practice o f simultaneous recording o f the stages o f commitment and accrual, which prevents a reliable timely overview o fthe actual level o fcommitted expenditures.161 6.96 Annual reports. Law 550 presents an adequate legal framework for accrual-based government accounting, and provides for the requirement o f the MHCP to submit the Annual L 161. Other weaknesses identifiedby the CGR include: (i) lack or inadequate use of the SIUE in some cases, the which has preventedthe identification with enough detail of some expenditures financed through rotating funds; and (ii) recordingormodificationofcertaintransactionsaftertheclosingdate.SeeCGR(2005). the 127 Public Sector Investment Account'62to the National Assembly and the CGR by March 31 o f the next year. However, the mechanisms (methodologies, training, subsidiary records) to put this requirement into effect are still under development. For this and other reasons, such as the identifiedbutpendingclean-up o f certain account balances, the public sector financial statements are not yet produced, not even for the central administration. 6.97 The MHCP does prepare, on a yearly and timely basis, a Budget Execution Report. Event though this report does not include cash balances'63 nor the accounting methodology used, it does present ample information on revenues and expenditures o f the PGR.'64These reports are usually published within three months after the end o f the year. 6.98 Poverty-reduction expenditure tracking. The budget documents, as well as in-year and year-end execution reports, all identify public spending and transfers associated with poverty- reducing activities, including HIPC debt relief, as well as other external and internal sources o f financing for those programs. Inline with international practice, poverty-reduction expenditure i s tracked through the "tagging" o f specific line items in the budget classification matrix, a process made directly in SIGFA by the MHCP on the basis o f poverty spendingdefinition by SETEC.'65 The latter prepares periodical reports on implementation o f poverty-reduction expenditures. The described procedure helps to ensure that, in terms o f find management and monitoring, no physical fimds or other parallel structures are needed-thus strengthening institutionalization. 6.99 Conclusions. Timely, relevant and reliable financial information is required to support fiscal and budget management and decision-making processes. 6.100 The information on budget execution (per month, quarter and year) is prepared on a timely basis, supported by a good recording system and by a good system o f reconciliations o f bank accounts handledby the Treasury, all o fwhich are key features to control fiscal discipline, transparency and scrutiny. Moreover, the budget formulation, execution and recording systems allow for the tagging and monitoring o fpoverty-reduction expenditure. 6.101 However, execution reports are still not supplemented with data on bank balances and, even less, with accounting financial statements. These elements are necessary to corroborate the integrity o f the currently produced reports, and to increase the information and scrutiny on patrimonial elements that, due to their nature, are not reflected in the budget execution reports. The development o f mechanisms to produce financial statements is one o f the main challenges assumedby the MHCP within the framework o f its planto implement Law 550. L 162. It is understood that the presentation requirements for the Annual Investment Account (article 137 o f Law 550) also cover the Accounting Financial Statements (article 138), but the Law i s not completely explicit on this point. 163. In the absence of financial statements, a first critical step for transparency would be to reconcile budget execution with bank balances at the end o f the year. For example, as mentioned by the CGR (CGR, 2005), the budget execution report o f 2004 includes expenditures o f C$1,796 million classified as "other" under the concept o f "internal financing". Presumably, these funds represent an increase o f financial assets, but in absence o f the reconciliation with bank balances, this presumption cannot be corroborated. In 2005, the amount o f "others" was reduced to C $ l 1.4 million. 164. Among other information, the annual budget execution report presents the execution o f revenues and expenditures according to different classifications (economic, administrative, functional, per financing source), the allocations and transfers to decentralized entities, the investment projects, grants and loans, debt service, budget modifications, expenditures financed through debt relieffunds, and expenditures connectedto the Poverty Reduction Strategy. 165. The scope o f this P F M assessment does not cover the quality o fpoverty spending definition. 128 6.102 On the other hand, it is also necessary to examine with greater detail and support the efforts o f the different sectors, mainly o f the Ministries o f Education and Health, to compile and process more information on the resources received (or not) allocated to service-delivery units (schools and health centers). Apart from being an essential accountability tool, this type o f information i s necessary to asses the operational efficiency o f the mechanisms to transfer and use funds indecocentrated programs. External scrutiny and auditing 6.103 This section analyzes institutional mechanisms to scrutinize public finances, with a focus on the functions o f external auditing and o f legislative oversight o f the budget and its implementation. 6.104 External auditinn. Inprinciple, an effective external auditing helps to guarantee integrity o f public finance information and accountability for the efficient and legal use o f resources. In accordance with its Organic Law, the CGR i s the institution in charge o f carrying out financial, compliance and other audits, in public sector entities. These audits must adhere to the Government Auditing Norms (NAGUN).'66Additionally, Law 550 establishes that the CGR will audit the Budget Execution Report submitted by the MHCP, and send it to the Commission of Economic, Financial and Budget Affairs o fthe National Assembly. 6.105 Eventhough the members o fthe Superior Council o f the CGR are elected by the National Assembly, the CGR itself is an independent and autonomous constitutional entity. Inline with the provisions o f its Organic Law, the CGR submits its reports to the superior authority o f the entity audited. The National Assembly only receives the annual performance report o f the CGR in systematic manner, but can request andreview special audits. According to the Constitution, the CGR must make public the results o f its investigations and, according to the NAGUN, the audit reports have a public nature once approved by the Superior Council. These can be found in the Documentation Center o f the CGR and, selectively, inits Internet page (www.cm.gob.ni). 6.106 As is evident in its annual performance reports, external audits made by the CGR do not comprise all entities, and constitute mostly special examination^.'^' Financial audits are conducted primarily by private firms, subject to CGR review, but these audits are limited to certain decentralized entities and projects with external financing. Although there are no public sector financial statements as explained before, the annual Budget Execution Report is not audited by the CGR.16*Performance audits are not conducted. 6.107 In accordance with CGR instructions, the entities must implement its recommendations within a maximum term o f three months. The CGR has an information system that records the number o f recommendations, officers to whom an administrative or civil liability, or a criminal presumption has been determined, and the correlated amounts when an economic loss has been established. The recommendations are monitored but, in general, the responses -though formal- are delayed or not very thorough. N o annual reports are produced to give account on compliance by entities inthe implementationo frecommendations o faudits previously conducted. L 166. In general, the NAGUN are consistent with the rules o f the International Organization of Supreme Audit Institutions (INTOSAI). The NAGUN also adopt in a supplementary manner the International Auditing Standards (IAS) for financial audits. 167. See CGR (2006). 168. In 2005 an "evaluation", not an audit, was performed on the 2004 budget execution (CGR, 2005). A plan is underway to prepare a first audit o fthe Budget Execution Report, covering fiscal year 2006. 129 6.108 Legislative apuroval of the budget. The powers o f the National Assembly in budget matters are clear, known and generally respected. The pertinent legal framework is contained in the Constitution and in Law 550, which has strengthened the oversight role o f the legislature, attributin important control functions to the Commission o f Economic, Financial and Budget Affairs,16' with the support o f the General Directorate o f Analysis and Monitoring o f Public Expenditure. This unit has stable personnel devoted to analyze and monitor the budget, and to this end, prepares reports for the exclusive use o f deputies (theyare not published). 170 6.109 The scope o fbudget examination i s broad. It comprises the bill o f law and the analysis of its annexes, which -as indicatedbefore- comprise the fiscal policies and the fiscal framework, the medium-termpriorities o f the MPMP, and the details o f expenditures and revenues for the next fiscal year, amongst others. The Assembly has enough time (2 months, between October 15 and December 15) to carry out this review. 6.110 While the budget initiative belongs constitutionally to the executive, the legislature may propose amendments. Law 550 regulates the amendment procedures, both for the bill o f the annual budget law and to the annual law itself during execution. The legislative branch cannot modify the budget ceiling, unless it defines the sources o f revenue for such increase.171 The President has the power to totally or partially veto the amendments proposed by the Assembly, both to the annual budget (as happened for the budgets o f 2005 and 2003), as well as to subsequent amendments proposed. 6.111 The modifications to the budget law during its execution are made by law and, thus, are subject to legislative scrutiny.'72 Law 550 indicates that the legislative branch will process the modifications with priority, within a maximum term of 60 days. The rules inbudget reallocations are clear and set forth strict limits to the executive: the MHCP can only reallocate budget line items, without prior legislative approval, between the same entity and even then within certain restrictions (e.g., it i s prohibited to reallocate from investment to current expenditures, and MHCP must inform the Commission o f Economic, Financial and Budget Affairs o f every reallocation o f the investment expenditure). 6.112 While Law 550 introduced greater discipline in the approval o f budget modifications, an unintended consequence has been the restrictions to receive short-term grants, which given their nature andthe donors' different fiscal years, are difficult to anticipate when the budget proposals L 169. The Commission gives an opinion on the bill o f law o f the PGR, issuing a majority opinion and a minority opinion. In 2005, the plenary session adopted the minority opinion for the budget o f 2006. The Commission is formed by a non-fixed number o f deputies (11in 2005 and 16 in2006) and is renewed annually. These factors can weaken the institutionalization of the financial and budget expertise in the legislative body. In other countries, the duration o f the mandate inpermanent commissions i s usually longer. 170. Itmustbe statedthat Nicaragua is one offew countries inthe regionthat has suchoffice o ftechnical advisory services inbudget matters. 171. Law 550 establishes the mechanisms to incorporate new sources o f revenue during the discussion and approval o f the annual budget law. It sets forth consensual mechanisms between the executive and legislative branches, through a Technical Committee formed by the MHCP and the Commission o f Economic, Financial and Budget Affairs, which has to render a decision within a term o f 10 days. 172. Law 550 broadened legislative control towards areas until then exempt from such procedure; for example, in matter o f additions due to loan and grant operations. Before, they were approved ex post facto by means o f a retroactive amendment to the budget law, usually at the end o f the fiscal year, applying the principle o f 'legislative silence' inthe case o f loans and grants. The exception currently kept is related to budget additions for entities' own revenues (rentas con destino especifico), which are reported on a monthly basis by the MHCP to the Commission o f Economic, Financial and Budget Affairs. 130 are prepared. At the same time, there are no sufficient incentives for the executive to spend political capital in the passing o f budget modifications for small donations. Given that these grants usually bear limited impact on fiscal discipline and public expenditure policy, a more streamlined approach such as ex-post reporting under a reasonable aggregate ceiling, could be considered so as to preventundesirable alternatives, such as off-budget hnding implementation. 6.113 Legislative scrutiny of audit reports. On budget execution, the legislative branch, through the General Directorate o f Analysis and Monitoring o f Public Expenditure, maintains access to SIGFA and conducts periodical monitoring (each month through direct access to execution figures; quarterly through the in-year execution reports prepared by the MHCP; and annually through the Budget Execution Report submittedby the MHCP). 6.114 Law 550 establishes that the National Assembly i s entrusted to approve or reject the budget execution annual report (although it does not indicate ifthis process is made through law, and thus, subject to veto). Previously, the executive, through the MHCP, has to substantiate such report by the second week o f May. As noted before, the same law asks the CGR to submit its audit on the report to the Commission o f Economic, Financial and Budget Affairs o f the National Assemblybefore the appearanceo fthe Ministryo fFinance. 6.115 However, there are dysfunctions in the legislative scrutiny o f the external audit reports. As explained earlier, not all audit reports conducted by the CGR are informed to the legislative branch in a systematic or compulsorily manner. Only those audits conducted per request of the same legislature are submitted to it. These reports are reviewed within an approximate period o f one year (there i s no fixed term to examine these reports) by the Commission o f Economic, Financial and Budget Affairs or by the specialized commissions that have required such reports. 173 6.116 The legislature performs hearings and interpellations on an occasional manner on the main conclusions o f the audit reports, but does not usually issue formal opinions on them or monitor their implementation. The monitoring o f audit recommendations is done by the same CGR, but there i s no legal obligation to inform the legislative power on their effective implementation bythe government, e.g. through its annual report. 6.117 Conclusions. Effective scrutiny by the legislature and thorough external audit is an enablingfactor in accountabilityfor fiscal and expenditurepolicies and their implementation. 6.118 There are positive aspects in the clarity and application o f the legal framework with respect to the legislative review and approval o f the annual budget law, as well as in the mechanisms to approve in-year budget modifications, recently regularized through Law 550. It must be noted, however, that strict ex-ante legislative approval can affect the country's capacity to benefit from short-term grants, which given their nature are difficult to anticipate at the time o f budget formulation. Elements could be introduced into the law to better balance the capacity o f the government to receive this type o f grants (which bear little fiscal and public expenditure impact), and the legislature's right to oversee public finances. 6.119 As for the ex post scrutiny o f public expenditure, although guaranteed by law, inpractice is limited because the National Assembly does not receive all external audit reports, and when it L 173. The National Assembly, as a consequence o f the review o f CGR reports, may request special studies on specific matters. Infact, these requests make up to great extent the regular work of the CGR, but its effective use by the legislative branch is deficient. 131 does, their review and discussion take a significant amount o f time, with minimal subsequent monitoring. 6.120 With respect to the Office o f the Controller General o f the Republic (CGR), and important recent step was the preparation o f an evaluation o f the 2004 annual budget execution report. However, since this activity did not constitute a financial audit, its scope was limited in comparison to international practice. On the other hand, for the audit reports that are indeed produced (most o f them o f a "special" type), the monitoring o f recommendations is made in a formal fashion but, in general, the response from implementing entities is delayed and not particularly thorough. The monitoring system that the CGR i s putting into practice is another important step that would help to improve monitoring duringfuture years. 6.121 The absence o f a financial and compliance audit on budget execution limits guarantees o f information integrity and the effectiveness o f accountability for the efficient and legal use o f public resources. Consequently, emphasis should be put on the CGR's plans to prepare the first PGR execution audit, andon the future sustainability o f the practice. Donor practices 6.122 This section analyzes some elements o f the practices o f providers o f external assistance that impact upon the performance o f the national PFM system. 6.123 Predictabilitv of budnet supt7ort. The degree o f certainty o f annual budget support, as well as its distribution throughout the fiscal year, impacts upon the capacity o fthe government to implement its budget plans. Inthis sense, two practices usually recommendedto the providers o f external assistance are: (i) send information to the government on the annual amounts to foreseen, at least six weeks before the government submits the budget to the legislative branch; and (ii)to reach an agreement with the government on the quarterly programming o f disbursements at the start, or before the start, o fthe fiscal period. 6.124 In Nicaragua, an essential step in that direction was the signature, in May 2005, by the Government and the Budget Support Group (BSG)'74o f a Joint Financing Arrangement (JFA) which purpose, inter alia, is to facilitate greater predictability in external aid and its alignment with the budget system. The JFA has incorporated the good practices cited in the previous paragraph through the requirements to: (i) formally communicate the intended budget support around June o f the preceding year, and its confirmation by September 15; and (ii) decide on a quarterly disbursement calendar inNovember o f the preceding year. 6.125 Given the recent implementation o f the JFA framework, there i s room for improvement, particularly in terms o f ensuring greater correspondence between the annual and quarterly commitments and actual disbursements. Granted, this i s not an easy task, knowing the different budget support approaches to which providers o f external assistance are bound in their internal regulations, e.g. broad-based vs. sectoral support, fixed vs. variable tranches, policy actions vs. outcomes. 6.126 It is also important to note that the JFA does not yet include all providers o f external assistance who provide budget support, and that the commitments are not always confirmed on L 174. The providers of external assistance that form the BSG are the European Commission, Finland, Germany, The Netherlands, Norway, Sweden, Switzerland, United Kingdomand the World Bank. 132 the deadline fixed inthe JFA.17' Prior to the signing o fthe JFA, inthe limited cases when annual budget support projections were delivered, the discrepancies with the plans were due mainly to noncompliance with prior conditions (including adequate macroeconomic and fiscal conditions) 6.127 Financial information on investment projects. Inprinciple, donor support to projects can be channeled in various ways, with varying degrees o f participation by the government in the planning and management o f the resources. While the government should be able to budget and report on the assistance transferred incash, it depends on the providers o f external assistance for budget estimates and reporting on implementation o f aid in-kind. Donor reports on cash disbursements are also important for reconciliation between donor records and government project accounts. 6.128 In Nicaragua, donor practices on the financial information provided to the government for budgeting and reporting are not uniform. Some providers o f external assistance disburse primarily though advances to rotating finds, a procedure that gives certain autonomy to the government for budgeting execution. Others present regularly the disbursement projections, although not necessarily linkedto the budget preparation cycle. The information is not generally submitted inaccordance with the detailed classifications used by the government, but their level o f aggregation allows the latter to break it down by budget lines without major difficulty. The information on in-kindgrant projections seems scarce.'76 6.129 With respect to ex-post information on disbursements made, this information is usually made available to the government through access to on-line systems, quarterly or biannual reports submitted within two months subsequent to each period, or in response to specific requests.177The Ministry o f Foreign Affairs incorporates and publishes disbursement data inthe Official Cooperation Information System (www.svsoda.cancilleria.gob.ni). However, this information is not used yet in a systematic manner to reconcile financial figures against budget records. 6.130 Use of national procedures. National systems for management o f funds are those established in local legislation and regulations, and applied by the mainstream line management functions o f the government. The use o f different procedures (specific to providers o f external assistance) could divert capacity away from managing the national systems. Conversely, the use o fthese systems by the providers o f external assistance can help to focus efforts on strengthening and complying with the national procedures also for domestically funded operations. Direct budget support (general or sector based) will by definition use national procedures in all respects Other types o f financing, e.g. earmarked budget support, basket finds and discrete project funding, may use some or no elements o fnationalprocedures. 6.13 1 InNicaragua, the use o f national systems has increased inrecent years, particularly to the extent that budget support and common funds have substituted partly the assistance provided before almost exclusively through tied projects. However, although there is no complete L 175. The medium-term review o f 2005 was delayed due to, inter alia, the deviation from the programwith the IMF and the corresponding absence ofa "letter o f agreement" by the IMF on macroeconomic and fiscal aspects. 176. For purpose o f this report, the concept o f in-kind grants includes assistance granted through direct administration o f the cooperating agencies or through agreement between themandNGOs. 177. Providers o f external assistance, who accounted for over 70 percent o f disbursements o f external loans and grants budgeted in2006, provided this information periodically. 133 presumably cover less than 50 percent o f such resource^.'^^ The preference still shown for information to quantify the use o f national systems for external loans and grant^,"^ they specific project procedures reflects, in part, the concerns o f providers o f external assistance for the weaknesses described before inthe country procurement and auditing systems. 6.132 Conclusions. Important agreements have been reached to try to align external funding with the national budget system. Worth highlightingis the Joint BudgetFinancing Arrangement (JFA), which includes commitments on the provision o f information that will improve predictability o f budget support. Also worth noting is the growing use o f national systems and the prompt access o f the government to information on disbursements made by the providers o f external assistance. 6.133 On the other hand, it mustbe acknowledged that the cited actions have only recently been introduced, and thus, their impact is still not to full potential. Future actions could concentrate in the incorporation o f a greater number o f donors to the efforts underway, in terms o f timely provision o f projections and disbursements (and greater convergence between both), incash and in kind, and greater use of national procedures in investment projects. All of the above is consistent with the National Harmonization and Alignment Action Plan. C. ReformProcess Recent Reforms 6.134 Within the framework o f dialogue around the Country Financial Accountability Assessment (CFAA) report o f 2003, an ambitious two-year action plan was prepared with the objective to address certain weaknesses found in systems and procedures. As detailed in Annex 1, and briefly inthe following paragraphs, there was a mixed record o f implementation -although inabsolute terms a majority of actions were implemented or partially implemented, evidencing the commitment to reform-.However, it must be acknowledged that most o f the actions took place in the second year, and thus, their impact upon the performance o f the system has just recently beennoted, as inferred from the conclusions o fthe preceding chapter. 6.135 Implementation arrangements. InNovember 2003 an inter-institutional agreement18' was issued to implement the government action plan to improve Public Financial Management (PFM), based largely on the actions suggested by the CFAA that fell under the realm o f the executive branch. Its implementation and monitoring took place under the strong leadership o f the MHCP, particularly the Directorate o f the SIGFA Project (currently the General Directorate o f Technology). However, inother entities, and even some normative directorates o f the MHCP, L 178. For such estimate, it i s necessary to calculate the average of the proportion of external funds that use national systems for each o f the four areas of procurement, paymentsiaccounting, auditing and reporting. It has not been possible to gather information at this level o f detail for all funds. 179. O f the loans and external grants incorporated in the 2006 budget, 29 percent corresponds to budget support and 3 percent to common fund-type operations (Supplementary Social Fund, FONSALUD, PRORURAL). 180. Government o fNicaragua (2003). 134 the cited agreement was not fully owned.'*' Moreover, there was no mechanism to monitor the areasrelated to external scrutiny and auditing.'82 6.136 Legal framework. Based on studies about the country legal framework and comparative international legislation, the MHCP prepared a modern bill o f law o f financial management that eventually derivedin Law 550 o f August o f 2005, as amended (Law 565 o f November o f 2005) As explained in the different sections o f the preceding chapter, the Law incorporated features largely consistent with good international practice for the different components o f the budget management system. 6.137 Budnet formulation. In April 2005, the MHCP adopted a strategy and action plan to develop a medium-term budget framework in N i ~ a r a g u a . ' ~ ~ The document is based on international experience inthe adoption o f this type o f instruments and provides for an adequate sequence o f gradual implementation.Additionally, the 2006 and 2007 budget documentation showed relevant improvements with respect to preceding years, most importantly the incorporation o f the medium term fiscal, budgetary and sectoral expenditure frameworks, as well as the budgets for almost all public sector entities. 6.138 On the other hand, a basic methodology was prepared to estimate recurrent costs of the public investments program, but it was not complemented nor has been put into actual practice yet. With respect to the reclassification o f current expenditures included in the capital budget, some improvements have been made with new projects, but the criteria for -and actual- reclassificationhave not been developed. 6.139 Financial Management and Audit Integrated Svstem (SIGFA). Interms o f the continuous improvement o f the information tool e-SIGFA, relevant progress was made with the technological platform and certain procedures (e.g., control o f rotating funds, single collection form). Furthermore, certain administrative systems were developed (cash flow programming, procurement and contracting, civil service and public assets), but their implementation and integration is still limited. The coverage o f entities that use SIGFA was extended, but not under a clear strategy to incorporate decentralized entities and "third level" implementing units. With respect to security, progress was made in the administration o f users and roles for the different subsystems, intelecommunications and partially in logbooks, but not so in the external security audit. 6.140 Treasuw. The methods to record and control rotating funds were improved, including the "APEX" and "ADEX" procedures that allowed incorporation into the PFM system o f projects financed with external loans and grants. Also, the introduction o f the single collection form facilitated the transfer and reconciliation o f information on internal revenues. On the other hand, the development o f detailed programming o f cash flows and gap management as part o f the e- SIGFA, and o f criteria to sequence the processing o f payment orders, had little progress. Likewise, the implementation o f the payment system through electronic fund transfers (ETF) has experienced delays. L 181. In effect, the areas under the control of the MHCP, particularly through technical assistance coordinated under the SIGFA Project, were the ones that showed higher levels of implementation. 182. Certain political economy conditions prevented an effective coordination betweenthe executive and the CGR duringthe two years coveredbythe actionplan. 183. MHCP (2005). 135 6.141 Internal control and internal auditing. InSeptember 2004, the CGR issued new Internal Control Technical Norms for the Public Sector (NTCI), which are generally consistent with international practice. The CGR conducted induction and training activities for the implementing public sector entities. Similarly, the MHCP also conducted training activities, including for internal auditors, in areas related mainly to the information system e-SIGFA. However, instruments o f sector tracking o f public expenditure flows (e.g., "expenditure tracking surveys") were not implemented. 6.142 Deconcentration and decentralization of budaet execution. The diagnosis o f the financial management models for decocentrated and decentralized budget execution was not performed. It i s known, however, that the Ministry o f Health prepares on a regular basis financial execution reports that cover its de-concentrated units (some o f which use a sectoral financial management system called "SIAFI". Given its complexity, more difficult has been the effective implementation o f sound procedures for adequate expenditure recording, reporting and monitoring inthe decentralized units o fthe education sector 6.143 Accounting and financial statements. Interms o f restructuring the accounting function, progress was limited (it assumed bank reconciliations, but kept the management o f assets). The process to clean up initial balances advanced to the level o f actual identification o f the required accounting adjustments, but its implementation was not officially made. New reports were designed, and the annual Budget Execution Report was improved, but the reconciliation against cash balances, the addition o f comparative historical revenue and expenditure data, and the identification o f accounts payable in arrears, were not added. With Law 550, the execution reports on transfers to decentralized entities are now required. 6.144 External auditing. Under its modernization project, the CGR prepared some studies related to its organizational structure, updated its technological tools, prepared auditing manuals and the NTCI, and trained its personnel. Furthermore, it started to publish some o f its auditing reports in the Internet and, for the first time, prepared a report to evaluate budget execution (of 2004). However, this report didnot constitute a financial and compliance audit, with its pertinent opinion, on the budget execution prepared by the MHCP. There are plans underway to prepare such a first audit. 6.145 Public participation. The executive adopted a strategy o f access to information (EVA) and incremented the quantity and quality o f financial information in the public domain (www.consu1taciudadana.aob.ni). Progress was also made in the publication o f procurement processes. However, these progresses have not been supplemented with a multimedia strategy that includes other means to the citizens with no Internet access. 6.146 Coordination of external aid. The maintenance o f public investment project records has been strengthened, including for projects financed with external loans and grants, which are now incorporated into the budget.There i s a linkage between the e-SIGFA and the SNIP that makes it easy to compare the information within the two systems. However, the reconciliations are not made in a regular manner, at the stage o f budget execution, between the data in SIGFA, SNIP and SYSODA. On the other hand, progress was made in coordinated sectoral assistance ("SWAps"), particularly inthe health and rural development sectors. 136 6.147 Human resources. In general, progress was made in the implementation o f the Civil Service Law (Law 476),'84 including the development o f the Civil Service Integrated System (SISEC) -bearing an indirect though relevant effect on PFM-.In the case o f financial management officers, both the MHCP and the CGR have implemented specific training programs, as indicated before. However, budget limitations prevented the development o f more continuous and sustainable programs. 6.148 Public debt records. The Public Debt General Law and its Regulations were approved, and the first annual public debt policies were issued. Under the new legal framework, the coordination and exchange o f information between the MHCP (that records internal debt) and the B C N (that records external debt) has improved. Internal debt records have also improved, although in two separate databases (DMFASEIGADE and other registry developed internally). Work was undertaken on the conceptual framework for the automatic link between DMFASEIGADEand SIGFA, but it hasnotbeen developed. 6.149 Revenue System. In general, the process to implement projects for strengthening management o f revenues and customs required more time than initially anticipated by the collecting agencies. The cross-checks o f internal information have improved, but not necessarily so with external data. As for the coordination with the Treasury, the establishment o f collection accounts andthe single collection forms improved the flow o f information and o f funds. In2005, a study to estimate fiscal expenditure was concluded, but these assessments are not made yet ina systematic manner or identified inbudget documents. Continuation of the Reform 6.150 Government ownershiu and leadership. As noted in the receding paragraphs, an ambitious process o f reform in different fronts was launched, with relevant progress overall and some stumbling blocks. Commitment o f the government was formally expressed inthe National Development Plan (see Chapter I). The approval o f Law 550 and its amendments showed a positive stance from the executive and legislative branches towards the enhancement o f transparency and management o f public finances.It i s expected that the gradual development o f the participation and consensusbuilding system will improve the mechanisms o f dialogue among government, civil society, private sector and international community in development matters, including PFM. 6.151 At the operational level, the key implementation instruments are the annual operating plans o f the different projects that support PFM modernization, such as Public Sector Technical Assistance, Efficiency and Transparency in State Contracting, Strengthening o f Tax and Customs Administration and -in the case o f the CGR- its Modernization Program.As for budget support, the public finance area o f the performance assessment matrix (PAM) o f the JFA is aligned with the National Development Plan's matrix to reform and modernize public administration. 6.152 Coordination. It was explained before that MHCP's strong leadership has been a critical element to implement PFMreforms. The coordination o f providers o f external assistance inthis area has also improved significantly, e.g., through the operation o f the Budget Support Group (BSG), the governance sector "table", and the increasingly joint financing o f public programs. L 184. Advances include the issuance of regulations, classification of positions, progress in accreditation (even though not at the pace initially envisaged) and development of the SISEC, amongst others. 137 However, coordination o f the reform between the MHCP and sector entities has not been equally effective-as evidenced by the initial problems in implementation o f Law 550-.Likewise, coordination has been weak with regards to external audit reform, entrusted to the CGR (a constitutionally autonomous entity). 6.153 Sustainability. It must be recognized that, to a good extent, reforms achieved have been made with strong support o f technical assistance hired under projects with external financing. Therefore, notwithstanding that the extensive use o f national financial management systems and their incorporation into the legal framework are signs o f institutionalization, their sustainability will depend also upon other aspects, mainly: (i) professionalization o f public servants, with the the effective application o fmerit-based human resource management, per the Civil Service Law; and (ii) buildingthe government's own capacity to formulate, implement, supervise and evaluate public sector modernization projects, particularly as external financing i s gradually aimed more towards budget support rather than specific projects. D. Main Conclusions 6.154 Good performance o f public financial management (PFM) institutions and systems allows governments to achieve and balance the three interrelated objectives o f budget management: aggregated fiscal discipline, efficient allocation o f resources consistent with public policy priorities, and operational efficiency. This Chapter assessed PFM performance in Nicaragua based on an international framework o f reference that addresses seven critical dimensions: (i) credibility o f the budget; (ii) comprehensiveness and transparency; (iii) budget planning; (iv) predictability and control in budget execution; (v) accounting, recording and reporting; (vi) external scrutiny and audit; and (vii) donor practices that affect PFM.'*' 6.155 Credibility of the Budget. From 2003-2005, expenditure execution usually exceeded the amounts budgeted, posing a fiscal discipline risk. However, this risk did not materialize because the over-execution o f expenditures corresponded mainly to domestic revenues, grants and concessional loans that also exceeded budget forecasts. Even when in both cases budget credibility was affected, it should be noted that their effects were distributed in a relatively uniform manner among the different implementing entities, and there are no significant concerns on payment arrears. 6.156 The credibility o f the budget is a critical feature o f the ability o f the government to control fiscal discipline and prevent shortcomings in the financing o f sector budgets. It is expected that with the recent enactment o f the Financial Management and Budget Regime Law (Law 550), which sets forth strict limits to budget modifications, budget outcomes will increase the reliability o fthe budget as policytool. 6.157 Comprehensiveness and transparency. The budget information in Nicaragua i s ample, based on a good classification system (albeit not consistent with the latest international best practice), and has a comprehensive institutional coverage as far as the budget document per se is L 185. This report is based primarily o n PFMperformance measurement analytics undertaken through a partnership o f the Government o f Nicaragua with the BritishDepartment for International Development (DFID), the European Commission (EC), the Inter-American Development Bank, and the World Bank. The performance measurement framework was developedby the Public Expenditure and Financial Accountability (PEFA) partnership. 138 concerned. But that is not the case with the execution reports which, up to now, include only the General Budget o f the Republic (PGR) and not the execution o f revenues from the rest o f the central government. At the same time public access to information i s limited due to the absence o f certain key information (financial statements, audit reports, reports o f resources received by service-delivery units, and comprehensive publication o f procurement and contracting processes). Likewise, the limited transparency o f the fiscal decentralization system and the difficulty o f monitoring the aggregate fiscal risk o f the public sector are areas in need o f improvement. 6.158 The ability o f the government to control aggregate fiscal discipline o f the public sector could be affected if fiscal neutrality o f transfers to municipalities is not attained, and if the mechanisms to compile and consolidate all public finances are not implemented. On the other hand, the scrutiny on the government's financial management -a key element to improve the strategic allocation and operational efficiency o f the use o f funds- is limited in view o f the absence inthe public domain o fthe aforementioned key information. 6.159 In the short term, improvements can be expected with the preparation o f execution reports for all budgets and o f financial statements (both are requirements stipulated by Law 550), the revision o f rules and their application vis-a-vis current expenditures in investment projects, the implementation o f transparency inprocurement through the State's Procurement and Public Contracts Integrated System (SICCE), and the publication of customized financial information on resources received and used by service-delivery units, particularly inthe education and health sectors. To the extent that decentralized entities (by function and territory) comply with the requirements o f Law 550 on provision o f information, the monitoring of aggregate fiscal risk will be facilitated, although the creation o f capacity in the MHCP to carry out this task may possibly take more time. Finally, it is well known that subjecting further decentralization progress to a framework o f fiscal neutrality is both critical and urgent. 6.160 Budczet danninx. The annual formulation o f the budget is made in an orderly fashion, with due participation o f the implementing entities, notwithstanding the small margin -because o f earmarked funds and "fixed" expenditures- for flexibility. Institutionalization o f the national public investment system (SNIP) i s growing, particularly at the pre-investment assessment stage, but monitoring and evaluation remain weak. As for the medium term budget framework, the steps are recent but relevant. The framework has a clear legal basis, and the MHCP has an adequate strategy in place to implement this new instrument in stages, which should consider integration o f SNIP into the process. 6.161 In the short to medium term, the capacity to prepare or refine costed sectoral strategic plans needs to be developed for reconciliation o f the top-down and bottom-up multi-year budget planning. The public investment program (PIP) should be based on those plans, with due consideration to recurrent cost implications. Once they are comprehensively implemented, the elements that compose the medium term framework, i.e. the fiscal framework and the sectoral expenditure framework, will reduce fiscal risks and provide informative elements that will increase the quality and consistency o f decisions on the strategic allocation o fresources. 6.162 The effort to incorporateresults elements inthe budgetingprocess is incipient and limited by budget rigidities. Basic goals and budget indicators have been developed, but the accountability framework has not. Enhancements to the dimensions and scope o f indicators, and 139 to the capacity to measure the marginal cost o f changes inperformance, should be progressively built. 6.163 As i s expected from such a significant overhaul o f the budget system, which should be gradually implemented over the medium and long term, there are capacity gaps in executing entities and in the MHCP that need to be addressed. And, inevitably, any effort to modernize budget planning and programmingwill be limited to the extent that significant legally earmarked budget allocations remain. 6.164 Predictability and control in budget execution. There are strengths, especially interms o f fiscal discipline, in the centralization o f treasury balances through the Single Treasury Account (CUT), as well as in the controls for contracting and recording public debt, albeit further enhancements are possible. Inother areas there is more room for improvement. 6.165 Compliance with the timely recording o f expenditure commitments, e.g. through automatic links with the SICCE, needs to be ensured. Similarly, the mechanism o f direct payments by the Treasury should be improved, requiringbetter coordination between the MHCP and the Central Bank. The development o f the Civil Service Integrated System (SISEC) and the extension o f the Fiscal Payroll System (SNF) should continue with the purpose o f developing a consolidated payroll system, which in turn should be subject to systematic audits. The implementation o f the Technical Internal Control Norms (NTCI) needs to be complementedwith information systems that assess their performance. Finally, internal audits require greater professionalization, more systematic risk-based approaches, greater dissemination and better follow-up to its reports. 6.166 The procurement processes and correlated statistics will be more transparent and efficient through the ongoing development o f the SICCE. There is also a need, though, to reform procurement legislation (a draft is already available) in line with international practice. Specific areas for improvement include bidders' registration, guarantees, price adjustment, confidentiality o f bids, bid evaluation and award, bidder's access to review o f procurement decisions, responsive and responsible bidder, suspension o f bidders, procurement o f consulting services, sanctions regime, and options for procurement consolidation strategies (e.g. contratos rnarco). 6.167 Evidently, weaknesses in internal controls may diminish the operational efficiency inthe use o f resources and create opportunities for corrupt practices, abuse and waste. Likewise, weaknesses in the controls o f commitments and payments may generate fiscal risks. Further attention to systems, processes and controls for budget execution are therefore necessary to ensure greater operational efficiency, fiscal discipline and transparency. 6.168 Accounting, recording and reoorting. The information on budget execution (per month, quarter and year) i s prepared on a timely basis, supported by a good recording system and by a good system o f reconciliations o f bank accounts handled by the Treasury, all o f which are key features to control fiscal discipline, transparency and scrutiny. Moreover, the budget formulation, execution and recording systems allow for the tagging and monitoring o f poverty-reduction expenditure. 6.169 However, execution reports are still not supplemented with data on bank balances and, even less, with accounting financial statements. These elements are necessary to corroborate the integrity o f the currently produced reports, and to increase the information and scrutiny on patrimonial elements that, due to their nature, are not reflected in the budget execution reports. 140 The development o f mechanisms to produce financial statements is one o f the main challenges assumedby the MHCP within the framework o f its planto implement Law 550. 6.170 On the other hand, it i s also necessary to examine with greater detail and support the efforts o f the different sectors, mainly o f the Ministries o f Education and Health, to compile and process more information on the resources received (or not) allocated to service-delivery units (schools and health centers). Apart from being an essential accountability tool, this type o f information is necessary to asses the operational efficiency o f the mechanisms to transfer and use funds indecocentrated programs. 6.171 External scrutinv and auditing. There are positive aspects inthe clarity and application o f the legal framework with respect to the legislative review and approval o f the annual budget law, as well as in the mechanisms to approve in-year budget modifications, recently regularized through Law 550. Itmustbe noted, however, that strict ex-ante legislative approval can affect the country's capacity to benefit from short-term grants, which given their nature are difficult to anticipate at the time o f budget formulation. Elements could be introduced into the law to better balance the capacity o f the government to receive this type o f grants (which bear little fiscal and public expenditure impact), and the legislature's rightto oversee public finances. 6.172 As for the ex post scrutiny o fpublic expenditure, although guaranteed by law, inpractice i s limited because the National Assembly does not receive all external audit reports, and when it does, their review and discussion take a significant amount o f time, with minimal subsequent monitoring. 6.173 With respect to the Office o f the Controller General o f the Republic (CGR), and important recent step was the preparation o f an evaluation o f the 2004 annual budget execution report. However, since this activity did not constitute a financial audit, its scope was limited in comparison to international practice. On the other hand, for the audit reports that are indeed produced (most o f them o f a "special" type), the monitoring o f recommendations is made in a formal fashion but, in general, the response from implementing entities i s delayed and not particularly thorough. The monitoring system that the CGR i s putting into practice i s another important step that would help to improve monitoring during future years. 6.174 The absence o f a financial and compliance audit on budget execution limits guarantees o f information integrity and the effectiveness o f accountability for the efficient and legal use o f public resources. Consequently, emphasis should be put on the CGR's plans to prepare the first PGR execution audit, and on the future sustainability o f the practice. 6.175 Donor practices that affect PFM. Important agreements have been reached to try to align external hnding with the national budget system. Worth highlighting is the Joint Budget FinancingArrangement (JFA), which includes commitments on the provision o f information that will improve predictability o f budget support. Also worth noting is the growing use o f national systems and the prompt access o f the government to information on disbursements made by the providers o f external assistance. 6.176 On the other hand, it must be acknowledged that the cited actions have only recently been introduced, and thus, their impact i s still not to full potential. Future actions could concentrate in the incorporation o f a greater number o f donors to the efforts underway, in terms o f timely provision o f projections and disbursements (and greater convergence between both), in cash and 141 in kind, and greater use of national procedures in investment projects. All of the above is consistent with the National Harmonization and Alignment Action Plan. PFM Reform 6.177 Duringthe two years o f implementation o f the governmental action plan to improve PFM (2004-2005), 86anambitious process o f reform in different fronts was launched, with relevant * progress overall and some stumbling blocks. Commitment o f the government was formally expressed in the National Development Plan. The approval o f Law 550 and its amendments showed a positive stance from the executive and legislative branches towards the enhancement o f transparency and management o f public finances. It i s expected that the gradual development o f the participation and consensus building system will improve the mechanisms o f dialogue among government, civil society, private sector and international community in development matters, including PFM. 6.178 At the operational level, there i s financing available to implement the different projects that support PFM modernization.'*' As for budget support, the public finance area o f the performance assessment matrix (PAM) o f the JFA is aligned with the National Development Plan's matrix to reform and modernize public administration. 6.179 The strong leadership o f the MHCP has been a key element to implementation o f PFM reforms. The coordination o f the providers o f external assistance in this area has also improved significantly. However, the coordination o fthe reform between the MHCP and sector entities has not been equally effective -as evidenced by the initial problems inimplementation o f Law 550-. Likewise, the coordination has been weak with regards to the reform o f external auditing, entrusted to the CGR (a constitutionally autonomous entity). 6.180 Onthe other hand, it must be recognized that, to a large extent, the reforms achieved have been made with the support o f technical assistance contracted under projects with external financing. Therefore, notwithstanding that the extensive use o f financial management systems and its incorporation into the legal framework are signs o f institutionalization, its sustainability will also depend upon other aspects, mainly: professionalization o f public servants, with the effective application o f merit-based human resource management; and (ii) development o f governmental capacity to formulate, implement, supervise and evaluate modernization projects, particularly as external financing gradually shifts from specific projects to budget support operations. L 186. 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Human Development Sector Management Unit, Latin America and the Caribbean Region. Report No. 36426-LAC. January, 20, 2007. World Bank and Inter-AmericanDevelopment Bank (2003). Nicaragua: Country FinancialAccountability Assessment. World HealthOrganization (WHO), 2006.Core Indicators. Geneva. http://www.who.int/whr/2005/whr2005 en.pdf Zapata, Juan Antonio. 2006. "El Gasto Pcblico Municipal en Nicaragua." Paper prepared for "Construyendo capital social por medio de lareforma fiscal" (Proyecto Regional RS-T1009). 146 Annex A Annex A Technical Note on the Efficiency of Public Spendingin Nicaragua A.1 This Annex discusses the relative efficiency o f public spendinginNicaragua compared to that in other developing countries, summarizing the findings o f ongoing research at the World Bank*@and the Inter-American Development Bank'89 on the measurement o f efficiency in public spending.'" Inthis research, efficiency is measured as the distance between a country's current input-output combination inthe production o f public services and an empirically derived world production possibilities frontier. One such production possibilities frontier i s shown in Figure A.1, along with the different combinations of Inputs (X) and Outputs (Y) observed in countries A, B and D, which lie on the frontier, and for countries C and G, which lie inside the frontier. The countries lying on the production possibilities frontier are characterized by either spending the least amount on inputs among all the countries producing a similar level o f output, or by producing the greatest output among all the countries with similar levels o f spending on inputs. FiguresA.l: The ProductionPossibilitiesFrontier (based on Data Envelopment Analysis approach) v 0 ` x* xc Inputs A.2 Using the construct in Figure Al, efficiency can be measured in terms o f amount o f inputsused or interms o f outputs produced. The input-orientedmeasure o f efficiency incountry C is calculated as the distance OX* dividedby the distance OXc. The output-oriented measure o f efficiency for country C i s calculated as the distance OYc divided by the distance OY*. With L 188. Herrera, Santiago and Gaobo Pang, (2004), "Efficiency of Public Spending in Developing Countries: An Efficiency Frontier Approach", World Bank working paper, December. 189. Machado, Roberto (2006), "El gasto en 10s paises centroamericanos y Republica Dominicana: eficiencia agregada, eficiencia-insumos y eficiencia-resultados", IDB Working Paper, September. 190. The efficiency measurements discussed inthis Annex focus on the narrow concept o ftechnical efficiency and do not extend to the broader concept o f allocative efficiency, which would require comparable data on input prices across countries that i s largely unavailable. 147 Annex A this method o f calculation, all the countries that lie on the productionpossibilities frontier exhibit an efficiency measure o f 1.0, while all countries lying insidethe frontier (to the right and below) have efficiency measures less than 1.O. A.3 Herrera and Pang (2004) have constructed a set o f production possibilities frontiers for a number o f activities in the education and health sectors, using information on public expenditures and output indicators from a sample o f over 140 developing countries. There are eight output indicators in education referring to primary and secondary enrollment (gross and net), average years o f schooling, first and second level completion rates and the literacy rate among youth aged 15-24 years. Each o f these output indicators i s related to total public expenditures in education to derive single-output/single-input measures o f efficiency.19' The same i s done inhealth by relating total public expenditures on health and four output indicators referring to life expectancy at birth, DPT immunization, Measles immunization and the disability-adjusted life expectancy (DALE) index, which takes into account both mortality and morbidity. A.4 While single-inputhingle-outputmeasures o f efficiency are the simplest to calculate, they also have some shortcomings. One is that they do not take into account private spending on health and education. Another is that they do not take into account any factors other than direct spending on health and education that may have a significant impact on sector outcomes. Since different countries rely on these other factors to varying extents (which may depend inpart on their relative prices), single-input measures o f efficiency tend to be biased against those countries that rely least on these other inputs. Similarly, the single-input/single-output measures fail to acknowledge the existence o f tradeoffs in the delivery of outputs. For example, countries with the same spending on education may have widely diverging outcomes in one output indicator versus another, depending on the subs-sector emphases given in each country. Focusing on one single outcome indicator versus another could, therefore, bias the relative measures o f efficiency dependingon the outcome indicator chosen. To account for the potential biases associated with single-inputhingle-outputbased measures, Herrera and Pang (2004) also generate measures o f spending efficiency based on a multiple combination o f inputs and multiple combinations o f outputs. In education, the multiple combination o f inputs includes teachers per pupil and the adult literacy rate, in addition to sector spending levels. In health, the combination o f inputs includes public and private expenditures inthe sector, and the adult literacy rate.19* The RelativeEfficiencyof EducationSpending AS Table A1 presents the efficiency scores measured for the various outcome indicators in education, both using input-oriented measures and output-oriented measures, as well as the single and multiple input/output combinations, with data for 1996-2002. These scores are L 191. Instead o f using total public expenditures inthe x-axis of the empirically constructed production possibilities frontier, Herrera and Pang (2004) use an orthogonalized measure o f public expenditures, derived as the difference between actual public expenditures (in education or health) and the amount predicted on the basis o f GDP per capita. 192. These estimates o f efficiency are subject to statistical variability. The confidence intervals associated with each efficiency score are fairly easy to calculate for the single inputlsingle output case, but not so for the case o f multiple inputs and outputs. This is one reason why this paper puts less emphasis on those findings vis-a-vis the single inputloutput findings. 148 Annex A presented for Nicaragua and the other Central American countries, together with the average scores exhibitedby other regions around the world. A.6 Table A1 indicates that the efficiency o f public spending on education in Nicaragua i s considerably lower than the Latin American average under the input-oriented measures. Nicaragua scores an average o f 0.52 (for single input/output measures), compared to an average o f 0.57 inCentral America and 0.58 for Latin America. A similar picture also emerges from the comparisons o f output-oriented efficiency measures,'93 where Nicaragua achieves an average efficiency score o f 0.47 versus Central America and Latin America averages o f 0.54 and 0.65. Looking at the individual output-oriented measures, Nicaragua appears to exhibit the greatest inefficiencies inthe indicators related to secondary education. A.7 Using multiple inputs and outputs, a similar picture o f relative inefficiency prevails, though somewhat less pronounced than under the single input/output measures. While the absolute efficiency scores in this case are higher than when using the single inputhingle output measure, Nicaragua's score is lower than the Central andLatin American regional averages, both underthe input-oriented andoutput-oriented measures. Overall, these findings suggest that there i s ample room for increasing the efficiency o fpublic education spending inNicaragua, especially at the secondary level. The RelativeEfficiencyof Health Spending A.8 The efficiency scores o f public spending on health are presented in Table A2. Contrary to the picture that emerged ineducation, the efficiency o fpublic spending on health inNicaragua does not appear to be appreciably different from the average efficiency scores achieved in the Central and Latin America regions. Using the input-oriented single input/output measures, for example, Nicaragua exhibits an efficiency score o f 0.65, compared to an average o f 0.65 in Central America and o f 0.69 in Latin America and the Caribbean. Using the output-oriented measures, Nicaragua's average efficiency score o f 0.90 is virtually identical to the Central America and L A C averages o f 0.91 and 0.90. The same efficiency picture emerges when using multiple inputs and outputs, with Nicaragua exhibiting similar scores to the two regional averages. L 193. A number o f countries exhibit contrary patterns in efficiency, showing a relatively high efficiency score under the input-oriented measure and a relatively low measure under the output-oriented measures, or vice-versa. This is most notable in the cases o f Guatemala and Panama, and may be related to the concave curvature o f the production possibilities frontier, which reflects decreasing returns to scale. Nicaragua (and Honduras), however, exhibit very low efficiency scores under bothmeasures. 149 Annex A CentralAmerica andPanama Other RegionalAverages PAN Ave.1 LAC AFR EAP ECA MNA SAS 0.68 0.75 0.74 0.69 0.74 0.67 0.65 0.75 0.80 0.75 0.77 0.68 0.78 0.72 0.68 0.71 0.61 0.70 0.69 0.65 0.69 0.67 0.63 0.70 0.62 0.72 0.69 0.64 0.71 0.71 0.64 0.72 0.24 0.29 0.32 0.21 0.36 0.37 0.18 0.25 0.31 0.32 0.36 0.21 0.43 0.48 0.20 0.26 0.25 0.29 0.32 0.22 0.37 0.33 0.19 0.27 0.63 0.72 0.72 0.66 0.73 0.86 0.63 0.72 0.52 0.57 0.58 0.50 0.60 0.60 0.48 0.55 EDU22 gross 0.85 0.73 0.87 0.96 0.83 0.72 0.83 0.82 0.88 0.83 0.72 0.73 0.91 EDU32 gross 0.88 0.75 0.94 0.99 0.85 0.78 0.87 0.89 0.92 0.89 0.86 0.92 0.96 EDU32 net 0.87 0.78 0.94 1.00 na 0.91 0.90 0.93 0.87 0.94 0.93 0.92 1.00 EDU33 0.86 0.91 0.98 1.00 0.92 1.00 0.94 0.89 0.91 0.97 0.94 0.80 0.95 EDU33 BL na 0.73 0.95 1.00 0.87 1.00 0.91 0.89 0.91 0.97 0.94 0.81 0.95 Average 0.86 0.78 0.93 0.99 0.87 0.88 0.89 0.88 0.90 0.92 0.88 0.84 0.95 OUTPUT-OrientedMeasures Single InpuffSingleOutput PrimaryEnrollment-- Gross 0.73 0.76 0.86 0.81 0.79 0.77 0.79 0.82 0.62 0.79 0.72 0.67 0.72 -- Net 0.80 0.91 0.88 0.84 0.82 0.98 0.88 0.93 0.64 0.93 0.90 0.79 0.78 Secondary Enrollment-- Gross 0.43 0.43 0.46 0.30 0.26 0.53 0.40 0.61 0.23 0.50 0.70 0.54 0.39 -- Net 0.37 0.48 0.48 0.28 na 0.64 0.45 0.66 0.26 0.58 0.84 0.60 0.44 Average Years of Schooling 0.42 0.56 0.48 0.32 0.44 0.79 0.50 0.60 0.32 0.63 0.79 0.53 0.38 FirstLevel Complete 0.22 0.29 0.32 0.33 0.29 0.43 0.31 0.36 0.19 0.49 0.50 0.22 0.20 Second Level Complete 0.07 0.11 0.04 0.06 0.20 0.49 0.16 0.24 0.09 0.37 0.38 0.26 0.22 Youth Literacy Rate (ages 1524) 0.74 0.98 0.88 0.79 0.85 0.97 0.87 0.94 0.72 0.95 0.99 0.88 0.66 Average 0.47 0.56 0.55 0.47 0.52 0.70 0.54 0.65 0.38 0.66 0.73 0.56 0.47 MultipleInputs& Outputs EDU22 gross 0.77 0.77 0.86 0.81 0.79 0.78 0.80 0.85 0.68 0.83 0.80 0.71 0.79 EDU 32 gross 0.86 0.78 0.89 0.97 0.82 0.78 0.85 0.89 0.82 0.88 0.89 0.91 0.90 EDU 32 net 0.83 0.91 0.92 1.00 na 0.98 0.93 0.96 0.79 0.97 0.96 0.92 1.00 EDU 33 0.84 0.99 0.98 1.00 0.93 0.10 0.96 0.98 0.98 1.00 1.00 0.99 0.99 EDU 33 BL 0.75 0.70 0.82 1.00 0.77 1.00 0.84 0.86 0.86 0.94 0.93 0.80 0.89 Average 0.81 0.83 0.89 0.96 0.83 0.73 0.87)0.91 0.83 0.92 0.92 0.87 0.91 The combinations of multiple inputs and outputs referred to above are as follows: Inputs outputs EDU22 gross pub. exp.; teachers/pupils gross primarylsecondary enroll. EDU 32 gross pub. exp.; teacherslpupils; adult liter. gross primarylsecondary enroll. EDU 32 net pub. exp.; teachers/pupils; adult liter. net primarylsecondary enroll. EDU 33 pub. exp.; teacherslpupils; adult liter. Ist/ 2nd level complete; youth lit. EDU 33 BL pub. exp.; teacherslpupils; adult liter. 1st/ 2nd lev.comp.; ave.yrs.sch. Note: these figures represent the measurements based o n the Data Envelopment Analysis model with varial .e returns to scale. Source: Based on data for 1996-2002, from Herrera, S. and G.Pang (2004). 150 Annex A I CentralAmerica andPanama Other RegionalAverages .ifeExpectancyat Birth 0.63 1.00 0.63 0.71 0.65 0.56 0.70 0.69 0.65 0.72 0.58 0.73 0.69 nmunization DPT 0.63 0.53 0.66 0.71 0.68 0.55 0.63 0.68 0.66 0.73 0.63 0.76 0.71 nmunization Measles 0.72 0.53 0.69 0.71 0.73 0.53 0.65 0.69 0.65 0.73 0.67 0.76 0.71 )isabilityAdjusted Life Expectancy 0.63 0.61 0.63 0.71 0.65 0.58 0.64 0.70 0.65 0.72 0.60 0.71 0.69 Average 0.65 0.67 0.66 0.71 0.68 0.55 0.65 0.69 0.65 0.73 0.62 0.74 0.70 MultipleInputs& Outputs iealth 22 0.81 1.00 0.79 0.88 0.81 0.80 0.85 0.82 0.85 0.82 0.72 0.91 0.93 iealth 32 DPT 0.81 1.00 0.79 0.89 0.81 0.80 0.85 0.83 0.86 0.82 0.74 0.91 0.94 iealth 32 MEA 0.91 1.00 0.79 0.89 0.82 0.80 0.87 0.83 0.86 0.82 0.77 0.91 0.94 iealth 33 0.81 1.00 0.79 0.89 0.81 0.91 0.87 0.87 0.86 0.82 0.80 0.93 0.94 Average 0.84 1.00 0.79 0.89 0.81 0.83 0.86 0.84 0.86 0.82 0.76 0.92 0.94 OUTPUT-Oriented Measures Single InpuVSingle Output .ifeExpectancyat Birth 0.89 1.00 0.91 0.85 0.86 0.97 0.91 0.92 0.63 0.87 0.91 0.90 0.83 nmunization DPT 0.91 0.90 0.95 0.79 0.96 0.96 0.91 0.87 0.62 0.83 0.95 0.90 0.75 nmunization Measles 0.98 0.88 0.96 0.83 0.98 0.92 0.93 0.91 0.63 0.83 0.95 0.90 0.71 )isability Adjusted Life Expectancy 0.84 0.96 0.89 0.79 0.88 0.95 0.88 0.90 0.56 0.83 0.90 0.86 0.79 Average 0.90 0.93 0.93 0.81 0.92 0.95 0.91 0.90 0.61 0.84 0.93 0.89 0.77 iealth 22 0.94 1.00 0.95 0.89 0.96 0.98 0.95 0.93 0.81 0.91 0.97 0.97 0.96 iealth 32 DPT 0.94 1.00 0.95 0.89 0.96 0.98 0.95 0.94 0.81 0.91 0.97 0.97 0.96 iealth 32 MEA 0.99 1.00 0.96 0.89 0.98 0.97 0.96 0.94 0.80 0.91 0.96 0.98 0.96 iealth 33 0.94 1.00 0.96 0.89 0.96 0.99 0.96 0.95 0.82 0.91 0.97 0.98 0.97 Average 0.95 1.00 0.95 0.89 0.96 0.98 0.96 0.94 0.81 0.91 0.97 0.98 0.96 II le returns to scale. Source; Basedon data for 1996-2002,from Herrera, S. and G.Pang(2004). The Scope for Efficiency Gains A.9 Based on the preceding comparisons, there i s potentially much scope for improving the efficiency o f Nicaragua's public spending in education and to a lesser extent also in health. Considering the single-variable, input-oriented measures o f efficiency, where Nicaragua exhibits an average score of 0.50 in public education spending under both the input and output oriented measures, there is room for raising efficiency by around 50 percentage points through the adoption o fpractices applied by the countries at the efficiency frontier. According to this result, Nicaragua could in principle reduce its total public spending on education by half with the adoption o f such practices, and still achieve the same education outcomes as it currently has. Or alternatively, it could double the value of its outcome indicators by adopting such practices while maintaining the level o f public education spending the same. In health, there appears to be 151 Annex A potential room for increasing efficiency by 35 percentage points or by 10 percenta e points, dependingonwhether an input-orientedor output-oriented efficiency measure is used.1k Efficiency Scores at 75th Percentile of: Potential Efficiency Gain I I World Distribution I LAC Distribution Nicaragua w.r.t. 75th percentile of: Score Country I Score Country I score World LAC INPUT-OrientedMeasures (Single InpuVSingleOutput) Distribution EDUCATION (% reduction incost) Primary Enrollment ---Gross 0.76 Romania 0.86 ElSalvador 0.71 0.06 0.17 Net 0.79 Syria 0.91 PeN 0.69 0.13 0.25 SecondaryEnrollment -- Gross 0.71 Armenia 0.73 Chile 0.67 0.05 0.06 -- Net 0.73 Georgia 0.74 PeN 0.69 0.05 0.07 Average Years of Schooling 0.31 Turkey 0.39 Chile 0.23 0.27 0.42 FirstLevelComplete 0.36 Mexico 0.40 El Salvador 0.23 0.37 0.44 Second LevelComplete 0.33 Peru 0.40 ElSalvador 0.23 0.32 0.44 Youth Literacy Rate(ages 15-24) 0.77 Oman 0.81 El Salvador 0.69 0.10 0.14 Average 0.60 0.66 0.52 0.13 0.21 HEALTH Life Expectancyat Birth 0.70 Fiji 0.71 Guatemala 0.63 0.10 0.12 ImmunizationDPT 0.71 China 0.71 PeN 0.63 0.11 0.11 ImmunizationMeasles 0.73 Honduras 0.73 Honduras 0.72 0.02 0.02 DisabilityAdjusted Life Expectancy 0.71 St. Kitts & Nevis 0.71 Guatemala 0.63 0.12 0.12 Average 0.71 0.72 0.65 0.09 0.09 I OUTPUT-OrientedMeasures(SingleInpuVSingleOutput) EDUCATION (% increasein outcomes) PrimaryEnrollment- Gross -- Net 0.81 Guatemala 0.86 El Salvador 0.73 0.10 0.17 0.96 Tonga 0.98 Panama 0.80 0.21 0.23 SecondaryEnrollment -Net -Gross 0.68 Czech Rep. 0.71 Chile 0.43 0.59 0.66 0.79 Tajikistan 0.76 Guyana 0.37 1.14 1.06 AverageYears of Schooling 0.64 Jordan 0.72 Trinidad & Tob. 0.42 0.51 0.70 First LevelComplete 0.38 Philipines 0.39 Mexiw 0.22 0.73 0.77 Second LevelComplete 0.32 Hungary 0.27 Peru 0.07 3.44 2.75 Youth LiteracyRate(ages 15-24) 0.99 Jordan 0.99 Argentina 0.74 0.35 0.35 Averag 0.70 0.71 0.47 0.48 0.50 HEALTH Life Expectancyat Birth 0.94 St. Lucia 0.96 Trinidad & Tob. 0.89 0.05 0.08 ImmunizationDPT 0.96 Latvia 0.94 Trinidad & Tob. 0.91 0.06 0.03 ImmunizationMeasles 0.96 Jordan 0.96 Brasil 0.98 -0.02 -0.02 DisabilityAdjusted Life Expectancy 0.92 Hungary 0.96 Costa Rica 0.84 0.10 0.15 Average 0.95 0.96 0.90 0.04 0.06 Source: Lachler, based on data for 1996-2002 from Herrera and Pang (2004). A.10 While countries should certainly strive to position themselves on the efficiency frontier, the measures and reforms neededto achieve a position on the frontier may be beyond the present political or technological capacity o f many developing countries. It is more reasonable to assume that, through a concerted reform effort, a country may raise its efficiency scores to the levels attained by countries that rank at the 75thpercentile o f the world or regional distribution o f efficiency scores. Comparing Nicaragua's efficiency scores with the scores prevailing in these countries, therefore, would provide a more realistic measure o fpotential efficiency gains than the earlier comparison with the countries at the efficiency frontier. Such a comparison i s camed out inTableA3. L 194. These percentage point differences in health spending are derived as the simple differences between the efficiency score at the efficiency frontier (1.0) and the average score (single inpudsingle output) exhibited by Nicaragua under the input-oriented measure (0.65) and under the output-oriented measure (0.90). 152 Annex A A.11 Table A3 presents the scores achieved by the countries that rank at the 75'h percentile o f the world distribution and o f the L A C distribution o f efficiency scores for each social sector indicator, and compares them to the scores obtained for Nicaragua. The last two columns in Table A3 indicate the potential efficiency gain that could be had by moving toward the top quarter o f the distribution. Using the input-oriented measures, these figures suggest that Nicaragua could reduce its total spending in education by between 13 and 21 percent (depending on whether the World or L A C distribution o f efficiency scores i s used as the comparator) without sacrificing education outcomes. In health spending, the fiscal savings through these potential efficiency gains are more modest, averaging 9 percent.195 A.12 Usingthe output-oriented efficiency measures, the results in the lower half o f Table A3 suggest that Nicaragua could raise its average education outcomes by close to 50 percent, while keeping total education spending the same. Again, the potential efficiency gains in health are more limited, averaging between4 and 6 percent.'96 ExplainingVariations in EfficiencyAcross Countries A.13 Herrera and Pang (2004) also have made an attempt to identify some o f the factors that explain efficiency scores across counties. This is done by examining the statistical association between the efficiency scores discussed earlier and several explanatory variables through a Tobit regression analysis, using country sub-samples o f varying sizes over two time periods. The independent variables used in this regression analysis are (i) the overall size o f government expenditure, (ii)the size of the public wage bill, (iii) per-capita GDP, (iv) the degree o f urbanization, (v) the prevalence o f HIV/AIDS, and (vi) the degree o f income inequality. The main findings from these regressions are the following: 0 Larger government expenditures are negatively associated with efficiency scores. This suggests that there is a trade-off between efficiency and size o fpublic expenditure, which may be reflecting eventually declining economies o f scale in the provision o f public services. Higher wage expenditures are negatively associated with efficiency scores in education, but not in the context of health indicators. Higher wage bills may be reflecting the prevalence o f stronger unions in the public sector, which generally does not promote sector efficiency. Urbanization i s positively associated with efficiency scores inalmost all output indicators in both sectors, except for Life Expectancy. The positive association is possibly reflecting the greater economies o f scale in the delivery o f public services available to a more concentrated population, while the negative association with the efficiency indicator for Life Expectancy may be reflecting a greater incidence o f crime and opportunities for dissolute living inurbanareas. L 195. These potential fiscal savings were calculated as (1 - (EWE*)), where EHrepresents the efficiency score exhibited by Nicaragua and E* represents the efficiency score exhibited by the country at the upper 25th percentile o f the L A C or World distribution. 196. These potential percentage increases in outcome indicators were calculated as ((E*/ EH) l), - where EH represents the efficiency score exhibited by Nicaragua and E* represents the efficiency score exhibited by the country at the upper 25th percentile o f the LAC or World distribution. 153 Annex A 0 HIV/AIDS prevalence is negatively associated with efficiency in the health sector, as would be expected, but yields mixedresults ineducation. 0 The Gini coefficient measuring income inequality is negatively associated with efficiency ineducation, but shows no systematic relationinhealth. EfficiencyofPublicSpendingin Terms of OverallPerformance A.14 Machado (2006) has recently extended the preceding analysis to measure the operational efficiency o f public spending in terms o f a country's overall development performance, for a sample o f 19 Latin American countries over the period o f 1990-2003. In this analysis, overall economic performance is measured through a set o findicators inseven areas: distributive equity, macroeconomic stability, economic performance, education, health, institutional development and poverty level. 97 Table A.4 Indicators of Public Sector Performance in Latin America Macro Economic Equity Stability Perform. Education Health Inst. Dev. Poverty Overall Performance Indexes calibrated to average 1.O Argentina 0.99 0.10 1.01 1.09 1.oo 1.04 0.76 1.29 1.15 Belize na 1.12 1.31 0.98 1.62 na 1.43 Bolivia 0.87 2.19 0.95 1.01 0.89 0.66 0.54 0.63 Brasil 0.91 0.48 0.88 1.03 0.98 1.19 0.82 0.80 Chile 0.92 0.84 1.33 1.01 1.08 2.69 1.92 1.57 Colornbia 0.90 0.61 0.88 0.98 1.01 0.50 0.82 0.64 Costa Rica 1.05 0.94 1.20 1.04 1.09 2.10 1.94 1.64 Ecuador 0.98 0.42 0.84 1.06 1.03 0.38 0.45 0.86 El Salvador 1.oo 1.30 1.03 0.95 0.98 1.10 0.32 0.84 Guaternala 0.95 5.16 1.03 0.90 0.94 0.39 0.49 0.80 Honduras 0.97 0.81 0.94 0.95 0.95 0.56 0.42 0.58 Mexico 1.06 0.45 0.97 1.06 1.04 1.22 0.70 1.19 Nicaragua 1.22 0.69 0.92 0.91 0.97 0.78 0.23 0.82 Panama 0.93 2.12 1.14 1.04 1.37 1.05 1.34 1.oo 1.06 Paraguay 0.91 0.77 0.77 0.99 0.22 0.56 0.55 Peru 0.96 0.28 1.03 1.04 0.98 0.75 0.49 0.86 Dominican Rep. 1.02 0.50 1.19 0.96 0.94 0.87 0.65 0.84 Uruguay 1.17 0.12 0.82 1.04 1.04 1.83 4.73 1.58 Venezuela 1.19 0.08 0.74 1.03 1.02 0.00 0.58 0.87 Average 1.oo 1.oo 1.oo 1.oo 1.oo 1.oo 1.00 I 1.oo Source: Machado (2006), Table 5. A.15 Table A4 presents the performance scores for each indicator, as well as an overall performance score that i s calculated as a simple average o f the other scores. (Note that each o f L 197. These performance indicators were constructed as follows: 0 Distributive equity i s measured by the Gini index. Macroeconomic stability i s measured by the variance o f the growth rate and the inflation rate over the period 1990-2003. Economic performance is measured by the average rate o f growth and the average unemployment rate (both averaged over 1990-2003), and GDP per capita in2004 (based on PPP). Educationperformance is measured by the literacy rate and the primary enrollment rate. Healthperformance is measured by life expectancy at birthand the infant mortality rate. Institutional development is measured with the indicator developed inKaufman, Kray and Mastruzzi (2006); and Poverty is measuredby the percentage o f the population living with less that 2 US$ per day in2003. 154 Annex A the indicator measures has been calibrated so that it averages 1.O across all countries.) Nicaragua scores below the average in each one o f the performance indicators, except for the distributive equity indicator, and exhibits the largest shortfalls in the area o f poverty. Offhand, one would expect Nicaragua to score below the regional averages, as most o f these performance indicators tend to be positively correlated with the level o fper capita GDP and considering that Nicaragua represents one o f the poorest countries in Latin America; see the right hand side o f Table A5, which compares the levels o f per capita GDP in 2004 (expressed in Purchasing Power Parity terms). Table A.5: Public Expenditure Levels Public Expenditures GDPlcapita Total Social Education Health 2004 II (percent of GDP, average 1990-2003) (in PPP US$) Argentina 25.0 16.1 3.4 3.7 $12,222 Belize 20.7 12.0 4.9 2.5 $6,201 Bolivia 23.3 7.5 4.2 1.o $2,499 Brasil 45.5 25.3 5.2 4.2 $7,531 Chile 20.8 13.5 3.2 2.5 $9,994 Colombia 18.1 6.3 2.1 1.7 $6,669 Costa Rica 21.8 13.1 3.7 4.0 $8,714 Ecuador 17.7 5.3 2.2 0.8 $3,643 El Salvador 13.8 5.2 2.1 1.o 1.2 $4,633 Guatemala 11.7 4.9 2.1 $3,964 Honduras 24.6 8.5 4.7 2.7 $2,644 Mexico 19.6 10.5 4.5 2.9 $9,010 Nicaragua 20.4 7.7 3.4 2.9 $3,340 Panama 21.3 9.1 2.4 3.1 $6,689 Paraguay 13.5 5.8 2.8 0.8 $4,423 Peru 17.7 7.3 2.6 1.5 $5,219 Dominican Rep. 15.6 6.2 2.4 1.4 $6,846 Uruguay 28.2 18.9 2.8 2.6 $8,658 Venezuela 20.1 7.4 3.2 1.I $5,554 Average 21.o 10.0 3.3 2.2 $6,2341 Source: Machado (2006), Table 7 and Table 8.Total public spending refers to the consolidated general government, including social security, while social spending refers to public spending on education, health and nutrition, social security, labor and social assistance, housing and water & sanitation. A.16 Table A5 also presents the level o f public expenditures in each country as a fraction o f GDP for different expenditure categories. Total public spending as a share o f GDP inNicaragua is slightly below the regional average (20.4 percent versus 21 percent). Also, the share o f total social spending in Nicaragua i s below the regional average, even though the share o f public sector spending on health and education i s slightly higher than the regional average. Arguably, the performance indicators reviewed earlier are influenced by public policies and actions, which are related, in turn, to the amount o f public spending. This lends itself to estimating the efficiency o f public spending by comparing the relative scores on the overall performance indicators to the relative amounts o f total public spending. Similarly, the relative scores on the poverty performance indicator are compared to the relative level o f social spending, as shown next. 155 Annex A Table A.6 Public SpendingEfficiency Scores inTerms of OverallPerformance (Efficiency scores are basedon the Free DisposableHullapproach) Input-orienfed Outcome-oriented Guatemala 1.oo Guatemala 1.oo Belize 1.oo Belize 1.oo Ecuador 1.oo Ecuador 1.oo Costa Rica 1.oo Costa Rica 1.oo Venezuela 1.oo Venezuela 1.oo El Salvador 1.oo El Salvador 1.oo Nicaragua 0.94 Peru 1.oo Chile 0.91 Dominican Republic 0.98 Panama 0.90 Uruguay 0.96 Bolivia 0.80 Chile 0.96 Uruguay 0.78 Nicaragua 0.95 Paraguay 0.78 Panama 0.94 Mexico 0.73 Mexico 0.83 Honduras 0.71 Bolivia 0.79 Peru 0.70 Colombia 0.74 Dominican Republic 0.60 Argentina 0.70 Argentina 0.42 Paraguay 0.69 Colombia 0.38 Honduras 0.67 Brasil 0.14 Brasil 0.49 Source: Own calculations based on figures in Machado (2006) A.17 Table A6 presents the efficiency scores obtained by dividing each country's overall performance score in Table A4 by that country's total amount o f public spending per capita,'98 and comparing the resultingratio to the indicator achieved by countries situated on the efficiency frontier. Nicaragua's efficiency scores turn out to be close to the median scores for all the countries in the region. These findings suggest that Nicaragua does not stand out as particularly inefficient fi-om an overall public spending perspective, compared to other countries in the region. The earlier sector-specific findings, however, also suggest that Nicaragua needs to devote special attention to the quality o f education spending, which appears to have been much less efficient than other countries inthe region.. L 198. The data on public spending per capita was calculated by multiplyingthe first and the last columns inTable A5. The resulting efficiency scores presented in Table A6 differ from the ones derived by Machado (2006), who uses the GDP-share o f public expenditures, rather than the per-capita amounts employed here. 156 Annex B Annex B Basic Parameter Assumptions Underlyingthe FiscalSustainabilityAnalysis The figures for the NPV o f the future stream of public revenues shown in Table 2.7 were calculated on the basis o f equation (13) o f Annex A o f the 2004 Nicaragua DPR.'99 That equation i s reproduced below: b o = [s +me/(l+y)][(l+g)/(r-g)] + [ab,*/(l-ap)][p-(l+r*)/(l+g)]. Each o f the parameters contained in this equation i s defined in the table below, except for two composite parameters, a and y. The first o f these is defined as, a = (l+g)/( l+r),while the second denotes the nominal rate o f GDP growth, such that (19) =(l+g)( 1%). The figures presented inTable 2.7 in Chapter I1can be derivedby insertingthe parameter values for 2006 from the tables below, together with various combinations o f values for real GDP growth (g), the fiscal surplus ratio (s) and assumptions about donor lending behavior (p). (For reference, the parameter values that applied in2003 are also shown.) Kev Macroeconomic Parameter Values for Nicaragua in 2003 and 2006 Symbol Values 2003 I 2006 Domestic Economic Parameters Real GDP growth (%) variable variable Nominal domestic interest rate ($ indexed. %) gi 12.0 10.0 Real domestic interestrate (%) r 10.0 8.0 Inflation rate (YO) A 8.1 8.9 Monetary base (% o f GDP) m 8.5 7.3 External Economic Parameters Nominal (concessional) interest rate (%) i* 3.0 3.0 Real (concessional) interest rate (YO) r* 1.o 1.o Dollar inflation rate (%) A* 2.0 2.0 Policy Parameters Rate of currency depreciation (Y) & 6.0 5.0 Primary fiscal surplus (YOof GDP) variable variable Base money expansion rate (%) eS - - - ExternalDebt Level Nominal value o f external debt (YOo f GDP) bo* 104.0 70 NPVof external debt (% ofGDP) B 30.0 35.0 Growth o f external debt parameter 1/ P variable variable L 199 World Bank, (2004) "Nicaragua Development Policy Review: Sustaining Broad-Based Growth" (Report No. 29115-NI), December 3. 157 Annex B 158 Annex C Annex C Reviewof PublicSpendingon Education Main Findings of Previous Reviews C.l The 2001 PER recorded important accomplishments in the education sector since the 1990s, particularly with respect to expanding infrastructure and increasing access. An important milestone noted in the study was the substantive progress made on moving forward school autonomy efforts by decentralizing management and finance functions in the schools and by fostering active parental and community participation in decision-making at the school level. Despite visible gains in school enrollment and the sector's important shift towards decentralization and school autonomy, the study highlightedthe need to focus on increasing access to initial and preschool education for the cohorts aged 0-3 and 4-6, whose participationrates were found to be well below regional averages. C.2 The PER highlighted the existence o f a variety o f programs aimed at addressing similar objectives. Too often, however, programs lacked coordination and targeting. Greater selectivity in investments in infrastructure was suggested in order to strike an effective balance between buildingnew school infrastructure and ensuring proper maintenance o f existing classrooms to reduce unusually high rates o f deterioration. For this purpose, the PER had recommended greater reliance on the Preventive Maintenance Fund (PMF) operated by FISE as well as an in-depth study to ascertain with more precision the current stock and quality o f classrooms and related school infrastructure. Finally, the review found few programs targeted at improving curricula relevance, school retention at all levels and rural and disadvantaged populations who have the least access and survival inthe formal school system. C.3 The 2003 Poverty Assessment noted progress in improving primary education indicators, which gives some comfort in terms o f ensuring the achievement o f the Millennium Development Goals (MDG) for education by 2015. At the same time, the assessment found little progress on improving other key education outcomes, such as adult literacy levels or increased access to early childhood education and secondary education. In general, the assessment noted the critical role o f education in raising welfare levels in rural and urban areas, particularly among females. Female literacy was found to be a factor associated with the probability o f school attendance among children from extreme poor households. The assessment recommended the (i) establishment or scaling up o f programs targeted to vulnerable families with an integrated package o f services to help infants and preschool children with improvements in nutrition status and cognitive development; (ii) programs and mechanisms to reduce the direct and design indirect costs o f schooling for children and young people from extremely poor households for whom schooling costs are a major bamer to either enrollment or retention. C.4 The 2004 Development Policy Review (DPR) also recorded continued improvements in education indicators and significant progress on institutionalizingmanagement and administrative policies to improve service delivery and accountability at school level, most notably the continuation o f the school autonomy program. The review also pointed to immediate remaining challenges that needed to be addressed in order to reach the Millennium Development Goals (MDGs) by 2015. Chief among these are the need to accelerate efforts to increase the completion rate o f the 6-year primary education cycle, particularly in rural areas where almost a third o f children aged 7 to 12 were not in school, improving teacher qualification levels and strengthening institutional capacity in the Ministry o f Education to monitor programs, measure impacts and improve accountability at all levels. Given the constrained fiscal capacity o f Nicaragua, which leaves little room to increase expenditures education in a way that would be commensurate with current and emerging needs inpost primary education, the review suggested to focus, 159 Annex C at least in the short to medium term, on efforts to increase the efficiency o f expenditure and improve the quality o f the programs being offered in order to achieve better outcomes with the same level o f spending. C.5 The main recommendations emanating from the DPR are to (i) accelerate the implementation o f the school autonomy program, (ii) develop a vision to de-concentrate sector responsibilities to municipal level, especially functions related to administrative and pedagogical support to schools, (iii) scale down redundant functions at the central level, clarify roles and responsibilities at central level and improve the technical profile o f Ministryofficials, (iv) undertake a more systemic and comprehensive development o f the various levels o f the sector, particularly at secondary education to bring enrollment and financing in Nicaragua at par with regional and international levels, (v)promote greater accountability at school level by using the results from national student assessments to inform parents and assist teachers to improve their performance, and (vi) develop a human resource strategy with a particular emphasis on raising the profile o f teaching professionals and improve the quality o f teacher education programs. C.6 The preceding analytical studies have been consistent intheir findings and recommendations: it i s clear that Nicaragua will need to continue its efforts towards increasing access to primary education, particularly in rural areas and amongst vulnerable population groups to ensure it achieves the MDG o f universal completion o f primary education by 2015. At the same time, improving the quality o f primary education programs i s essential to ensure the gains achieved thus far are sustained inthe medium to long term. In addition, as the primary education system expands, it i s important to increase investments in other levels o f the system, most notably early childhood development, pre-school and secondary education. Since substantial investments inthe sector are not likely to materialize inthe short to medium term, nor are the required expenditures to reach strategic milestones in those levels well defined, it i s imperative that the Ministry improves the efficiency of current expenditure, while additional public and external resources are sought to cover much-needed investments in early childhood and secondary education. The next section takes stock o f recent developments in sector indicators, outcomes and expenditure to shed light on the likely magnitude o f expenditures needed in the medium term to expand coverage inpre- and post-primary education. C.7 Among the most noteworthy events that have taken place inthe sector since the publication o f the 2001 PER, have been the passage o f the Education Participation Law and approval o f the Education for All - Fast Track Initiative (EFA-FTI).The Education participation Law (413) was passed in 2002 thus providing a legal framework to scale up rapidly the incorporationof schools into the autonomous program with financial assistance from external partners. The EFA FTI Secretariat approved and disbursed financial allocations to Nicaragua worth USD 7 million for 2004-2005 and an additional USD 10 million for 2006-2007. Specific activities to be financed by the EFA FTI are incorporated in the Common Work Program and its corresponding Annual Program o f Activities. While the Ortega administration has embraced the EFA FTI, it has expressed concerns with aspects o f the Education Participation Law, particularly with the financial transfers provided to the schools. In fact, for the academic year beginning in2007 all financial transfers to the schools were stoppedpending a final decision on MINED for a way forward. The next section will provide a more detailed description o f the concerns and possible implications for the sector in broad terms and for the current education program supported with an IDA Credit. Trendsin Education Indicators C.8 Access and internal efficiency. Enrollment in primary education has increased in absolute terms from 838,437 students in 2000 to nearly 1million in 2006; representing an average annual growth rate o f about 2.1 percent over the period 2000-2006; Table C.l. The increase responds to greater efforts to increase first time enrollment in grade 1 to cater for the natural growth in the school age population. The positive trend i s supported by data from the two most recent household surveys, which highlights a 160 Annex C decline in the proportion of children aged 7-12 not attending school from 12.1 percent in 2001 to 9.4 percent in 2005. While the decline inthe proportion o f non-attendance is most evident amongst children fi-om extremely poor households, from 27 percent to 21 percent from 2001 to 2005, respectively, the proportion o f children out o f school remains extremely highand, therefore, inneedfor urgent attention. Teacher Education 7,460 6,201 6,774 6,243 5,886 5,351 5,479 Adult Education 51,293 83,413 78,316 66,347 89,074 91,961 99,623 Total 1,146,240 1 1,458,314 1,553,289 1,563,411 1,634,052 1,674,699 1,710,347 C.9 Inan effort to target programs aimed at this population, MINEDis actively working to identify needs and service gaps at municipal level to target and strengthen educational programs in underserved areas. An annual report with information on the status o f educational indicators across departments and municipalities and their relative ranking according to an index o f indicators i s being used to plan investments and design programs (Indice del Estado Educativo Municipal). According to the latest report, published in December 2006, the highest rankings were observed in the Departments of Carazo, Chinandega, Masaya, Esteli and Leon while the lowest ranlungs were observed in the Departments o f Matagalpa, RAAN and RAAS. The five municipalities with the highest enrollment rates and efficiency were Cinco Pinos, Moyogalpa, Puerto Morazan, Jicaral and San Juan del Sur. C.10 In terms of the distribution across levels of education, the primary education level holds the largest proportion o f the enrolled population, Figure C.l. While the proportion changed from 1995 to 2001, from 66 percent to 59 percent in 2001, the proportion has remained almost constant over the last five years. The changes inthe school pyramid are mostly due slight increases in access to preschool and secondary education. Figure C.l- Proportionof Enrollment by Level 1994-2006 I I I 1 m u " g s" s z E g g a s 3 3 N N W R Preescolar Primaria Secundaria 1 Docente Form. Educ.Adultos 161 Annex C C.11 The net enrollment rate in preschool education increased from 31.8 percent in 2000 to 41.7 percent in2005. Inprimary education the net enrollment rate increased from 84.1 in2000 to 91.9 in2005 and from 36.8 percent to 44.3 percent in secondary education over the same time period.*" In2005 the official age at entry in the first grade was also reduced from 7 years to 6 years to promote an earlier entrance into the formal school system, which i s consistent with international best practice. The policy appears to be yielding results: in 2005, approximately 75 percent o f first graders in urban areas where in the appropriate age range (6 and 7). Inrural areas, however, only 54 percent were in the appropriate age bracket; in fact, a third o f first graders were 9 years or older. Overall, the highest annual growth rates in enrollment for the 2001-2006 period are preschool and secondary education, which i s consistent with the existingpolicy framework supportedby the PRSP and the Common Work Program at the sector level. Average Level 2001 2002 2003 2004 2005 2006 2001-2006 SDecial Education 6.38% -3.09% 6.87% -3.44% -0.39% 0.54% 1.44% Source: IndicadoresMECD. Incluye Toda la Ofertade Cobertura del MECD C.12 With respect to internal efficiency indicators, progress has been steady since 2001, but it has also been slow. Repetition rates have remained unchanged since 2001, at around 11 percent for in primary education and 6 percent in secondary education. The proportion o f students who complete primary education inthe allotted time for the cycle (6 years), increased from 27 percent in 1997, to 36 percent in 2001 and 41 percent in 2006; Table C.3. Completion rates within six years are higher among female students and inurban areas. It i s important to note the substantive improvements o f this indicator inrural areas, from a low base o f 14percent in 1997, to 23 percent in2001 and 31 percent in2006. Increasing the proportion o f students who complete without repeating a grade i s o f particular importance not only to ensure learners become confident o f their academic abilities and prospects for their educational future (the likelihood o f dropping out increases sharply for overage students) but also to increase the efficiency o f resource use by creating more places inthe system. C.13 Improvements in the primary completion rate are hampered by a high rate o f repetition and drop out, and the fact that many students simply fail to register for the next school year. This last phenomenon i s most pronounced in the transition from first to second grade. Figure C.2 shows the decline in enrollment across successive years, from 2000 to 2005. As illustrated, in 2001 the absolute student enrollment in the first grade stood at 234,001, o f whom 22,198 students were repeaters while 20,122 students dropped out at the end o f the school year. According to these numbers, the eligible population that would have been able to enroll in second grade in 2002 was 213,879, however, the actual number o f students enrolled stood at 176,310. Furthermore, if the second grade repeaters (15,005) are subtracted from the 2002 enrollment, the net first time enrollment in the second grade is only 161,313 students. That means that 28,269 students that finished the first grade simply failed to register for the second L 200. The net enrollment rate was adjusted in 2005 to reflect the latest findings from the 2005 Census which indicates an inter-census rate of 1.7 percent as opposed to the 3.1 percent estimated usingthe 1995 Census. 162 Annex C grade in 2002. This same trend i s also observed in the transition from 2002 to 2003, and from 2003 to 2004; Table C.4. TableC.3 Percentageof StudentsCompletingPrimarySchoolin6 Years - Year I Total I Female I Male I Urban I Rural 1997 27 29 24 42.3 14.9 1998 31 34.4 27.2 48.8 16.8 1999 32.2 35.7 28.9 49.5 18.7 2000 35.4 39.2 31.9 54.1 21.5 2001 36.3 40.5 32.4 52.5 23.3 2002 38.5 42.8 34.6 59.2 27.7 2003 40.8 45.3 36.7 58.9 30.2 2004 40.9 45.1 37 60.8 30.2 2005 41.2 45.6 I 37.2 58.2 31.2 2006 41 45.2 37.1 57.3 II 31.3 **2006 i s preliminary Year FirstGrade Second Grade C.14 The drop out rate inprimary education remains high, particularly inthe early grades o f the cycle. The average annual drop out rate in grade 1 for 2000 through 2005 was 17.5 percent compared to 20 percent 1990-2000. Since 2005 there has been a marked improvement in lowering the drop out rates in grade 2 and beyond, which i s a commendable achievement for the Ministry.While there i s still some way to go to eliminate drop out inprimary education, the immediate challenge remains in grade 1which i s an exit point for a number o f students, see Table C.5. Year Grade 1 Grade2 Grade 3 Grade4 Grade 5 1990 23.5 7.5 9.8 11.9 10.9 1995 21.2 9.2 13.7 16.5 13.1 2000 19.9 1 10.2 I 9.6 11.9 I 8.5 2001 17.7 I 10.1 8.7 I 11.5 9.2 Data for 2006 are preliminary 163 Annex C (2.15 The factors associated with highdrop out rates in grade 1 are inmost instances related to a mix o f demand and supply side constraints. On the demand side, important factors include poor school readiness, language barriers and directhndirect costs o f school attendance. On the supply side, there are factors such as distance to nearest school, poor quality o f education facilities/services and lack o f qualified teachers with experience on catering for the needs o f students from extremely poor households many o f whom have never taken part in any kind o f early stimulation or school readiness programs. It should be noted that in 2005,2006 and 2007 the Ministry o f Education has implemented successfully various emergency programs in poor neighborhoods aimed at identifying and enrolling students aged 6-8 who were not attending school or had dropped out prematurely. These programs tend to be ad-hoc and expensive, so it i s important for the Ministry to devise strategies to retain students in grade 1 to decrease the need for annual emergency programs. This would free up financial resources for other important activities to improve the quality o f education.'01 While the precise magnitude o f demand or supply side constraints needs to be established, findings from recent household surveys indicate monetary problems as the most important constraint for primary school aged children especially those students living in extremely poor households in rural areas. For the secondary school aged population, the main constraints are financial, work activities and lack o f interest in schooling opportunities. This translates into about 40 percent, 1 percent and 43 percent o f the populations o freference, respectively. C.16 The situation in secondary education i s similar o f that in primary education with respect to the highlevel o fdrop out rates. The difference, however, is that whereas inprimary educationthe rates are on the decline, improvements in secondary are negligible, ifany at all; Table C.6. Table C.6 -Drop out Rates in Secondary Education by Grade, 1990-2005 Year I Grade 7 I Grade 8 I Grade 9 Grade 10 I 1990 21.9 I 4.2 I 1.4 II 3.8 I 1995 21.4 13.6 17.2 17.1 2000 19.2 10.7 12.1 8.8 2001 16.5 8.6 9.8 6.6 2002 20.3 13.1 16.4 10.9 2003 18.9 11.4 12.8 7.8 2005 es preliminar C.17 Oualitv Indicators. The total teaching force increasedby approximately 5,000 positions between 2002 and 2004, equivalent to approximately an 11 percent increase in the overall teaching force. As illustrated inTable C.7, teacher salaries also increased over the same time frame, even though the average teacher salary remains below the target benchmark (3.5 times GDP per capita) established under the EFA FTIindicativeframework. (2.18 Perhaps one o f the most serious problems in the sector, with a direct effect on the quality o f education, i s the increase in the number o f unqualified teachers (`empiricos'). At the primary education level, the percentage o f unqualified teachers had a slight increase, from 25.8 percen?" in 2002 to 26.3 L 201. The cost per successful student inthe Programa Aprestamiento en Vacaciones carried out inDecember 2005 was USD 20. Similarly, the Programa de Rescate de Matricula 2006 and the Programa Salvemos Primer Grado was USD 65 per student. 202. Radiografia del empirismo docente, JR Laguna, Diciembre, 2005 -Estadistica Escolar 2000-2005, MECD 164 Annex C percent in 2004, while in secondary education the increase was fairly substantial, fiom 37 percent to 51 percent. An in-depth study on the situation o f teacher qualification level in the education system in Nicaragua found that the highest proportion o f unqualified primary school teachers was registered in StateMunicipal, Non-autonomous schools (40 percent) while Autonomous Schools had the lowest proportion (19 percent). At the secondary level, the proportion o f unqualified teachers i s above 50 percent, irrespective o f type o f school establishment. While it would be important to study the factors associated with the observed differences in the teacher profile depending on the type o f establishment, it i s clear the proportion o f unqualified teachers remains dangerously highand warrants immediate action. Table C.7 Evolution of Teacher Salaries (innominal Cordobas) - 2000 2001 2002 2003 2004 2005 Average primary school 1,048.48 1,232.32 1579.45 1,616.85 1,931.93 2,529.37 teacher salary (inCdrdobas) Average primary school 1,109.61 1,293.45 1,617.87 1,655.27 1,970.35 2,615.42 teacher salary (in Average teacher inrelation 1.42 1.52 1.88 1.81 1.96 2.54 to times GDP per capita. Source: Direccidn General de Prospecciony Politicas (DGPP) Radiografia Empirismo 2004, Dic 2005,J.R. Laguna. Datos 2005 tornados deEstado de la Educacidn Basicay Media 2005, Gutitrrezy Laguna, MINED. C.19 It i s unclear the extent to which current teacher salary levels have had on staff turnover or on the persistently high proportion o f unqualified teachers, which remain in the system despite the Ministry's efforts to accelerate pre and in-service teacher education programs. Situationanalyses and working papers point to several factors which have had an impact on the poor quality of the teaching force, including (i) the lack o f a comprehensive teacher education reform policy; (ii) lack o f coordination between the the universities who have the responsibility o f secondary education teacher training programs and the MinistryofEducation; and (iii) lack ofan educational policy ofassigning experienced teachers to the the first 3 grades o f the primary education cycle, which are the most crucial years;204and (iv) the absence o f professional development programs for teachers, including pedagogical advisory services to support and strengthen teacher practice. C.20 The national student assessment camed out in 2002 showed that most students in the 3rd and 6th grades achieved basic levels o f proficiency in Spanish and Mathematics (Table C.8), with students in private schools generally exhibiting a margin o f 10 to 12 percentage points above public school students. The proportion o f students inbasic and proficient levels also varied by type o f establishment, with private school faring better compared to public schools. An analysis o f teacher profile factors and their impact on student performance indicated that only about half of the teachers feel well prepared to teach grade school Geometry while 39 percent felt well prepared to teach concepts related to probability in the sixth grade. An assessment was carried out in October 2006 to analyze trends in student learning and investigate the impact o f school-based associated factors on learning. In addition, in October 2006 Nicaragua participated in the regional student assessment (SERCE) coordinated by UNESCO. The assessment i s expected to become a rich database that will generate a series o f regionalhub-regional comparisons and lessons learned. L 203. Includes teacher salaries inprivate schools. 204. It is very revealing that in 2004, 24.6 percent of all first grade teachers were `empricos', while only 15.4 percent of all sixth grade teachers had this status; Laguna (2005). 165 Annex C Grade and Subject YOof Students with Basic Proficiency 3rd grade- Mathematics 61.7 3re grade-Spanish 71.2 6th grade- Mathsematics 88.1 6th grade- Spanish 69.7 C.21 School Management. The school autonomy program started as a pilot in 1993, with the participation o f 20 large, urban secondary schools that volunteered to participate. In 1995, the model was extended to primary schools with special adaptations inrural areas, and by 1997, a total o f 3,950 schools were participating in the autonomy program. The autonomy program was institutionalized with the Education Participation Law passed in 2002, along with its internal regulations for its operationalization. By 2006, a total o f 4,997 primary schools (or 58 percent o f the total) and 501 secondary schools (or 40 percent o f the total), enrolling a total o f 942,476 students, were operating under the Participation program,2o5 C.22 Key elements o f the EducationParticipationLaw are the decentralization o f decision making and o f financial resources to schools that are incorporated to the autonomous program. Financial resources, in the form o f grants, are transferred from the Ministry o f Education to the schools based on a capitation grant formula. On occasion, a nominal amount is added to cover minor school repairs and rehabilitation. School fees and levies are not official in Nicaragua, however, it is not uncommon to find schools collecting levies, fees or contributions to cover services ranging from maintenance of school grounds to school fairs and lotteries. Although there i s no information available on the proportion o f school-based revenue relative to the grant sent form the Ministry o f Education, anecdotal evidence indicates that in some cases school based revenue can be substantive. Evidence from qualitative studies indicates that school fees, coupled with the indirect costs o f schooling (uniform, shoes, materials, lunch meal, etc.), have a deleterious impact on school age children from extremely poor households who are unable to afford such expenses. In2007, the Ministryo f Education denounced the practice of collecting school fees and banned schools from charging students. While this i s an important step forward to removing demand side barriers, it i s equally important to ensure some o f the revenue that was used to finance educationally sound programs or grounds keeping facilities, can be offset by an increase in the Ministry's financial resources to the school. Otherwise, there is a risk o f deterioration to the school grounds or erosion in the quality o f service delivery. C.23 A recent analysis o f the profile and characteristics o f schools that have been incorporatedinto the autonomous model indicates these are heterogeneous with respect to size, urban or rural location, or average socio-economic level o f its students.206 The single most important factor positively and consistently correlated with good school management practice i s the strong and clear leadership from School Principals and School Councils. C.24 While the school autonomy program has not undergone a rigorous impact evaluation, a recent analysis o f the model yields some important findings. Among the positive aspects o f the program are the empowerment o f parents, students and teachers to identify, manage and solve issues affecting their school and its immediate community as well as better indicators such as lower repetitionrates, fewer unqualified L 205. School autonomy is one o f the aspects ofthe Education Participation Law. 206. Castro, Vijil, Cuadra, Alvarez y Traa, 1998, Evaluacion del Program de Autonomia; Castro y Vijil, 2004, Estudio sobre Participacion y Calidad Educativa para CERCA, AED. 166 Annex C teachers and higher test scores in 3`d grade Spanish as displayed inthe 2002 national assessment.207there are some less encouraging results, however, including a significantly higher than average student-teacher ratio, which i s not entirely surprising since the transfer i s based on a capitation grant, and the lack o f proper monitoring and evaluations mechanisms to provide oversight and compliance with fiduciary agreements, including payments for utilities and teacher end-of-year bonuses. A weakness o f the grant transfer program has been the lack o f a mechanism to mitigate against the perverse incentives that capitation grants can often have on enrollment. An enrollment audieo8 carried out in 2002 by the Ministry o f Education identified inflation in the enrollment statistics in the order o f 19 percent at the primary level and o f 23 percent at the secondary level. Since then, the Ministry has adopted several measures to correct the problem and while these have been effective in reducing over reporting o f students to 16 percent at the primary level and to 6 percent at the secondary level, the persistence o f this problem, coupled with other problems, prompted the Ministry to make some changes to the transfer formula in2005-2006. FigureC.2. Enrollment ,evelsby Type of School % Primary SchoolEnrollment byType of School % Secondary SchoolEnrollment byType of School 70% 60% .A, 50% W'I - .._...._.._.-._.._.-- ... .. , 40% 40" - 30% 30 ". - 207" 2 w - 10% insd- 0% oy,,-- 1998 2000 2w2 2004 2006 1998 2000 2002 2004 2006 EstatalNoAutonomo Autonomos EstatalNoAutonomo Autonomo 0MunicipalnoSubvenaon Autonomo PnvadoSin Subvenc Privado SmSubvencion Privado ConSubvencj PrivadoCon C.25 Given the positive aspects as well as the challenges o f the program, it would be advisable to undertake an in-depth study o f the autonomy model to identify the aspects and factors that have contributed towards successful outcomes as well as the aspects that have presented challenges overtime. The study would potentially inform decision makers in the Ministry on a possible way forward that maximizes the positive aspects/outcomes, particularly those linked to improving educational quality and eliminate those elements that have distorted the process o f decentralization and local administration. This analysis could begin by exploring the results o f the 2006 national assessment and should seek broad participation from all sectors of Nicaragua's education community. It would be advisable to modify the model within the existing legal framework, and tahng account the General Education Law, which stipulates that all education reforms must be broadly consulted (Articles 63 y 64). L 207. J.R. Laguna, Radiografia del empirismo, Dic 2005 208. Porta E. y Gutierrez R., "Estimacion del indice de veracidad de la matricula reportada por 10s centros autonomos" Managua, MECD, 2003. 167 Annex C Evolution of Sector Expenditures C.26 Since the late 1990s, there has been a marked upward trend on education expenditure. As illustrated in Table C.9 total expenditure on education has increased from 3.6 percent o f GDP in 2001 to 4.9 percent o f GDP in2005. For MINED, expenditure on education increased steadily from 2.5 percent o f GDP in 2001 to 2.8 percent o f GDP in 2005. About two-thirds o f the total expenditure on education i s allocated to MINED for pre-university education, a figure that has been constant for a decade. Compared to other countries in the region with similar level o f development such as Bolivia, Nicaragua allocates a lower proportion o f its budget for education. C.27 Within the education sector (excluding universities), the bulk o fresources are devoted to primary education (77.3 percent), followed by secondary education (12.7 percent) and adult education (5.2 percent). The proportions have remained constant over the last five years, with the only exception being adult education where expenditure increased from 2.3 percent to 5.2 percent o f the total expenditure from MINED in 2005. Overall, per student spending is highest at primary level (US$ 128) followed by secondary education (US$ 48) and pre-school education (US$ 20); Figure C.4. It should be noted that Nicaraguapresents a highly unusual case inwhich per student spending at the secondary level is not only below that o fper student spendingon primary, but well below, at less than half. 1998 1999 2000 2001 2002 2003 2004 2005'p Total ExnenditureonEducation 1.124 1.734 1.917 2.012 2.303 2.896 3.109 3.934 As % ofTotal Education lp: preliminary figures 168 Annex C Table C.10 Public EducationExpenditureas YOof GDP - (excludes tertiarv', 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 B FigureC.4 Per Student SpendingbyLevel 2002-2005 (in current US$) - $140 $120 $100 $80 $60 S40 $20 $0 2007 717177 711114 2005 HPREESCOLAR 0PlUMARIA HSECUNDARIA Source: MINED 169 Annex C C.28 Since 2003 the proportion o f the budget for education coming from the public budget has increased from 69.3 percent to almost 85 percent; Table C . l l . Similarly, the proportion o f grant resources shows an upward trend since 2003 (note that data for 2006 are still preliminary), making o f for almost one fourth o f the total resources allocated to the sector, while resources coming from external credits has decreased substantially. Overall the rate of budget execution in the sector i s high, averaging over 90 percent for public resources and grant financing. Table C.ll: BudgetAllocationand Actual expenditureby Source of Funds Cordobas (in `000) 2002 I 2003 I 2004 I 2005 I 2006 External Grants I 240,978 328,108 463,526 661,429 I 292,134 External Credits I 273,229 II 252,163 II 328,219 I 158,222 I 177,734 OwnResources 825 900 708 Total 1,646,227 1,817,860 2,167,733 2,612,562 2,717,797 Expenditure Treasury Resources I 1,120,776 I 1,229,899 I 1,373,057 1 1,784,533 I 1,550,228 OwnResources 0.0% I 0.0% 0.0% 0.0% 0.0% Total 100.0% I 100.0% 100.0% 100.0% 100.0% Treasury Resources 99.01% 99.44% 99.85% 99.57% 68.96% External Grants 87.60% 93.52% 81.28% 91.16% 77.55% External Credits 56.11% 94.03% 74.08% 91.14% 27.33% OwnResources - 98.67% 99.33% 100.00% 1Total C.29 The proportion o f the public budget devoted to primary education has remained constant at about 68 percent from 2002 to 2006, followed by an average o f about 12 percent respectively for secondary education and centrally/common projects and activities; Table C.12. With respect to external grants and credits, the bulk o f expenditures are allocated centrally. It i s important to highlight that the majority o f external financing, whether grants or credits, have been earmarked mainly for primary education and for centrally executed activities and programs. 170 Annex C Cordobas (in `000) 2004 Total I 100.0% I 100.0% I 100.0% I 100.0% I100.0% I 100.0% I 100.0% I100.0% I 171 Annex C Main Conclusionsand Recommendations C.30 Despite important gains in increasing primary school enrollment, the education system in Nicaragua continues to lag behind on key access, quality and equity indicators at all levels o f the system. At this juncture, it is imperative to accelerate efforts aimed at (i)expanding access to preschool educational programs to ensure children are prepared for enrollment and successful completion o f the primary education cycle; (ii) expanding teacher education programs to raise the technical and pedagogical standards o f unqualified teachers, improve teacher practice and promote better learning outcomes; (ii) implementing targeted programs for the school age population in rural areas and in the Atlantic cost to improve schooling outcomes; (iii)expanding access to secondary education and/or job training opportunities for youth aged 15 to 24 years to ensure they have the shlls needed to transition effectively into the world o fwork. C.31 Cost. Financing. and Sector Expenditures. In order to estimate the costs and financing requirements neededto improve the quality o f education and expand access beyond the primary education cycle, it would be useful to carry out an in-depth analysis o f sector allocations, efficiency o f resource utilization and projections of sector requirements, takmg into account the likely macro fiscal envelope over the next ten years. The following specific measures are recommended: ~~ Continue to monitor the implementation o f poverty focused programs inthe context o f Nicaragua's Poverty Reducing Strategy and ensure the most effective and efficient use o f resources in the education sector. Develop a medium-term cost and financing framework for the education sector that incorporates the poverty-focused program along with targets for new investments in early childhood development, preschool and secondary education to inform decision making on what and how much to invest in the various sub-levels to achieve universal completion ofprimary education as well as key regional targets on enrollment in pre and post primary education levels. This could be a tool to guide new versions o f the Common Work Program (CWP), which receives financing from the Government and the international cooperation, including the World Bank and the EFA FTI. Develop a monitoring an evaluation system to track the implementation o f the CWP and provide information on sector expenditure in real time. Ideally, the system would be compatible with the country's public financial management information system. C.32 Sector Administration and Management. Inlight o f the successes with school based management and community empowerment in decision making processes, it i s important to maintain the core principles o f the decentralization program, while at the same time acknowledging that some aspects need updating based on accumulated experience and evolving social, economic and political context. Inthat context, the following measures are recommended: 0 Support initiatives to strengthen school-based decision-making and resource allocatiodmanagement. More specifically, linkresource allocationto specific school quality improvements projects/activities, while strengthening local monitoring and implementation capacity in schools and municipalities. 0 Strengthen the institutional capacity o f the Ministry o f Education by introducing a monitoring and evaluation system that provides timely and accurate information on education indicators, outcomes and impacts, as well as on the implementation o f the Common Work Program, which at this moment i s too fragmented. 0 Disseminate key education indicators on school and student performance to promote social accountability and generate support to improve service delivery. A first step could include an analysis o f the 2006 national student assessment, which could be useful to identify schools that require additional assistance to reach a desirable standard o f quality. 172 Annex C C.33 Imuroving Access and Oualitv. The following measures are recommended to improve access and quality o f education inNicaragua: Develop a demand-side program that can follow through with the recommendation made inthe 2004 DPR to "design programs and mechanisms to reduce the direct and indirect costs o f schooling for children and young people from extremely poor households for whom schooling costs are a major barrier to either enrollment or retention". Prioritize the Atlantic Coast and the Central regions in carrying out infiastrcture investments to improve the supply o f schools andteachers inremote areas. Expand pre-school education coverage, at least at the third level (children aged 4 and 5), and follow up on the recommendations o f the 2004 DPR to focus on establishment or scaling up of programs targeted to vulnerable families with an integrated package o f services to help infants and preschool children with improvements innutrition status and cognitive development. Develop a human resource strategy in the sector with a particular emphasis on raising teacher qualification levels. In developing such a strategy, special attention should be given to revamping existing pre and in-service teacher education programs, establish incentives to discourage the practice o f hiring unqualified teachers and design an effective pedagogical support system to promote better teacher performance. Strengthen the first three grades o f the primary education cycle by (i) harmonizing the curriculum in these three grades to emphasize reading, writing and mathematics logic and comprehension, (ii) assigning the most experienced teachers to the first three grades, and (iv) ensuring an adequate supply of classroom and learningmaterials.. Design and implement an education policy that i s attuned to the special issues facing rural areas and putinplace anincentive systemto attract qualifiedteachers inrural areas. Expand opportunities for secondary education, implement targeted programs to ensure that the youth aged 15 to 24 years have a second chance to complete their studies (primary or secondary) and ensure short term training courses are demand driven. 173 Annex C 174 Annex D Annex D Review of Public Spending on Health Main Findings of the 2001 PER D.1 The PER 2001noted that the Nicaraguan Health Policy in the 90s was centered on the extension o f coverage to the poor segments o f the population and highrisk groups (children and pregnant women), tryingto place- more emphasis onprevention than on the provisiono f direct medical attention. The report concluded that while access to services by the poor improved during the 1990s, they also had the following shortcomings: (a) they tended to overlap with or duplicate each other (there were 8 different models o f primary health care in the public health system), (b) they were characterized by excessive investment in infrastructure and spending on central administration spending, and (c) the programs to provide these services generated little systematic information about their costs and effectiveness. D.2 The following recommendations were offered to address these shortcomings and improve the efficiency o f sector expenditures. To improve operational efficiency, the report recommended, (i) preparing a complete analysis o f all investments in sector infrastructure, evaluating the level o f utilization o f the infrastructure and the sustainability o f associated recurrent costs, (ii) reducing the duplication o f programs and administrative costs by establishing just one model o f primary health care. This goal was achieved through the design and approval o f the Integrated Model o f Health Care (MATS or Modelo de Atencidn Integral de Salud). (iii) Reaching a consensus among donors regarding overall sectoral proposals, and (iv) developing an appropriate system o f information gathering to allow systematic monitoring and evaluation o f programs. This is underway through a new work scheme o f the Statistical Unit. D.3 To improve allocative efficiency, the report recommended greater focus on, (i)improving the management o f medical inputs, (ii)offering one standard primary health care package - after having identified the most cost effective one, (iii) managing personnel more efficiently, with an emphasis on recruiting more nurses and other technical staff, instead o f physicians, and (iv) developing and extending health and nutrition programs directed to households, instead o f an infrastructure-based model o f health care delivery. D.4 The report concluded that the implementation o f institutional reforms had been uneven and slow. Many o f the reforms faced implementation difficulties and required a concerted effort from all key stakeholders. Although the health sector reforms had considerable support during their inception, they had lost their momentum and needed to be revitalized. As the following sections o f the present report will show, Nicaragua has made progress in some areas including sector outcomes, but most o f the efficiency and equity issues still remainto be addressed. Health Sector Overview Evolution of Key Sector Outcomes D.5 Since 2001, Nicaragua has made gradual, but steady, progress in a number o f key health indicators; Table D.1. Infant and child mortality rates have declined together with chronic malnutrition rates. While maternal mortality rates based on MOH data also decreased from 2001 to 2005, it must be noted that these are mainly from facility-based and not nationally representative surveys.2o9The most L 209. This figure i s likely to be underestimated. For example, the 2000 MOH MMR estimate of 87.6 deaths per 100,000 is substantially smaller than the WHO Core indicator estimate of230 per 100,000. 175 Annex D recently available data for percentage o f attended births by skilled health personnel-which i s a well- recognized proxy to measure MMR i s from 2000 at 67 percent. With regard to other indicators that are related to maternal health, prenatal coverage increased very slightly from 70 percent to 71.6 percent although more progress was made interms o f the percentage o f women who had four prenatal visits and those who gave birth in health facilities. However, family planning coverage declined. Also, while the percentage o f children who received the BCG vaccine increased, the percentage o f one-year old children who received vaccinations against polio, DPT(diphtheria, pertussis, and tetanus), and MMR (measles, mumps,andrubella) decreased. Table D.l HealthOutcomes and Outputs, 2001and2005 Key Performance Indicators 2001 2005 Infantmortalityrate (per 1,000 live births) 35" 30b Underfive mortality (per 1,000 livebirths) 40" 37b Chronic malnutrition (children < 5 years o f age) 20.2a 18.1c(2004) Maternalmortality rate (per 100,000) 107.2d 86Sd Institutional births ('YO) 50.6 58 Prenatal care coverage e?) 70.2 71.6 Pregnant women who had4 prenatal visits (%) 48.8 56 Family planning coverage e?) 24.5 12.9 On year old childrenwho received BCGvaccine 98 102 One year old children who receivedpolio vaccine 92.6 86.7 Oneyear old children who receivedDPT (Diptheria, Pertussis, andTetanus) vaccine 92 86.2 One year old childrenwho receivedMMR(measles, mumps,rubella) vaccine 101.6 96.3 Sources: "ENDESA 2001; bWDR2006, 'SEWN 2004, dMOHstatistics (INS 2004-2008 document) Progress in Meeting the Millennium Development Goals D.6 While Nicaragua has made progress in reducing infant and child mortality rates, as shown in Figure D.l, it i s still slightly off-track in reaching its infant and child mortality MDGs. In terms o f maternal health, while the MOH-based estimates are promising because they indicate a declining trend in maternal mortality rates, the MOH 2005 estimate o f 86.5 per 100,000 i s still very far fkom the 2015 MDG goal set by the Government o f 20 per 100,000. It i s also highly recommended that a nationally representative survey be conducted to make it comparable with the WHO 2000 estimates o f 230 deaths per 100,000. If undertakmg such a survey i s not feasible then the proxy-for MMR-indicator, i.e. the percentage o f women who deliver attended by a shlled health professional should be updated because the most recently available published data for Nicaragua i s 67 percent in 2000. Moreover while the percentage o f children under 5 years o f age who are stunted has declined from 24.5 percent in 1998 to 18.1 percent in2004 (WDI 2007) it i s not clear whether the country i s on track with regard to meeting the 2015 MDG nutrition goal because o f the absence o f comparable 1990 data to adequately track progress. Readily available Government documents do not also appear to specify the MDGtarget for nutrition. D.7 According to the latest Living Standard Measurement Study (LSMS), carried out in 2005, respiratory illnesses, followed by chronic illnesses, diarrhea, and s k m ailments are the most common types o f diseases inNicaragua (Figure D.2a). Three o f these diseases (respiratory, diarrhea, and skm) are largely preventable ones. Respiratory diseases are relatively more prevalent among individuals in the poorest quintiles while chronic illnesses are most common among individuals in richest quintile. On the other hand, indigenous people and agnculture producers are more likely to suffer fkom diarrhea and other multiple types o f illness (Figure D.2b). 176 Annex D Figure D. 1Progresstowards meeting the MillenniumDevelopment Goals inHealth, Nicaragua 1990-2005 Infant Mortality11,OOO Under 5 mortalityl1,000 I n 10 - +Actual MOGGoal lPI0 1995 m m ZDlS Maternal Mortality, 100,000 Note: MMR estimates and goals basedon Government o fNicaragua MOH statistics 2007. Sources: World Development Indicators, DHS for 2001 data for IMR and U5M. 177 Annex D Figure D.2a Figure D.2b Morbidity in Nicaragua 2005 I 0 drmcIllness 15% 58% 1Ph 0Chronicillness 0Otherlrnultiple 5% Skinlaccidentlviolence Sources: LSMS 2005, authors' calculations Health Services Provision D.8 The main actor in the health sector i s the Ministry o f Health (MOH) which operates through a network consisting of 28 general and 4 chronic disease hospitals, 868 health posts and 175 health centers. The Nicaraguan Social Security Institute (INSS) i s the second largest provider of public health services. INSS covered 439,000 active workers in 2006, and an estimated 296,000 dependents, although its coverage has beenrecently extended to include children from 6 to 12years o f age o f active affiliates. Table D.2 Health Facility accessedin previous month (2005) Type of Facility Consultations Extrapolation to total Number YO population Health Center and Health Posts 543.341 50.9 2.776.818 , , Public Hospital (MOH) 1371208 12.8 701,220 Total MOH 680,549 63.7 3,478,038 Private Clinics 189,475 17.7 968,338 Private Hospitals 12,364 1.2 63,188 Private Providers 201,839 18.9 1,03 1,526 INSS (Private Health Previsional Institutions 119,739 11.2 611,942 Others 65,687 6.2 335,702 Total 1,067,814 100 5,457,208 Source: LSMS Survey 2005. D.9 The realnumber o fbeneficiaries i s unknown, however, as INSS has not compiled reliable figures. According to the most recent LSMS survey, 64 percent of the populationuses MOH facilities, 19 percent use the private sector, 11.2 percent use the INSS, and 6.2 percent use other providers or facilities (including traditional medicine). Extrapolating from the LSMS figures, the total population covered by MOHis around 3,500,000 people. 178 Annex D Evolution of Key Sectoral Expenditures Overall Sectoral Expenditures D.10 According to 2004 NHA figures, health expenses in Nicaragua are 8 percent o f GNP.210MOH - expenditures fluctuated yearly since 1997, both due to national budget restrictions and donor contribution fluctuations, reaching2.8 percent o f GDP by 2004. INSS expenditures as a share o f GDP increased by 62 percent, from 0.8 percent in 1997 to 1.3 percent in 2004. Household expenditures comprised 3.3 percent o f GDP in2004. D.11 National Table 4.3. caraeua: Contribution to Health SDend g by Source. 1997-2004. - expenditures have grown in U S IRaL LWLL lpga a 8 L -?ppL aJM- Dollar terms since 1997, 49.3 49.3 49.3 49.3 53.9 55.3 increasing by 50 percent from htral PUBLIC SECTOR Govment 37 1 37 8 33 5 35 6 36 5 38 8 US$ 258 million in 1997 to US$ MinistryofHealth 35 0 35 8 31 0 31 5 32 1 35 6 386 million in2004. In2004, 55.3 MinistryofGovemance 0 6 0 7 0 8 0 6 0 6 0 5 MinistryofDefense 10 0 8 0 7 0 6 0 6 0 5 percent was spent by the public DecentralizedInstitutions 0 4 0 4 0 6 2 8 3 1 2 0 sector and the remaining 44.7 Other Ministries 0 1 0 1 0 3 0 1 0 1 0 2 NSS percent by the private sector. The 12 0 II3 15 5 13 3 I 69 165 'ublic Enterprises 0 3 0 2 0 3 0 4 0 5 0 0 0 0 MOH spent 35.6 percent (US$ PRIVATE SECTOR 50.7 50.7 50.7 50.7 46.1 44.7 138 million) while INSS spent PrivateInsurance 0 0 0 2 0 1 0 3 0 8 0 9 16.5 percent (US$ 64 million) of Households 49 4 49 7 48 2 47 1 42 I 41 I NGO 0 8 0 3 1 9 1 9 1 7 2 0 total health expenditures. ----- - PrivateF h 0 4 0 5 0 5 1 4 I 5 - 0 7 Households have a large share TOTAL. GENERAL 100.0 100.0 100.0 100.0 100.0 100.0 (41.1 percent or US$ 159 million) -- exceeding that o f the MOH. INSTlTlJTdN - -- EUC TEiF TEEZ lB7=100 JMiL Aaaa- lpBp -zpae -2ML 9009 I I The 2006 executed budget o f the MOH amounted to mtralP ~ L I CSECTOR 100.0 112.6 104.4 124.6 133.6 141.8 167.0 168.2 Government 1000 1149 94 4 1197 1204 135 7 1629 1569 US$178.6million, increasing by MinimyofHealth 1000 115 6 92 7 112 I 112 1 1329 1590 1527 30 percent since 1999. This MinistryofGovernance 100 0 1185 134 1 1197 1183 1306 1275 1160 executedbudget i s about 3 percent MinistryofDefense 100 0 88 5 79 9 79 3 78 3 1146 912 814 Dec Institutions I00 0 1213 1749 942 3 10069 4567 781 6 8003 o f GNP and 15 percent o f the total Other Ministries 1000 82 1 225 7 89 8 99 8 125 1 1486 201 4 Government executed budget. JSS 1000 IO66 135 4 1385 I72 4 1640 1836 2070 ublicFins 1000 72 8 105 5 I72 5 220 9 0 0 0 0 00 D.12 The total annual health PRIVATE SECTOR 100.0 113.0 104.6 124.9 111.2 125.4 124.7 132.2 PrivateIns 1000 10910 606 3 2125 1 6085 9 92186 89605 80946 expenditure per capita increased Households 1000 I13 5 1018 1189 1042 1227 1133 1248 from US$ 56 in 1997 to $72 in NGOS 1000 44 5 258 8 299 5 259 7 1325 351 9 383 5 2004 (Figure D.3). With the PrivateF h s ----- 1000 138 6 122 5 416 3 421 4 81 7 6839 2447 exception of INSS, the NHA do TOTAL GENERAL ----- 100.0 112.8 104.5 124.7 122.2 133.5 145.6 150.0 not indicate the covered Sources: MOH , NHA. DGPD.authors' calculations population for each sub-sector. If one takes the total population net o f INSS affiliates then per capita spending by MOH i s about US$ 28, but if we consider a covered population of 3,500,000, as Table D.2. suggests, then IHSS per capita spending i s US$ 51per capita. The annual average cost in the case o f INSS affiliates is US$ 176 in2004 and US$ 135 if one includes both affiliates and dependents. The incorporation o f children occurred recently, plus the coverage extension o f the informal sector population decreased its spending per capita. The per capita costs of INSS are significantly higher -ranging from 3.9 times in2003 to 6.5 times in 1999 L 210. Nicaragua keeps a good system of National Health Accounts (NHA), although the most recently published figures only extend until 2003. This section uses 2004 unpublished NHA data and other sources, updating most o f the informationup to 2006. 179 Annex D - than MOHper capita spending, ifthe total population net o f INSS i s considered (as indicatedbefore, the true coverage by MOHi s not known; just estimated). FigureD.3 AnnualHealthSpendingper CapitabyInstitution;1997-2004. InUS$ - -_ - __ ___ I Sources: MOH, NHA, authors' calculations D.13 With respect to spending by health function, medical inputs and curative services comprise a substantial portion of expenditures (a combined share o f 84 percent in 2002 and 77 percent in 2003), while the combined shares o f preventive services and training and research are significantly lower at 10 percent in2002 and 14.6 percent in2003 (Table D.4) TableD.4 Shares of TotalHealthSpendingbyFunction(%) Health Function 2002 2003 Curative Services 41.8 33 Preventive services 8.2 7.3 Medical inputs 42.7 43.8 Training and Research 1.6 7.3 Administration 4.4 5.7 Others 1.3 2.9 Total 100 100 Sources: MOH, NHA. Ministry ofHealth D.14 Sources o f funds. The MOH shows a high dependency on external aid, especially with regard to capital outlays. This is a concern because it has implications for sustainability. In 2006, the Current Budget was financed mainly by the Treasury (83 percent), cost recovery (3.4 percent), debt relief (9.3 percent), and donations (4.4 percent). In early 2007 the government eliminated charging user fees for services, although no studies have been undertaken to assess its likely impact. D.15 Even though Treasury funds have increased inthe last two years, especially in 2006 (rising from a low o f US$l.OS million in 1998 to US$10.8 million in 2006), investmentlcapital expenditures have depended heavily on foreign aid over the years. In2006, donations and loans amounted to US$23 million or 68 percent of allotted funds for capital spending, even though national funds increased to US$10.8m. 180 Annex D Foreign aid's share peaked in 2001, when it reached 96 percent o f a total capital outlay o f US$43.8 million. The hnds allotted for 2007 investments also reflect a similar pattern, with only US$2.0 million from Treasury funds and US$46.6 million from foreign funds, or 96 percent o f total. Figure4.4 .MOHfunds alloeat D.16 Allocation o f MOH Funds. Even though disposable funds in MOH have Current Transfer: $7.3 I increased during the decade, the trends in budget line items show reasons for concern. Personnel services increasedby 33 percent - B Investment - from US$ 70 million in 2004 to US$ 93.5 million in 2006. During this period, its share o f the executed current budget rose from 57 percent to 60 percent. There are growing pressures on public sector wages and salaries from the public sector unions, which the new government i s taking into Sewbes;b24,O account in policy directives that promote increasing local health salary levels to approach those prevailing in the Region.*ll Although Non- Personnel Services increased from US$20 1 million (2004) to US$24 million (2006), its relative share has slightly declined from 16 percent to 15 percent. Among all line items, the share of drugs, however, has fallen the most (from 19 percent of the current budget in 2004 to 15 percent in 2006). Duringthis period, capital outlay shares fluctuated, ending upat US$23.4millionin2006. TheNicaragua Social Security Institute (INSS) D.17 The INSS i s the other large health care provider in Nicaragua. INSS began in 1955 as a direct health service provider and transferred all its facilities to the MOH in 1979 when the Sandinista Government took office. In 1993 with a new administration, INSS became again autonomous and its financing and service provision functions were separated. Direct provision o f health services were outsourced to private and public accredited institutions, altogether 49 Empresas Medicas Previsionales (Medical Insurance Institutions, PMIs). Employers, employees and government contribute to INSS, in varying percentages based on given benefit systems. The Rigimen Integral, or full health package, receives 15 percent o f its financing from the employer salary roll, 6.25 percent from employees, and 0.25 percent from the government, totaling 21S O percent. D.18 INSS pays a uniform monthly capitation fee equal to US$ 14.4 (2005) for each active affiliate in order to provide a given package o f services for himherself and hisker dependents. Coverage i s not universal in terms o f covered benefits, dependents and age limitations, although it was recently extended to cover children from six to twelve years o f affiliates. The new government intends to expand benefits and to also increase service coverage to rural areas and informal sectors. While this policy may appear sound from a long run point o f view, it also poses significant challenges in the short run. Inparticular, extending benefits and coverage will impose a financial, epidemiological and intergenerational risk to PMIs. Their size is relatively small and the majority will not be able to meet the financial cost o f L 211. In 2006 a several months-long strike by health workers crippled the health system and resulted in a large increase inmedical staff salaries. The directive to approach salary levels prevalent inneighbouring countries poses a strong fiscal threat, considering, for example, that the MOH of El Salvador includes a 7 percent annual obligatory increase in ministry salaries in dollar terms, and that Nicaragua's per capita income is only half o f the Salvadoran level. 181 Annex D increasing health demand, triggered by more benefits, more dependents, retirees, and aging beneficiaries, and a decreasing net income due to rising costs and a fixed per capita income. Deficits will arise and bankruptcies could likely follow. D.19 Inorder to mitigatetheserisks, two major stepswill needto betaken: Enhanced efficiency. INSS appears to over-consume certain services, such as drugs with no epidemiologicaljustification--a natural consequence o f free prescriptions and delivery2I2. In order to be more cost effective in its approach to health care, a strong primary health care and preventive policy would also be required.213 While efficiency improvements are necessary, they also require investments inknowledge management, regulation, supervision and monitoring, a stewardship role to be taken by the MOH. Thus, in order to be able to properly carry out these responsibilities well, the MOHrequires institutionalstrengthening. Increased capitation spending. The capitation quota has stayed almost unchanged inreal terms since 1994, and the revenues generated from increasing it could be used to finance the proposed extra benefits and population coverage. The overall size, gender and age structure o f MPIs, as well as family size and the consumption o f health services would need to be carefully studied in establishing benefits and capitation schemes. Thus, minimum size requirements and an adjustment o f the capitation system to include age and gender structures should be discussed and approved. However, authorities must keep in mind that any financing increase will burden the production costs o f the private sector and therefore affect its competitive edge in increasingly open regional and extra- regional markets. This concern suggests that users should partially contribute to financing their consumption o f healthservices. D.20 Furthermore, in order to help ensure a rational use o f health services, the government's intention to establish fi-ee health services should be reconsideredand this policy should be restricted to the poor and to the population inneed. As a long-run policy, the Government could establish a fixed fee scheme with well specified exemptions, inorder to avoid the future financial collapse o f the system. TheRelative Efficiency of Health Spending D.21 Chapter I1(Section B) compared the efficiency o f public spending in health in Nicaragua, based on the analytical fi-amework presented in Herrera and Pang (2004). By relating total public health expenditures and two other inputs (adult literacy and private expenditures) and four output indicators referring to life expectancy at birth, DPT (Diphteria, Pertussis and Tetanus), Measles immunization and the Disability-adjusted life expectancy (DALE) index, which takes into account both mortality and morbidity,214 results indicate that in contrast to the education sector, the efficiency o f public spending on health inNicaragua i s similar to the average efficiency scores achieved in the Central and Latin America regions. Using the input-oriented single input/output measures, for example, Nicaragua exhibits an efficiency score o f 0.65, compared to the Central America and Latin America averages o f 0.65 and 0.69, respectively. Using the output-oriented measures, Nicaragua's average efficiency score o f 0.90 i s virtually identical to the Central America and LAC averages o f 0.91 and 0.90. The same efficiency picture L 212. Consumption o f medication varies from 9.8 drugs per year per beneficiary for 12 small M P I o f an average size of 2,212 members, to 24.3 drugs per year per beneficiary for the two largest MPIs o f 34,154 members in average. Consumption by region also shows significant variations. There is ample need and room for regulation, auditing measures and quality controls, both to oversee under- and over-prescription o f pharmaceuticals, and regulations. 213. INSS benefits exclude preventive examinations. 214. Herrera, Santiago and Gaobo Pang, (2004), "Efficiency o f Public Spending in Developing Countries: An Efficiency Frontier Approach", World Bank Working Paper, December. 182 Annex D emerges when usingmultiple inputs and outputs, with Nicaragua having similar scores to the two regional averages. Inhealth, the potential room for increasing efficiency ranges from 10 to 35 percentage points, depending on whether an output-oriented or input-oriented efficiency measure i s used. Figure D.5a RelationshipbetweenUnder-5 Mortality Rates and per capita healthexpenditures(PPP) Under five mortality and per capita health expenditure lnder 5 Mortality (2004). 80 I 1 70 Duilvla , . 50 Guatemala 40 30 20 10 0 1 I 0 200 400 600 800 1000 1200 Health expenditure per capita ($PPP) Source: WDR Core indicators 2006. Based on latest comparable data across countries. Figure D.5b RelationshipbetweenChild Stuntinglevels andPer Capita Health ExpendituresinPPPterms (2004)* % Child stunting & per capita health expenditure (2006) _. ,", 0 200 400 600 800 1000 1200 per capita health expenditure (US$) Note: *Based on latest comparable data across countries. Source:WHO Core Indicators, 2006, Honduras 2004 figures estimated based on 2001 data and DHS 2005/06. 183 Annex D D.22 A study by Evans et al. (2006) estimated the efficiency o f the health system o f 191 countries by comparing levels o f health outcomes and health inputs (health expenditure per capita and education level). The study finds that it i s difficult for systems to be efficient with annual health per capita expenditures lower than US$80. Nicaragua's per capita health expenditure i s higher than US$80, but it can still improve the efficiency o f health spending in terms o f some key indicators such as under-five mortality rates; Figure D.5a. Nicaragua has a higher under-5 mortality rate than Peru, Ecuador, and Venezuela although their per capita health expenditures in PPP terms are relatively similar. On the other hand, interms o f chronic malnutrition among young children (Figure DSb), Nicaragua is doing relatively well relative to other countries with similar PPP health expenditures per capita such as Ecuador, Peru and Bolivia. However, it has higher stuntinglevels compared to Venezuela. D.23 Some allocative issues that need to be addressed relate to drug procurement and provision and humanresources. 0 Pricing and availabilitv o f drugs. A recent study found that the average price o f a list of 35 generic medicines in Nicaragua was 10 times higher than the price paid by an Interamerican Development Bankproject inArgentina (Meerhoff, 2004a). Also, inNicaragua, the public drug and medical supply agency (CIPS) provides subsidized or fi-ee drugs. According to MOH estimates, however, only 45 percent o f the population in need has access to these drugs, while the rest face prohibitively high prices for non-generic drugs. 0 Human resources. As shown in Figure D.5, while the number o f physicians per every 10,000 habitants i s high given Nicaragua's level o f development, the number o f nurses per 10,000 habitants i s low. Figure D.6 DistributionofNursesand Physiciansper 10,000 inhabitants in relation to GDP per capita, Nicaragua relative to other LatinAmerican Countries Nurses Physicians * PAN2033 40 URYZOO? . 35 - A i URY2W3 2 *ARG2OW 30- ~ W ~ W o 0 . 225- r B W W l -.ge 20- GTM2W3 ARGZM .-.-mp 15- 0 r o - rGTM2003 @w3 s a PRYZOW Log GDP per capita 2004 7 50 8 00 850 900 950 Log GDP per capita2004 Source; Argel-Urdinola and Tanabe 2007 based on WHO, PAHO and WB indicators. 0 Despite having a relatively high number o f physicians relative to its level o f development, staff distribution issues remain and regions do not benefit equally. About 50 percent o f the physicians live and work in Managua (Dussault and Franceschini, 2003). So far, initiatives to improve health workers' deployment have not been successful. However, Nicaragua's experience with social services personnel deployment i s worth noting. It i s based on an identification o f health region needs in the country and workers are to remain in their assigned positions for several years before they can move to other places. They are also replaced once they leave. Such a strategy could be extended to health care workers (WB 2007). The implementation o f an efficient incentive system that promotes health worker productivity i s a priority issue for the sector reform agenda. 184 Annex D Institutional Issues D.24 External Donors and the Sector Wide Amroach. Nicaragua has done a substantial amount o f work in health policy reform that serves as a strong foundation for the SWAP in health. Inmid-2004 the M O H released the ten-year National Health Policy and its corresponding 2004-2015 National Health Plan. During the same year, the MOH released a draft Five-Year Implementation Plan detailing how it would operationalize its National Health Plan. The fundamental goal o f this plan i s to increase access to health care services o fthe poor people, especially to effective maternal and child health care. D.25 As a result o f this effort, a number o f important development partners (World Bank, Holland, Sweden, Austria, Finland, and Spain) and representatives o fthe GONsigned a Code o f Conduct (COC) in 2005, outlining the framework o f future cooperation to support the implementation o f the health sector plan for 2005-2009. During the same year, these parties signed a Joint Financing Arrangement (FA) stipulating procedures to transfer and report funds provided through (sector) budget support. Throughthe signingo fthese documents the framework for a SWAP inthe healthsector inNicaraguawas established. D.26 The signed COC and JFA provide a strong legal and procedural framework to the SWAP process. Many financial management issues still need to be improved and intermediate safeguards will be necessary in several areas for the medium term (e.g. in audit, procurement). The GON's Integrated Financial Management System, SIGFA, could have been defined better interms o f reconciling accounts. Furtherreformi s being introducedon the SIGFA. D.27 Many o f the features o f the ideal SWAP have not yet been tested since the process has just started. It still remains to be seen if donors will be able to align their support with the GON's planning and budget cycle and make pledges o f medium-term financial support and disburse funds in accordance with the needs and regulations o f the Ministry o f Finance. However, the donors and GON have also learned that the SWAP depends on donor coordination in alignment with government strategies supporting the National Health Plan. Financial support from donors may vary according to their own mandates and operational arrangements. These available financing alternatives have enriched the policy dialogue within the SWAP. D.28 Decentralization. Duringthe 1990's, MOH initiated a health reform process that included the organization o f Local Systems o f Integral Health Assistance (SILAIS, Sistemas Locales de Atencidn Integral a la Salud) throughout the country. The MOH established, as one o f the main health sector strategies, the strengthening o f the SILAIS and Primary Care services. The MOH focused on the integral development o f health care services at the local level, strengthening and supporting the decentralization process. The National Health Plan (NHP) for 2004-2015 includes a decentralization plan based on the principle o f separation o f functions (stewardship, financing, provision and insurance) and the transfer of faculties, decision-making authority and resources to health providers. The Plan states that the SILAIS will become both managers and providers o f health services, complementingthe stewardship role of the Ministry.Further, MOH has plans to redefine the functions of the SILAIS and local health networks. SILAIS will be responsible for delivering a package o f basic health services (PBHS) in accordance with MOH's new health care model. The delivery o f this package will be achieved through a capitation transfer to the SILAIS, which inturn will purchase services from local public providers (municipios), and qualified private providers, mainly NGOs. M O H will enter into management agreements with SILAIS (Convenios de Gestion), which will be the basis for the capitation transfers o f the community health- financing scheme to SILAIS. These management agreements introduce a system o f performance-based evaluation as they link budget allocation to agreed upon benchmarks related to productivity, quality and patient satisfaction. Municipalities are participating actively in this programming and budget exercise by developing their annual operation plans, which then become the core o f the SILAIS annual plan. 185 Annex D Preliminary evidence suggests that these agreements have provided more autonomy to SILAIS in the planning and allocation o fresources for their operations (World Bank 2005). D.29 In addition, the NHP established a set of strategies and activities to consolidate the decentralization plan, including: (i)strengthening the professional capacity o f local management staff, and the regional, departmental and municipal councils; (ii) developing accountability mechanisms and monitoring and evaluation indicators for the decentralizationprocess; (iii) designing norms that permit the purchase o f hospital services; and (iv) developing a long term plan to transfer the responsibilities and resources for health provision to municipalities. The NHP also mentions the implementation o f a decentralized human resource management, but it does not specify the responsibilities o f the SILAIS in this area (NHP 2003). D.30 To support the decentralization plan, the SWAP in health i s funding technical assistance necessary to develop the institutional capacity o f the SILAIS and local administration units (rnuni~ipios)~'~implementing the expansion of the basic package o f health care and implement the for strategic lines mentioned above. Civil society will play an active role in auditing the actual delivery and quality o f services to the community. A community committee will advise and ultimately endorse the provider annual workmg plan and periodically (e.g., quarterly) provide monitoring feedback to the provider and the supervisory SILAIS. Finally, the SWAP will also support decentralization by: (i) providing advocacy and technical assistance to municipal governments and the Autonomous Governments o f the Atlantic Coast on the organization and management o f their regional health systems; and (ii) decentralizing management o fthe MOHhumanresource function to the SILAIS and hospitals. D.31 In spite of the original purpose o f decentralizing key functions to the SILAIS, the degree of power and decision-making authority transferred to them was low. In terms o f the finance function, Bossert et al. (2001), found that SILAIS administered only 19 percent o f the budget at the primary level o f care. Moreover, the SILAIS' actual control of expenditures was moderate since these are limited to non-personnel services and material and supplies, which account for less than 10 percent o f the total SILAIS budget. This situation also contributes to the SILAIS' limited flexibility to make intra-budget reallocations. Regarding user fees and the allocation o f their own revenues, the SILAIS could charge for those activities that they manage directly (i.e., inspections) since the local administration units are the ones entitled to set user fees at the health facilities. Inboth cases, there was autonomy to allocate these revenues according to their priorities. Both SILAIS and the municipalities can receive direct financial aid from international donors to carry out specific healthprograms. D.32 Bossert et al. (2001) also found a very low degree o f autonomy to perform service organization functions, which still applies to the present situation inNicaragua. The SILAIS have no influence on the management and budget o f hospitals intheir regions, since MOH allocates resources to hospitals directly. The M O H still controls the funding, planning and implementation o f the main public health programs, which reduces the capacity o f SILAIS to follow their own operational program. Another factor that reduces SILAIS' management autonomy are the MOH imposed budget ceilings that limit their ability to deploy medicines and medical supplies according to their programming needs. On the other hand, the SILAIS have the right to propose hiring, transferring and dismissing personnel although they are not allowed to actually implement personnel related actions or to set salaries for their staff. SILAIS can have contracts with private providers for complementary services such as maintenance, laboratory, etc., although there i s a central office in charge o f maintenance. Similarly, with regard to governance, Bossert (2001) reports that many o f the Health Boards (Juntas de Salud) at the local level were not functioning, and the ones that were had a very limited role in the decision-making o f main SILAIS operations. However, community participation i s very high at the local health unit. Health Boards participate in the approval o f annual operation and emergency plans. In addition, both local governments and communities have already been participating in health service provision through the co-financing o f preventive L 215. The local health administration units are referred as "municipios" inNicaragua. 186 Annex D maintenance o f health centers. Municipalities can request funds to finance preventive maintenance through the presentation o f an Annual Maintenance Plan, which includes the individual projects and community maintenance committees who are responsible for carrying out the work. D.33 Nicaragua has to strengthen management agreements with the SILAIS and introduce more incentives to make them work more effectively. In order to do this, further institutional strengthening at the local level i s needed, as well as the political commitment to push it. Similarly, a major effort on buildingupmorerobust monitoring and evaluation systems i sneeded. D.34 Inspite of the limitations presentedhere, Nicaraguahas been the most ambitious inplanning to further decentralize services to SILAIS and municipalities, compared to neighboring countries, such as El Salvador, Honduras and Guatemala. It also has the longest experience with decentralization. The data on decentralized funding suggest that those municipalities in SILAIS with higher levels o f decentralized budgets showed better health coverage rates. A key next step is to assess the performance of the management agreements with SILAIS. Conclusionsand Recommendations D.35 Nicaragua has made progress in a number o f key performance indicators including the reduction o f child mortality rates and under-nutrition, as well as improvements in key maternal health indicators. Nevertheless, Nicaragua i s still slightly off-track in reaching its infant and child mortality MDGs. In terms o f maternal health, while the MOH-based estimates seem promising because they indicate a declining trend in maternal mortality rates, the MOH 2005 estimate of 86.5 per 100,000 i s still very far from the 2015 MDG goal set by the Government o f 20 per 100,000. It i s also recommended that a nationally representative survey be conducted to make it comparable with the WHO 2000 estimates o f 230 deaths per 100,000. If undertaking such a survey i s infeasible then another option is to update the proxy-for MMR-indicator (percentage o f women who deliver attended by a skilled healthprofessional) in order to determine if Nicaragua i s on track to reach the 2015 target o f 100 percent, because the most recently available published data for Nicaragua i s for 2000 (67 percent). Moreover while the percentage o f children under 5 years o f age who are stunted declined from 24.5 percent in 1998 to 18.1 percent in 2004 (WDI 2007) it is unclear whether Nicaragua i s on track because o f the absence o f comparable 1990 data to adequately track progress; readily available Government documents also do appear to specify nutrition MDGtargets. D.36 Despite progress made in a number o f key health indicators, inequities remain among income quintiles, urbadrural areas, and indigenoushon-indigenouspopulations. Inaddition, family coverage has declined by almost half from 2001 to 2005, as well as coverage o f certain key vaccinations (DPT, MMR, and polio) for one year old children. D.37 Total health expenditures have increased in real terms, with a significant emphasis on curative care and medical inputs and personnel costs. Preventive care and training and research receive substantially less (7.5 percent each) and spending on drugs has remained stable innominal terms (US$24 million) and declined as a percent o f total expenses (2004: 19percent; 2006: 15 percent). Efficiency gains could be made in terms o f rationalizing health care and spending especially terms o f (a) improving its focus on cost effective preventive care and health promotion measures -together with a corresponding increase in their budgetary shares in order to make a meaningful difference inbasic health, nutrition, and population indicators especially for poor and disadvantaged children and women, (b) the INSS, (c) the allocation o fpersonnel, and (d) procurement o f drugs. D.38 The Government has issued policy directives that focus on three main areas: (i) role of the the MOH as steward o f the sector, (ii) on health services supply, and (iii) on health demand. actions actions The recommendations that follow take these directives as guides and build on them based on the analysis 187 Annex D undertaken. In addition, emphasis i s placed on the inclusion o f policies on sector financing and resource allocation. Stewardship Role of the MOH All healthsub-sectors are subject to M O Hrules, supervision andcontrol: MOHfacilities, INSS, MPIs, private sector, NGOs, others. It follows that the MOHneeds a comprehensive institutional strengthening program, to effectively address the challenges ahead. Adapt the model health care package to epidemiological, ethnic, cultural and local specifications. A team o fspecializedpersonnel is neededto reformulateexisting definitions andprotocols. Operations research has to be done, with an action and results oriented strategy. Implement quality assurance and assessmentmechanisms at all levels and sub-systems. Strong technical support i s requiredinthis field, and verifiable targets needto be identifiedand met such as reduction o fwaiting lines, specific indicators o f efficiency and equity improvements. Ensure that sectoral targets are well aligned and consistent across programs and strategies over a specific period o f time (PRSP, National HealthPlan, etc.). Actions on health supply (with related technical and donor support) More equitable delivery o fhealth services especially inthe Atlantic Region, where the number o f health care facilities i s much lower while the needs are higher. This usually forgotten region i s now an important focus o f the new administration. The new government intends to invest more resources inthis region to improve its health indicators and it would be important to closely monitor ifactions are on track. Conduct a thorough inventory o f health sector investments, both interms o fhospital equipment and infrastructure, inall sub-sectors, and assessment o f future needs from a systems based approach. Establish a drug-purchasing and distributingagency. Assessment and support to its development, organization, implementation and operation. Assess traditional healthpractices, its effectiveness, and whether some o f them can be integrated as part o f health promotionand provision o f services Establishhealth protocols at all levels (ambulatory and hospital care, by ailment). Ensure uniform quality standards for health services providedby MPIs for INSS. Standardize healthinformationand management information systems, throughout the whole sector, for public and private facilities Develop MOH's capacity to provide adequate supervision, assessment, and follow up actions. Renew support to local participation. Assess decentralization issues and identify ways to address them. For example, Nicaragua has to strengthen management agreements with the SILAIS and introduce more incentives to make them work more effectively. A key next step i s to also assess the performance o f the management agreements with SILAIS. Actions on health demand Review and revise current benefit packages and their proposed extension interms o ftheir impact on health financing needs, operational costs, physical investments, humanresource needs and resource usage. Extend service coverage to more segments o f the population under the Integrated Health Care Model (MAIS) 188 Annex D Guarantee cost-free healthassistance to the poor segments o fthe population. Economic and financial impact need to address possible adverse equity problems (subsidies to higher income groups), and other related issues. SectorPnancing and resource allocation: Formulatebudget requests and allocate resources inaccordance with healthneeds at the local level. This underscores the needto consider local epidemiologicalprofile and other location- specific factors. Allocate more budget to cost-effective preventive and health, nutrition, and family planning promotion services (this i s key because about 30 percent o f the population, based on the LSMS 2005, survey resort to self-medication which can potentially pose healthrisks ifinappropriate), as well as to trainindcapacity buildingand research/M&E activities Calculate the fiscal implications o fthe policy directive, which states that all health technical staff and professionals will receive salary levels that are competitive to the rest o f the Central American countries and its possible impact on other health-related expenditure categories such as drugs and training. Evaluate the impact of free services on service use and operation Inthe caseofINSS, consider the feasibility o festablishing different capitationpayments that consider cost and riskby age and gender, and the inclusion o f cost- and overuse- containment strateges, as well as improvingpublic andprivate partnerships arrangements. Findandproposenew financing sources to increase the nationalhealthbudget from sustainable domestic sources, and reduce reliance on external funds. 189 Annex D 190 Annex E Annex E Review of Public Spendingon Social Protection Main Findings of Previous Reviews E.l The 2001 PER had found that the individual social protection programs are generally well targeted, particularly because beneficiary identification largely relies on targeting mechanisms (geographical targeting as well as means-testing). But as a group, the programs are fragmented and are not guided by a clear strategy. Clear priorities for social protection are lachng, both in how to best address vulnerabilities and in definingwho the priority groups among the vulnerable are. The coverage of ongoing programs was very modest. Ifthere were no overlap inthe coverage o f different programs, it was estimated that spending by the Ministry o f the Family could in principle reach as many as 450,000 children and adolescents. This only represented around one-third o f the total poor and extreme poor children aged 0-18. To the extent that there are significant overlaps, which i s likely, coverage would be even smaller. E.2 Given that the largest among the vulnerable population inNicaraguaare children, the focus o f the social protection programs was considered appropriate. However, the 2001 PER also recommended that the overall social protectionstrategy be extended to encompass other important vulnerable groups. One o f the most important i s poor worlung-age adults affected by economic instabilities (e.g., coffee price declines), natural shocks (e.g., droughts) or individual shocks (e.g., health shocks), who needprograms to protect them from wide income variations. There have been few programs in place that effectively address this group. FigureE.l Poverty Trends 60 50 40 30 20 10 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 ~ Source: INEC (2006). Evolution of Key Sector OutcomeIndicators since 2001 E.3 Progress inpoverty reduction has been disappointing. Indeed, in spite o f modest declines during the 199Os, povertyremains highand social indicatorsweak inNicaragua. Recent poverty indicatorsfrom the 2005 Living Standards Measurement Survey show that progress in poverty reduction has slowed down further, with a headcount o f 46.2 percent for the poor and 14.9 percent for the extremely poor. Nicaragua has experienced a reduction in inequality (from a Gini coefficient o f 50.4 in 1993 to 41.0 in 2005) over the past decade, associated with a reduction in the depth o f poverty. The poverty depth 191 Annex E (measure o f the average distance o f the poor's consumption to the poverty line) o f the very poor has decreased by about 30% between 1998 and 2005. However, the actual number o f poor has not shown improvements (even ifthey are less poor on average). Poverty inits many dimensions i s particularly acute inrural areas and the Atlantic coast: in2001, 62 percent o fthe poor and 76 percent o fthe extremely poor live inI Source: INEC (2006). E.4 In addition, the poor in Nicaragua exhibit a relatively high vulnerability, linked to both the frequency of covariate shocks (including natural disasters and commodity price shocks) and to household- level shocks (including health shocks). Coverage mechanisms for these risks are underdeveloped in Nicaragua, leaving many household without means to insure against these risks. For instance, interms o f coverage for health care costs (National Social Security Institute), while 24 and 13 percent o f the population in Managua and the Pacific have health insurance, respectively, coverage i s only 4 percent in the Center and the Atlantic, only 3.4 percent in rural areas and as little as 2.5 percent for the poorest quintile Figure E.3: Access to health insurance, 2005 " _ I_ 24 B 1 - 2 2 3 1 Income quintiles Source: Poverty Assessment, onbasis o f LSMS 2005 192 Annex E E.5 The high level o f poverty and vulnerability i s reflected in very poor outcomes in terms o f nutrition in the country. Despite improvements, more than one child under the age o f 5 out o f every five children i s chronically malnourished. The situation i s particularly dire in rural areas (27 percent prevalence) and amongst the very poor (37 percent amongst the poorest quintile)'16. Figure E.4 Prevalence of Stunting in Nicaragua among children aged 0-59 months, 2005 25 20 0 E 15 3 8 LF 10 5 0 0-5 6-11 12-23 24- 35 36-47 48- 59 National Urban Rural I E.6 Many social indicators also are strongly correlated with poverty status and vulnerability. For instance, the level o f maternal care i s lower inrural areas, indigenous areas and among the poorest. The level o f preventive health care for the highest quintile i s three times higher than the poorest. Similarly, literacy, enrolment, attendance and completionremain low inparticular amongst the poor and inrural and Atlantic areas: at age 17 enrollment rates for boys inrichest quintile are 4 times larger than for boys inthe poorest quintiles; net secondary enrollment in rural areas is half o f that in urban areas (28.1 vs. 61.1. percent); and one out o f four young people between the ages o f 15 and 24 years is illiterate in extremely poor households (vs. 4 percent for the n~n-poor)~'~. C. Evolution of Sector Expenditures E.7 Unlike education or health, social protection i s generally not defined as its own sector, but rather as a "strategy" that involves most sectors. Since it cuts across sectors and i s integrated into a wide variety o f types o f programs and projects, it i s often difficult to disaggregate how much budget i s specific to social protection. Inthis chapter, we have aggregated expenditure from the programs and institutions fully dedicated to social protection. This includes five main actors: the President's offices, the Ministry o f the Family, the Ministry for Labor, the Social Emergency Investment Fund (FISE), and the National Social Security Institute (INSS) 218.The total allocated to social protection programs in these institutions varies greatly from year to year, fluctuating between less than 0.5 percent of GDP to almost 2.0 percent o f GDP. After exhibiting large fluctuations, the share o f various institutions in this total has stabilized since 2002, with the Ministry o f the Family and FISE representing about 30 percent and over 60 percent o f the L 216Poverty Assessment (on basis of LSMS data for 2005) 217Poverty Assessment (on basis o f LSMS data for 2005). 218 As defined here, public spending on social insurance only includes central government transfers to the Nicaraguan Social Security Institute (INNS) as a co-financier o f health and pension benefits for its affiliates. INSS budgeted approximately U S 1 2 0 million in expenditures for 2001, of which only about US$1.7 million are central government transfers (approximately 1.2% o f overall financing). 193 Annex E expenditure on average, respectively. A very large share o f the social protectionbudget as defined here i s financed with external resources (around 75 percent inthe case o f the Ministryo f the Family and FISE). Figure E.5 Public Expenditures on Social Protection (as % o f GDP) 2 00% -, - . ._ .. A Total SP spending 175%1 - 150% b 125% (3 'c :100% g Q) 075% n 0 50% 0.25% 0.00% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 1991 1995 2000 2001 2002 2003 2004 2005 Presidency (Social Action Secretariat and Social Emergency Fund) 0.00% 0.60% 0.27% n/a 0.04% 0.03% 0.03% 0.04% MinistryofLabor (wio INATEC) 0.15% 0.05% 0.09% 0.05% 0.05% 0.05% 0.04% 0.03% Ministryofthe Family 0.00% 0.00% 0.42% 0.22% 0.22% 0.49% 0.58% 0.30% Social Emergency Investment Fund (FISE) 0.00% 0.09% 0.13% 0.12% 0.46% 0.95% 1.18% 0.62% National Social Security Institute (INSS) 0.38% 0.04% 0.01% 0.00% 0.00% 0.00% 0.00% 0.00% TOTAL 0.54% 0.79% 0.91% 0.53% 0.77% 1.52% 1.84% 0.98% Figure E.6 Public Expenditures on Social Protection (Share o f institutions intotal) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0Yo 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 E.8 Social protection programs and activities are typically undertaken by a myriad o f actors, often within their regular operations, which are not included in the sector expenditure totals reported in the Figures above. For instance, the Ministry o f Education might have a program o f scholarships for poor 194 Annex E high-achieving students, which could be considered a social protection program, as it helps the poorestby releasing some o f their constraints to access services. In addition, the spectrum o f activities which could be considered as part o f social protection i s very broad. E.9 The GON has developed and adopted a Social Protection Strategy, which uses a rather broad fi-amework to define the national social protection "system". It encompasses activities and programs o f "Atencion Inmediata y directa para recuperar bienestar minimo", other activities geared towards the "Entrega de beneficios para atender causas directas de vulnerabilidad", and finally a broader set o f LLaccionesde desarrollo economico y social para las causas indirectas de vulnerabilidad". InNicaragua, the first set o f activities would involve institutions like the Ministry o f the Family, MINSA, MECD and INIFOM, the second would involve FISE, INWL and INATEC in addition to the core agencies, while the last set would involve MAGFOR, INTA, IDR, and MIFIC. This makes the analysis o f the "sector" rather difficult and subjective. Inview o f the large number o f institutions involved, the articulation o f a Social Protection Strategy represents an important step inthe rationalization and coordination o f actors in the area o f social protection. However, its implementationhas been rather limitedto this date. E.10 Patterns and trends. Expenditures on social protection programs exhibit a very erratic pattern - with large fluctuations in the total amounts devoted to the various programs and institutions and large fluctuations inthe share o f specific programs and institutions inthe total. Interms o f percentage o f GDP, the two extremes were 2.3 percent in 1993 and 0.64 percent in 1998. Even from one year to the next, changes can be dramatic -For instance, the sector went fi-om 2.12 percent o f GDP in2004 to 1.14 percent in 2005, a reduction by 46 percent. These fluctuations are partly linked to particular emergency relief operations, but, more generally, they reflect a lack of adequate planning and budgeting capacity for social protectionprograms. This has an important adverse impact on their effectiveness and continuity. E.11 One o f the challenges o f social protection i s that it typically requires counter-cyclical funding - larger resources are neededintimes o f lower economic growth and/or disasters. On the other hand, social protection programs typically involve lower fixed costs (e.g. salaries) than other ministries (e.g. health or education) and hence face less resistance to budget cuts in times o f fiscal consolidation. This particular aspect o f the sector makes it a prime candidate for large cuts or shifts. This i s illustrated above, in Figure E.6, which shows the share o f different programs in the total. It is also a sector where administrations typically attempt to develop flagship programs that are strongly identified with a particular administration and hence have lower chances o fbeing continued after political transitions. E.12 Executed versus planned expenditures: When focusing on the differences between planned expenditure and actual expenditure, a few programs -namely the programs run fi-om the Presidency and the FISE - appear particularly erratic. FISE executed over 700 percent o f its planned expenditure in 1995 and almost 400 percent in 1997. The variability seems to have decreased over the years, although large discrepancies still persist (e.g. FISE spent 1.65 times its planned expenditure in2004. E.13 Sources o f Funding: One o f the weaknesses o f the programs in the social protection area i s their uncertainty and erratic nature (in addition to fact that small, pilot-type, uncoordinated, gaps, duplication, etc.). Part o f that uncertainty i s linked to the sources o f funding for these programs. To illustrate the situation, Table E.l presents the sources o f funding for the Ministry o f the Family's and FISE's capital expenditure. The dependency on external fimding for the two institutions has improved over time. For instance, for the Ministryo f the Family, the share o f external financing decreased from 90 percent in2004 and 2005, to 74 percent in2006 and a planned 75 percent in2007. However, this share remains very large and the dependency still results in disruptions in programs - programs stopping before being completed, programs on hold for short periods o ftime, etc. -which limit their effectiveness and sustainability. 195 Annex E Figure E.7 PublicExpenditureson Social Protection(Executed as percent o fBudget) 800% T- ___ ___I___._ _I___________II___~I_______I__I__.____ ----I_ 400% Resldency (SocialFund) 300% 200% 100% 0% I 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 E.14 The Nicaraguan Social Security Institute (INSS) covers a relatively small number o f (mostly non- poor) Nicaraguans, as illustrated in Figure E.3, but had a large impact on the budget inthe early 1990s - and accounted for almost 0.4 percent o f GDP. Since 1994, however, the institute has had a surplus and has not been a burden on the budget. This might be related to the efforts in increasing the number o f insuredworkers - from 200,000 in 1993 to 430,000 in2006 - and to the current demographic structure o f the INSS's participants. Indeed, the current system has a significant actuarial deficit (estimated at C$ 271,573 millions) which represents a significant contingent liability. As a result, the Government is studying alternative options for reform. The initial reform proposal presented by the High Commission for the Reform o f the Pension system (which adjusted the contribution rate, the age o f pension, and the indexation o f benefits) still involves a deficit starting in 2040 and reaching up to 6 percent o f GDP by 2065. The Inter-institutional Technical Commissionis currently studyingalternative scenarios. D. Assessment ofAllocative and OperationalEfficiency E.15 The disappointing human development results described earlier occurred despite gains in GDP per capita growth and substantial resources dedicated to poverty reduction programs (about half o f public spending, equivalent to about 15 percent o f GDP). This suggests potentially large inefficiencies in public spending - both in terms o f their allocation, interms o f their operational efficiency, and interms o f their quality. The multiplicity o f programs and projects, lack o f coordination, high operational costs, lack o f targeting, and resulting gaps and duplications are often cited as keys to understanding the limited impact on poverty. E.16 One o fthe most critical issues notedinthe area o f social protectioni s the low level of allocational . efficiency. Two important factors contributing to this are the poorly targeted social security system and program fragmentation: Limited access to insurance mechanisms. Access to health insurance i s very limited, as described above, with only 17 percent o f urban households and 4 percent o f rural households affiliated. Similarly, pension coverage i s relatively low, with only 20 percent o f urban elderly and 3 percent o f rural elderly receiving pension benefits. For both these elements, there is a strong bias towards the richer segment of the population: 40 percent o f the pension benefits are received by workers in the 196 Annex E richest quintile versus 4 percent for the poorest quintile. Health insurance covers only about 2.5 percent o fhouseholds inthe lowest q~intile"~. E.17 Fragmentation of programs. Nicaragua suffers from a fragmentation o f its programs across social sectors and within each sector by levels, as well as duplication o f efforts and overlap o f programs. For example, MINSA and the Ministry o f the Family both manage nutrition programs that use the same protocols, but are not coordinated. Overlaps and lack of coordination are also perverse within institutions and agencies. For instance, the operations o f the Red de Proteccion Social and o f PAININ, both in the Ministryo fthe Family, were not coordinated andledto duplicationinparticular areas o fimplementation. There have been some efforts to foster local coordination of projects (the Ministry o f the Family started reorganizing its programs in 2006 but coordination at the local-level remains an issue, overlaps amongst food programs and early childhood development interventions). The recently developed Social Protection Strategy provides an opportunity to work on this issue. FigureE.8: Sourcesof fundingfor the Ministryof the FamilyandFISE-2003-2007 E 100% Prestamos Extemos 90% DonacionesExtemas 80% Rentas del Tesoro 70% 60% 50% 40% 30% -- 20% 10% 0% 1 2003 12004 I 2005 1 2006 12007 2003 I 2004 j 2005 j 2006 2007 ' 1 Emergency Social Inwstment Fund Ministry of the Family 1 CaDital exoenditure 2003 2004 2005 2006 2007 (actual) (actual) (actual) (actual) (planned) Ministry of the Family Treasury Resources 13% 10% 10% 26% 25% External grants 14% 11% 23% 1% 2% External credits 73% 79% 67% 73% 73% FISE Treasury Resources 13% 11% 12% 30% 24% External grants 3% 3% 10% 21% 13% External &edits 84% 86% 78% 50% 63% Source: Ministerio de Hacienda. Debt relief funding and earmarkedtaxes are included inthe "Treasury Resources" category. L *I9These figures only refer to the distribution o fbenefits from health insurance and pensions. They do not take into considerationthe contributions made by workers and households towards these systems. The analysis of the funding and contributions is necessary for a full analysis o f their distributional impacts. 197 Annex E Another critical issue i s the poor quality o f services and outcomes: 0 Targeting and coverage. Most programs in social protection are o f a "pilot" nature, covering very small groups in the country. This raises two issues in terms o f effectiveness o f public expenditure - the targeting o f these programs could often be improved with larger-scale interventions, and the resulting services provided to different communities vary largely across the country, limiting the horizontal equity o f the programs. Coverage o f the population i s a key issue in Nicaragua's social protectionprograms, as mentioned earlier. 0 Qualitv o f services: The social protection services also suffer limitations in terms o f their quality, partly due to the erratic nature o f financing for programs and their uncertain continuity (which prevents from the establishment o f strong, effective structures) and partly due to the inability o f the social protection programs to coordinate with other programs and service providers (for instance, the Ministry o f the Family and MINSA have not managed to enter into service provision contracts for beneficiaries o f the Red de Proteccion Social). In addition, the efficiency o f social protection programs depends by nature on complementary investments in the sectors o f health, education, and other sectors such as rural development, water, or credit. As a result, lack o f coordination i s more than a missed opportunity for increasedefficiency/quality, it i s actually a cause for lower efficiency. E.18 Finally, the other critical issue for social protection programs in Nicaragua i s their limited operational efficiency. This is attributable to, 0 Large fluctuations infinancing (see above) limits stability and continuity o fprograms, Highvariability inthe costhenefitso fdifferentprograms, 0 Large overhead costs o f central activities: One o f the issues with multiple, small, programs i s the resulting highcentral activity costs. Some efforts have been made to reduce these costs, in particular inthe Ministryo fthe Family, which has reorganized to centralize some o f the financial management and procurement activities for all its programs (GON, 2006); 0 Weak institutions, 0 Absence o f monitoring and evaluation mechanisms to monitor inputs,outputs, processes, outcomes and impact usinga sector-wide framework. This i s associated with a relative lack o f transparency inthe operations (partly linked to small-scale nature o fprograms and to erratic implementation); and 0 Humanresource bottlenecks (poor salaries, skewed incentives, inadequate skills/qualifications, not focused on results, highturnover). E. MainConclusionsandRecommendations E.19 Greater planning and coordination o f social protectionprograms and social programs in general i s a key element to increased impacts. Rationalizing some o f the existing programs would help reduce their implementation costs. The main actions recommended to improve program coordination and effectiveness are presented below: 0 Program Consolidation. The consolidation o f the programs could start with a few programs, and gradually integrate projects and programs in a coherent way, avoiding overlapping between agencies and filling gaps, while rationalizing a large amount o f interventions with little demonstrated impact. The social cabinet can play a role inproviding guidance and coordinatingthese activities. 0 Strengthened analytical foundations. Develop a map o f the social protection sector that includes an inventory o f existing programs and services provided by all stakeholders in the country (public, private, civil society), an analysis o f the existing gaps in supply o f services, social spending analysis, an analysis o f targeting mechanisms used in service provision and service allocation in the recent past, and an analysis o f impacts, strengths and weaknesses o f selected programs. 198 Annex E 0 Strategic Planning and Monitoring. Stronger central strategy, planning mechanisms, and M&E systems would help implement the coordination, improve the design o f program, and develop a sector-wide approach. Unified and integrated mechanisms would provide a basis for a more programmatic support by the international partners, which could contribute to reducing the fragmentation and duplication of programs. Stronger social accountability mechanisms are fundamental parts o f this effort, and experiences have shown how they can contribute to increased impact on the ground, inparticular at the municipal level. 0 Regional Coordination. Develop mechanisms to centrally coordinate the allocation o f programs across geographic zones. This would result in improved targeting o f resources, and to greater synergies between programs. This would cut across all human development programs. Central coordination i s an important element to ensure the targeting of central expenditure to the areas most in need, in particular in the context of decentralization. Strong central institutional arrangements would be required, which are not currently in place. In addition, some central agencies would need institutional strengthening to play their roles effectively. Propose a national approach rather than an approach where each program decides where to intervene - leading to some municipalities receiving no programwhile other similar municipalitiesreceive 3 or 4 programs. 0 Local Coordination. Consolidate initial efforts to foster local coordination o f projects. This could include developing mechanisms to harmonize eligibility criteria for householdshndividuals, mechanisms to propose a unique window for social services, and mechanisms to provide accompaniment to families and individuals in accessing services. 199 Annex E 200 Annex F Annex F Review of PublicSpendingon Transport Summary of Findingsfrom Previous Sector Reviews F.1 The 2001 PER and 2004 DPR reported that Nicaragua's economic performance was being restrained by an inadequate level o f transport infrastructure and services. The country no longer has a railroad, domestic air transport i s in its infancy and its seaports were run down. Over 95 percent o f freight and passenger transport moves by road, however, so that this represents the most important transport infrastructure sector - for both domestic and international traffic - and the greatest source o f potential bottlenecks. The PER also argued that the inadequate transport infrastructure represented an important obstacle for the poor trying to escape poverty. Given the need at the time to recover fi-om the extensive damages to the road network that hadbeen inflicted by hurricane Mitch in 1998, the Ministryo f Transport and Infrastructure (MTI) had at one point been assigned up to 18 percent o f the total central government budget. The transport investment program was also reoriented to play a stronger poverty reducing role by including investments beyond the trunk segments o f the network and the start-up o f the "adoquines" (small cement paving blocks) program for rural road stabilization, which offered a much higher level o f service for rural roads than the traditional gravel alternative. F.2 The main factors contributing to the inadequate level o f transport infrastructure were diagnosed as the following: Limited road network coverage. Nicaragua has the largest territory in Central America and the smallest economy, and so it i s not surprising that i s should exhibit the lowest density o f paved roads inthe region. However, the 1995 transport sector reviewzz0noted that the coverage o f Nicaragua's transport infrastructure i s generally adequate given the country's medium-term growth prospects, but that the existing infrastructure i s inpoor condition. Unsuitable Road Design. Inter-city roads in Nicaragua typically consist o f shoulder-less two lane roads, with under dimensioned bus stops and parkmg areas alongside the pavement and wide variety o f different users (e.g., cars, buses, trucks, cycles, pedestrians). Beyond the predominantly poor condition o f the roads themselves, the mixed traffic and the general lack o f complementary infrastructure adds a further burden to road transport. Poor Rural Transport Infrastructure. Access to pavedroads i s limited and very disparate: according to the LSMS, less than one-fourth o f all Nicaraguans have access to paved roads. This proportion declines to 7 percent for the extreme poor and 11 percent for the poor. Many rural roads are simply impassable duringmuch o f the 6-month longrainy season. Inadequate Maintenance, Planning, Funding and Implementation Arrangements. Except for routine maintenance by micro-enterprises on selected links, the 2001 PER found that maintenance was not being carried out adequately, which resulted in premature road deterioration. Important factors contributing to poor maintenance were the inconsistent and untimely releases o f budgetary allocations, and institutional limitations inthe MTIthat hampered the planning and implementation o f maintenance. An important initiative to help address this problem was the creation o f a Road Maintenance Fund (FOMAV). The absence o f legislation to set up a dedicated fuel levy, however, limited the effectiveness and sustainability o fthe RoadFund. 220. World Bank, 1995, "Nicaragua: Recovery inthe Transport Sector". 201 Annex F Weak Planning and Programming by the Transport Ministry. The MTI had made significant progress by 2001 inranking investments interms o f economic priority and the Government's strategic goals, while paying adequate attention to maintenance and to their environmental and social aspects. However, there remained a need to develop the MTI's basic capacity to carry out road condition inventories, to improve staff training, to seek least cost solutions to technical and engineering problems associated with road and bridge maintenance, as well as to foster the development o f the local consulting and contracting industries. Furthermore, there was a need to strengthen the procurement and contracting management functions, which are crucial to fostering the participation o f private contractors and timely completion o f the road improvementprogram. Limited Implementation Capacity and the Use of Parastatals. In the mid-l990s, MTI's implementation capacity was limited to about 60 km o f major road rehabilitation per year. This poor implementation record was partly due to the continued reliance on state construction companies (COERCOs) that lack dynamismand to a weak local construction industry. Bothare linked: although the COERCOs represent a mechanism for rapid deployment, which proved useful after Humcane Mitch, their existence inhibited the creation o f efficient companies inthe long run. Accordingly, the 2001 PER recommended that the COERCOs be downsized to the minimumneeded for emergencies and remote areas, while malung greater use o f the private contractors. This is considered a more efficient way to develop the country's implementation capacity than trying to improve the performance o f the COERCOs. InefJicient Vehicle Fleet and Inadequate Regulatory Oversight. Nicaragua had a fleet o f about 230,000 vehicles in2000 (an average o f 0.05 vehicles/person - one of the lowest inthe region), andit was estimated that about 50 percent o f the freight transport fleet i s more than 14 years old and a significant share is over 20 years old. Freight transport services are provided entirely by the private sector. Technical and safety regulations were found to be sufficiently developed, while MTIlacked adequate monitoring and enforcement capabilities. Unclear Sector Management Roles. While the MTI i s responsible for managing the entire primary and rural road network and for regulating road, sea and air transport, the division o f roles and responsibilities between the MTI, the rural development agency (IDR), and the municipalities, especially for the maintenance o f rural infrastructure and the management o f transport services, remained unclear. To address this problem, the 2001 PER recommended the preparation o f (i) a study to help identify the appropriate roles andresponsibilities o f the key players, help foster efficient sector development, and avoid the duplication o f efforts and (ii) a strategy for decentralizing the management o f the road network and transferring most o f the secondary and rural road segments o f the network from MTIto the municipal governments. Ineflcient Urban Transportation Services. About two-thirds o f the traffic flow (vehkm. or todun.) in Nicaragua is concentrated in the urban areas. Past JICA and Bank-financed studies found that while there i s adequate urban road space for the existing vehicle fleet and population, the cities showed deficiencies inall aspects o f traffic and transit management. Evolution of Key Sector OutcomeIndicators F.3 There has been considerable progress made in the road transport sector after 2001, with most o f the trunk roads having been rehabilitated by 2006. However, Nicaragua still remains relatively under- endowed with road infrastructure, which could become a bottleneck to economic growth if it i s not addressed adequately. F.4 Size o fRoad Network. The size o f Nicaragua's road network has remainedmore or less the same since 1999, totaling around 19,000 kms. The proportion o f paved roads has increasedmodestly, however, 202 Annex F from 10 percent in 1999 to 11 percent in 2003, resulting in slight increases in the territorial density and population density o f pavedroad coverage; Table F.1. Table F.l PavedRoadInfrastructureinLatinAmerica Territorial Density Population Density (meters road/Km2 area) (meters roadcapita) 1992 1999 2003 1992 1999 2003 Costa Rica 109.8 154.5 161.9 1.75 2.20 ElSalvador 82.8 94.4 -- 0.32 0.32 --1.98 Guatemala 32.0 44.7 -- 0.36 0.44 -- Honduras 21.4 24.8 -- 0.44 0.44 -- Nicaragua 13.2 14.0 15.8 0.44 0.37 Panamit 30.7 52.2 -- 0.94 1.40 --0.39 Central America Ave. 48.3 64.I -- 0.71 0.86 -- Bolivia 1.6 2.5 3.9 0.24 0.33 0.48 Ecuador 22.3 28.8 25.9 0.58 0.66 Paraguay 7.4 6.9 -- 0.67 0.52 --0.57 Peru 5.8 7.8 0.34 0.40 Uruguay 55.3 45.6 --8.0 3.16 2.44 --0.38 Source: World Bank, World Development Indicators. F.5 Condition o f RoadNetwork. Inthe absence o f any resurfacingor reconstructionduringthe1980s, Nicaragua's road network had deteriorated to the point where only about 12 percent o f it was in good or fair condition. This improved significantly during the 1990s. Inspite o f the setback caused by humcane Mitchtoward the end o fthe decade, the proportion o froads in good or fair condition rose to 19percent by 1999. Since then, this proportionhas continued to improve at a more moderate pace, reaching 20 percent in2006. F.6 Inspite ofthe gains made since 1999, the quality ofroad infiastructurestill remains amongthe lowest in Central America. According to the Ministry of Transportation and Infrastructure (MTI), more than 75 percent o f the total road network inNicaragua i s inpoor condition. As detailed inTable F.2, the trunkand collector roads havenow beenmostly restored to good condition, andhave been essentialto the economic recovery. ] However, the overall low share o f the network in good condition is due mainly to the abysmal condition o f the other categories (secondary, tertiary and unclassified roads), which together represent 87 percent o f the total network. This largely reflects the low level of investments, coupled with an inadequate maintenance regime that has resulted in premature road deterioration. These findings suggest that the poor quality o f roads, rather than their availability, i s the principal bottleneck in this sub- sector. Table F.2 RoadConditionby Category Road Category Length (km) Share in good/fair condition (1) 2000 2006 2000 2006 1.Trunk (asphalt) 1,752 1,752 71% 74% 2. Collector (asphalt and adoquin) 636 636 78% 88% 3. Rural axes (gravel and adoquin) 5,015 2,052 38% 40% 4. Rural all-weather (gravevother) 3,071 16% 5. Unpaved and seasonal 11,544 11,525 0% 6% Total 19,036 19% 20% Note: (1) Roads with a Roughness Index (IRI) <7. 203 Annex F Evolution of Expenditures in the Transport Sector F.7 Sector expenditures rose in the hurricane Mitch year (1998) and for two years thereafter, responding to the need for emergency reconstruction o f the road network. Since then, MTI's expenditures have declined sharply, such that by 2005, MTI's spending had fallen below the level o f 1996 in real terms; Table F.3. Ingeneral, annual budgetary allocations for MTIappear somewhat low for a country at Nicaragua's stage o f economic recovery. Table F.3. Evolution of Transport Sector Expenditures; 1998-2006 1998 1999 2000 2001 2002 2003 2004 2005 2006b in millions US Dollars Total Central Gov. Expend. 635.9 856.4 862.7 842.1 821.3 1000.1 1015.1 1117.3 1204.2 Sector Budget (Const. & Transp.) 169.6 253.9 213.1 196.3 146.8 159.2 191.0 124.5 - MTI Budget 70.2 124.6 107.4 91.3 65.8 70.7 85.2 87.4 101.5 As % of GDP Total Central Gov. Expend. 17.8% 22.9% 21.9% 20.5% 20.4% 24.1% 22.3% 22.3% 22.4% Sector Budget (Const. & Transp.) 4.7% 6.8% 5.4% 4.8% 3.6% 3.8% 4.2% 2.5% - MTI Budget 2.0% 3.3% 2.7% 2.2% 1.6% 1.7% 1.9% 1.7% 1.9% As % of Total Central Government Expenditures. Total Central Gov. Expend. 100% 100% 100% 100% 100% 100% 100% 100% 100% Sector Budget (Const. & Transp.) 27% 30% 25% 23% 18% 16% 19% 11% - MTI Budget 11% 15% 12% 11% 8% 7% 8% 8% 8% /Memo: exchange rate (C$/US$) 10.58 11.81 12.68 13.44 14.25 14.94 15.73 16.41 17.57 Source: StatisticalAnnex Tables. Note: All figuresrefer to actual expenditures,exceptfor 2006, which refersto the budget. F.8 At the post-Mitch peak in 1999, the MTI executed 15 percent o f the total central government budget, which was appropriate inview o f the massive reconstruction needs. However, this could not be maintainedand even though the overall budget increased, MTIhas been assigned a decreasing share since then, reaching a low o f 8 percent o f total budget in 2005. Details on the initial, revised and executed budgets follow inTable F.4. During2002-2006, the MTIinitial budgets tended to be unrealistically small, given the emergency road restoration needs and hence the executed budget in general exceeded it by a significant margin. Still, the executed budgets were moderate and, except for 2001, were always less than 10percent o f the total Central government executed budget. This is quite an impressive achievement for the MTIto have managed such a major recovery program in this period with a relatively small share o f the budget. The decline inbudget execution ratios in2005 and 2006, however, are cause for concern. Assessment of Allocative and OperationalEfficiency F.9 The overall road sector performance has been good interms o f the allocation and use o fresources and i s improving continually. Investments are still set by the budget but users pay directly for an increasing share o f the maintenance o f the most trafficked roads via the road maintenance fund. The use o f least-cost construction techniques, such as adoquines, represent an efficient allocation o f resources and result in the provision o f higher than traditional service levels for rural traffic, as the alternative to gravel- surfaced roads. The balance between recurrent and capital expenditures reflect a focus on reconstruction needs during the period 2001-2006, and was warranted at the time, but i s not expected to continue. The fact that road improvements are selected largely on the basis o f their economic justification (using the Bank's HDMmodel) provides hrther comfort inthat allocations are being made on an efficient basis. F.10 In terms o f operational efficiency, most transport services for roads, ports and airports are concessioned or owned and operated by the private sector. Anecdotally, the level o f operational efficiency varies highly. The most efficient i s probably the Managua airport which, following its modernization program, now offers facilities and levels o f service that are better than its Central 204 Annex F American neighbors and compare well with international airports elsewhere. Although domestic air travel has not been improved much, it is still quite adequate. The airports modernization has been financed largely by passenger user charges and does not have much public sector budget implications. There i s more o f a public sector expenditure implication in the port sector, but this again i s very small. The concessioned operations at Corinto and other ports are operating reasonably well. TableF.4 BudgetedandExecutedMTIExpenditures (in US$millions) Initial Budget Modified Budget Executed % ExecutedI Initial Item Current Capital Total Current Capital Total Current Capital Total Current Capital Total 2001 CG Budget 478.4 450.6 929 318.5 319.9 946.7 374.5 214.2 754.6 78% 48% 81% MTI 5.5 105 110.4 5.5 105 110.4 3.7 87.6 91.3 68% 64% 83% ._______________________________________------- MT/ Shareof t p U budget 17.90% 7.00% 40.90% 12.10% 2002 CG Budget 447.8 290.2 738 13.9 0 761.7 441.3 264.8 706.1 99% 91% 96% MTI 4.3 58.5 62.8 0 0 73.7 3.9 61.8 65.8 92% 106% 105% F.ll For road transport, there i s a subsidy for urban passenger transport that i s not completely transparent and i s justified by the operators because the government supposedly sets bus fares too low. This subsidy needs to be examined carefully. Given the low income levels o f bus users, it may be justified, but this needs to be demonstrated. Freight transport is not subsidized, but operators need to be licensed by the MTI. Freight services are reasonably efficient and there are indications that operator revenues are better than in the past as modest fleet renovation activities seem to be taking place. The improvement o f the trunk road network has been a major boon to the efficiency o f freight transport operations. F.12 Interms of the supply of road infrastructure, the use of adoquines has also contributed to an increase in technical efficiency since it minimizes the consumption o f economic resources in its construction and maintenance. Road users also realize increased savings over the gravel surfaced alternative. In most low traffic volume situations, gravelling has long been the preferred option for surfacing when upgrading earth roads because it i s less costly than asphalt. However, Nicaragua i s ahead o f many countries in addressing the paradox o f sustainably improving low traffic volume by using the non-traditional adoquinado option, which provides an all weather service quality similar to asphalt but 205 Annex F has a lower life cycle cost than gravel. To understandwhy, one must examine how gravel roads are built, the highlyvariable level o fuser service they provide and their highly demanding maintenance regimes.221 The Casefor Adoquines F.13 There are major concerns about the efficacy o f rural road gravelling/ re-gravelling, both from a financial and economic viewpoint as well as from a social and environmental viewpoints. The main concerns fiom the financial and economic viewpoint can be summarized as follows: Gravel is depleted rapidly by heavy vehicle traffic. Gravel loss rates per annum are typically on the order o f 30-50 mm, depending on such factors as traffic, vehicle type, climate and terrain. The top 30-50 mm wearing layer can be lost annually and hence, without frequent re-gravelling, the entire 100-12Omm o f gravel can be lost within 3-5 years. The cost o f periodic re-gravelling and routine maintenance o f gravel roads can be very high. Re- gravelling costs are typically in the range o f US$5000-30,000 per km per year depending on factors such as the thickness o f the gravel layer, gravel quality, haulage distance, haul conditions, intensity o f equipment technology used, location, increasing scarcity o f high quality gravel supplies and the resultant rising unit costs, plus budgetary, planning and organizational requirements. In addition routine maintenance costs related to gradindreshaping, patching and off-carriageway operations require a further U$2000 - 3000 per km per year. The required timely annual provision o f the financing, logistical and managerial arrangements for such maintenance programs are not usually met even indeveloped countries. Very often, spot improvement gravelling may be the optimum solution for unpaved road maintenance. However selective gravelling in practice i s difficult to implement and resources are wasted. The attendant equipment intensive technology o f using graders for re-gravelling purposes i s not sustainable in a number o f countries where it would be preferable to employ alternative methods o f maintaining unpaved roads involving local communities to a greater extent and utilizing local resources and management more extensively. Moreover, in many countries, the number o f graders required to maintain a large network o f gravel roads inreasonable condition i s simplynot available. Technically also, even with such a high consumption o f resources, gravel roads usually have an International roughness index (IRI)considerably greater than 5 m/km and hence may not represent an optimal solution fiom the user standpoint for vehicular traffic. Neither do they facilitate non- motorizedmodes such as bicycle traffic. F.14 The main concerns from the social and environmental viewpoints are the following: L 221. As part o f the construction and maintenance cycle, natural gravel materials are usually excavated from borrow pits or quarries placed on a carefilly engineered roadbed to a thickness o f typically 150-2OOmmto form an all weather running surface. A gravel road surface can be appropriate and cost effective in many circumstances. These include situations where (i) sufficient quantities o f gravel are available that meet the required surfacing specifications. Also, gravel extraction should be managed in a way to minimize adverse environmental damages from the usually open pit mining approach used; (ii) haul distances fiom the quarries to the roadbed are relatively short; (iii)the terrain is not steep and longitudinal road gradients are less than about 6 percent; (iv) rainfall is low or moderate and the seasons do not extend continually for many months. Some drymg time is needed between rains; (v) traffic is relatively low or about less than 150 vpd; (vi) dust generation in the dry season is not severe; (vii) financing and other resources will be available timely and adequately for annual and periodic maintenance. However, increasingly these criteria are not being met and the concept o f managing efficiently more than 75 percent o f a national network as gravel roads is being questioned from both the provider and the user side. 206 Annex F There is a continuous demand associated with gravel roads ( and to large extent asphalt roads) for the use o f a non-renewable wasting layer, derived from a natural resource which is being depleted seriously inmany countries; Gravel roads require a continuous cycle o f mining or extracting rocks from mountainsides, rivers or pits, crushing, sorting and placing the resultant gravel in a roadbed for it to be worn away by traffic, 8~ washed away by rain, or ground into very fine particles by passing traffic which leads to the generation o f excessive dust, etc. Environmentally, this cycle i s becoming less and less desirable. Dust generation causes adverse impacts in terms o f being a health hazard for communities living adjacent to the road as well as causing pedestrian, animal and vehicle safety problems related to visibility and overtaking movements. Inaddition, dust emissions cause damage to crops and natural habitats. Gravel roads are too often slippery and dangerous inwet weather, especially in steep terrain, causing access problems for communities. F.15 Insum, gravel inthe longrunmay not be an appropriate or sustainable solution for many road locations in developing countries. This has long been recognized, but the standard alternative option of the asphalting o f rural roads i s usually very difficult to justify economically, given thek highinvestment costs and the low traffic volumes usually prevailing on such roads. Still, the main alternative to gravel in many countries has been low cost asphalt surface dressings for roads with sufficient traffic volumes (>250vpd) and other characteristics but they remain difficult to justify, even when `social appraisal' approaches are considered. These low cost asphalt techniques still actually cost more than adoquines and mostly serve to keep the gravel in place and provide a smoother riding surface for a few years before becoming extensively potholed and requiring costly overlays. These overlays mean that good quality gravels will needto be extracted from the quarries or borrow pits once again. F.16 Inthe case of adoquines, the roadbed (also gravel) needs to be builtonly once in 30 years. A finished surface o f IRI<4 can then be maintained indefinitely via basic routine maintenance that can be carried out by local labor units (better organized as micro-enterprises). No more recourse i s needed to the gravel quarries for periodic maintenance as i s the case for gravel and to a lesser extent asphalt roads. The users can also expect to enjoy a continued high level o f service and reduction in vehicle operating costs. From all considerations, adoquines are probably the most cost effective solution for many roads o f traffic levels from 40 -2000 vpd.222 Sector Expenditure Framework F.17 Both the provision and maintenance o f infrastructure leave a lot to be desired inNicaragua. This was due to various factors in the recent past, especially inadequate maintenance funding levels, a weak construction industry and poor operations o f service companies. In recent years, IDA has maintained a high level dialogue with the Authorities on these issues, especially on the budgetary and other funding mechanisms for maintenance, the need to improve the institutional framework, and on the advantages of increased private sector participation in infrastructure construction, operation and maintenance to the extent feasible. The poorly maintained road network places the major investments of the past 5 years at risk and prevents the development o f least-cost transport services, especially in rural areas. Full establishment o f the Road Maintenance Fund (FOMAV) and the use o f private contractors that are awarded contracts via a public bidprocess could be a major part o f an efficient solution to thisproblem. F.18 The increased regional competitiveness that is expected to arise from the Central America Free Trade Agreement (CAFTA) also heightens the urgency to address the road infrastructure deficit. A well developed and maintained road network i s essential to maximizing Nicaragua's potential for dynamic, L 222. More infoxmation on the low traffic volume roads paradox in low income countries is available from the reportby the SSATP on the Roads Economic Decision Model (RED) Sept 2006 workshop. 207 Annex F export led economic growth. To improve its prospects for competing under CAFTA, Nicaragua must overcome the huge backlog o f maintenance and investment in road infrastructure. The allied agenda o f policy and institutional change in this sector will involve: (i) improving the quality o f rural roads and ensuring year-round rural accessibility. Such road improvements should be part o f a strategy aimed to strengthen rural-urban linkages and to foster commerce and agricultural development; (ii) designing mechanisms to protect infrastructure investments from bearing a disproportionate share o f the burden o f periodic fiscal adjustments and, conversely, to increase investments if fiscal space allows it; (iii) promoting a suitable regulatory framework for private sector participation in the construction, operation and maintenance o ftransport infrastructure, and (iv) improving urban transportation systems. F.19 The previous government had set certain targets inthe Plan Nacional de Desarrollo (PND) 2005- 2009 for the road sector, the most important o f which calls for improving the quality o f 1200km o f the secondary andrural roadnetwork by adoquin stabilization. About 300 kmo f this goal has been met, and a further 300km is being financed under the Fourth IDA Roads project. However, it seems that it will be difficult to achieve the 2009 goal unless a major redirection o f investment resources i s done by the government. Conclusions and Recommendations F.20 Sector performance has improved considerably as evidenced by the increased length o f the road network in good or fair condition and the first true extensions in last 20 years in the lengths o f high quality roads as a result o f the adoquin program. A related benefit arises from the fact that these extensions were obtained at least cost both in terms o f investment and maintenance. Furthermore, they feature a higher domestic content than other technologies. F.21 There has been a sharp reduction in MTI's budget share in the post-hurricane Mitch period. Government needs to take advantage o f the current window o f opportunity to make what are essentially once-in-30-years investments to extend the adoquin roads network, as rising prices for petroleum products and other raw materials will soon make other approaches even less attractive. A budget increase for MTImay be needed for this purpose. However, the fall in budget execution ratios during 2005 and 2006 trigger concerns about MTI's absorption capacity. This decline needs to be reversed before contemplating budget increases. F.22 Emphasis needs to be placed on efficient planning, especially with regards to the application o f design standards that are appropriate for road traffic levels and normal rates o f growth. There has been a growing tendency to design roads to meet excessively highadministrative standards (e.g. insistingthat all collector roads must be 7 meters wide) rather than adhere to much less costly standards that would be appropriate to meet the requirements o f the prevailing traffic volumes and likely growth rates. F.23 The key message, then, i s one o f continuity and expansion o f the policies and programs that have been carried out fairly well by the MTI during 2001-2006. In the context o f that strategy, the PER recommends that particular attention be devoted to the following measures: Investments to improve and expand the paved road network to the levels o f other low income comparator countries. Given the success o f the trunk roadrehabilitationprogram so far, the next order o fpriority i s to improve the grid o f secondary and major rural roads (the distributor network) that link to the trunk roads and serve the productive zones. The scaling up o f existing adoquinado programs represents a cost-effective alternative to asphalt or gravel paving o f roads, especially for the secondary network. Emphasizing maintenance. It will be essential that the roads that have been rehabilitated are not left to deteriorate (as inthe past) and once again allowed to become bottlenecks. A comprehensive program o f maintenance, including the guaranteeing o f funding arrangements via the FOMAV and the use o f 208 Annex F least-cost public bidcontractual approaches for works implementation represent an indispensable part o f the strategy to increase paved road coverage. Even then, it will be many years before Nicaragua can close the gap inpavedroads vis-a-vis other countries inthe region; 0 Clarifying and strene;theninp; sub-sector institutional arrangements: Although the IDA project supported institutional restructuringhas produced significant positive results, MTI i s still affected by overall weaknesses in planning and programming. There i s still a need to develop MTI's basic capacity to carry out road condition inventories, to fully install the Pavement Management system, to seek least cost solutions to technical and engineering problems associated with road and bridge maintenance, as well as to help foster the development o f the local consulting and contracting industries. Aside from MTI, the FOMAV needs appropriate technical assistance, particularly in contracting and procurement procedures so that it can develop the capacity eventually to manage the maintenance o f the entire core road network. For overall sustainability and efficient road management, further analyticalwork i s neededto identify the appropriate roles and responsibilities o f the key players (both at central and local level, and including INIFOM, IDR and the municipalities) and to promote synergies while avoiding a duplication o f efforts 0 Imuroving urban mobilitv by restructuring public transportation services and developing improved mass transit corridor management in Managua. This could be designed as part o f an integrated bus routes development and improved traffic demand management program. 209 Annex F 210 Annex F Annex G Review of Public Spendingon Water and Sanitation Sector Organization and Governance G.1 The water and sanitation sector comprises the following institutions: the national water utility (ENACAL), the regulator (INAA), the Social Investment Funds (FISE), the rural water committees (CAPS) and the policy body CONAPAS which itself i s a commission with a small executive secretariat including the Presidential Secretariat (SETEC), the Health Ministry (MINSA), the Environment Ministry (MARENA), the Institute for Territorial Studies (INETER), ENACAL, INAA and FISE. ENACAL serves about 60 percent o f all water users, the CAPSabout 30 percent, and the remaining 10 percent is served by the departmental water companies in Matagalpa and Jinotega, as well as a few small municipalities. G.2 CONAPASi s responsible for the formulation o f sector policies. Under the Bolafios Government, CONAPAS approved a sector strategy inOctober 2005 that is oriented towards reaching the sector MDGs and i s in line with the National Development Plan. The sector strategy identifies five areas o f attention: improving the legal and institutional framework; expanding the access to water and to sanitation; implementing efficient, participative and decentralized operational models; financial sustainability; and improving environmental conditions. The elaboration of the sector strategy also gave rise to the sector round table as a coordination forum between Government, donors and NGOs. In October 2006 Government and donors agreed on a road map to complete a SWAP, and in December 2006 signed a Code o f Conduct on Alignment and Harmonization. In order to implement the sector strategy, pending issues include the elaboration o f strategic and annual operation plans o f the key sector institutions, a sector medium-term expenditure framework as well as a monitoring system. This, in turn, may allow agreement on a Memorandum o f Understanding with interested donors on a common financing mechanism. G.3 The Ortega administration i s still in the process o f defining its sector strategy and deciding on the future o f CONAPAS. Nevertheless, it has clearly voiced its opposition to privatization measures in the sector and indicated that, in the framework o f the recently approved water law, a new "National Water Authority" may assume political leadership inthe sector. G.4 ENACAL operates water supply and sanitation systems in urban areas, defined as localities with more than 500 households. ENACAL's performance has been severely hampered by both inefficiency and politicization. An DB-financed service contract for ENACAL started in early 2006 after several years o f intense discussions. The business consultant presented a restructuring proposal in December 2006 and i s supposed to follow-up on its implementation for another two years, based on a fee structure providing incentives to effectively improve operational efficiency in the commercial, administrative and technical areas. The new administration has questioned the service contract claiming that it is a "veiled privatization", and recently decided to cancel the modernization program. Apart from ENACAL, the departmental water companies in Matagalpa and Jinotega are the only operators in urban areas. The experience in terms o f decentralization and private sector participation (a five year management contract) has triggered promisingresults interms o f service quality, especially for the poor. The new administration views this model with scepticism, and the ENACAL President recently dissolved the Boards (Junta Directiva) o fbothwater companies and subordinated them to the Board o fENACAL. G.5 INAA is responsible for the regulation o f service quality and tariff adjustments. Ad hoc political interference has up to now prevented INAA (just as the regulators for the energy and telecom sectors) from exercising these functions. It i s not clear how the constitutional reforms that among other things 211 Annex F include the creation o f a supra-sectoral regulator SISEP under parliamentary control and that were suspended until January 2008 may affect this limitation. The new Government has stated that it will tackle ENACAL's inefficiencies and try to improve service quality first before taking any decisions on tariff adjustments. G.6 FISE, inter alia, is in charge o f promoting access to water supply and sanitation in rural areas. The operation o f these systems i s delegated to CAPS. While the municipal law - in contradiction to sector laws - does assign competences for the water sector to municipalities, their involvement has been limited inthe past, apart from some support to the CAPS. Sector Expenditure Structure and Trends G.7 Investments inthe sector duringthe 2002-6 Table G.l Investmentsinthe Water and period totaled USD 178 millions, or an average o f Sanitation Sector US$ 35 millions per year. This i s equivalent to 0.75 Year Category Cost (1000 USD) percent o f GDP, which i s about four times the UrbanWater 10.970,2 average in the L A C region during 1991-2000. Of 2002 Urban Sewage 10.756,s Rural W&S 8.722,9 this total, 37 percent has been assigned to urban Total 30.449,5 water supply projects, 31percent to urban sanitation UrbanWater 12.684,s projects and 32 percent to rural water and sanitation UrbanSewage 2.868,O projects (the latter includes ENACAL and FISE). 2003 Rural W&S 12.313,s To allow for a correct interpretation o f these Total 27.866,l numbers, especially on urban sanitation, one has to UrbanWater 14.736,6 take into account that the Sanitation o f Lake Urban Sewage 9.127,2 Managua Program that i s being implemented since 2004 Rural W&S 16.347,6 2004 alone i s worth about US$65 millions. Total 40.211,4 Urban Water 10.695,4 G.8 Currently, decisions on expenditure Urban Sewage 12.683,5 priorities, particularly investments, are basically 200s Rural W&S 12.494,8 driven by emergency and political considerations, Total 35.873,6 very rudimentary planning by ENACAL and FISE, UrbanWater 15.881,3 and donor offers o f grants and concessionary loan Urban Sewage 20.273,O financing. Donor contributions cover almost all 2006 Rural W&S 7.559,3 investment financing. The Government's and Total 43.713,7 ENACAL's counterpart financing i s limited, Urban Water 64.968,O reflecting the latter's very modest cost recovery 2002-06 Urban Sewage 55.708,2 RuralW&S 57.438,l capacity. In contrast, the sector strategy developed Total 178.114,3 earlier by CONAPAS provides the basis for a more systematic planning process. It estimates the investments necessary to reach sector MDGs at US$ 592 millions duringthe 2005-15 period, o f which US$286millions i s neededinthe first five years. G.9 ENACAL i s a loss-making public enterprise whose jnancial situation has deteriorated further in the last three years to the verge o f illiquidity. Structural factors include a highpercentage (56 percent) o f unaccounted-for water (half o f which i s supposedly due to illegal connections) and low labor productivity (7.6 employees per 1000 water connections). The collection rate (88 percent) and the micro metering (some 40 percent) also clearly lag behindregional standards. Combinedwith the dramatic increase inthe energy bill (which makes up to 40 percent o f operating costs) and given the tariff freeze (see below), the cost coverage ratio has fluctuated between 0.69 and 0.86. As a consequence, the operative cash flow before financing has beennegative inthe last three years. 212 Annex F Table G.2 Summary Balance Sheet, Income Statement, and CashFlow Category I 2003)I 20041I 2005 provisions and adjustments -15.045 14.871 -2.939 Depreciacion -7.974 -9.162 -7.548 adjustments for last years 14.298 -25.421 -907 other provisions -3.299 -1.174 -2.344 ResuIt ILoss) -12.020 -20.886 -13.738 IExchange rate: C$ to USD I 15,55151 16,3291 I 17,14551 213 Annex F Institutions 0 a 50 + 856 6,76 I,69 0,475 0,375 0,094 8,56 14,49 4,27 0,475 0,805 0,237 Rest of the Country SubsidisedCustomers 0 a 20 + 1,06 2,13 0,64 0,059 0,118 0,036 1,06 2,83 0,86 0,059 0,157 0,048 ResidentialCustomersI 0 a 20 4,24 4,85 1,45 0,236 0,269 0,081 21 a50 + 4.24 6,20 1,78 0,236 0,344 0,099 4,24 13,04 337 0,236 0,724 0,198 ResidentialCustomersII 0 a 50 + 9,46 7,72 2.38 0,525 0,429 0,132 9,46 14.68 4,OO 0,525 0,815 0,222 Exchange rate C$ to US$ on 12/31/06 16.0028 214 Annex F G.11 The sector features a complex mix o f badly targeted indirect and hidden subsidies described below: The Government transfers all donor funds, both loans and grants, to ENACAL by way o f grants. While this i s a common practice in other countries, it constitutes a substantial subsidy for the company and indirectly to all water users irrespective o f their living standards. By the same token, the Government since 2005 transfers subsidies to ENACAL to cover operational losses without any specific obligations regarding service quality or focalization o f investments. The block tariff system includes significant cross subsidies between user and consumption categories that in principle do provide for a redistribution from higher to lower income segments but are still poorly targeted due to a lack o f clear classification o f users to these categories and due to the high volume o f the first consumption block @Om3 instead o f 10m3per month necessary to cover basic water needs). Fixedrate tariffs are applied to a highproportion o f water users because o f low micro metering rates, mostly without regard to poverty considerations. Retirees are offered a 30 percent discount on their respective tariffs. Being retirees implies that the users had worked in the formal economy and, therefore, are unlikely to belong to the poorest income quintiles. So called poor districts ("asentamientos") do not pay at all for water services. Again, the classification o f users i s too rough to allow for a pro-poor targeting. G.12 There are no exact data available to calculate the amount o f these subsidies. Overall, however, they tend to benefit the affluent consumers, who generally consume more water than the poor and who are more likely to be connected to sewage systems. This comes at the expense of those not connected, particularly in rural areas, who are predominantly poor and who have been penalized by low levels of investment. Sector Outcomes G.13 According to the 2005 census, coverage ratios for urban and rural water facilities are 94.2 percent (of which 87.5 percent are connected to piped systems) and 64.1 percent, and those for urban und rural sanitation are 95.7 percent (of which 31.1 percent are connected to sewage systems) and 69.5 percent, respectively. These data indicate an increase o f coverage for sanitation, but a stagnation o f coverage for water inthe last 10 years. G.14 More importantly with regard to sustainability, these quantitative indicators merely concentrate on access to infrastructure, but do not reflect effective water and sanitation use. Therefore reaching the MDGs linked to the sector, i.e. effective access to water and to sanitation, as well as for reducing infant, under-five mortality and malnutrition, all o f which are partly caused by water related diseases, remains a major challenge. Effective use is primarily affected by the following factors: ENACAL suffers from a high degree o f inefficiency in terms o f water losses, lack o f domestic metering, low collection rates as well as labor and energy cost (see above). These performance indicators have basically remained unchanged in the last decade. As a consequence ENACAL continues to be totally dependant on donor financing for its investments. The lack o f financial resources has produced significant water rationing because o f the absence or delay o f reparation and rehabilitation works and also due to programmed rationing in order to save 215 Annex F energy costs. Overall service quality i s low and has sparked frequent user protests in the last two years. Poor water quality i s a serious issue, especially inrural areas. Table G.4 Water and Sanitationcoverage Category National Urban Rural 1995 2005 1995 2005 1995 2005 Water 81.4 81.8 94.3 94.2 64.9 64.1 Piped Systems 55.5 62.7 83.8 87.5 18.4 27.4 Sanitation 77.6 84.8 94.3 95.7 55.6 69.5 Sewage Systems 17.2 19.4 29.9 31.1 0.6 0.0 Table G.5 MDGsRelatedto the Water Sector PRSP Goals (MDGs) Base Actual Forecast PRSP 2015 Target for 2001 2015 Target 2015 will be Achieved? Infant Mortality (per 1,000 live 58 31 27 20 Possible births) (1993) Under-Five Mortality (per 1,000 live 72 40 35 24 Possible births) (1993) Chronic Malnutrition ("A) 19.7 17.8 12.3 7 Unlikely (1998) Access to Water (%) ... 70 85 100 Unlikely Access to Sanitation (YO) ... 85 88 95 Possible G.15 The described outcomes have been disappointing when viewed against the relatively highlevel o f sector spending. (This applies even when we exclude the Lake Managua Program, which has absorbed a significant amount o f investment, but has not yet been completed.) Donor-financed infrastructure investments have mainly concentrated on rehabilitation o f existing systems that fail prematurely due to inappropriate management and have merely kept up with population growth to maintain coverage ratios. Investments, however, didnot lead to improvements in service provision and quality. The reasons for this low spending efficiency predominantly relate to the political and institutional shortcomings in the sector. Underlying factors are the discretionary political interference inregulatory and operational mattes, limited institutional capacities in the case o f ENACAL, CONAPAS and INAA, and an inconsistent legal framework. Main Sector Issues and Policy Recommendations G.16 Planning: The previous sector strategy developed by CONAPAS provided a sound basis for future sector planning and the allocation o f resources. While the sector policy vision o f the new administration may differ from the one o f its predecessor, there appears to be room for forging a consensus on the key sector outcomes that are desired and on adequate policies for reaching them. Designatinga policy body (such as CONAPAS) with sufficient political weight and institutional capacity will be a key decision. As long as the sector strategy i s operational and backedby the necessary political leadership, a SWAP approach would be the mode o f cooperation preferred by donors. G.17 Regulation: It i s important that INAA be given full autonomy intariff setting. Interms o fpolitical timing, the Government/ENACAL may have to restore user's confidence first by improving efficiency 216 Annex F and service before adjusting tariffs - although there i s probably no perfect timing for tariff increases. Furthermore, I N A A ' s power o f supervision needs to be strengthened by systematically linking any subsidies from the general budget to improvements in performance indicators, to be defined in the concession contract between ENACAL and INAA. Moreover, the current subsidy system needs to be reviewed and revised in order to create a more effective pro-poor targeting o f direct and indirect subsidies. G.18 Urban areas: Improving service quality and efficiency o f ENACAL i s one o f the most urgent priorities inthe sector. It i s recommended that ENACALtake substantial measures inthe commercial area (reduction o f non-technical losses, increase o f metering and collection) and in terms of reduction o f personal and energy cost. The presented deconcentration alternatives should be considered, balancing economies o f scale and proximity to clients. The Matagalpa-Jinotega experience should be carefully evaluated. G.19 Rural areas: In the past, FISE focused primarily on small social infrastructure investments, and less on sustainable operation o f water systems. Subsequently, however, FISE has been strongly involved in local development cooperating with municipalities and communities, and developed considerable experience in this area. That i s why the responsibility for the rural sub-sector should stay with FISE (rather than be reverted to ENACAL). Municipalities should be given a more determinate role in supporting CAPs in their communities. Alternatively, a group o f CAPs could consider to jointly contract micro-businesses to share the cost o f qualified administrative and technical support. Additionally CAPs need to be given a legal status to effectively manage the operation and maintenance o f their systems. G.20 Integrated approach to sanitation: Hygienic behavior i s critical to achieving the envisaged health outcomes. Given the past focus on water and sanitation infrastructure, a more integrated approach to sanitation, particularly inrural areas, i s requiredto successfully tackle the patternof existing water related diseases. 217 h e x F 218 Annex H Annex H A Note on the Energy Sector H.l Incontrast to the Transport and WaterEanitation Sectors, the Energy sector has a modest direct fiscal impact relative to the overall economic and social impact o f this sector. Since the power sector is largely in private hands, attention focuses mainly on the development o f a sound sector policy and regulatory framework, rather than on undertaking public investments. This Section highlights the main sector developments since 2001, and summarizes the main policy recommendations that emerge from the World Bank's recentlyprepared Nicaragua Energy Sector Policy Note. Summary of Findingsfrom Previous Reviews H.2 Electricity generation had become a significant development bottleneck inNicaragua by the mid- 199Os, resulting in regular blackouts and prompting efforts to transform the sector from a public monopoly to a competitive, market oriented system with significant private participation. Energy distribution fimctions were mostly privatized, transmission activities remained in public hands and generation activities were split between the public and private sectors. The sector reforms initially succeeded in improving sector efficiency levels and in mobilizing private investments, and by 2001, nominal electricity production capacity had grown to over 600MW, while maximum demand had grown more gradually to 400MW. As noted in the World Bank's 2004 Nicaragua Development Policy Review (DPR), electricityproductioncapacity was not expectedto become a constraint inthe mediumterm. H.3 The 2004 Nicaragua DPR also identified several important shortcomings inthe sector: Nicaragua's electricity consumption i s the lowest in the region - even lower than what would be predictedby its level o fdevelopment. Nicaragua relies predominantly on thermal generation: 82 percent o f the country's electricity production i s based on oil products. This i s the highest ratio inthe region. (A major bottleneck to the diversification o f energy sources was the legal prohibition against private investment inhydro-electric power plants with greater than 5MW capacity.) Less than half o f Nicaragua's population had access to electricity, giving it the lowest coverage ratio intheregion Distribution-related losses for the entire system were very high, amounting to 30 percent o f net electricity production The cost o f electricity was among the highest in Central America, especially for commercial and industrial consumers, while residential users benefitedfrom cross-subsidies The combination o f a weak regulatory framework and deficient pricing policies, limited the attractiveness o f Nicaragua's energy market for potential private investors and was considered one o f the strongest barriers to the expansion o f electricity coverage. H.4 To overcome these shortcomings, the DPR recommended, (i) increasing access to electricity services, especially in rural areas, by talung advantage o f off-gnd technologies, (ii)developing the regional electricity market to take advantage o f economies o f scale, (ii) strengthening the regulatory framework, and (iv) encouraging greater private sector participation by removing prohibitions against private investment in hydroelectric plants, correcting the asymmetric fiscal treatment o f different technologies, and fostering a more competitivemarket environment. 219 Annex H Evolution of Key Sector Indicators since 2001 Suuulv and Demand H.5 Electricity supply didnot increase as expected, so that the energy sector is once again threatening to become a major development bottleneck in Nicaragua. Although the installed nominal generation capacity increased from 638MW in 2001 to 751MW in 2006, effective capacity (i.e., power that i s actually available) only increased from 536MW to 589MW. The difference between nominal and effective installed capacity appears to have increased since 2002, and i s due mainly to the operation o f older thermal power plants that require overhaul or replacement, and the exhaustion o f the existing geothermal reservoir. Table H.l Nicaragua: Installed Power Generation Capacity (MW) 2001 2002 2003 2004 2005 2006 TotalNominal InstalledCapacity 638.1 655.2 679.7 742.2 757.2 751.2 Total EffectiveInstalledCapacity 535.9 574.3 595.8 607.7 627.0 588.6 Difference 102.2 80.9 83.9 134.5 130.2 162.6 Source: World Bank(2007), "Nicaragua: Energy SectorPolicyNote" H.6 While effective capacity increased by less than 2 percent per annum from 2001 to 2006, electricity demand has increasedat roughly 4 percent. By mid-2006, the reserve margin was only 30 MW (or 6 percent o f total demand), which is inadequate and resulted in the recurrence o f system-wide blackouts and power rationing. The situation improved in 2007 with the installation o f thermal plants sponsored by the Venezuelan government, which i s projected to add up to 60MW in new (albeit expensive) generation capacity. Access and Electrification H.7 According to data from the United Nations Economic Commission for Latin America and the Caribbean (ECLAC), electrificationinNicaragua was around 47 percent in 2001 and 54 percent in2005, which shows impressive progress during the last five years. This is due in good measure to the organization o f Fondo de Desarrollo de la Industria Eldctrica Nacional (FODIEN) and its electrification programs, which have benefited from the support o f donors and multilateral organizations. Nevertheless, Nicaragua's electrification rate remains the lowest among the Central American countries; Figure H.1. Figure H.l:Electrification Rates in Central America, 2005 1 100 8 90 8o 70 60 50 Costa Rica Panaml Guatemala El Salvador Honduras Nicaragua Source: ECLAC. 220 Annex H H.8 The data in Figure 6.1 may be under-estimating Nicaragua's electrification rate: according to the 2005 Census, around 68 percent o f all dwellings have electricity service. Unlike the ECLAC figures, which are based on data from the utilities, the Census figures ignore whether residential connections are legal or not. Evenwith the higher coverage figures from the Census, however, Nicaragua still exhibits the lowest electrification rate in the region, behind Honduras. The Census figures also show a great dispersion inaccess to electricity, with the electrificationrate averaging around 92 percent inurban areas, butonly 36 percent inrural areas. Distribution Losses H.9 Distribution losses have continued to be very high, in spite o f privatization. Energy losses currently amount to around 28 percent o f total energy injected into the distribution system; barely lower than the 30 percent losses estimated in 2001. These losses should be n o more than 14 percent under moderately efficient conditions. Of the 28 percent in total electricity losses, about half corresponds to "technical losses" which are within the control o f the distribution company, though they may require additional investments to be undertaken. (Systems similar to Nicaragua's operating with an average level o f efficiency should exhibit technical losses below 10 percent.) The other half o f total electricity losses corresponds to "commercial losses"; un-metered consumption and electricity theft. It i s estimated that these commercial losses are due in equal part to illegal connections in poor neighborhoods (and the distribution company's inability to enforce payments), and to faulty meters and electricity theft by large companies. These losses should be reduced to practically zero, but require, both, more concerted cost recovery efforts by the distribution company and greater cooperation by the Authorities. PricingPolicies H.10 The basic tariff scheme inNicaraguais similar to others inthe region, with final consumer prices consisting o f various elements, including an allowed "pass-through" component to account for changing generation costs and a value-added component to finance investments indistribution. However, the tariff structure i s overly complex, involving an excess o f categories and different charges, which complicates the commercial process and confuses customers. There i s also a significant cross-subsidization in the structure o f electricity tariffs, with industrial, pumping and irrigation prices well below the average tariff, while commercial prices are well above. Residential prices are near the average electricity tariff in Nicaragua, which also happens to be close to the average in the region - below those observed in El Salvador, Guatemala and Panama, but above those in Costa Rica and Honduras. The price o f industrial energy inNicaragua, however, i s among the highest inthe region, which means that other countries have been cross-subsidizing this market segment even more than Nicaragua. Regulatory and Policy Framework H.11 A cornerstone o f the sector reforms introduced in the late 1990s was the implementation o f phased tariff changes to ensure cost-reflecting tariffs and focused subsidies. These measures were never systematically implemented by the regulator, however, in part because o f the unpopular consequences that the tariff increases mandated by sharply higher oil-based generation costs would have among consumers. Another reason has been the increased political confrontation between the Executive and Legislative branches o f government that developed since 2002. Failure by the regulator to apply the cost- reflective tariff rule meant that tariffs lagged and the distribution company's financial performance suffered, which in turn, had adverse repercussions on the finances o f the generators. The absence o f predictable regulation and stable tariff policies, in turn, created uncertainties that discouraged private investors, and the hoped-for private investment innew generation never took place. 221 Annex H H.12 The absence o f predictable regulatory and policy framework arguably represents the main factor responsible for the energy crisis that has been building since 2002. Not surprisingly, energy policy figures prominently in the Government's agenda. Among the first steps taken by the Ortega Administration upon taking office has been the creation o f a new Ministry o f Energy and Mines (MEM) in January 2007, replacing the previously low profile National Energy Commission (CNE) and taking over some o f the functions from the energy regulator, INE. Hopefully, this institutional reform can help to reduce the hctions that previously existed between CNE and INE, and to lift the ensuing policy stalemate. The Fiscal Impact of the Energy Sector's Performance H.13 Despite recent performance shortcomings, the power sector has not been a major burden on the government's finances. The main source o f financial losses inthe energy sector has been the gap between the tariff level mandated by the sector pricing rules and the actual price allowed by the regulator. Until August 2006, the actual price had been consistently below the mandated price, resulting in an estimated loss o f US$1.2 million per month during the year ending in September 2006. (The accumulated losses from October 2003 and September 2005 amounted to an estimated US$36 million.). While it would appear that this financial loss was largely privatized - effectively borne by the private distribution company - the eventual payment o f the accumulated losses by the public sector, suggests that the burden eventually does fall on the public sector. Starting in September 2006, the actual price was aligned with the mandated tariff level, so that there should no longer be any the financial losses arising from this source. H.14 With the elimination o f the tariff gap, the direct fiscal costs associated with the power sector currently are limited to three sources: (i)losses incurred by the government-owned electric utility, ENEL, from supplying small and isolated loads, (ii) incurred by the public transmission company, losses ENATREL, for failing to charge transmission fees that cover all transmission costs, including capital depreciation, and (iii) the foregone revenues from waiving the value-added tax for consumers below 150kwh/month, which represents the main direct subsidy granted in the sector. These fiscal costs add up to an estimated US$15 million per year, o f which the largest component i s the direct subsidy; Table H.2. Table H.2: DirectFiscal Costsfromthe Energy Sector ENATRELLosses US$ 3.5 million (estimated for 2007) ENELlosses attributableto isolated systems US$ 2.5 million (estimated for 2007) Value-Added Tax waiver (cons. < 150 kwh) US$ 8.9 million (actual in2006) ' Total US$ 14.9 million Source: World Bank (2007), "Nicaragua: Energy Sector Policy Note" D. ConcludingSummaryandRecommendations H.15 Except for the commendable progress made in expanding access to electricity since 2001, the energy sector reforms introduced in the latter half o f the 1990s have not had their expected impact. In particular, there has been little progress made in diversifying power generation away from oil and distribution losses continue to be extremely high. Most importantly, there has been little new investment in electricity generation, so that the reserve margin has fallen to very low levels, once again resulting in system-wide blackouts and power rationing. While the recent installation o f additional generation capacity with Venezuelan assistance offers a short-run remedy to this problem, additional actions are needed to ensure a long-run solution to the sector's shortcomings. H.16 The Energy Sector Policy Note prepared by the World Bank focuses attention on the following four measures to improve sector performance: 222 Annex H 0 Defusing the confrontation with the private distribution company and seelung a common ground for improving service (based on the quantification o f the losses incurred in the sector, quantification o f the debts owed by the different actors in the sector, and an operational audit o f the distribution company), with the ultimate aim o f re-establishing investor confidence and encouragmg sector investments. 0 Simplifying the electricity pricing structure (and abiding by it), while reviewing the existing subsidization scheme, which represents the largest single fiscal cost emerging from the sector, but may not be reaching the poorest households. Extendingelectricity service by strengthening the rural electrification fund, FODIEN. 0 Update existing studies for hydro-electric and geothermal projects to feed into a long-term sector expansion plan, givingpriority to developingnew projects within a regional context. 223 Annex H 224 Annex I Annex I Reviewof PublicSpendingon Agriculture andRuralDevelopment Key Findingsfrom Previous Sector Reviews 1.1 The main finding o f the 2001 Public Expenditure Review with respect to the Agncultural and Rural Sector (ARS) was to identify the absence o f a clearly articulated rural sector strategy that outlined the Government's priorities for the sector and established indicators to monitor progress towards them. The absence o f such a strategy was found to contribute to the wide fluctuations observed in sector public spending across years. Also reflecting the lack o f strategic guidance was that many rural programs under the direction o f MAGFOR either (i) were poorly targeted, (ii) data to confirm the effectiveness o f lacked targeting where it existed, or (iii) were beyond the scope and mandate o f MAGFOR, while programs that provided compensatory assistance in response to emergencies (e.g., Hurricane Mitch) did not define an exit strategy through which beneficiaries would eventually "graduate" from such assistance. Moreover, some public programs appeared not to provide a public service at all and, as such, had no reason for existing. 1.2 A related finding o f the 2001 PERwas that the project selection process and donor coordination were very deficient. Relative to its population, Nicaragua ranks among the countries with the highest donors' contributions for public spending in the rural sector. Yet, the lack o f focus, variability over time and space, and ever-changing agendas strongly affected the effectiveness o f these investments during the 1990s and early 2000s. To address these issues, a two-pronged approach was recommended: (i) that the role o f the Technical Investment Committee (consistent with Decree 61 o f 2001) be strengthened to ensure that projects financed through external sources demonstrate their compatibility with expressed Government priorities; and (ii) that eligibility requirements be explicit in order for public sector projects to access external finance.223 A separate World Bank Agriculture Sector Report (2002) also concluded that, in order to improve the effectiveness o f public spending in agnculture, government needed to prioritize the strategic coordination and effective use o f donor resources. 1.3 Other key sector recommendations included the need to strengthen property rights and public policies inthe ARS. An intensificationo frural titling was recommended, coupledwith the modernization o f the property registry. Various fiscal incentives were also flagged for review, namely: (i)agricultural input and machinery imports, (ii) distortions and (iii) export Government intervention in factor markets (e.g., financial and marketing services). B. AgriculturalPerformance,2001-2006 1.4 The Agnculture and Forestry sector accounts for about 18 percent o f GDP and 38 percent of total employment, and generates some 65 percent o f total exports. Agriculture occupies a total area o f almost one million hectares, o f which 80 percent i s dedicated to crops for internal consumption, with the remaining 20 percent going for traditional export crops (e.g., coffee, bananas). From 2000 to 2005, agricultural GDP grew at an annual rate o f 8 percent, almost double that o f total GDP. L 223. Inthis context, the PERalso argued infavor o fnarrowing the definition o fpoverty-reducing expenditures in the Nicaragua PRSP. In 2001, some 80 percent o f the capital budget for the ARS was registered as poverty- reducing, yet the linkages between such spending and poverty reduction were weak in many cases and non-existent inothers. The Government was encouraged to prioritize those programs with proven track records inraising rural workers' capacity to increase incomes, as well as those programs which indirectly reduced rural poverty (e.g., technology transfer, productive infrastructure investments). 225 Annex I 1.5 Of the total population o f some 5.2 million, 45 percent live in rural areas. In Nicaragua, both poverty and rural are intertwined: 64 percent o f the rural population i s poor (1.5 million people, World Bank 2003), and 40 percent o f these live in extreme poverty. For these families, agriculture provides about two-thirds o ftheir income. 1.6 Since 2001, yields for the major commodities have been fairly constant and, in some cases, have actually declined; Table D.l. While total production has trended upward over the period, this increase i s almost exclusively a result o f an extension o f the agricultural fkontier, with little evidence o f an intensification having occurred. Achieving increased yields - a desirable outcome in order to enhance competitiveness o f the sector - i s a function o f both the application o f technological packages (e.g., improved seeds, fertilizers, etc.) and the know-how to effectively do so. The data indicate that Nicaragua may be lagging on both fronts. Inaddition, when compared to other Latin American countries, yields for Nicaraguan commodities are consistently below the regional mean yields; Table D.2. Conversely, the data indicate that Nicaragua i s the leader in banana yields, achieving almost twice the regional mean yield. TableD.l Indicatorsfor KeyExportandDomesticCrops, Nicaragua2001-2006 Crop 2001-2 2003-4 2005-6 Area Production Yield Area Production Yield Area Production Yield Export Coffee 156.1 1,469.6 9.4 165.2 1,820.0 11.0 182.0 2,100.0 11.5 Sesame Seed 11.8 92.0 7.8 11.8 118.0 10.0 16.5 129.3 7.8 Sugar Cane 58.2 3,459.1 59.4 62.8 4,510.6 71.8 66.5 4,198.2 63.1 Banana 2.7 3,349.1 1,240.4 1.4 3,089.6 2,206.9 1.6 2,614.6 1,634.1 Tobacco 1.9 40.3 21.2 2.2 49.9 22.7 2.7 65.9 24.4 Peanut 30.8 1.774.2 57.6 33.0 2.065.0 62.6 44.1 2.672.3 60.6 Domestic Rice (Gold) 120.6 3,520.7 29.2 133.3 3,826.8 28.7 137.2 4,528.5 33.0 Rice (Secano) 78.5 1,587.1 20.2 85.0 1,782.7 21.0 82.0 2,016.8 24.6 Rice (Irrigated) 42.1 1,933.6 45.9 48.3 2,044.1 42.3 55.2 2,511.7 45.5 Beans 330.1 3,890.3 11.8 414.6 5,067.4 12.2 303.8 4,632.3 15.2 Corn 454.8 9,237.0 20.3 564.3 12,949.2 22.9 556.0 12,069.9 21.7 Sorghum 64.2 1,955.4 30.5 80.6 2,549.3 31.6 62.3 1,800.4 28.9 Soybean 3.0 91.5 30.5 5.5 160.0 29.1 3.8 123.7 32.6 Note: Area in`000 manzanas; Production in`000 quintales; 2005-6 figures estimated through 10131/2006 Source: MAGFOR Dept. o f Statistics C. Overview of Public Expendituresinthe Agricultureand Rural Sector 1.7 The agricultural and rural public sector (SPAR) comprises four agencies: (i) Ministry o f the Agriculture, Livestock and Forestry (MAGFOR), (ii) the National Institute for Agncultural Technology (INTA), (iii)the National Forestry Institute (INAFOR); and (iv) the semi-autonomous Rural Development Institute (IDR). Additionally, the Ministry o f the Environment and Natural Resources (MARENA)has responsibility for environmental oversight and regulation, natural resource management and protected areas.224Law 2901, promulgated in 1998, defines the roles and responsibilities o f the agncultural public sector institutions: MAGFOR i s the lead agency, formulating agricultural, rural and forestry policies and strategies. INTA generates and transfers agncultural technology. INAFOR manages the forestry sector and maintains the National Forest Registry and Inventory. Both INTA and INAFOR are under the overall direction o f MAGFOR. IDR executes strategies, programs and projects in L 224. MARENA i s not included inthe SPAR budget. 226 Annex I sustainable rural development with an emphasis on productive rural investments and answers directly to the Executive under the policy guidance o f MAGFOR. Table D.2 Yieldcomparisons,selectedcountriesand commodities, 2005 (in '000 kg/ha) Country Tobacco Bananas Coffee Corn Rice Sesame Sorghum Soybean Sugar Seed Cane Argentina 2.48 21.18 - 7.36 6.34 5.19 2.73 63.28 Bolivia 0.92 10.29 0.98 2.42 2.54 0.63 3.07 1.80 47.20 Brazil 1.78 13.56 0.94 3.04 3.34 0.78 2.02 2.32 72.85 Chile 3.19 - 11.23 4.67 Colombia 1.99 27.23 1.24 2.81 5.32 3.70 2.00 93.60 Costa Rica 1.98 53.95 1.11 2.08 3.97 0.60 73.05 Ecuador 1.92 27.67 0.42 2.06 3.90 0.87 1.49 1.96 72.76 El 1.83 10.83 0.55 2.94 7.21 0.75 1.59 2.27 81.16 Salvador Guatemala 2.22 52.52 0.88 1.78 2.41 0.63 1.23 2.69 97.37 Honduras 1.48 43.20 0.80 1.53 2.43 0.79 0.96 2.11 74.16 Mexico 1.88 29.23 0.41 2.73 5.07 0.64 3.45 1.77 69.53 Nicaragua 1.57 59.66 0.67 1.47 3.17 0.62 2.01 2.15 89.08 Panama 1.85 36.60 0.78 1.35 2.15 0.49 3.36 0.77 50.59 Mean Yield 1.93 32.16 0.80 3.29 4.04 0.68 2.55 2.05 73.72 Note: Yield leaders inbold Source: FAOSTAT 1.8 Total annual SPAR expenditures over the period 2001-2005 averaged US$41.3 million; Table D.3. Capital expenditures accounted for about 84 percent o ftotal expenditures, somewhat highrelative to the other sectors.225A significant decline inpublic spending took place in2005, with capital expenditures falling by 41 percent from the previous year.226 There appears to be little correlation between the trend lines for both current and capital expenditures: while capital expenditures grew substantially through 2004, current expenditure growth was flat, and actually turned negative from 2003-2005. This calls into question whether adequate budgetary resources are being assigned for maintenance and upkeep o f capital acquisitions and remains an issue for further analysis. TableD.3: The AgricultureandRuralSector (SPAR) Budget; 2001-2006 2001 2002 2003 2004 2005 2006 Planned: Current 10.0 7.4 6.0 5.7 8.0 9.1 Capital 68.2 45.4 43.9 47.8 46.6 53.6 Total Budget 78.2 52.8 49.9 53.6 54.7 62.7 Executed: Current 7.0 7.2 6.4 6.3 6.0 0.0 Capital 19.0 39.2 43.2 45.3 26.7 0.0 Total Executed 26.0 46.4 49.6 51.6 32.7 0.0 ExecuteuBudgeted 33.2% 87.9% 99.3% 96.4% 59.8% CapitaWTotal(Executed) 73.1% 84.5% 87.1% 87.8% 81.6%" Annual Variation: Capital 106.2% 10.1% 5.0% -41.2% 15.0% Total 78.5% 6.8% 4.1% -36.7% 14.6% Note: Figures are for Programmed Source: PER Dataset, includesMAGFOR, INTA and IDR L 225. This is likely due to the assignment of all external loans and donationsas Capital Expenditures. 226. During 2005, the country suffered a setback, reflecting inpart the oil price shock and an increasedpolitical polarization which put a strain on relationsbetweenthe legislative and executivebranches. 227 Annex I 1.9 After a lackluster budget performance in 2001, primarily in regard to capital expenditures, execution remained quite strong through 2004, with minimal overshooting in 2003 and 2004. The downturn in capital expenditures in 2005 was accompanied by a nearly 50 percent reduction in budget execution. The SPAR Budget 1.10 The combined SPAR budget for 2007 totals US$72.8 million. MAGFOR (along with INTA and INAFOR as dependent agencies) represents 60 percent o f the total budget, while IDR comprises the remaining 40 percent; Table D.4. Since 2004, the total SPAR budget has grown (in dollar terms) by 50 percent. From 2006 to 2007, the budget grew by 16 percent (in dollars terms) despite a devaluing currency, 1.11 Several issues stand out in assessing the 2004-07 SPAR budget allocations, namely: (i) capital expenditures are consistently the bulk o f expenditures, ranging from 83 to 88 percent of total; (ii) there has been a shift away from IDR and toward MAGFOR in resource allocations; and (iii) provision for recurrent expenditures varies widely among SPAR institutions, with IDR having virtually no recurrent budget. Two factors combine to explain the bias toward capital expenditures. Close to two-thirds o f the SPAR budget is financed through external sources (i.e., international cooperation); these resources, under Nicaragua's budget policies, are required to be channeled via the capital expenditure budget, even though a portion o f these resources may actually have been allocated for recurrent expenditures. Finally, budget weaknesses on the side o f recurrent expenditures can translate into spotty coverage or the virtual absence o f a field presence for the SPAR institutions, which makes technological uptake and progress on the part o f the rural producers more difficult to achieve. Table D.4 The SPAR Budget 2004-2007 (US$ million) Yo TOTAL Current Capital Total Current Capital Total 2007 MAGFOR 11.60 32.46 44.06 15.9% 44.6% 60.5% INTA 2.68 8.76 11.44 3.7% 12.0% 15.7% INAFOR 1.65 2.42 4.07 2.3% 3.3% 5.6% IDR 0.12 28.62 28.74 0.2% 39.3% 39.5% TOTAL 11.72 61.08 72.80 16.1% 83.9% 100.0% 2006 MAGFOR 8.97 21.99 30.96 14.3% 35.0% 49.2% INTA 1.98 6.41 8.40 3.2% 10.2% 13.3% INAFOR 1.64 2.24 3.88 2.6% 3.6% 6.2% IDR 0.12 31.82 31.94 0.2% 50.6% 50.8% TOTAL 9.09 53.81 62.90 14.5% 85.5% 100.0% 2005 MAGFOR 7.78 17.25 25.03 13.8% 30.7% 44.6% INTA 1.87 4.40 6.27 3.3% 7.8% 11.2% INAFOR 1.62 0.15 1.77 2.9% 0.3% 3.1% IDR 0.13 31.02 31.14 0.2% 55.2% 55.4% TOTAL 7.90 48.27 56.17 14.1% 85.9% 100.0% 2004 MAGFOR 5.56 18.05 23.61 11.5% 37.2% 48.7% INTA 1.85 4.72 6.58 3.8% 9.8% 13.6% INAFOR 1.22 0.31 1.53 2.5% 0.6% 3.2% IDR 0.13 24.71 24.84 0.3% 51.0% 51.3% TOTAL 5.70 42.76 48.46 11.8% 88.2% 100.0% Source: MHCP. 228 Annex I D. The NationalProgramfor AgriculturalandRuralDevelopment(PRORURAL) 1.12 In 2005, the SPAR, in conjunction with international aid agencies, joined in a Sector-wide Approach (SWAP) known as PRORURAL, in the context o f the National Development Plan (2005-09), which seeks three overarching objectives: (i) higher incomes and reduced poverty; (ii) and better higher employment; and (iii) increased investment and exports.227 Additionally, PRORURAL was intended to provide support for improved aid coordination and to complement the assistance from international cooperation agencies insustainable agnculture and forestry. The estimated cost o f the seven components that comprise PRORURAL for the period 2005-2009 i s US$411.5 million; Table D.5. This implies an average annual spending under PRORURAL o f US$82.3 million, or almost double the historical average o f the annual SPAR budgets. It will be crucial to carefully accompany the absorptive capacity of the SPAR institutions vis-&vis these budget allocation, particularly given the wide variations in budget execution since 2004; see Table D.3. 1.13 Two overarching goals fkame the activities undertaken by PRORURAL, namely (i) annualized Agricultural GDP growth o f 6.24 percent over the period 2005-09, and (ii) annual agricultural exports growth o f 20 percent. A driving element o f PRORURAL i s the promotion o f a more efficient use o f available resources, before accessing new, additionalresources. More specifically, budget allocations for MAGFOR (and their subordinate agencies: INTA and INAFOR) and IDR and the various programs already considered under the budgeting process with MHCP, would be reoriented toward the activities and objectives set forth under PRORURAL. Nonetheless, the financial resources being brought to bear on the rural sector under PRORURAL represent a substantial increment to historical SPAR budgets. While efficiency gains may be expected and, in fact, envisioned under the Program, just how the SPAR institutionswill be able to effectively deploy such large budgets remains to be seen. Table D.5 PRORURALBudgetby Components(Planned&Committed)2005-09 (US$ million) Planned Commitments PRORURAL Institution 2005 2006 2007 2008 2009 Total % Total YO Component Total Planned (1) Technical INTNFUNICN 6.2 9.5 10.7 11.7 9.5 47.6 12% 10.6 22% Innovation INAFOR (2) FoodSafety/ DGPSN 9.4 6.9 7.0 7.3 7.5 38.1 9% 23.7 62% Animal Health MAGFOR (3) Sustainable INAFOW 0.4 7.9 6.2 5.1 3.7 23.3 6% 7.1 30% ForestDev. MAGFOR (4) Prod. Support 16.5 41.1 38.6 24.0 25.0 145.2 35% 112.9 78% Services IDR (5) Infrastructure 3.0 14.0 14.0 19.0 20.0 70.0 17% 14.6 21% IDR (6) Inst.Mod. and MAGFOWIDR 10.3 18.7 18.8 17.4 16.4 81.6 20% 29.1 36% Strengthening INAFOWINTA (7) Forest' Ag. MAGFOW IDR 1.2 1.4 1.1 1.0 1.0 5.7 1% 2.2 39% Policy and INAFOW INTA Strategy Total 47.0 99.5 96.4 85.5 83.1 411.5 100% 200.2 49% Source:Multi-annualbudget 2005-09, MAGFOR L 227. The World Bank initially sought to take part in the SWAP through which PRORURAL is funded; however, the Bankwithdrewandinsteadfinancedthe stand-alone SecondAgricultural Technology Project (ATP-11). 229 Annex I 1.14 Yet concerns o f absorptive capacity may prove to be moot, since actual financial commitments to PRORURAL - at about US$200 million - so far only account for about one-half o f the Program's planned budget. Commitments vary substantially by component, with Component 2 (Food Safety and Animal Health) and Component 4 (Financial Support Services) already at funding levels o f 62 percent and 78 percent, respectively, whereas the remaining five components show commitment levels o f 22-39 percent only.228 1.15 By institution, the largest financing gap lies with IDR: only about one-half o f its budget is fully funded; Table D.6 Core commitments to MAGFOR under PRORURAL approach 80 percent, while its ancillary agencies - DGPSA, INTA and INAFOR- show commitments o f 62 percent, 27 percent, and 23 percent, respectively. In 2005, PRORURAL was virtually fully funded; actual performance for 2006 is still being determined, yet the collective SPAR-PRORURAL budget was, at this writing, far in excess o f financial commitments. A similar scenario could play itself out in2007-09. Table D.6 PRORURALBudgetbyInstitution(Plannedand Committed) 2005-09 (US$ million) Planned ImplementingAgencies 2005 2006 2007 2008 2009 Total %Total MAGFOR 8.7 16.2 14.3 5.7 5.7 50.6 43% DGPSA 9.9 7.2 7.4 7.6 7.9 40.0 10% INTA 7.9 10.4 10.7 9.9 9.2 48.1 12% INAFOR 2.2 12.7 9.9 8.3 6.7 39.8 10% IDR 17.5 49.5 50.0 49.0 51.0 217.0 53% CompetitiveFunds(FUNICA) 0.8 3.5 4.1 4.8 2.8 16.0 4% TOTAL 47.0 99.5 96.4 85.3 83.3 411.5 100% Committed ImplementingAgencies 2005 2006 2007 2008 2009 Total YOTotal MAGFOR 11.9 13.6 11 2.3 2.1 40.9 20% DGPSA 9 4.7 4.1 4.1 3 24.9 12% INTA 3.7 2.4 2.4 2.3 2.1 12.9 6% INAFOR 2.6 1.7 1.6 1.6 1.6 9.1 5% IDR 18.3 23.3 23.2 23.2 16.6 104.6 52% CompetitiveFunds(FUNICA) 0.8 1.8 1.8 1.8 1.2 7.4 4% TOTAL 46.3 47.5 44.1 35.3 26.6 199.8 100% FinancingGap ImplementingAgencies 2005 2006 2007 2008 2009 Total %Total MAGFOR -3.2 2.6 3.3 3.4 3.6 9.7 5yo DGPSA 0.9 2.5 3.3 3.5 4.9 15.1 7yo INTA 4.2 8.0 8.3 7.6 7.1 35.2 17% INAFOR -0.4 11.0 8.3 6.7 5.1 30.7 15% IDR -0.8 26.2 26.8 25.8 34.4 112.4 53% CompetitiveFunds(FUNICA) 0.0 1.7 2.3 3.0 1.6 8.6 4% TOTAL 0.7 52.0 52.3 50.0 56.7 211.7 100% Note: Slight differences vis-a-vis Table D.5 due to rounding error. Source: Multi-annual Budget (MAGFOR) L 228. While not including the multi-annual budget, there appear to be other commitments (either in process or actual) that, when confirmed, couldreduce the financing gap to as little as US$83.2 million. 230 Annex I Preliminary Outcomes -PRORURAL 1.16 The SPAR institutions have made positive strides in tracking outcomes under PRORURAL. A monitoring, evaluation and learning system i s in place (SISEVA) to document results across both components and institutions; while still a work in progress, the SISEVA will ultimately bring together and unify results monitoring across the institutions that comprise the SPAR. For 2006, budget execution totaled US$57.45, or about 77 percent o fplanned; Table D.7. 1.17 Ina sector-wide programlike PRORURALthat cuts across a large number of institutions and is funded by a various sources, developing relevant summary indicators i s a challenge. Figure 7.1 represents a first attempt by the SPAR institutions to gauge physical progress. The physical execution of PRORURAL was commensurate with the financial outcomes for 2006. Nearly 75 percent of the programmed products where achieved. Across the components, achievement o f physical outcomes ranged from a low of 56 percent (Technological Innovation) to nearly 90 percent (Production Support Services). Table D.7 BudgetPerformance-PRORURAL(US%million) 2006 Component - PRORURAL Budgeted Executed %Executed YOtotal (1) Technical Innovation 5.59 4.74 85% 8% (2) FoodSafety and Animal Health 5.85 5.07 87% 9% (3) Sustainable Forest Development 1.61 1.31 81% 2% (4) Production Support Services 33.13 24.52 74% 43% (5) Infrastructure 10.49 8.32 79% 14% (6) Inst. Modernization and Strengthening 16.94 12.84 76% 22% (7) Forest andAgricultural Policy and Strategy 0.84 0.64 76% 1% TOTAL 74.45 57.45 77% 100% Note: exchangerate - 18 Cordobas=US$l Source: MAGFOR - Annual Report PRORURAL Figure7.1 PhysicalPerformance-PRORURAL,by Component(2006) For Dev Prod Ser Tec Inn San lnf'ra Modem Pol-Strat Mean -- PRORURAL Source: MAGFOR. 231 Annex I I. AmajorexpectedoutcomeofthePRORURALexerciseisgreatercoordinationofaiddelivery, 18 both among the SPAR institutions and among external donor agencies. Evidence o f such coordination i s the Memorandum o f Understanding that serves as a consensus statement (signed by all parties involved) laying out the objectives, scope and intended outcomes o f PRORURAL. An agreed set o f performance indicators are included in the Memorandum, monitoring o f which would be undertaken under the SISEVA, both annually and bi-annually, depending on the indicator in question. Table D.8 reports progress on these agreed indicators during 2006 across the seven components o f PRORURAL. Inall, 25 indicators are followed, o f which 12 are provided with benchmarks for 2006. For the twelve indicators with complete information, the performance o f PRORURAL is quite strong, with actual performance in most case significantly exceeding the benchmark. Component 1 (Technological Innovation) and Component 2 (Food Safety and Animal Health) show the most complete data among the seven components. E. MainFindingsandRecommendations 1.19 Agricultural output has been growing almost twice as fast as overall GDP during 2000-2005, but most o f that growth i s attributable to extensions o f the agricultural frontier, rather than increases in agricultural productivity. This continues a pattern that was already observed in the 1990s and that i s ultimately unsustainable. It also suggests that at least some o f the more important problems that had been undermining sector productivity inthe 1990s must still be present today. Two such problems identified in earlier sector reviews were the absence o f a clear and prioritized rural sector strategy to guide public sector interventions, and the lack o f adequate donor coordination. These were held largely responsible for the very inefficient public spending that has taken place inthe sector and the uneven program execution. Moreover, the issue o f donor coordination retains its paramount importance, considering that two-thirds o f the sector budget i s financed with external resources.) 1.20 A major step forward toward addressing these two problems was taken in 2005 with the establishment o f a Sector-Wide Approach for the Agnculture and Rural Sector in the overall context o f the National Development Plan. This approach, named PRORURAL, commits the sector's public institutions and the main international aid agencies to following a single, common and coordinated strategy, focusing on raising sector output and export growth levels. Two major outcomes expected from PRORURAL are (i) greater coordination o f aid delivery, both among sector institutions and donor agencies, and (ii)agreement on a set o f performance indicators that will serve to monitor sector performance and guide corrective interventions. PRORURAL aims to improve the efficiency o f resource allocation inthe sector, before seeking to access additional resources. Nevertheless, budget plans through 2009 envisage a doubling o f annual financialresources inthe sector, which draws attention to the need for raising absorptive capacities and maintaining steady program execution levels. 232 Annex I Table D.8 PerformanceIndicators-PRORURAL, by Component(2006) PerformanceIndicators Responsible Benchmark Actual Institution 2006 2006 1. Technological Innovation # producersreceivingtechnicalassistance INTA, 29,800 31,132 FUNICA, INAFOR INTA's innovationtechnology, portfolio increases# validated INTA 134 188 technologiessupportingexport commodities, food safetyandfood security, and environmentalsustainability . Annualfoundationandregisteredseedproductionof food grains INTA 228 TM 147.5T M exceeds 230 metric tons, while vegetable, pastureandtuber seed 230 ha. 135 ha. productioncoversmore than230ha. # producerstrainedin foodprocessing,and/or business administration INTA 1,000 2,709 andmarketing. #serviceproviderscertifiedby INTA accordingto accepted standards INTA (INTA establishedan operationalsystem for accreditation). %producerorganizationsthat participatein TA activitiesthrough INTA, FUNICA 8% 34% FAT with access to finance and linked to productmarkets. % INTA's indigenouspeopleclients are women. INTA 20% 24% National forest inventoryandvaluationexercise/ informationavailable INAFOR 100% 5% for plannindmgt of forestrysector (% completed) 2. Food Safety and Animal Health %adforest exportsnot rejected DGPSA 99.9% 99.9% #exportcompaniesHAACP-certified DGPSA 100 121 3. Sustainable Forest Development Variation rate invalue of forestryexports INAFOR -0.54 4. ProductionSupport Services #smallandmediumproducersreceivingfinance (by gender) IDR 12,070 Financereceivedby small- mediumscaleproducers(by gender) IDR C$ 168.6m. 5. Infrastructure # direct beneficiariesfrom infrastructureinvestments IDR 104,700 6. Inst. Modernization and Strengthening Human and financialresourcesdeploy by territory and institution. _ - - MAGFOR H:263; F: C$101m INTA H:-; F:- DGPSA H:485; F:23 m. INAFOR H:-; F:- FUNICA H:-; F:- IDR H:-; F:- Distribution o fPRORURAL budget financing between national MAGFOR N:-; Ext: - and external cooperation sources (by institution and territory) INTA N:-; Ext: __ IDR N:-; Ext: - INAFOR N:37 m; Ext: 38 m. FUNICA N:-; Ext: - #/TerritoriaI Delegations o f SPAR Institutions created to MAGFOR 16 implement PRORURAL. INTA IDR INAFOR 10 FUNICA %Governmentinstitutionsinvolvedandparticipatingdonorsrate MAGFOR 80% PRORURAL'S implementationandmonitoringarrangements as satisfactory.. 233 Annex I PerformanceIndicators Responsible Benchmark Actual Institution 2006 2006 The Planning,Monitoring andEvaluationunit of MAGFOR is fully SPAR 6 2 operational and producingregular reports. The technical-technicalstaffratio of MAGFOR, INTA, INAFOR MAGFAOR 45/55 45/55 and FUNICA has increased. INTA 49151 68132 INAFOR 63/37 75/25 FUNICA 54/46 59/41 10additionalforest managementplans are approved. INAFOR 3 41 The Governmentbudget integrates 75 percent ofMAGFOR, INAFOR MAGFOR, 0 0 and INTA's salariesand operatingcosts (partially financedunder the INTA project). 7. Forest and Agricultural Policy and Strategy %NationalCouncilofProductionmembers satisfied with their MAGFOR participationinthe formulationhmplementationof PRORURAL. %internationalcooperationinDRP Sub Table that have aligned MAGFOR 64% cooperation strategiesto the sector-widepolicy. %spendingofthe institutionsimplementingPRORURALthat MAGFOR correspondto MPMP. Source: MAGFOR- MemorandumofUnderstanding,PRORURAL(2005). 234 Annex J Annex J BudgetTransferAllocationby Municipality,2006-2007 2007 Allocation (millions of cdrdobas) Tax Revenue (Proyecto de PGR 2007) 18,291.08 7% allotted to Transfers 2007 1,280.38 Managua share (2.5%) 32.01 Total to distribute among 152 municipalities 1,248.3 7 235 Annex J Municipality Cat. 2007 Budget Transfer ** A 2006- 2007" ElCrucero + ElTuma - La Dalia La Libertad + La Paz Centro Larreynaga- Malpaisillo Masatebe + Mateare Matiguas Muelle de 10s Bueyes MuyMuy ++ Nandaime Paiwas d a Potosi RioBlanco ++ Rosita ++ SanCarlos SanMarcos Santo Doming0 Sto. T o m s Chontales Siuna Somotillo Somoto ++++++ Telica Tola Villa Sandino ++ Villanueva Waslala ++ + Altagracia Buenos Aires ++ Catarina Comalapa Condega Desemboc. Cruz de Rio Grande +++ Dipilto + Diriomo Dolores ElAlmendro ElCastillo ElCoral ElCUB ElJicaral ElJicaro E lRealejo ElSauce ElTortuguero +++ Esquipulas ++ 5.90 1 1.18 1 2.69I 2.16 I 2.08 8.11 1 38% 236 Annex J 2007 Budget Transfer ** 237 Annex J Cat. Municipality Cat. 2006 Total 2007 Budget Transfer ** YOdif. 2007 A Budget (millions of cordobas) 2006- 2006- Transfer 2007 2007* (revised)* * Pop. Fiscal Tax Execution 2007 equity collection of TOTAL efficiency transfer 3.77 Niquinohomo Palacaguina G SanJuande Limay G Santa Lucia + G Yalaguina H CincoPinos H CiudadAntigua H La Conquista H La Paz de Carazo H Las Sabanas H Murra I H 1Prinzapolka Totogalpa TOTAL 1,044.54 312.09 312.09 312.09 312.09 1,280.38 -- StandardDeviation (exc. Managua) 2.90 2.09 2.86 1.57 0.20 3.74 -- Max. (exc. Managua 16.56 I 12.92I 15.20 I 7.34 I 2.17 I 23.67 I 271% 1.85 I 0.00 I 0.00 I 0.00 I 0.00 I 2.27 I -51% 6.70 2.05 2.05 2.05 2.05 8.21 29% Median 6.19 1.32 1.11 1.48 2.16 7.43 22% Source: ***Municipalcategories for 2006 from AMUNIC, for 2007 from TRANSMUNI (MHCP) 2007 budgetproposal 238 Annex K Annex K ImplementationStatusof CFAA Action Plan, January 2006 CFAA Action Plan(Januarv. 2004) Status as of Januarv. 2006 1.Implementationarrangements 1a. The Government, IDA and IDBagree on a Memorandum o f Completed. Understanding for the implementation o f the Government actionplan for improving PFM lb. Sign Government interagency accord for the implementation o fthe Completed. Government Action Plan (GAP) IC. identifyfinancingsourcesforGAP Fully Completed. 2. Legal framework 2a. Complete inventory o f PFMlaws and regulations, determine Completed. duplications and or inconsistencies 2b. Present draft FinancialAdministration Law to National Assembly Comdeted. 2c. The National Assemblv amroves FinancialAdministration L a w Comdeted. 3. BudgetDevelopment 3a. Calculate recurrent cost implications o f the Public Investment Completed (i.e., interms o f initiating the Program[In the context of the PRSC, the action was agreed asfollows: actions). SECEP has initiated the routine calculation of the recurrent cost implication of PIP and MCHP has initiatedplans to create MTEF on this basis.] 3b. Prepare mediumtermprojections o f fiscal revenues and Completed. expenditures 3c. Identify and disclose all public funds inthe 2005 national budget Substantially completed with the 2006 document national budget document. 3d. Complement the budget document with explanations o f the Completed with the 2006 nationalbudget underlyingmacroeconomic framework and fiscal policy document. 3e. Initiate adequate classification o f capital and recurrent expenditures Completed (i.e., interms o f initiating the actions). 3f. Identify and disclose all public funds, and consolidate them, inthe Substantially completed with the 2006 2006 national budget document nationalbudget document. 3g. Break-down composition o f current and capital transfers, and Substantially completed. Sub-functional institutional and functional classifications classification has not been adopted, but programmatic classification is used. 3h. Relate specific outputs to budgeted costs insector development Not completed. Inretrospect, the initial plans, to serve as a basis for ex-ante feasibility and ex-post execution timetable for this action was too optimistic. 3i. Prepare fiscal budget under a Medium-Term Expenditure Partially completed with the 2006 Framework national budget document. 3j. Classify capital and recurrent expenditures adequately Not completed. Underlying work started, see No. 11, but there are important political economy obstacles to this action. 4. Integrated FinancialManagementSystem 4a. Continue implementing SIGFA's treasury module inthe central Completed (i.e., interms o f continuing government implementation). 4b. Start implementation o f the humanresources modules consistent Completed (i.e., interms o f starting withthe Civil Services Law implementation). 4c. Complete design and integration of SIGFA's procurement and Not completed. Work inprogress. physical assets module inthe central Government 4d. Appraise and enhance the security system and procedures N o t completed. Systems andprocedures have been enhanced, but the formal audit has not vet been undertaken. 239 Annex K CFAA Action Plan(January, 2004) Status as of January, 2006 4e. Prepare a strategy for extending SIGFNCUT coverage at Not completed. individual transaction level to noncommercial autonomous and decentralized entities 4f. Increase third level coverage, particularly inlarge implementation Completed (i.e., interms o f increasing units such as hospitals coverage). 4g. Initiate implementation o f SIGFA to INIFOM, IDR, FISE and Substantially completed. Initiated in ENACAL INFOM, IDR, FISE and other entities, but not ENACAL. 4h. Implement SIGFA's human resource ,procurement andphysical Not completed (work inprogress). In assets module inthe central Government retrospect, the initial timetable for this action was too optimistic. 4i. Increase coverage o f other public sector entities and local Completed (i.e., interms o f increasing governments coverage). 5. Treasury Sa. Prepare detailed cash flow programs for budget releases, Substantially completed. Cash flow disaggregated by institution, to allow for planning and managing programs are produced, butneedto be availabilities improved. 5b. Agree and document reconciliation procedures with DGI, DGA, Substantially completed. Reconciliation BCNand other banks procedures have been implemented, but needto be improved. 5c. Eliminate decision-making inscheduling individual expenses and Not completed. Work inprogress. payments at the central level, except for salaries and internal and external debt services 5d. Initiate treasury Single Account coverage at individual transaction Not completed. These entities fall under level to INIFOM, IDR, FISE and ENACAL. the single treasury account system, but not at the level o f individual payments. 6. Internal Control & Internal Audit 6a. Prepare and fund action planto strengthen internal controls and Completed. A training actionplan (six internal audits inat least 10 central government institutions, including events, 240 internal auditors o f 17 MTI,MECDandMINSA. entities) was imdemented bv MHCP. 6b. Initiate execution o f Government-led public expenditure tracking Not completed. surveys 6c. Implement action plan to strengthen internal controls and internal Partially completed. Work inprogress, audits, and incorporate feedback from continued execution o f through the introductiono f the new expenditure tracking surveys internal control norms (NTCI) and correlated training by CGR (41 events in 2005, with 920 public sector officers attending). 6d. Clarify roles among internal audit units, MHCP, the Office o f Completed. Public Ethic and the CGR 6e. Start implementation o fnational internal audit coordination office Dropped. 6f. Set up committees for control and follow up to internal and external Completed (incertain entities, though audit reports inall executive branch entities effort was not sustained). 7. Deconcentrated Budget Execution 7a. Evaluate the effectiveness o f financial management and audit Not completed. arrangements under the: (i) programs for education participation (school autonomy) and de-concentration o f MECD's territorial delegations; and (ii) MINSA`s basic health care units and deconcentrated hospitals, and their relation to SIGFA 7b. Accordingly, design program o f recommended actions Not completed. 7c. Implement program o f actions Not completed. 8. Monitoring and evaluation 240 Annex K CFAA Action Plan (January, 2004) Status as ofJanuary, 2006 8a. Implement an effective monitoring and evaluation system, yielding Completed(as monitored under periodic reports instruments other than the CFAA). 8b. Systematically take effective actions on the basis o f the M&E Dropped (action to be monitoredunder reports instruments other than the CFAA). 9. Accounting and financial reporting 9a. Restructure the government accounting function to focus on Partially completed. The accounting analysis and reporting, and less o n transactional work. Segregate directorate participates more on reporting government asset administration from accounting function and reconciliations, but the asset administration was not separated. 9b. Complete review and determination o f 2002 initial balances o f Not completed officially. central government 9c. Prepare enhanced budget execution report for 2003 including a Not completed. cash balance reconciliation, historicalrevenue/expendituretrends, and level o fpayment arrears 9d. Ensure budget transfers are documentedbyproper accountability Not completed. Work inprogress under reports on use of funds according to respective legal and normative new FMLaw. framework 9e. Present enhanced budget execution report for 2004 to the same Not completed. The report has been detail as the budget document enhanced, but the items mentioned inNo. 42 have not been incorporatedyet. 9f. Initiatereporting o f output indicators inkey programs Not completed (work inprogress under new FMLaw). Inretrospect, the initial timetable for this action was too optimistic. 9g. Cover all central government entities and consolidate them inthe Not completed. Work inprogress under budget execution report new FMLaw. 9h. Enforce audit andpublication o f financial statements o f all public Not completed. Work inprogress. sector decentralizedand autonomous entities and state enterprises 9i. Implementplan for issuance o f government financial statements Not completed (work inprogress under compatible with international practice new FM Law). Inretrospect, the initial timetable for this action was too ODtirniStiC. 10. ExternalAudit 1Oa. Make satisfactory progressper the indicators o fthe program for Dropped. It was agreed with the MOF modernization o f CGR that actions under the control o f the CGR -an independent body- would not be part o f the agreed FMAction Plan. Other donors support the CGR. lob.Endorse a realistic planfor, and show progresstoward, producing Not completed (additionally see No. 49). a comdiance. financial audit reDort o f government accounts 1Oc. Issue annual audit on the government's budget execution report Not completed (additionally see No. 49). 1Od. Implement plan for audit o f government financial statements Not completed (additionally see No. 49). 10e. Independentaudit fmto issue audit report o f CGR's financial Not completed (additionally see No. 49). statements 11.PublicParticipation 1la. Prepare a draft law on public access to information after broad Completed (i.e., interms o fpreparing the participatory process draft law). 1lb.The NationalAssembly approves law on public access to Not completed. information 1IC. arrangements for access to information onpublic Establish Completed. finances 1Id. Provide training to civil servants- and awareness for the general Completed, interms o f the Voluntary public- on the rights o f access to government information Strategy for Access to Information (EVA). 241 Annex K CFAA Action Plan (January, 2004) Status as of January, 2006 1le. Enhance quality, clarity andusefulness o f financial information Completed. available to public 1If.Improve dissemination media, includingpostinginthe internet Partially completed. and other means where such access i s unavailable 12. External aid coordination 12a. Put inplace efficient procedures to channel multilateral loan Partially completed. Loan accounts are disbursements through treasury single account (CUT) part o f the CUT, but the direct payment procedure i s not yet efficient. 12b. Develop internal control and accountability procedures for the use Completed through new FMLaw and o f funds transferred from central implementation agencies annual budget execution norms. 12c. Put inplace efficient procedures to channel grants disbursements Partially completed. Budgetedgrant through the CUT accounts are part o f the CUT, but the direct payment procedure i s not yet efficient. 12d. Incorporate all public investment projects/ programs into the Partially completed. Incorporationhas official registry o fpublic investments and reconcile systematically been increasingly fulfilled, but systematic against government accounting records reconciliations are pending. 12e. Agree on specific financial management arrangements for SWAps Completed (FONSALUD and for Education For All fast track initiative strategy and the -_ PRORURAL, not education). agriculture/forestry development program 12f. Collaborate inthe organization o f WB/IDB assessment and Dropped. training o f audit firms 12g. Recordall external aid funds channeled through public sector Completed. entities inthe SIGFNCUT, incoordination withsignatory agencies and donors. 13. HumanResources 13a. The National Assembly approves Civil Service Law Completed. 13b. Execute training programs for financial managers and internal Completed. auditors inspending entities 13c. Begin implementation o f merit-based system for civil servants in Completed (interms o fbeginning the executive branch implementation). To be monitoredunder instruments other than the CFAA. 13d. Prepare proposals to include public administration and public Dropped. audit inthe universities program 13e. The CCPA strengthens accreditation framework for authorized Dropped. It was agreed with the MOF public accountants that actions under the control o f the CCPA -an independent body- would not be part o f the agreed FMAction Plan. Other organizations support the CCPA. 14. Debt management 14a. The National Assembly approves Public Debt Law Completed. 14b. Enact Public Debt Law's regulations, including the procedures Completed. for extension o f loans to autonomous and state-owned entities and for issuance o f government guarantees 14c. Clean up the debt databases and fully load domestic debt loans in Partially completed. MHCP uses a debt SIGADE, including general information and individual transactions management information system different from and, in addition to, SIGADE. 14d. The MCHP and B C N effectively coordinate public debt Partially completed. Coordination has management including the consolidation o f SIGADE database and its been enhanced, though under separate automatic integrationto SIGFA jystems. Automatic links to SICOIN 3ending. 14e. Report debt and contingent liabilities information inthe ?Jot completed. Debt is reported, though government financial statements lot through financial statements (see No. 38). 242 Annex K 243 Annex K 244 Annex L Annex L ModelOutlinefor Sector ExpenditureReviews This Annex presents a generic outline for Sector Expenditure Reviews that seeks to cover most of the topics that are generally treated in such reviews. The data required to cover many o f these topics may not always be available for each sector, however, and the relevance o f each topic is likely to vary depending on the individual sector being analyzed. The model outline i s therefore better treated as a checklist o f possible ideas to pursue in an expenditure review, rather than as a rigid blueprint that all reviews must follow. I. IntroductionandSectorOverview. 0 Strategic Context o f the Sector Expenditure Review 0 Role o f government versus private enterprise inthe sector 0 Definition o fthe sector institutions to be covered by the sector review 0 Summary o f the main findings from previous expenditure reviews 0 Key sector issues to look out for inthis review 11. Level and Evolutionof Sector Finances A. Analysis o f Sector Expenditures 0 Summarize the major trends insector resource allocation 0 Analysis by institutional classification a. Sector expenditures by level o f government (i.e., central government, department level, provincial levels, local levels) i.Comparisonwithspendingallocations/trendsinothercountries b. Evolutiono fsector expendituresbyministries/agencies. c. Evolution o f sector expenditures by programs i.Intra-sectoral spending allocations (e.g., Administration versus Service Delivery within ministries) 0 Analysis by economic classification (personnel, operations and maintenance, capital expenditures, interest) d. Staff remunerations and incentives, evolution o f sector employment, personnel management issues i.Comparisonofwage/employmentlevelsinothercountrieswithsimilarper- capita income levels ii.Comparisonofwage/performanceindicatorswithcomparableprivatesector entities e. Investment expenditures versus current expenditures i.Balancebetweencapitalandmaintenanceexpenditures a. Comparisons with CapitaVmaintenance balance in other countries and sectors . ii.Recurrentcostimplicationsofsectorinvestmentprogram The targeting o f sector expenditures a. Incidence o f sector expenditures by geographic location i.Urbanversusrural b. Incidence o f sector expenditures by income quintile 245 Annex L c. Incidence o f sector expenditures by gender/age B. Analysis of Sector Financing 0 Sources o f financing (gov't. budget, donor resources, localhtate level resources) 0 Cost recovery (payment for services) a. Sector subsidization policies b. Incidence analysis o f subsidies 111. Analysisof Sector OutcomesandPerformance . A. Analysis o f sector outcomes: patterns and trends o f interest or concern, impact o f sector performance on economic development Comparisons with sector performance indicators inother comparator countries. B. Provisiono fsector services by .. Region Type o fbeneficiary (income group, gender group or age group) i.Effectsofuserfeedcostrecoveryonuseofservices C. Alternative models for providing sector services .. Opportunities for decentralizing service provision Opportunities for private sector participation IV. The Efficiencyof Sector Expenditures A. Summary o f findings from earlier cross-country efficiency analyses o f public expenditures (e.g., based on data from Herrera and Pang (2004) or Machado (2006), as discussed in the World Bank's PER). B. Discussion o f `production function' linkingsector expenditures with sector outcomes. . Comparison o f sector-specific efficiency indexes with the indexes calculated for other countries, or across different periods. V. Sector ExpenditureFramework A. Present the sector policy and expenditure priorities identifiedby the government inthe PRSP or other policy document. a. Compare public priorities with the sector needs or service gaps identified earlier in the discussion on sector outcomes (Section 111) b. Ifpossible, identify the specific short andmedium-term sector outcome targets envisaged bythe government B. Develop an expenditure framework for achieving the sector targets envisaged by the authorities, and estimate the total fiscal cost o f achieving those targets with existing technologies and efficiency indexes. 246 Annex L C. Alternatively, using the existing sector budget determine the most efficient intra-sectoral allocation o f funds in terms o f best responding to the sector priorities identified earlier without changing the overall sector expenditure amount. D. (The findings from this section shouldprovide usefulinputsfor the annualplanning exercises contemplated for the `mesas sectoriales' that were set up by the Nicaraguan authorities to advise on sector policies.) VI. Sector OrganizationandGovernanceArrangements A. Review o fkey findings fromNicaraguaC F M C P A R B. Planning and budgeting wocesses, including procedures for allocating resources across different sector programs and activities. a. Prioritization o f policies/programs in sector plan and review o f methodology for prioritization. i.Isreferencemadetonationalplans? ii.Istherearoleforcivilsocietyintheprioritizationprocess? b. Preparation o fthe sector investment program i.Aresectorinvestmentplanscoordinatedwithrecurrentexpenditureplans? c. Correspondence between plans and budgets d. Budgetpreparation process; estimation o funit costs (ifany?) and existence o f a Medium TermExpenditure Frameworkwithin sector e. Engagement o f line personnel anddecentralized agencies inbudgeting process C. Budget execution and fiscal transparency a. Timeliness andpredictability o f disbursements to Ministry,and from Ministry to agencies and local entities, and from local entities to beneficiaries b. Adequacy o fexpenditure control mechanisms, includingprocurement i.Importanceofinternalandexternalaudits ii.Estimatesoftheextentof`expenditureleakages' D. Monitoring and evaluation arrangements a. Are arrangements inplace to systematically monitor sector outcomes and evaluate sector performance? b. D onewprojects systematically develop baseline indicators? E. Donor coordination mechanisms a. How well are donor funds integrated into the budget process? b. Is a SWAP arrangement inplace? i.WhatfurtherreformsareneededtoenableSWAParrangements? VII. Recommendations ...... Onthe strategic role o fthe State inthe sector Onexpenditure allocations On sector finances (including cost recovery) On efficiency-raisingmeasures Onsector prioritizationprocesses Onsector organization 247 248 m m m o m m m ? ? ? - ? % ? ? -'909 - N m r - m - 0 m m m m - N N ? ? E r- -Nmm - T Y ? - N m r - b - ? a s - N m 0 2 -0 E ? or- m N N N b 0 m -?- m r '? m n - t - t o o o o m t o o w coat r @ r Y IC r C IC IC 7 Y IC c %- c r 0 a C s Y a T a c 2 IC 0 r d IC r cf IC D ( D m r r r (I C a d m- f 4 C (v- cf U 0 U d n 9U Q -8c !-C c a -Ec m 2 7 0 2 7 0 I WJ e, N rg N bP I C UI -b P Q :41 e - -7 c 0 cd C 5 .3 Y 0 rn .3 Y ;; cd C 4 C E C E C 2 c 4 C E m m N C E C E C 4 -E e C I .- 2E C Y -c* G m-00 m c o m m w c c o b - ILI) 0) - C Dc F d 0 3 cd Dc 0 7 .r( Y u: .I v1 Y hl Dc 3icd Dc C u: U t- v Dc v z U U t- F t- Lr F v v 7 v Lr hl 0 v d a- oc z t- d d v1 d C Dc r.F c r- \c z F r- C W C W N r s g 3 .- P) .-0 -0 e, E v1 0 5 v) 3 x Y) a, L .-m 6 l o m m o c o co .-E0 .-5a m 0 n 5P I 3 a 3a 0 z .- s E a S 55x ,o m U .- C a, 0 I m -0 a, .- c E .-v) I 5C .. c a, C a, LL 3 Statistical Annexes 261 StatisticalAnnexes I STATISTICAL ANNEX TABLE 82: WAGE BILL, BY INSTITUTION (C$) t mi 20031 2oq41 m5i 20861' m.2w 262 Statistical Annexes I STATISTICALANNEX TABLE 63: AVERAGE[GROSS MONTHLY WAGE BILL, BY INSTITUTION (C$) 1- Am0Zl 2 W f n 2>.'#$&! * i,i,-d* ~',2@0gl NORTH ATLANTIC REGtONAL GOVERNMENT SOUTH ATLANTIC REGIONALGOVERNMENT 627,413 REGIONAL NORTHATLANTIC COUNCIL REGIONAL NORTHATLANTIC COUNCIL 989,425 263 Statistical Annexes hlCARAGbAh fhSTITLTE OF TERRlrOR~ALSTUDIES hlCARAGLAN IYST TJTE OF STAD STICS AND CENSUS hlCARAGkAh hST TJTE OF SPORTS AND YOUTn NlrARAGllAk hOMFlu INST TbTE - .__ - - - .- NICARAGUAN ERERGV IhSTlTJTE hlCARAG-Ak hST TLTE OF WATER AND SEWER4GE hlCARAGLAN SOC~ALSFZJRITY IhSTlTJTE I\ CARAG 'Ah R RA D-VE Opt l E N l lhST TITE NICARAGUAN INSTITUTE OF HOUSING AND URBAN DEVELOPMENT NICARAGUAN INSTITUTE OF SME SUPPORT NICARAGUAN TOURISM INSTITUTE NATIONAL AGRICULTURAL TECHNOLOGY INSTITUTE NICARAGUAN AGRICULTURE AND FOREST INSTITUTE INTERNALREVENUE D~RECTORATE NATIONAL CUSTOMS DIRECTORATE NICARAGLJAN RADIO NATIONAL TEATHER HUMANS RIGHTS ATTORNEY'S OFFICE ,k.VERSIT ES PUBLICFINANCIALINSTITUTIONS SGdThATLAhT C SE.SOhA, GOLERtVldElT IREGiOhA.. 19RTqATAh- C COJ\.C i REGIONAL NORTH ATLANTIC COUNCIL I 264