Document of The World Bank - Documents &...

Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 51690-BR

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT FOR A PROPOSED LOAN

IN AN AMOUNT EQUIVALENT TO US$1,045 MILLION

TO

THE MUNICIPALITY OF RIO DE JANEIRO, BRAZIL

FOR A

FISCAL CONSOLIDATION FOR EFFICIENCY AND GROWTH

DEVELOPMENT POLICY LOAN

June 2, 2010

Economic Policy Unit

Poverty Reduction and Economic Management

Brazil Country Management Unit

Latin America and Caribbean Region

This document has a restricted distribution and may be used by recipients only in the performance of their official

duties. Its contents may not otherwise be disclosed without World Bank authorization.

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BRAZIL – GOVERNMENT FISCAL YEAR

January 1 – December 31

CURRENCY EQUIVALENTS

(Exchange Rate Effective as of April 30, 2010)

Currency Unit Real (R$) US$1.00 R$1.8

Weights and Measures Metric System

ABBREVIATION AND ACRONYMS

AAA Analytic and Advisory Activity Atividade de Análise e Consultiva

BCB Central Bank of Brazil Banco Central do Brasil

BILLIONDES National Bank of Economic and Social

Development

Banco Nacional de Desenvolvimento

Econômico e Social

CEM Country Economic Memorandum Documento Econômico do País

CFAA Country Financial Accountability

Assessment

Avaliação do Sistema de Gerenciamento

Financieiro do País

CIDE Contribution for Intervention in Economic

Activities

Contribuição de Intervenção no Domínio

Econômico

CMN National Monetary Council Conselho Monetário Nacional

COFINS Social Security Contribution Contribuição para Financiamento da

Seguridade Social

CPMF Provisional Contribution on Financial

Transactions

Contribuição Provisória sobre Movimentação

Financeira

CPS Country Partnership Strategy Estratégia de Parceria para o País

DPL Development Policy Loan Empréstimo para Políticas de Desenvolvimento

DSA Debt Sustainability Analysis Análise de Sustentabilidade da Dívida

EDI Integrated Preschool Program Espacio de Desenvolvimento Infantil

EMBI Emerging Markets Bond Index Índice de Títulos da Dívida de Mercados

Emergentes

ESW Economic Sector Work Estudos em Economia e Setoriais

FPE State Participation Fund Fundo de Participação dos Estados

FUNDEB Fund for Maintenance and Development of

Primary Education and of Teacher’s

Valorization (formerly FUNDEF)

Fundo de Manutenção e Desenvolvimento da

Educação Básica e de Valorizaçãodos

Profissionais da Educação

GDP Gross Domestic Product Produto Interno Bruto

GFS Government Financial Statistics Estatísticas Financeiras do Governo

HDI Human Development Índex Índice de Desenvolvimento Humano

IBGE Brazilian Institute of Geography and

Statistics

Instituto Brasileiro de Geografia e Estatística

IBRD International Bank for Reconstruction and

Development

Banco International para Reconstrução e

Desenvolvimento

ICMS Brazilian State Value-Added Tax Imposto sobre Circulação de Mercadorias e

Serviços

IDB

IETS

Inter-American Development Bank

Institute for Studies on Labor and Society

Banco Inter-Americano de Desenvolvimento

Instituto de Estudos do Trabalho e Sociedade

IDEB Basic Education Indicator Indice de Desenvolvimento da Educação

Básica

IDE-Rio Education Indicator for Rio Indice de Desenvolvimento da Educação - Rio

IFC International Finance Corporation Corporação Financeira Internacional

IFI International Financial Institution Instituições Financeiras Internacionais

IGP-DI General Price Index –Domestic Availability Índice Geral de Preços – Disponibilidade

Interna

IMF International Monetary Fund Fundo Monetário Internacional

INDG Institute for Managerial Development Instituto de Desenvolvimento Gerencial

IPCA Consumer Price Index Índice de Preços ao Consumidor Amplo

IPTU Municipal Property Tax Imposto sobre Propriedade Predial e

Territorial Urbana

IPVA Tax on Motor Vehicle Property Imposto sobre a Propriedade de Veículos

Automotores

ISS Tax on Services Imposto Sobre Serviços

LDO Law of Budgetary Guidelines Lei de Diretrizes Orçamentárias

LDP Letter of Development Policy Carta de Política de Desenvolvimento

LFT Financial Letters of the Treasury (Bonds) Letras Financeiras do Tesouro

LOA Annual Budget Law Lei Orçamentária annual

LRF Fiscal Responsibility Law Lei de Responsabilidade Fiscal

MTEF

MoRJ

Medium Term Expenditure Framework

Municipality of Rio de Janeiro

Arcabouço Fiscal de Médio Prazo

Prefeitura Municipal de Rio de Janeiro

NCD Net Consolidated Debt Dívida Consolidada Líquida

NCR Net Current Revenue Receita Corrente Líquida

NFE Electronic Tax Invoice Nota Fiscal Eletrônica

NPV Net Present Value Valor Presente Líquido

NRR Net Real Revenue Receita Líquida Real

OECD Organization for Economic Co-operation

and Development

Organização para a Cooperação e

Desenvolvimento Econômico (OCDE)

OSCIP Civil Society Organization with Public

Interest

Organização da Sociedade Civil de Interesse

Público

OS Social Organization Organização Social

PAC Growth Acceleration Program Programa de Aceleração do Crescimento

PAF Program of Fiscal Adjustment Programa de Ajuste Fiscal

PB Participatory Budgeting Orçamento Participativo

PEFA Public Expenditure and Financial

Accountability

Método de despesa pública e responsabilidade

financeira

PER Public Expenditure Review Revisão de Despesa Pública

PME Employment Monthly Survey Pesquisa Mensal de Emprego

PNAD National Household Survey Pesquisa Nacional por Amostra de Domicílios

PPA Multiyear Plan Plano Plurianual

PPP Public-Private Partnership Parceria Público-Privada

PROES Program of States’ Banks Restructuring Programa de Reestruturação de Bancos

Estaduais

PSIA Poverty and Social Impact Assessment Avaliação de Impactos Sociais e de Pobreza

PYAG Pay As You Go System Sistema de Repartição Simples

RBM Results Based Management Gerência centrada nos resultados

SELIC Headline Interest Rate from Central Bank

(Clearance and Trustee System)

Taxa Básica de Juros do Banco Central

(Sistema Especial de Liquidação e Custódia)

SMF Municipal Secretariat of Finances Secretaria Municipal de Fazenda

SME Municipal Secretariat of Education Secretaria Municipal de Educação

SMS Municipal Secretariat of Health Secretaria Municipal de Saude

STN National Treasury Secretariat Secretaria do Tesouro Nacional

SUS National Health System Sistema Único de Saúde

SWAP Sector Wide Approach Abordagem Setorial Ampla

Vice President: Country Director:

Sector Director: Sector Manager:

Sector Leader: Task Team Leader:

Pamela Cox Makhtar Diop Marcelo Giugale Rodrigo A. Chaves Pablo Fajnzylber Yaye Seynabou Sakho

BRAZIL

MUNICIPALITY OF RIO DE JANEIRO FISCAL CONSOLIDATION FOR

EFFICIENCY AND GROWTH DEVELOPMENT POLICY LOAN

TABLE OF CONTENTS

I. INTRODUCTION .................................................................................................................. 1 II. COUNTRY AND MUNICIPALITY CONTEXT.................................................................. 4

A. Current Macroeconomic Outlook ......................................................................................... 4 B. Recent Economic Developments in the City of Rio de Janeiro ............................................ 8 C. Macroeconomic Outlook and Debt Sustainability in the Municipality of Rio de Janeiro .... 16

III. THE GOVERNMENT’S PROGRAM AND PARTICIPATORY PROCESSES .................. 20 A. The Government Program .................................................................................................... 20 B. Participatory and Consultative Process ................................................................................ 29

IV. BANK SUPPORT FOR THE GOVERNMENT STRATEGY .............................................. 31 A. Rationale for Bank Involvement and Link to Current Country Partnership Strategy

(CPS) and Forthcoming CPS ................................................................................................ 31 B. Choice of Instrument and Relation to Other Bank Operations ............................................. 33 C. Collaboration with the International Monetary Fund (IMF) and Other Donors ................... 36 D. Lessons Learned ................................................................................................................... 38 E. Analytical Underpinnings ..................................................................................................... 39

V. THE MUNICIPALITY OF THE CITY OF RIO DE JANEIRO FISCAL

CONSOLIDATION FOR EFFICIENCY AND GROWTH DPL ....................................................... 41 A. Operation Description ........................................................................................................... 41 B. Policy Areas .......................................................................................................................... 47 C. Impact of the Government’s program on Fiscal Aggregates ............................................... 50

VI. OPERATION IMPLEMENTATION ..................................................................................... 52 A. Poverty and Social Impacts .................................................................................................. 52 B. Implementation, Monitoring and Evaluation ........................................................................ 54 C. Fiduciary Aspects and Disbursements .................................................................................. 55 D. Disbursement ........................................................................................................................ 56 E. Environmental Aspects ......................................................................................................... 57 F. Risks and Risk Mitigation .................................................................................................... 57

ANNEX 1: LETTER OF DEVELOPMENT POLICY ....................................................................... 61 ANNEX 2: OPERATION POLICY MATRIX – RESULT INDICATORS ....................................... 66 ANNEX 3: FUND RELATIONS NOTE ............................................................................................ 71 ANNEX 4: STATEMENT OF LOANS AND CREDITS .................................................................. 74 ANNEX 5: FISCAL AND DEBT SUSTAINABILITY ANALYSIS ................................................. 79 ANNEX 6: BRAZIL AT A GLANCE ................................................................................................ 90 ANNEX 7: THE DECENTRALIZING EFFECTS OF THE CONSTITUTION OF 1988:

SERVICE PROVISION, INTERGOVERNMENTAL TRANSFERS TO MUNICIPALITIES,

AND THE SMALL-MUNICIPAL-SIZE BIAS .................................................................................. 92 ANNEX 8: BRAZIL: IMPACT OF THE GLOBAL CRISIS ............................................................. 94

List of Figures

Figure 1: Industrial Production Activity Index and Unemployment Rate, 2002-10 .............................. 5 Figure 2: Inflation, 2002-10 ................................................................................................................... 5 Figure 3: Current Account, 2002-10 ....................................................................................................... 5 Figure 4: Ibovespa Stock Market Index, Sovereign Spreads, Exchange Rate, 2005-10 ........................ 5 Figure 5: Municipal GDP Real Annual Growth, 1985-2003 and 2004-07 ............................................. 9 Figure 6: Rio de Janeiro and Brazil, GDP decomposition, 2007 .......................................................... 10 Figure 7: Rio de Janeiro’s Investments, 2004–09 ................................................................................. 12 Figure 8: Revenue Decomposition as of 2009 (percent of Total Revenue) .......................................... 13 Figure 9: Fiscal Responsibility Law, 2004-14 ...................................................................................... 20 Figure 10: Rio de Janeiro Doing Business Report 2006 ....................................................................... 24 Figure 11: The Three Pillars of the Proposed DPL ............................................................................... 41 Figure 12: Fiscal Impacts of the Government’s Program...................................................................... 51 Figure 13: Evolution of LRF Indicators, with and without Bank Operation ......................................... 52

List of Tables

Table 1: Brazil Macroeconomic Outlook, 2009–12 ................................................................................ 7 Table 2: Municipal transfers revenues (expressed as percentage of total revenues), 2004-09 .............. 11 Table 3: Government Finance Statistics Figures, in thousand of Reais 2004–09 ................................. 14 Table 4: Evolution of Fiscal Responsibility Law (LRF) Indicators ...................................................... 14 Table 5: Evolution and Composition of Net Consolidated Debt, 2004-09 ........................................... 15 Table 6: Rio de Janeiro, Fiscal Projections, 2010-2014 ........................................................................ 16 Table 7: Rio de Janeiro, Capital Expenditure by Sector, 2009-13 ( percent ot total expenditure) ........ 18 Table 8: Federal Programs in Rio de Janeiro State ............................................................................... 36 Table 9: DPL Policy Pillars and Long Term Vision ............................................................................. 42

List of Annex Figures

Figure A5.1: Rio de Janeiro’s Fiscal Balances, 2004-09 ...................................................................... 79 Figure A5.2: Evolution of Current Revenues and expenditures from 2004 to 2009 ............................. 80 Figure A5.3: Evolution of Gross and Net Consolidated Debts, 2004-09 .............................................. 81 Figure A5.4: Consolidated Debt Composition, 2008-09 ....................................................................... 81 Figure A5.5: Evolution of Debt Service, 2004-09 ................................................................................ 82 Figure A5.6: Risk Analysis ................................................................................................................... 87

List of Boxes

Box 1: Fiscal Impact of the Olympic Games in Rio de Janeiro in 2016a .............................................. 19

Box 2: Complementarities between Rio State and the Rio Municipality DPLs .................................... 34 Box 3: Good Practice Principles on Conditionality .............................................................................. 39 Box 4: Prior Actions for First Tranche Loan Disbursement ................................................................. 43 Box 5: Conditions for Second Tranche Loan Disbursement ................................................................. 45

Map of Brazil ........................................................................................................................................ 96

The Rio de Janeiro Municipal Fiscal Consolidation for Efficiency and Growth Development Policy Loan was

prepared by an IBRD team consisting of Yaye Seynabou Sakho, Pablo Fajnzylber, Ngoc-Bich Tran, Fernando Blanco,

Cristian Quijada Torres, Barbara Bruns, William Dillinger, Andre Medici, David Evans, Jose Guilherme Reis, Evelyn

Levy, Juliana Wenceslau Biriba, Tarsila Velloso, Marcelo Caetano, Mario Rattes, Regis Cunnigham, Luciano

Wuerzius, Antonio Paulo Vogel de Medeiros, Antonio Velandia, Miguel Navarro Martin, Anderson Caputo Silva,

Armando Roselli, Ana Tereza Pereira, Erica Amorim, Zélia Brandt de Oliveira, Miguel Santiago, Tammy Lynn

Pertillar, Andresa Lagerborg, Ricardo Rocha Silveira Kai Kaiser, and João Pedro Wagner de Azevedo.

i

LOAN AND PROGRAM SUMMARY

BRAZIL

MUNICIPALITY OF RIO DE JANEIRO

FISCAL CONSOLIDATION FOR EFFICIENCY AND GROWTH DEVELOPMENT

POLICY LOAN Borrower

Municipality of Rio de Janeiro with a guarantee of the Federative Republic of Brazil. A

waiver is requested by the Board of Executive Directors to Bank policy for DPLs which

limits the definition of subnational borrower to states and provinces. Other than the

definition of borrower, all other provisions of Bank policy are applicable to this operation.

Implementing Agency

Municipal Secretariat of Finance of the City of Rio de Janeiro

Financing Data

IBRD Loan

Terms: Commitment-linked IBRD Flexible Loan with a variable-spread, denominated in

US Dollars, with an amortization consisting of customized repayments of principal,

payment dates of the 15th of each calendar month with a 1 month grace period, and 30

years of final maturity, with all conversion options selected, and the front-end fee and

premia for Interest Rate Caps and Collars to be paid by the Borrower from their own

resources. An additional transaction fee charged at a rate of one hundredth of one percent

(0.01%) of the Loan amount per annum applies for the Borrower’s selection of a monthly

amortization schedule for the Loan. Such transaction fee shall be added to the interest rate

applicable to the Withdrawn Loan Balance and shall be payable monthly on each Payment

Date.

Amount: US$1,045 million

Operation Type

Development Policy Loan, two tranche operation: First tranche amounting to US$545

million to be disbursed upon effectiveness and second tranche mounting to US$500 million

be disbursed in FY2011.

Main Policy Areas

The proposed loan will support policy actions in the following areas:

Creating fiscal space to expand public investment through improvement in revenue

collection and rationalization of pension expenditures;

Reforming public services delivery through: (a) improved government processes for

registering businesses; (b) improved access to quality family health and emergency

care services; and (c) improved early development of poor children, better quality of

primary schools (Escolas do Amanhã) in high-conflict slum areas, and system-wide

advances in student learning outcomes;

Strengthening the institutional framework for efficient service delivery through: (a)

implementing a medium term expenditures framework and results-based management

tools within the public sector, and (b) the creation of the institutional framework for

public-private partnerships (PPPs) to invest in infrastructure and service delivery

projects with the private sector.

Key Outcome Indicators for

the first tranche (by January

31, 2011) and for the second

tranche (by January 31,

2012)

Reduced NPV of the pension system’s actuarial deficit over the next 50 years by17% or

R$6.3 billion of which R$3.1 billion from parametric reforms (first tranche) and

R$3.2Billion from the recapitalization measures (second tranche);

Improved revenue collection, evidenced by a 4 percent increase in ISS tax collections

through the introduction of electronic fiscal invoice system (Nota Fiscal Eletrônica);

Reduction in the number of days required to obtain a municipal business license in Rio

from 20 days in 2009 to 12.5 days in 2010;

Doubling of family health care coverage from a January 2009 baseline of 6 percent to a

projected 12 percent in December 2011;

Annual reductions in student within year and between year dropout rates and annual

improvement in the national and municipal education indices IDEB and IDE-Rio for

Escolas do Amanhã from the 2009 baseline; and annual expansion in enrollments in

ECD centers and pre-schools targeted to low-income communities from 29,921

(crèches) and 77,845 (preschools) in 2009 baseline by 3000 new openings a year;

Implementation of the initial year of a 3-5 years MTEF strategy with associated

expenditures plan and financing plan;

ii

Implementation of Results Based Management, evidenced by annual evaluation of

performance contracts signed by the mayor with line secretariats;

Improved efficiency in stock management reduces losses in the stock of goods in the

health sector from 20 percent to 10 percent;

Establishment of a framework to enable PPPs to invest in infrastructure and service

delivery projects, evidenced by at least one project prepared by the PPP unit.

Program Development

Objectives and Contribution

to the Country Partnership

Strategy (CPS)

The objective of the proposed operation is to assist the municipality of Rio de Janeiro in

creating fiscal space which will be used for investments to improve the quality and

efficiency of public service delivery, especially in poor areas, through innovative programs

in health, education and private sector development. Other investments will strengthen the

institutional framework for efficient service delivery through the implementation of a

medium term expenditures framework, results-based management with the public sector,

and PPPs with the private sector.

The proposed operation is fully consistent with and closely linked to the objectives of the

Brazil CPS, 2008–11, which include sound macroeconomic management; fiscal

consolidation; efficient public sector management; better investment climate; increased

quality of education and health expenditures, especially at the subnational level.

Risks and Risk Mitigation

The operation is subject to three main risks:

1. The main implementation risk of the operation is related to the fact that the city’s

administration is relatively new and may overestimate the pace of reforms or may not have

sufficient support from civil servants with longer experience in the public sector. As a

result, poor implementation of the agreed measures could result in delays in the second-

tranche disbursement. The Bank is supporting the efforts of the municipality to reinforce its

implementation capacity including through a Bank technical assistance loan in the main

areas of the loan, close supervision during implementation, as well as facilitating

knowledge exchanges with other countries and other subnational governments in Brazil.

2. The main political risk is related to the presidential and state elections in November

2010. Though the municipal government is not up for election, the administration may have

limited political space to implement deep reforms because it may face a complex political

situation and groups with entrenched political interests may oppose the proposed reforms.

In particular, this may be the case for pensions, where reform means reducing benefits for a

defined interest group. However, the design of the operation is a mitigating factor because

the reforms targeted in pensions are focused on future public servants which cause a lower

political risk. In addition, the preparation of the World Cup and the Olympics implies that

the federal and state government will likely support and foster continuity of the

municipality’s strategic programs.

3. The main risk in implementing the PPP program relates to the city’s weak institutional

capacity to manage an incipient PPP program as well as contingent liabilities that may

result from PPPs. The Bank is supporting the municipality in designing a well-planned and

executed capacity-building program and in the hiring of advisors to mitigate this risk. The

potential risks from contingent liabilities are mitigated through the setting up of an

institutional framework with adequate checks and balances and a guarantee fund that will

cover payments when called for. The institutional framework provides an additional

mitigation factor as it warrants an active role from the City’s treasury to assess the need for

guarantee, monitor and budget for potential contingent liabilities according to best

practices.

Operation ID Number

P111665

1

IBRD PROGRAM DOCUMENT FOR A PROPOSED

FISCAL CONSOLIDATION FOR EFFICIENCY AND GROWTH

DEVELOPMENT POLICY LOAN TO THE

MUNICIPALITY OF THE CITY OF RIO DE JANEIRO

I. INTRODUCTION

1. This document presents a proposed two-tranche Development Policy Loan

(DPL) of US$1,045 million to the Municipality of Rio de Janeiro (MoRJ) in Brazil.1 The

loan would support the MoRJ in its efforts to achieve faster growth and improve the quality

and coverage of social services, particularly in poor and violent areas of the city.

2. Among Brazilian cities, Rio is second only to São Paulo in population and

contribution to gross domestic product (GDP). Rio’s population was about 6.2 million in

2008 and its GDP was R$128 billion (US$57 billion) in 2007. The city is twice as large as

Uruguay in population and GDP. The city’s budget is Brazil’s 10th largest, behind the federal

government, the seven biggest states, and the city of São Paulo.

3. Rio is affected by social and economic inequalities. The poor comprise about 13

percent of the population, and the wealthiest 4 percent have incomes 44 times greater than the

poorest 8 percent, who earn the minimum wage or less. Poor people live in neighborhoods

often characterized as slums, called favelas, with inadequate water, sewerage, road access,

schools, and health facilities. In recent decades, slums have expanded both horizontally and

vertically—despite a number of municipal initiatives to limit them. The favelas are now home

to nearly 19 percent of the city’s population.

4. Rio’s social conditions are partly the result of a long period of economic decline.

The transfer of the national capital to Brasília in 1960 removed a primary engine of the city’s

economy. Like many other parts of Brazil, Rio then suffered from the economic stagnation

that began with the 1973 oil crisis and persisted through the international debt crisis of the

1980s and various domestic economic setbacks. But Rio fared worse than other key Brazilian

cities. While São Paulo, Recife, and Brasília continued to grow, Rio’s economy shrank at an

average annual rate of 1.1 percent between 1985 and 2003. As a result, formal-sector

employment levels stagnated and poverty rates did not fall as fast as they did in the rest of the

country. The city’s finances also suffered. Along with other Brazilian subnationals, Rio has

received a series of bailouts in which the federal government has assumed the majority of the

city’s outstanding obligations in return for fiscal reforms.

5. Rio is now poised for a turnaround. Brazil’s overall economic performance has

improved since the introduction of the Plano Real stabilization program in 1994. Rio’s fiscal

adjustment since 2000 has resulted in a more sustainable level of debt, and growth has picked

up since 2004, fueled by a positive domestic and international demand. Despite the

improvement, Rio’s economic growth is well below other state capital cities in Brazil. The

city is laying the foundations for faster growth by increasing investment in physical and

human capital and strengthening government institutions. Stepping-up growth will allow the

1 World Bank policy (OP 8.60) provides for DPLs to be extended to subnational governments but limits the

definition of subnational to states and provinces. A waiver is sought from the Board of Executive Directors of

the World Bank to this definition to allow this DPL to be extended to the Municipality of Rio de Janeiro. All

other provisions of Bank policy would remain applicable to this operation.

2

city to sustainably foster fiscal advances and respond to its unique social challenges. The

proposed operation will support: (i) policies to create fiscal space for physical investment; (ii)

innovations in service delivery to simplify businesses’ registration processes and improve the

quality of health and education services; and (iii) measures to modernize public sector

management. The city has been chosen to host the Soccer World Cup in 2014 and the

Summer Olympics in 2016. Even though those events do not drastically change the city’s

growth strategy, they will require frontloading some planned physical investment and can be

seen as opportunities for growth. Beyond the World Cup and Olympic Games, however,

challenges remain—in particular, improving public service delivery in poor areas and laying

the foundations for faster growth.

6. Since taking office in January 2009, the city’s administration has taken

significant steps to address these challenges and improve Rio’s prospects. To tackle the

immediate concerns about the efficiency of expenditures and the after effects of the global

financial crisis, it has slashed recurrent expenditures, temporarily frozen investment, and

launched an effort to upgrade tax administration. The city has also devised well-defined 4-

and 10-year development strategies based on: (a) generating fiscal space for capital

investment; (b) improving the quality of social services, particularly in low-income areas; and

(c) modernizing the city’s internal administrative processes to reduce costs and enhance

performance.

7. The proposed loan would enhance this strategy with three major components

that support continued improvements:

The fiscal space component will help generate additional resources for public

investment through measures to improve revenue collection and reduce pension

costs.

The service-delivery component will support expansion of innovative approaches to

primary and emergency health care as well as preschool and primary school

programs in low-income and violence-prone areas. This component will also help

improve government processes for registering businesses.

The public-sector management component will support the establishment of a

system of results agreements for key municipal functions and the implementation of

some elements of a medium-term expenditures framework. The component will also

support reforms in public procurement and management and establish a framework

to enable PPPs to invest in infrastructure and service delivery projects.

8. As a municipal DPL, the proposed operation represents an innovation in Bank

operations for three reasons. First, the DPL will support efforts to better align policies at

different levels of government—federal, state, and municipality. The DPL has been

designed in conjunction with the State of Rio de Janeiro Fiscal Sustainability, Human

Development, and Competitiveness DPL. The operation will thus help achieve better policy

integration and coordination at different levels of government. For instance, the DPL-

supported programs are tackling poor learning outcomes at the municipal level through

expanding early childhood education for low-income children, strengthening the teaching of

basic literacy skills, and providing targeted support for schools in high-crime areas. At the

state level, the focus is complementary and set on reducing the age-grade distortion, offering

over-aged students a chance to graduate on time by following a special compressed

3

curriculum with intensive teacher support. To the extent that this innovative approach proves

successful, it could be replicated in other Brazilian states and large municipalities—and

perhaps in other countries as well. Rio’s relatively high policy and institutional capacity and

level of development makes it a suitable place for the Bank to start an innovative development

model that directly engages with the city while vertically integrating the state and federal

levels.

9. Second, the proposed operation is the first of a new generation of policy reforms

geared at enhancing fiscal consolidation at the municipal level in Brazil. The proposed

operation closely resembles and shares its rationale with previous Bank DPL operations that

support fiscal consolidation at federal and state levels in Brazil. In the first generation of

DPLs, the Bank supported fiscal consolidation of the federal government; in the second

generation, the Bank addressed fiscal consolidation of the states of Ceará, Minas Gerais, Rio

Grande do Sul, and Alagôas. This third generation of reforms targets fiscal consolidation at

the municipal level.

10. Third, this proposed operation represents an innovation in Bank engagement

with cities that are the main providers of essential public services, making them critical

for the country’s success in promoting growth, reducing poverty, and ensuring that all

citizens receive services of equal quality. The Federal Constitution of 1988 makes municipal

governments autonomous entities of the Brazilian Federation, independent of both the state

and federal governments. The Constitution reserves for the municipalities the power to

legislate over matters of local interest and gives them principal responsibility for providing

essential public services, including education (until 9th

grade), health, sanitation, garbage

collection, and general urban infrastructure. Funding mechanisms for such services as health

and education allow the federal government to influence policy, but responsibility for

implementation resides with subnational entities, including municipalities.

11. The proposed operation will enable the Bank to support Rio with the

knowledge, expertise, and technical advice needed to implement reforms. In this respect,

the Bank will draw from experiences with subnational governments in Brazil, including

operations in Alagôas (Fiscal and Public Sector Reform, 2009), Rio Grande do Sul (Fiscal

Sustainability for Growth, 2008), and Minas Gerais (Partnership for Development, 2006).

These operations have provided the Bank with substantial subnational experience in the kind

of fiscal and public-sector management reforms now being pursued by Rio’s municipal

government.

12. The proposed operation and associated Bank support meet the criteria for

engagement with subnational governments in the CPS with Brazil for 2008–11. The

operation has been prepared based on the following principles of engagement: (a) the

municipality’s ownership of the program; (b) policy measures that respond to the

municipality’s present and future needs; and (c) a sound basis for a long-term partnership with

the Bank. As specified in the CPS, the preparation of this DPL has been approved by the

National Treasury Secretariat (STN).

4

II. COUNTRY AND MUNICIPALITY CONTEXT

A. CURRENT MACROECONOMIC OUTLOOK

13. The global economic crisis’ impact on the Brazilian economy was immediate

and strong, but the country has demonstrated significant resilience. Twelve consecutive

quarters of GDP growth since 2006 were interrupted by seasonally adjusted declines of 3.5

percent in fourth quarter 2008 and 0.9 percent in first quarter 2009. Based on fourth quarter

2009 data, Brazil had a year-on-year contraction of 0.2 percent for 2009. The decline owed

much to a 9.9 percent drop in investment.

14. Resurgent growth, solidifying aggregate demand, and record-low

unemployment indicate that a swift and strong economic recovery is underway. Seasonally adjusted growth resumed in second quarter 2009 and continued through the end of

the year. The recovery of domestic demand has been driven by a strong resumption of

investment starting in the second half of 2009 as well as a strengthening of consumption.

15. Industrial production, capacity utilization, retail sales and the jobless rate also

point to a buoyant first quarter 2010. Seasonally adjusted industrial output capacity

utilization and retail activity kept expanding at a fast pace (see Figure 1). Recovery in the

industrial sector has been driven mainly by manufacturing. A record number of jobs were

created in first quarter 2010, and the seasonally adjusted jobless rate was lower than a year

ago. The recovery is expected to continue in 2010 and beyond. Market expectations for GDP

growth for 2010 are close to the before-crisis growth peak. The fast pace of recovery and

seasonal and temporary factors led to increases in inflation, starting in October 2009 (see

Figure 2). It reached a seasonally adjusted 5.1 percent in March 2010, moving up the target

range’s center of 4.5 percent. In April, the central bank raised interest rates by 1 percentage

point. Markets expect that this move as well as possibly subsequent ones would reduce

inflation concerns for 2011. Market expectations for inflation are 5.2 percent for 2010.

16. Strong economic recovery is widening the current account deficit and fueling

international investors’ confidence in Brazil. Depressed global demand led to declines in

both imports and exports in 2009. The current account deficit narrowed in 2009, mostly

because of a smaller deficit in the services and income balance. The domestic and global

recovery in first quarter 2010 has increased the seasonally adjusted trade surplus, but these

factors were not sufficient to compensate for the widening of the services and income deficit.

As a result, the current account deficit is widening and expected to reach 3 percent of GDP in

2010 (see Figure 3). The Real has appreciated to its pre-crisis level—at about R$1.75 per

dollar. The exchange rate is increasing exporters’ concerns over declining competitiveness in

international markets. Interest rates are at record lows—with the SELIC policy rate at 9.75

percent. Even so, they are still attractive compared to rates in developed countries. In March

2010, the BOVESPA stock market index reached its highest level since June 2008, matching

its pre-crisis level (see Figure 4). Capital inflows have moved above their pre-crisis trend,

which led the government to impose a 2 percent tax on foreigners’ bond and equity

acquisitions and a 1.5 percent tax on American Depositary Receipts (ADRs) to slow portfolio

investment inflows. The country’s international reserves reached US$244 billion by the end of

March 2010, well above the pre-crisis peak. Sovereign spreads are below their pre-crisis

levels at about 170 basis points.

5

Figure 1: Industrial Production Activity Index and

Unemployment Rate, 2002-10

Figure 2: Inflation, 2002-10

Source: IPEA

Source: BCB

Figure 3: Current Account, 2002-10

Source: BCB

Figure 4: Ibovespa Stock Market Index, Sovereign Spreads, Exchange Rate, 2005-10

Source: LCSPE Macromonitoring Indicators: World Bank

0

2

4

6

8

10

12

14

90.0

95.0

100.0

105.0

110.0

115.0

120.0

125.0

130.0

135.0Jan-0

2

Aug

-02

Mar-

03

Oct-

03

May-0

4

Dec-0

4

Jul-05

Feb

-06

Sep

-06

Ap

r-07

No

v-0

7

Jun-0

8

Jan-0

9

Aug

-09

Mar-

10

(In

du

str

y A

cti

vit

y In

dex)

(Un

em

plo

ym

en

t R

ate

%

)

Industrial Production Activity Index and Unemployment Rate, 2002-10

Industrial Production Index (s.a) Unemployment Rate

-2

3

8

13

18

23

28

33

Feb

-02

Jun-0

2

Oct-

02

Feb

-03

Jun-0

3

Oct-

03

Feb

-04

Jun-0

4

Oct-

04

Feb

-05

Jun-0

5

Oct-

05

Feb

-06

Jun-0

6

Oct-

06

Feb

-07

Jun-0

7

Oct-

07

Feb

-08

Jun-0

8

Oct-

08

Feb

-09

Jun-0

9

Oct-

09

Feb

-10

12 - Month Accumulated Inflation, 2002-10

Consumer Price Index (IPCA) Wholesale Price Index, IPG-M.

-5

-3

-1

1

3

5

Oct-

02

Fe

b-0

3

Ju

n-0

3

Oct-

03

Fe

b-0

4

Ju

n-0

4

Oct-

04

Fe

b-0

5

Ju

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5

Oct-

05

Fe

b-0

6

Ju

n-0

6

Oct-

06

Fe

b-0

7

Ju

n-0

7

Oct-

07

Fe

b-0

8

Ju

n-0

8

Oct-

08

Fe

b-0

9

Ju

n-0

9

Oct-

09

Fe

b-1

0

% o

f G

DP

Current Account and Foreign Direct Investment,

2002-10 (12 Months accumulated flows)

Current Account Foreign Direct Investment

1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

3.1

100

200

300

400

500

600

700

800

900

Jan

-05

Ap

r-0

5

Au

g-0

5

Dec-0

5

Ma

r-0

6

Jul-

06

No

v-0

6

Ma

r-0

7

Jun

-07

Oct-

07

Jan

-08

Ma

y-0

8

Sep

-08

Jan

-09

Ap

r-0

9

Au

g-0

9

Dec-0

9

Ma

r-1

0

Ex

ch

an

ge R

ate

(R

$/U

S$

)

EM

BI

Sp

rea

ds

(Ba

sis

Po

int)

Brazil EMBI + Sovereign Spread and Exchange Rate, 2005-10

EMBIPLUS Exchange Rate

22000

32000

42000

52000

62000

72000

Jan

-05

Ap

r-0

5

Au

g-0

5

Dec-0

5

Ma

r-0

6

Jul-

06

No

v-0

6

Ma

r-0

7

Jun

-07

Oct-

07

Jan

-08

Ma

y-0

8

Sep

-08

Jan

-09

Ap

r-0

9

Au

g-0

9

Dec-0

9

Ma

r-1

0

Ind

ex

-E

nd

of

Da

y

IBOVESPA Stock Market Index, 2005-10

6

17. A favorable pre-crisis external environment and sound economic policy choices

helped foster resilience, create strong macroeconomic foundations, and restore economic

growth. Five factors have been at work. First, far-reaching structural reforms and price

stabilization in the 1990s were followed by consistent adoption of sound macroeconomic

policies in the past decade. Second, floating exchange rates and the accumulation of foreign

reserves have allowed Brazil to adjust well to external shocks. Third, adoption of an inflation-

targeting regime has contributed to lowering inflation to the center of the target range,

enabling the independent central bank to focus on countercyclical monetary policy. Fourth,

the Fiscal Responsibility Law (LRF) framework has generated significant primary surpluses,

which contributed to decreases in net debt and fiscal adjustments prior to the crisis. Fifth, a

pre-crisis boom in commodities and buoyant global demand helped dramatically reduce

Brazil’s fiscal and external vulnerabilities.

18. The strong fundamentals built in the last decade have allowed the use of a wide

range of policy tools. The government used its increased fiscal and external solvency and

enhanced credibility to adopt expansionary fiscal and monetary policies during the crisis.

Monetary, fiscal, and quasi-fiscal countercyclical policies have included lowering the SELIC

policy rate to a historical low of 8.75 percent, reducing the reserve requirement on financial

institutions, injecting credit into the financial system through public banks, extending credit

lines to exporters, and more modest tax exemption measures- mainly of the IPI tax.

19. In sum, the macroeconomic policy framework for Brazil is considered adequate

for the purposes of the proposed Development Policy Loan. Strong fundamentals built in

the last decade have allowed the country to smooth the impact of financial turmoil with

relative speed. The macroeconomic outlook reflects this strong resilience to external shocks.

In the baseline scenario (A), growth projections reflect a gradual recovery to 5.5 percent in

2010 and 4.8 percent for 2011 and debt dynamics indicate a continued reduction of debt levels

from 42.8 percent of GDP in 2009 to 38 percent of GDP in 2012. The inflation is expected to

pick up in 2010 and to lie above the target at 5 percent and get back to the center of the target

inflation in 2011. In the low case scenario (B) growth recovery is more gradual at 5.0 percent

in 2010 and at 4.5 percent in 2011. The inflation will reach 6 percent in 2010 and will recover

gradually the inflation target in 2012. In both scenarios, the macro framework is adequate

with net debt gradually decreasing and fiscal balances improving (see Table 1).

7

Table 1: Brazil Macroeconomic Outlook, 2009–12

20. Despite the country’s overall resilience, the crisis has put strains on the finances

of subnational governments, and these forces are likely to slow the resumption of growth

in some parts of the country. Subnational governments suffered considerable reductions in

fiscal revenues, both as a result of lower tax collections and reduced federal transfers. With

the hard budget constraints and limited credit access imposed by LRF, subnational

governments had limited space to implement countercyclical fiscal policies. Instead, they cut

discretionary expenditures, mainly investments. In Rio, economic activity suffered from the

crisis—in particular, industrial production and retail sales. However, tax revenues remained

resilient.

Political Context

21. Eduardo Paes (PMDB) was elected Rio’s mayor for four years at the end of

2008. His campaign platform promised renewed economic opportunities. Support for the

mayor comes mainly from the poorest segments of the city, but he has been gradually winning

support from the middle class as well. The mayor is a close political ally of President Lula

Indicators 2009

(A) (B) (A) (B) (A) (B)

National Accounts

Real GDP Growth (%) -0.2 5.5 5.0 4.8 4.5 4.5 4.2

Consumption Growth (%) 4.0 5.3 4.2 5.0 4.8 5.6 3.9

Investment Growth (%) -9.9 6.8 9.6 4.5 3.7 0.5 7.4

Investment (% of GDP) 16.6 19.2 17.9 19.1 17.8 18.3 18.2

Public sector 2.8 2.5 2.5 2.8 2.8 3.2 3.2

Private sector 13.8 16.6 15.4 16.2 15.0 15.1 15.0

Gross National Savings 14.6 15.7 14.6 15.5 14.3 15.3 15.2

External Sector

Trade Balance (US$ bi) 25.4 15.9 18.1 19.1 21.4 21.4 21.0

Current Account Balance (US$ bi) -24.3 -67.9 -65.6 -72.4 -69.8 -64.9 -64.9

Current Account Balance (% of GDP) -1.5 -3.5 -3.4 -3.6 -3.4 -3.0 -3.0

Foreign Direct Investment 25.9 33 33 35 35 35 35

International Reserves (US$ bi) 239 270 268 286 283 290 289

Debt Service to Exports (%) 28.6 12.0 12.0 12.6 12.6 11.7 11.6

Interest Payments to Exports (%) 9.1 4.7 4.6 4.8 4.7 4.7 4.6

Nominal Exchange Rate (eop) 1.7 1.76 1.8 1.8 1.8 1.9 1.9

Public Sector

PS. Primary Balance (% of GDP) 2.1 3.0 2.9 2.8 2.8 3.0 2.9

PS. Overall Balance (% of GDP) -3.3 -1.8 -2.1 -1.2 -1.5 -0.8 -0.9

Net Public Sector Debt (% of GDP) 42.8 42.0 42.3 39.2 39.7 37.7 38.4

Gross Gen. Gov. Debt (% of GDP) 62.8 70.0 70.0 68.0 68.0 66.0 66.0

Prices and Economic Activity

Consumer Inflation (%) 4.3 5.0 5.5 4.5 4.8 4.5 4.5

Wholesale Inflation (%) -1.7 6.0 6.8 5.0 5.2 4.5 4.5

Headline Interest Rate (% eop) 8.8 10.5 10.5 10.5 10.5 10.0 10.0

Unemployment (%) 8.1 6.9 6.9 6.5 6.5 6.5 6.5

Industrial Cap. Utilization (%) 79.8 85.0 85.0 86.3 86.3 86.0 86.0

Source: IMF, BCB, IBGE, WB Calaculation

2010 2011 2012

8

(PT) and Rio de Janeiro State Governor Sérgio Cabral, who is from his political party

(PMDB). Up for re-election in October 2010, Governor Cabral is currently leading the polls.

22. Regardless of who wins the upcoming federal and state elections in October

2010, the political leadership of Rio municipality is expected to receive continued

support. A change in political leadership at the state level is not likely to have a significant

effect on policy continuity and relations with the city. At the national level, any of the two

leading presidential candidates—São Paulo State Governor José Serra (PSDB) and Minister

Dilma Rousseff (PT)—share broad development priorities and would likely maintain agreed

cooperation with the city. In addition, the ―halo effect‖ of the World Cup and Olympics would

effectively shield the municipal government as both the state of Rio and the federal

government are committed to making those events a success.

B. RECENT ECONOMIC DEVELOPMENTS IN THE CITY OF RIO DE JANEIRO

23. Rio de Janeiro’s municipal government is comparable in size to a state

government or small country. Rio’s GDP is the second largest among Brazil’s cities, trailing

only São Paulo, and fifth when compared to state governments. Measured against countries,

Rio has a GDP about twice as large as that of Uruguay or Costa Rica. In 2009, the city had a

budget of R$11.3 billion (US$5.1 billion), including capital transfers. It made Rio Brazil’s

10th

largest public sector entity—behind the federal government, seven state governments,

and São Paulo city. In a city of more than 2 million households and a high population density,

Rio’s municipal government is the key actor in social and economic development. These

responsibilities generate large expenditure needs.

24. The city of Rio de Janeiro has experienced a trend of economic deterioration. In

the 1960s, economic activity migrated to other states, mainly São Paulo. First, manufacturing

left and then the financial sector, leading to declines in the flow of resources that had

supported the city’s industrialization in previous decades. Industrial production dropped

significantly the first part of the 1980s, and the city’s share of Brazil’s real GDP fell

significantly over the next two decades. Since then, Rio’s growth has picked up, although at a

lower level than Brazil’s other capital cities (see Figure 5).

9

Figure 5: Municipal GDP Real Annual Growth, 1985-2003 and 2004-07

Source: IBGE, McKinsey (2006).

25. Rio’s economy boomed from 2004 to 2007, led by the performance in services.

The service sector grew strongly during 2004-07, reflecting the demand from a large

population of federal retirees and the presence of big state-owned enterprises. In 2007,

services represented about two-thirds of the city’s economy (see Figure 6). In the three-year

boom, retail grew robustly, led by sales in construction materials, cars, and pharmacy

products. Fiscal revenues are mostly based on services and real estate taxes. They have

performed well, boosted by the services needs of important oil-based industries, the real estate

boom, and reforms to improve tax-collection efficiency. Industrial production performance

lagged behind the country as a whole, with many years of decline that reduced it to about 10

percent of the city’s economy.

0% 2% 4% 6% 8%

Rio de Janeiro Fortaleza

São Paulo

Porto Alegre Recife

Brasília Curitiba

Salvador Belo Horizonte

Manaus

Municipal GDP Real Annual Growth, 2004-07

4.7 percent 2.8 percent



0.2 percent - 0.1 percent

- 1.1 percent - 1.1 percent

Manaus Brasilia Recife

Fortaleza Belo Horizonte

São Paulo Curitiba

Salvador Porto Alegre

Rio de Janeiro

Municipal GDP Real Annual Growth 1985-2003

10

Figure 6: Rio de Janeiro and Brazil, GDP decomposition, 2007

Source: Municipal Secretariat of Finance

26. Going forward, Rio’s growth will continue to be anchored by services—tourism,

call centers, telecommunication, as well as energy and knowledge-based services. Improvements in infrastructure and human capital, coupled with reforms to improve the

business environment, should thus be critical for enhancing the performance of Rio’s

economy in the medium term. Economic growth should in turn contribute to fiscal

consolidation through increased revenues and improved debt dynamics.

Federal, State, and Municipality Interactions

27. Municipal governments are autonomous entities, providing essential public

services in Brazil. The Constitution of 1988 gives the same legal status to states and

municipalities, greatly expanding their spending obligations and increasing public-sector

employment benefits. This constitution also increased revenue-sharing transfers to states and

municipalities and earmarked revenues for social responsibilities. As a result, municipal

governments like Rio’s became the main providers of essential public services in Brazil. Rio’s

large service delivery responsibilities imply large expenditures needs. At the same time,

municipal governments became autonomous entities in the Brazilian Federation, independent

from both state and federal authorities. Hence, policy reforms cannot be imposed on Rio by

higher levels of government; the initiative must come from the city itself.

28. The fiscal arrangement between the municipality and the federal and state

governments is appropriate for the purpose of the proposed DPL. The municipality

receives from the state transfers stemming from ICMS (Brazilian State Value-Added Tax) and

IPVA taxes (Tax on Motor Vehicle Property), oil royalties, and FUNDEB (Fund for

Maintenance and Development of Primary Education and of Teacher’s Valorization, the fund

for basic education).

Pesos Setoriais no PIB (2007)

0%

10%

67%

23%

5%

24%

14%

56%

0%

10%

20%

30%

40%

50%

60%

70%

Agropecuária Indústria Serviços Impostos sobre produtos

Município do Rio de Janeiro Brasil

Agribusiness Industry Services Taxes on products

Municipality of Rio de Janeiro Brazil

11

Table 2: Municipal transfers revenues (expressed as percentage of total revenues), 2004-09


29. The macroeconomic framework of the state of Rio is considered adequate and

its fiscal situation is deemed sustainable. Revenue transfers from Rio state to Rio

municipality should not be affected in the medium term. Rio state transfers to the city

benefited from a favorable economic environment in Brazil and worldwide, a boom in

commodity prices that increased oil sector royalties, and significant improvements in tax

collection efforts (ICMS). Between 2004 and 2008, Rio state’s tax revenues increased by 25

percent, largely due to growth in ICMS collections and an 80 percent rise in oil and gas sector

revenues. During the financial turmoil in 2009, the municipality of Rio recorded increasing

transfers and tax revenues because the economies of both the state and the city are heavily

based on services.

Fiscal Situation of the Municipality of Rio de Janeiro

30. After continual fiscal deterioration through the 1990s, Rio de Janeiro has

achieved some fiscal consolidation. The city produced a strong fiscal-adjustment effort in

the past decade through compliance with the LRF’s strict borrowing controls.2 Unfortunately,

this fiscal adjustment was largely done by reducing investment. As a share of total

expenditures, it fell from 11 percent in 2004 to 9 percent in 2008. However, efficiency gains

remain to be achieved to improve expenditure quality. During the financial crisis, investments

have been cut to 4 percent of total expenditures to generate a primary surplus in 2009 (see

Figure 7).

31. Despite fiscal adjustment, debt reduction, and compliance with LRF, Rio still

faces significant mandated expenditures. The city needs to continue the process of fiscal

consolidation to improve the composition and quality of expenditures. Personnel outlays have

been increasing and now represent more than 50 percent of current expenditures. The growth

of mandated expenditures in health, education, pensions, and debt service exerts a strong

pressure on municipal finances. Therefore, the set of discretionary expenses that could be

reduced would be mostly limited to investment. Debt service as represented by interest

2 The signing of the debt renegotiation contracts with the National Treasury Secretariat (STN) in 1997 and the

enactment of the LRF in 2000 obligated subnational governments to adopt fiscal adjustment efforts by

incorporating hard budget constraints into a single, unifying framework. Under Law 9496 of September 1997

and the Provisional Measure 2185 of 2000, the STN refinanced the bond debt of 25 states and 180 municipalities

over 30 years. The strict observance of the debt renegotiation contracts and the LRF resulted in significant

improvements in subnational governments’ fiscal performance and a decline in subnational indebtedness from 18

percent of GDP in 2003 to 14 percent in 2008.

2004 2005 2006 2007 2008 2009

Federal Transfers 15% 11% 9% 14% 11% 11%

of which royalties 0.5% 0.6% 0.8% 0.7% 0.6% 0.4%

State Transfers 17% 19% 19% 16% 15% 14%

of which royalties 0.7% 0.9% 1.0% 0.8% 1.0% 0.7%

Multigovernamental Transfers (FUNDEB) 9% 9% 9% 9% 9% 10%

Capital Transfers 0% 0% 1% 0% 1% 1%

Total Transfers (% of total Revenue) 41% 39% 38% 39% 37% 36%

12

payments and net amortizations are still a considerable part of expenditures, and the LRF

prevents the municipality from directly contracting new external credit operations.3

Figure 7: Rio de Janeiro’s Investments, 2004–09


32. Rising deficits in the civil service pension system are another culprit in the

increase of current expenses. Retired personnel and their beneficiaries (survivors) represent

44 percent of all municipal claimants, and pension benefits consume more than 40 percent of

total personnel expenditures. The difference between the pension scheme’s contributions and

benefits is projected to reach almost 10 percent of Rio’s net current revenues in the next five

to ten years.

33. Pension system imbalances also affect the fiscal situation of the three levels of

government in Brazil. As a result, the federal government amended the Constitution in 2004

to authorize expenditure reductions in select pension benefits and specific increases in social

security contributions. Rio’s pensions systems have yet to take advantage of those provisions.

34. Despite being discretionary, public outlays for goods and services have

contributed to expenditure rigidity because they are increasingly associated with

recurrent service delivery obligations. Furthermore, some investment expenditures generate

future operating costs that lead to further budget increases.

35. As a result of past excessive borrowing and high interest costs, debt service also

consumes a significant portion of Rio’s revenues. Projections indicate that Rio will

continue to pay the LRF cap of 13 percent of its net current revenues for debt service until

3 The LRF prevents highly indebted states to access credit operations, except for debt restructuring. The LRF

explicitly prohibits debt refinancing operations between different levels of government, which moderates the

moral hazard problem in intergovernmental fiscal relations derived from sequential bailouts. It also set limits on

personnel costs, credit operations, total debt, debt services, and guarantees. Under Senate resolutions 40 and 43,

borrowing is prohibited if: (i) consolidated net debt exceeds two times net current revenue (NCR); (ii) new credit

operations exceeds 16 percent of NCR and; (iii) debt service exceeds 11.5 percent of NCR. In addition,

borrowing is prohibited if it violates the debt reduction schedules set by the debt renegotiation contracts under

Law 9496, and issuance of subnational governments´ bonds is prohibited through 2020 for states with debt less

than their NCR and through 2025 for other states.

0%

2%

4%

6%

8%

10%

12%

-

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

2004 2005 2006 2007 2008 2009

% o

f To

tal

Exp

en

dit

ure

Tho

usa

nd

R$

Rio de Janeiro's Investments, 2004-09

Gross Capital Formation

Financial Investments

Gross Capital Formation (% of total expenditure)

Financial Investments (% of total expenditure)

13

2012. Assuming an annual real growth rate of 3.5 percent for municipal revenues, Rio will

begin to pay down the stock of residuals by 2011. Even if the debt path is declining, the large

debt service obligations prevent the municipality from new borrowing, unless it is for debt

restructuring.

36. Rio’s expenditure program is considered adequate for the purposes of the

proposed DPL. The evolution of revenues, expenditures, and fiscal balances from 2004 to

2008 indicates that Rio’s fiscal performance has improved. During this period, the primary

balance recorded average surpluses of R$348 billion and grew by 28 percent. In 2009, the city

generated a primary surplus of R$1.394 billion by drastically cutting gross capital investment.

The fiscal adjustment was based on the 19 percent growth in municipal revenues over the four

years. Revenue growth was mostly driven by increased Tax on Services (ISS) collections,

which in 2009 accounted for 44 percent of total revenues (see Figure 8). After 2006, revenue

growth accelerated with the faster growth in Brazil’s economy. The municipality was less

successful in controlling its current expenditures, particularly those related to wages and

salaries and goods and services. After tightly controlling expenditures from 2004 to 2006,

when they grew by a mere 3 percent, current expenditures ballooned from 2006 to 2008,

growing by 18 percent (see Table 3).

Figure 8: Revenue Decomposition as of 2009 (percent of Total Revenue)

Source: Secretaria Municipal de Fazenda.

Tax Revenue44%

Social Contributions

7%

Other Current Revenue

13%

ICMS10%

FUNDEB10%

SUS8%

IPVA3%

Royalties1%

Others4%

Capital Transfers1%

Transfers36%

Revenue Structure as of 2009- Transfers Composition -

Social Contributions

7%

Other Current Revenue

13%

Transfers36%

IPTU11%

ISS24%

ITBI3%

Impostos3%IRRF

3%

Tax Revenue44%

Revenue Structure as of 2009- Taxes Composition -

14

Table 3: Government Finance Statistics Figures, 2004–09

(In thousands of Reais)

Source: Secretaria Municipal de Fazenda, MoRJ, and staff calculations.

37. By 2009, the city’s macroeconomic and fiscal situation was sound and in

compliance with the prudential limits set out in the LRF. In fact, strong revenue

performance and debt reduction have allowed the municipality to improve in all indicators

monitored by the federal treasury under the LRF. These are related to personnel expenditures,

indebtedness, revenue collection, and debt services (see Table 3 and Table 4).

Table 4: Evolution of Fiscal Responsibility Law (LRF) Indicators

(R$ Thousand of 2009)

Source: Secretaria Municipal de Fazenda

38. Net consolidated debt significantly decreased from 79 percent of NCR in 2004 to

25.4 percent five years later. Although the outstanding consolidated debt decreased during

the period, the decrease in net consolidated debt has been reinforced by the increasing sales of

financial assets, which drastically reduced the stock of net consolidated debt (see Table 5).

2004 2005 2006 2007 2008 2009

I. REVENUE 9,527,430 9,109,707 9,506,243 10,405,360 11,248,365 11,471,969

Taxes 3,322,995 3,498,812 3,694,426 3,958,400 4,782,939 5,059,928

Social Contributions 624,442 626,059 685,066 725,444 787,267 793,059

Transfers 3,952,279 3,575,234 3,676,009 4,141,131 4,148,077 4,176,040

Other Revenues 1,627,713 1,409,602 1,450,742 1,580,385 1,530,083 1,442,943

II. EXPENSE 8,185,536 8,239,614 8,454,166 9,289,034 9,972,847 9,908,361

Compensation of Employees 3,580,714 3,689,421 3,824,790 3,932,621 4,496,238 4,372,848

Goods and Services 2,663,282 2,520,435 2,477,338 3,166,629 3,105,180 3,006,165

Interest Payments (paid) 544,765 567,366 590,656 597,807 615,614 679,796

Pensions 1,396,775 1,462,391 1,561,382 1,591,977 1,755,816 1,849,552

III GROSS OPERATING BALANCE (I - II) 1,341,894 870,093 1,052,077 1,116,326 1,275,518 1,563,608

IV. TRANSACTIONS IN NON FINANCIAL ASSETS 910,956 663,128 787,681 964,143 879,670 400,729

V.PRIMARY BALANCE (VI + Net Int. Payments) 439,419 247,238 314,781 293,350 519,614 1,393,988

VI. NET LENDING / BORROWING (III - IV) 430,938 206,965 264,396 152,183 395,849 1,162,879

VII. TRANSACTIONS IN FINANCIAL ASSETS AND LIABILITIES -17,196 -219,520 164,465 -298,543 -599,948 -265,844

New Loans 241,063 89,366 26,356 9,867 50,904 29,970

Amortizations net 216,063 228,551 265,641 255,968 250,426 272,086

Amortizations paid 285,098 303,077 347,032 343,257 358,769 376,697

Amortizations received 69,036 74,526 81,391 87,289 108,342 104,611

Asset sales 2,454 23,142 429,329 8,241 20,315 60,631

Financial Investments 44,650 103,476 25,578 60,683 420,739 84,359

TOTAL BALANCE (VI + VII) 413,742 -12,555 428,861 -146,360 -204,099 897,035

Legal

Limit

% NCR VALUE % NCR VALUE % NCR VALUE % NCR VALUE % NCR VALUE % NCR VALUE % NCR

Personnel Expenditures ≤ 60% 3,922,658 46.0% 4,416,367 52.5% 4,711,965 53.8% 4,465,594 46.8% 5,208,325 51.7% 5,153,217 49.5%

Of which Executive ≤ 54% 3,670,000 43.1% 4,143,600 49.3% 4,422,273 50.5% 4,171,445 43.7% 4,909,711 48.7% 4,842,724 46.6%

Of which Legislative ≤ 6% 252,658 3.0% 272,767 3.2% 289,692 3.3% 294,149 3.1% 298,614 3.0% 310,493 3.0%

Net Consolidated Debt ≤ 120% 6,736,566 79.1% 5,339,832 63.5% 4,527,698 51.7% 3,974,103 41.7% 4,844,328 48.0% 2,638,916 25.4%

Credit Operations Revenues ≤ 16% 241,063 2.8% 89,366 1.1% 26,356 0.3% 9,867 0.1% 50,904 0.5% 29,970 0.3%

Debt Services ≤ 11,5% 829,864 9.7% 870,444 10.3% 937,689 10.7% 941,064 9.9% 974,382 9.7% 1,056,493 10.2%

8,519,970 8,412,162 8,750,525 9,536,920 10,083,441 10,401,075

2009

Net Current Revenue (NCR)

Indicators2004 2005 2006 2007 2008

15

Table 5: Evolution and Composition of Net Consolidated Debt, 2004-09



Economic and Fiscal Impact of the Global Financial Crisis

39. The global financial crisis had some temporary effects on economic activity. The

growth rate of commercial activity fell 2 percentage points from the third to fourth quarter

2008, led by declining sales for cars and auto parts, construction material, and clothing. Retail

growth slowed, and industrial production growth dropped significantly due to poor results

from the metallurgic sector, the pharmaceutical industry, and the beverages industry.

40. However, the financial crisis had only a mild overall impact on the

municipality’s macro and fiscal situation. This is due to the fact that Rio’s tax revenues are

mainly based on services (ISS) and on real estate (IPTU), which were both resilient to the

crisis. Overall, tax revenues and social security contributions increased by 5 percent from

2008 to 2009, while current transfers remained at the same level. For instance, the state

transfers linked to the industrial activity (IPI-EXP) decreased by 19 percent in 2009, but they

account for only 0.7 percent of the transfers received by the municipality. Capital transfers,

which represent 1 percent of total revenues, decreased about 15 percent. Other current

revenues, which include interest revenues and the industrial and services revenues, which

amount to 13 percent of total revenues, experienced similar decreases.

41. Rio’s unemployment rates slightly worsened in the months following the crisis,

but they have stabilized and even improved with the midyear recovery. The city’s

unemployment rate had been steadily improving prior to the crisis, falling from 8.3 percent in

2002 to about 5 percent in 2008. With the crisis, the rate increased for a few months before

resuming its downward trend. Overall, the employment rate has been more resilient in Rio

than in the rest of Brazil.

42. In 2009, the municipal government cut capital expenditures. Two main reasons

motivated this decision: First, upon taking office in January 2009, government authorities

froze expenditures and investment to allow time to review current outlays and elaborate a

municipal strategic vision. Second, in anticipation of potential adverse effects from the global

crisis, the administration reduced capital expenditures. This allowed the administration to

generate a primary surplus. Only debt service and personnel expenditures continued to

increase. During the period, primary revenues rose 5.8 percent and primary expenditures

increased 1.8 percent.

2004 2005 2006 2007 2008 2009

Consolidated Debt (I) 10,455,412 9,881,702 9,723,694 9,479,292 10,055,560 9,094,454

External Debt 1,041,423 895,162 760,397 563,297 762,693 504,487

Domestic Debt 9,413,989 8,986,540 8,963,297 8,915,995 9,292,867 8,589,967

National Treasury (STN) 8,337,338 7,953,979 7,872,718 7,898,351 7,965,554 7,246,925

Banks 182,273 162,773 147,929 128,678 149,365 146,262

Other Debts 894,379 869,788 942,649 888,966 1,177,947 1,196,780

Financial Assets (II) 3,718,846 4,541,870 5,195,996 5,505,188 5,211,232 6,455,538

Net Consolidated Debt (I)-(II) 6,736,566 5,339,832 4,527,698 3,974,103 4,844,328 2,638,916

Net Consolidated Debt/ Net Current Revenues (≤ 120%) 79% 63% 52% 42% 48% 25%

16

C. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY IN THE

MUNICIPALITY OF RIO DE JANEIRO

Macroeconomic Outlook for 2010–14

43. Rio’s medium-term and projected fiscal accounts show sustainable trends, and

the macroeconomic framework is adequate. Tax revenues and current transfers are

expected to be strong in 2010–14 because the municipality’s economy relies mainly on

services. Revenues driven by the tax on services (ISS) were resilient in 2009 and are projected

to keep growing for 2010-14. ISS administration is improving collections and will continue to

do so with the implementation of an electronic fiscal invoice (NFE). A user charge on public

lighting will bring significant additional revenues. On the expenditures side, however,

intrinsic rigidities related to personnel expenditures will continue to increase from previous

years, and gross capital formation will resume after 2009. Overall, fiscal balances are

expected to fall in 2011 as investment begins to recover, and they become increasingly

sustainable from 2012 onward (see Table 6).4

Table 6: Rio de Janeiro, Fiscal Projections, 2010-2014


Source: WB Staff estimates

Figures adjusted by the Consumer Price Index (IPCA)

44. Fiscal revenues are expected to be driven by tax receipts—in particular, the levy

on urban land and property (IPTU) and the ISS—and by current transfers, especially

4 These projections do not include the outcome of the proposed DPL operation.

2009 2010* 2011* 2012* 2013* 2014*

I. Total Revenue 11,471,969 11,957,152 13,006,262 14,133,084 15,353,467 16,675,532

Tax Revenue 5,059,928 5,661,726 6,249,025 6,884,495 7,574,675 8,324,431

Social Contributions 793,059 849,366 905,339 965,001 1,028,594 1,096,379

Other Current Revenue 1,442,943 878,231 917,751 959,050 1,002,207 1,047,306

Transfers 4,176,040 4,567,829 4,934,147 5,324,539 5,747,991 6,207,416

Current Transfers 4,055,356 4,440,508 4,801,096 5,185,501 5,602,696 6,055,583

Capital Transfers 120,684 127,321 133,051 139,038 145,295 151,833

Memo Items:

Net Current revenue 10,401,075 10,788,747 11,785,279 12,857,157 14,020,123 15,282,188

II. Total Expenditures 9,908,361 10,080,709 10,440,646 10,838,203 11,385,179 11,951,046

Employee Compensation 4,372,848 4,364,631 4,652,260 4,958,844 5,285,632 5,633,955

Goods and Services 3,006,165 3,156,473 3,298,514 3,446,947 3,602,060 3,764,153

Interest Payments 679,796 784,106 674,408 598,421 551,696 540,898

Transfers - - - - -

Pensions 1,849,552 1,775,499 1,815,464 1,833,990 1,945,792 2,012,040

III. Gross Operating Balance 1,563,608 1,876,443 2,565,617 3,294,882 3,968,288 4,724,487

IV. Investment in Non-Financial Assets 400,729 883,171 2,014,497 2,889,478 3,471,881 3,901,347

V. Primary Balance 1,393,988 1,306,256 733,206 489,349 510,474 802,217

(Primary Balance / NCR) 13% 12% 6% 4% 4% 5%

VI. Net Lending / Borrowing (Overall Balance) 1,162,879 993,272 551,120 405,404 496,406 823,140

17

those from the state, such as the ICMS and FUNDEB.5 The economies of Rio state and

Rio municipality are both heavily based on services, with industries accounting for only a

small share of GDP. This explains why the state transfers and the ISS tax are the sources of

growth of municipal revenues and why the state and the municipality’s economies were

resilient during a financial crisis that affected mainly industrial activity.

45. The liquidity gains and cost reductions from the debt restructuring of 20

percent of the municipality’s debt with the federal government would amount to about

R$1 billion in interest savings for the next three years, providing significant fiscal space

for financing capital expenses. In addition, the reforms supported by the operation will lead

to improvements in the ―above the line‖ variables—such as increased total revenues from the

tax measures and decreased interest, personnel, pensions, and operating expenditures.

Revenue increases and expenditure containment will further strengthen the municipality’s

medium-term fiscal consolidation and investment strategy.

46. Discovery of the Pre-Sal oil reserves will bring modest revenues to the city. Oil

parcels off the Brazilian seacoast near Rio de Janeiro and São Paulo have fueled speculation

about new sources of revenue as well as new revenue-sharing rules for the state, federal, and

municipal governments. In reality, the situation is very complex and subject to many

uncertainties. Therefore, the team chose to be conservative and account for only modest

revenues from Pre-Sal in the medium-term budget.

47. The legislation governing oil revenue may change to the detriment of the city.

Under current rules, Rio as an oil-producing municipality is entitled to royalties and special

participation rights for exploited fields and to federal and state transfers related to the oil

revenues. Although royalty revenues are shared among the Brazilian states, municipalities, the

National Treasury, public R&D funds and others, these rules, if left in place for the new

fields’ production, would double or triple Rio’s current oil revenue. However, the revenue-

sharing rules are under tough political negotiations at the federal and state levels, which could

expand the number of beneficiary states and municipalities and significantly reduce the share

allocated to Rio.

48. Other states and municipalities may receive a greater share of oil revenues. In

March 2010, the Brazilian House of Representatives approved an amendment to the oil-

reform bill that would force the three largest oil-producing states—Rio de Janeiro, Espirito

Santo, and São Paulo—to share more revenue from new fields with other states. The new

royalty revenue sharing system could potentially cause a revenue loss of almost R$5-7 billion

to Rio state. This potential drop in the state revenue would reduce transfers to Rio

municipality. In addition, the new revenue-sharing rule would also potentially reduce the

city’s direct oil revenue. The reform proposal now goes to the Senate for passage, months

before the start of the presidential campaign. If vetoed, the division of royalties will follow the

current methodology. Under it, states and municipalities that do not produce oil or are not

affected by loading and unloading of the product would only share 7.5 percent of revenue.

5 A detailed discussion on the fiscal assumptions is available in Annex 5.

18

Risks and Vulnerabilities

49. The main medium-term macroeconomic risk affecting the fiscal balances is

related to continued increases in personnel expenditures and pension deficits. On the

expenditure side, salary growth is the main driver of government expenses, including the

pension benefits that are based upon the latest salary. This suggests that controlling current

personnel expenditures and salary adjustments is important to strengthening fiscal balances.

Pension expenses also affect the sustainability of the fiscal balances, especially with Rio’

aging population.

50. On the revenue side, some fiscal components are rigid. Most sensitive would be

items that are service-driven, such as ISS taxes and ICMS transfers. However, the service

sector is expected to grow steadily. The recent financial crisis has demonstrated the strong

resilience of the economy to external shocks.

51. Risks related to oil revenue stem from the price of oil traded in international

markets. Oil production is expected to remain stable and then increase as new fields enter

into production. Such price fluctuations benefitted Brazil during the commodities boom of

2007-08. However, the global financial crisis depressed commodity prices, and royalty

revenues decreased from R$178 million in 2008 to R$122 million in 2009.

52. The upcoming Olympic Games in Rio de Janeiro are not expected to have a

negative effect on the municipality’s fiscal position. The federal government is partnering

with the state and municipal governments in financing the capital investment projects (see

Table 7 and Box 1). Unlike other recent Olympic Games, the budget will be guaranteed by the

Federal Government, not by the private sector. Therefore, any additional costs would fall

neither on the state nor on the municipality.

53. The Olympics are accelerating the execution of the existing development strategy. The municipality is undertaking infrastructure projects that are integral to its development

strategy, such as the Rapid Transit Bus lanes that will benefit the Olympics. Moreover,

funding from the federal government will partly finance this project. Thus, the incremental

investment expenditures associated with the Olympic Games are expected to be only a small

fraction of the city’s capital expenditures over the next four years. Table 7 details the capital

expenditure schedule from 2009 to 2013, including the share of Olympic expenditures. Other

expenses, such as security, are of the state’s responsibility.

Table 7: Rio de Janeiro, Capital Expenditure by Sector, 2009-13 ( percent ot total expenditure)

SECTOR SOURCE OF FINANCING 2009 (Actual) 2010 (Budget) 2011 2012 2013

HEALTH AGREEMENT AND CREDIT OPERATION 2% 14% 4% 0% 0%

OTHER SOURCES 98% 86% 96% 100% 100%

3% 8% 5% 9% 6%

EDUCATION AGREEMENT AND CREDIT OPERATION 0% 2% 3% 4% 3%

OTHER SOURCES 100% 98% 97% 96% 97%

12% 6% 6% 7% 14%

INFRASTRUCTURE AGREEMENT AND CREDIT OPERATION 73% 60% 55% 51% 24%

OTHER SOURCES 27% 40% 45% 49% 76%

76% 66% 71% 69% 61%

OLYMPIC GAMES AGREEMENT AND CREDIT OPERATION 25% 33%

OTHER SOURCES 75% 67% 100% 100%

0% 2% 5% 1% 0%

OTHER AGREEMENT AND CREDIT OPERATION 16% 62% 75% 72% 74%

OTHER SOURCES 84% 38% 25% 28% 26%

9% 18% 13% 13% 20%

100% 100% 100% 100% 100%

OTHER Total

TOTAL

CAPITAL EXPENDITURE BY SECTOR, 2009-13

HEALTH Total

EDUCATION Total

INFRASTRUCTURE Total

OLYMPIC GAMES Total

19

Box 1: Fiscal Impact of the Olympic Games in Rio de Janeiro in 2016a

The financing of the 2016 Olympic Games is covered by two budgets. The one for the Organizing Committee for

the Olympic Games (OCOG) includes all expenditures directly related to the games, such as the opening and

closing events. The non-OCOG budget is the responsibility of the federal, state, and municipal governments.

It covers public and private investments to build new sports venues and infrastructure works, including

airport expansion, transport improvements, and other operations (See Table 7).

The total OCOG budget is US$2.8 billion, with 31 percent from the International Olympic Committee (IOC), 45

percent from such private sources as marketing, ticket sales, and licensing, and 24 percent from the three levels

of government. Hence, conservative estimates show that the state, federal, and municipal governments need to

cover US$700 million, or US$233 million each.

The total non-OCOG budget is US$11.6 billion, with 34 percent allotted to projects already under way, 35

percent to projects already planned, and 31 percent to new projects.

The city’s expected total cost is approximately US$4 billion for 2010–16, which represents an average increase

of approximately 4.2 percent in total expenditures. Financing will be covered by loans from the Federal

Government.

Among the investments associated to the Olympic Games, the City will be in charge of the improvement of the

new Rapid Transit Bus lanes and new rail systems, both of which will be financed in a large extent by the

Federal Government. This project, which would contribute to the city’s growth, is expected to be implemented

through 2012. It is worth noting that the Rio will host one site of the 2014 FIFA World Cup, which will

accelerate the development of transport infrastructure well before 2016. Most of the sport venues will also be

paid by the Federal Government. The other major expenses are related to security (investments that will remain

after the games) and improvements in environmental management.

Source: http://www.rio2016.org.br/en/.

Fiscal Responsibility Law Indicators Projections

54. The main LRF indicators show a sustainable path for 2010–14. Personnel

expenditures as a share of net current revenue (NCR) are assumed to grow in line with the

personnel growth rate and the IPCA inflation rate (see Figure 9). Projections indicate a slight

increase after 2010—but remaining below the limit of 60 percent of NCR. The net

consolidated-debt-to-NCR indicator is expected to decrease from 2010 onward. The decline is

driven by projected surpluses in the overall fiscal balance, including net interest payments and

an NCR growth rate higher than the IGP inflation rate, which corrects the outstanding debt

stock. The jump projected for the net consolidated-debt-to-NCR indicator in 2010 results from

a conservative assumption that foresees no sales of financial assets. Given the amortizations

and the interest payments profile, debt service as a share of NCR follows a sustainable path,

with no major debt principal repayments expected for the next five years. (See Annex 5 for a

detailed analysis.)

http://www.rio2016.org.br/en/

20

Figure 9: Fiscal Responsibility Law, 2004-14

Source: WB Staff estimates, Municipal Secretariat of Finance

III. THE GOVERNMENT’S PROGRAM AND PARTICIPATORY PROCESSES

A. THE GOVERNMENT PROGRAM

55. The administration that took office in January 2009 won the municipal elections

on a platform of three main pillars: maintaining fiscal responsibility, implementing a

public sector modernization reform, and promoting private-sector development. Those

pillars support the administration’s objectives of guaranteeing equal opportunities for Rio’s

children and young people by improving public service delivery. The administrative reform

agenda is embodied in its multiyear plan, which focuses on actions and programs that will lay

the foundations of improved public service delivery and foster growth.

56. In addition, the new administration immediately confronted challenges related

to controlling expenditures in the face of the global financial crisis. Under the previous

administration, personnel and operating expenditures had grown considerably between 2006

and 2008. So had interest expenditures, with 90 percent of debt at 9 percent plus IGDP-DI, a

very volatile price index.

57. The municipal government’s response was to: (a) seek support from the World

Bank and the National Treasury to set up a debt-restructuring operation that would decrease

the interest costs and create fiscal space for investment; (b) implement a short-term fiscal-

adjustment program based on aggressive expenditure cuts in operating costs, longer-term

revenue collection, and pension benefits reductions;6 (c) implement innovative programs to

reform service delivery in poor and high-conflict areas; (d) reorganize and modernize the

municipal public administration system to introduce results-based management tools to

increase the quality and efficiency of expenditures as well as project units to monitor the

6 The government generated R$1.6 billion in primary surplus between January and April 2009, and Rio had the

best relative performance among all Brazilian Federation Entities on operational expenditures control.

0%

20%

40%

60%

80%

100%

2004 2005 2006 2007 2008 2009 2010*2011*2012*2013*2014*

% o

if N

et

Cu

rre

nt

Re

ven

ue

Fiscal Responsibility Law, 2004-14

Personnel Expenditure (≤ 60% of NCR)

Net Debt Consolidated ( ≤ 120% of NCR)

Debt Services (≤ 11,5% of NCR)

21

implementation of projects; and (e) partner with the private sector in the financing of

infrastructure investment and provision of public services through PPPs.

A-1 Fiscal Adjustment

58. The government’s program is focused on fiscal adjustment. First, Rio’s proposed

debt restructuring, would open fiscal space with interest expenditure savings and

improvements in the debt-service profile. Second, DPL-supported reforms on social security

and personnel expenses would contribute to increasing fiscal space for investments. Third, the

continuity and strengthening of the municipal tax revenue performance would reinforce the

expansion of fiscal space and foster growth.

Debt restructuring

59. The city’s high debt-service obligations affect the fiscal space available for

investment. Debt-service obligations represent more than 13 percent of the city’s real net

revenue. The high debt service stems from lax fiscal managements in the 1980s and 1990s,

which led to accumulation of public debt and federal bailouts.7 The bailouts’ terms are quite

expensive because of indexing to a volatile price index (IGP-DI) that makes the profile of

debt payments uneven. This has consequence for Rio’s fiscal space in the sense that any

accumulation of debt-service obligations reduces the availability of resources for investments.

60. The Federal Government would reduce the interest rate the Treasury charges

municipalities and states on their debt following a partial repayment. A legal measure

known as MP Nº 2,185-35 established the terms of the debt agreement between the Treasury

and municipalities and states. The refinancing period was set at 30 years, and the interest rate

was set at 9 percent plus inflation. The measure allows a reduction in the inflation-indexed

interest rate to 7.5 percent plus inflation if the state or municipality prepays 10 percent of its

outstanding debt stock with the Federal Government, or to 6 percent plus inflation if the

prepayment reaches 20 percent. Since taking office, Rio’s administration has taken steps to

seek a debt restructuring operation under the federal law.

61. The city is improving its debt management processes to further reduce its

exposure to interest rate, currency, fiscal, and financial risks. The reforms would allow

Rio to fund its expenditures in a timely manner and meet its obligations as they fall due

without maintaining too-high idle balances or running undue operational, credit, or market

risks. These measures could lead to increased credibility as obligations are met on time.

62. The municipality is strengthening its institutional capacity on debt and cash

management by supporting the municipal Treasury in three ways: (a) revising the

organizational structure to include a function to analyze the portfolio financial risks and

prepare strategies for managing assets and liabilities; (b) designing and implementing

integrated systems for debt recording and cash management to enhance the security and

7 As a result of the debt-restructuring operations of 1997 and 1999, the federal government became the main

creditor for 90 percent of Rio’s total public debt. Debt servicing on the refinanced debt, the so-called intralimite

debt, was capped at 13 percent of a municipality’s net revenues, defined as current revenues net of earmarked

revenues (Receita Líquida Real, RLR). Any debt service above the 13 percent cap was deemed residual and was

automatically recapitalized and added to the intralimite debt stock. Any residual debt balances at the end of the

contracts—in 2028 for states and 2032 for municipalities—were to be paid off in 10 years.

22

efficiency of data capturing and information sharing; and (c) training the staff involved in

debt and cash management to develop the necessary skills to undertake risk analysis, quantify

cost-risk tradeoffs, and prepare proposals for managing Rio’s assets and liabilities. These

measures will enable the development of analytical and strategic functions needed in the

municipal Treasury. They will also allow the municipality to better evaluate alternatives to

consolidate the management of its assets and liabilities.

Consolidating fiscal adjustment

63. Fiscal-adjustment rigidities in expenditures and revenues further contribute to

the reduction of the city’s fiscal space for investment. About 80 percent of municipal fiscal

revenues are allocated to mandatory expenses. The proliferation of revenue-earmarking

mechanisms on the revenue side (mainly for the education and health sectors) introduces

rigidities that further reduce the space for discretionary outlays in general and investment

spending in particular.

64. The reduced fiscal space is associated with the deterioration of municipal

service delivery, affecting efforts to reduce poverty and inequality. Incidence analyses of

public services indicate that reduced fiscal space will affect the quality of public service

delivery, particularly in poor areas. For instance, the inability to expand and improve the

quality of family health care and education services for younger residents is a factor that will

contribute to worsening income distribution in the future.

65. Expanding the city’s fiscal space would create room for sustainable investment

in improving the quality of public services, especially in poor and vulnerable areas, and

modernizing public-sector management. Restructuring Rio’s debt would be a first step in

achieving fiscal sustainability in the medium and long term. Fiscal sustainability will further

require the city to adopt strong, consistent, and continuous fiscal-adjustment measures, such

as those supported under the proposed operation. Those efforts include reducing the pressure

of current and personnel expenditures on the city’s finance finances and improving tax

revenue performance.

66. Achieving lasting fiscal sustainability will depend to a large extent on a strong

revenue performance that comes with faster growth. The government is adopting

measures to increase tax revenue. Given the restrictions on raising tax rates, these actions are

concentrated on improving tax collection’s efficiency. Other measures supported by the

proposed operation will contribute to laying the foundations for economic growth and foster

future revenue growth.

67. The DPL-supported measures focus on three fronts: (a) improving capacity for

taxpayer surveillance through the introduction of modern tax-evasion detection tools and the

integration of economic and fiscal databases; (b) enhancing the recovery of taxes in arrears

through the simplification of processes; and (c) re-establishing a user fee for public lighting as

a new user charge financing source.8 In addition to its revenue effect, the user charge has a

progressive nature because rates will vary according to private electricity consumption. Initial

8 This public illumination charge was adopted by several municipalities in 2004. However, the Supreme Court

declared it unconstitutional because it was not included in the tax code. In 2007, the national Congress approved

a complementary tax regulation allowing municipalities to impose this charge.

23

steps have been taken to implement these measures, and all the improvements will be

complemented by the introduction of results-based management tools that establish targets for

tax collections and the three other initiatives.

68. On the expenditure side, the fiscal-adjustment effort would be focused on

tightening control of operating costs and personnel expenditures. After taking office, the

current administration enacted several immediate measures to rein in spending on active staff.

These are: (a) a 30 percent reduction in the number of positions to be filled by political

appointments (cargos comisionados); (b) the elimination of the permanent incorporation into

salaries of commissions earned by direct public civil servants while working on indirect

administration; and (c) the revocation of a decree linking increases in salaries to increases in

the minimum wage. Going forward, Rio has proposed additional measures to curb personnel

expenditures, such as conducting an audit of the payroll bill, further reducing commissioned

positions, and implementing tougher controls on payroll management to reduce the incidence

of fraud or clerical errors that result in overpayments to staff members. Other potential

avenues for limiting personnel expenditures under consideration are related to better planning

of the workforce needed by the government to avoid overstaffing or higher salaries than

needed to attract, retain, or motivate personnel. Some of these measures would be

implemented prior to the DPL’s second tranche.

Pensions

69. Rio has an already mature system, with a ratio of pensioners and survivors to

active employees at 76 percent. This dependency ratio is much higher in Rio than in Brazil’s

other state capitals—an average of 43 percent—and states—an average of 55 percent—and it

is not all that far below the Federal Government’s 87 percent. The situation will be even more

delicate in the future because population aging tends to make the dependency ratio even

greater.

70. Rio is in the process of adopting some provisions mandated by federal law.9 The

city’s ability to reduce its pension obligations is governed by national limits on the scope for

pension reforms, laid out in Constitutional Amendment 41 of 2003. The basic rules regarding

eligibility, benefit formulas, pension indexation, and contribution rates are established either

in the federal Constitution or in federal laws.

71. Adopting reforms, including those laid out in the federal Constitutional

Amendment 41 would result in strong fiscal savings for the city. Those measures are

related to: (a) the benefit formula for pensions, which should be based on the average wage,

not on the worker’s last wage; (b) the inclusion of benefits based on inflation, and (c) the

correct replacement rate for survivor benefits should be at a marginal replacement rate of 70

percent above the Regime Geral de Previdência Social (RGPS) threshold, not 100 percent.

Rio also has a benefit for surviving single daughters that is not consistent with current

practices. The benefit was stopped in 2003; however, a pool of 2,800 single daughters is still

receiving it. The city is currently applying the correct eligibility conditions to teachers vis-á-

vis the Constitutional Amendment. Executing all these reforms would allow the municipality

to obtain a certificate of compliance with the pension legislation, issues by the federal

9 This section is based in large part on the report, ―Diagnostic of the Pension Systems of the Municipality of Rio

de Janeiro,‖ by Marcelo Caetano and Mario Rattes, and contributions from Bill Dillinger.

24

government (CRP, Certificado de Regularidade Previdenciaria). Not having the CRP would

imply a cessation of transfers from the federal government to the municipality. Currently the

city holds a judicial decision that allows it to receive transfers from the federal government

without having a CRP.

72. The city is exploring measures to reduce pension costs through administrative

reforms aimed at improving asset management and a proposed audit of the wage and

pension bill. The administrative measures under consideration include reforms to capitalize

the pension fund (FUNPREVI) including through future flows of royalties to be received by

the municipality, from the municipality real estate portfolio, or other equivalent measures. On

the asset-management side, the city is considering investing in technology for a new payment

system for pensioner and retiree benefits and a new database control system. Rio is improving

its investment policy by creating an investment controlling committee and elaborating

corporate governance strategy to improve the corporate governance of the pension fund. The

audit will be conducted in conjunction with the audit of active public servants, and it may turn

up significant numbers of people receiving payments for which they are not eligible.

A-2 Service Delivery Innovations

Business environment

73. One of the municipality’s main challenges is to improve the business

environment, including by reducing the excessive bureaucracy and discretion companies

experience in dealing with the government. In a Doing Business survey conducted at the

subnational level in Brazil in 2006, Rio ranked next to last among 13 municipalities in terms

of the ease of doing business locally (see Figure 10). In particular, company registration is one

area in which the city could improve. This has consequences on the business environment and

a firm’s decision to operate in the formal economy.

Figure 10: Rio de Janeiro Doing Business Report 2006

Source: Doing Business in Brazil (2006)

74. Seeking to take advantage of opportunities provided by the international events

taking place in Rio, such as the FIFA World Cup and the Olympic Games, the new

administration has a strategy for a more efficient business registration process that

would improve competitiveness and foster economic growth. As a first step, the

municipality has begun to address the cumbersome procedures needed to register a business.

This project, called Alvará Já, was initiated by Decree No. 30.568 on April 2, 2009, and it

will simplify registration and issuance of business licenses for activities with low sanitary risk

19

25

30

35

41

41

44

44

47

49

68

68

152

Minas Gerais

Bahia

Rondônia

Rio Grande do Sul

Mato Grosso do Sul

Mato Grosso

Santa Catarina

Ceará

Maranhão

Federal District

Amazonas

Rio de Janeiro

São Paulo

Number of Days needed to start a business

25

and/or environmental impact. The web portal for businesses to apply for licenses was

unveiled on September 8, 2009.

75. In addition to the Alvará Já, the municipal government is working to integrate

its business registration systems with organizations at the national and state levels. Rio’s

government is committed to joining the Integrated Registration System (REGIN) by 2010.

This reform will facilitate centralization of the registration process to minimize the number of

steps and time it takes for businesses to register and be licensed with the various levels of

government that regulate business activity in Brazil.

Health

76. Upon taking office, the current administration diagnosed three major

challenges facing Rio de Janeiro’s health system: (a) the lack of coverage and quality for

primary health care services, which interferes with meeting the poorest neighborhoods’ needs;

(b) poor management of hospitals and health facilities, which has led to inefficient use of

resources; and (c) chaotic organization of emergency services in municipal hospitals.

77. Rio state has 25 UPAs in operation, 16 of which are located in Rio City and 9 in

other municipalities. From 2007 to January 2010, these UPAS handled 4 million medical

treatments. By 2010, the state government expects to build 18 more UPAs, with the potential

to cover 2.4 million inhabitants in the city of Rio. 10

78. To increase efficiency, the municipal government is organizing a new Health

Management System based on social organizations. In an attempt to increase efficiency

and accountability and improve health outcomes, new public hospital and health unit

management models have been established in many of Brazil’s states and municipalities since

the 1990s. Experience so far has shown that public hospitals and health units under

autonomous management perform better than those run directly by the government. This

model was adapted recently to the municipal public administration environment and will be

used in several sectors, including health and education. Municipal Law Nº 5026 (May 19,

2009) authorized the city government to establish management contracts with social

organizations (OS) and defined the context in which these contracts will operate. The

municipal legislation defined OS as private nonprofit institutions that administer their own

assets, have managerial and financial autonomy, and develop an internal audit system.

79. To address these challenges, the government has developed a set of measures.

The main policies focused on primary health care are designed to: (a) increase the number of

family health teams, prioritizing the poorest neighborhoods that are without access to

adequate primary care; (b) create infrastructure for primary care by remodeling existing

facilities and building new Primary Health Care Centers (called Clínicas de Família) in these

areas and; (c) improve access to urgent and emergency care by building Emergency Care

Units (Unidades de Pronto Atendimento, or UPAs). All these policies have been developed

under the umbrella of the Saúde Presente project.

10

From January 2007 to June 2009, Rio state created 25 UPAs. Those areas include Iraja, Santa Cruz, Bangu,

Campo Grande, Belford Roxo, Tijuca, Duque de Caxias Ricardo de Albuquerque, Botafogo, Cabuçú, Marechal

Hermes, Vila Sarapuí, Ilha do Governador, Barra Mansa, Jacarepaguá, Penha, Campo Grande II, Realengo e

Engenho Novo.

26

80. Finally, to improve hospital urgent and emergency services, the Municipal

Health Secretary (SESDEC) is testing new processes by: (a) introducing patient risk

classification at the hospital’s check-in area, and (b) using the unit-dose medication system in

hospitals’ urgent and emergency care operations.

Education

81. Rio’s school performance, measured by student learning levels, grade

repetition, and dropout rates in primary school, is above average for municipal school

systems across Brazil. The city’s educational performance is also significantly better than the

Rio state system. However, Rio municipality lags other large public school systems in the

southeast and south of Brazil, which are comparable to Rio in terms of per capita incomes and

local resources. Average repetition rates in the Rio municipal system, for example, are well

above those for São Paulo, Curitibá, and Belo Horizonte.

82. Between municipal, state, and private providers, educational availability at the

primary school level is universal; however, preschool coverage, where the city has

exclusive public responsibility, is limited and day-care services are not available to many

infants and young children. The municipal system serves 705,659 students in 1,063 primary

schools, 253 city-run crèches, and 159 registered day-care facilities that are publicly funded

but managed by private-for-profit or NGO entities. Approximately 80 percent of municipal

enrollments are in primary schools (grades 1–9); 16 percent are in preschools (for children

aged 4–5 years) or day care centers (for children aged 3 months to 4 years); and 4 percent are

in evening adult literacy programs.

83. Upon taking office, the new administration conducted a comprehensive study

that identified a number of core educational challenges: (a) poor student learning

performance, revealed in weak literacy and math scores on the national Prova Brasil exam and

the municipality’s specially designed achievement tests; (b) extraordinary difficulties faced by

schools in high-crime urban neighborhoods; and (c) tremendous unmet social demand for

preschool and day-care services, which are a municipal responsibility.

84. Based on the results of the study, the Municipal Secretariat of Education (SME)

has moved impressively in the administration’s first year to craft and implement major

new initiatives in all three areas. They have the potential to transform the education system

and make it a model for many other municipalities in Brazil. The focus of the SME’s efforts

to improve student learning outcomes has been strengthening the teaching of literacy skills in

the early grades and helping older students with weak skills catch up. Priority and innovative

programs include: (a) Reforço Escolar—the establishment of new curriculum standards and

learning materials for core subjects aimed at helping teachers deliver a more challenging

curriculum more effectively; (b) Escolas do Amanhã—a comprehensive package of targeted

support to 150 schools in the most disadvantaged areas, seeking to create both state-of-the-art

educational institutions and community centers; (c) Espaços de Desenvolvimento Infantil

(EDIs)—a new model for primary care that integrates crèches and preschools and offers

health services; (d) Literacy courses—intensive remedial literacy programs, delivered in

partnership with a private foundation, targeted to the large number of fourth, fifth and sixth

grade students who have scored as functionally illiterate on the SME’s diagnostic tests; and

(e) Universidade Virtual do Educador Carioca—―on-demand‖ online courses and peer

tutoring to improve the effectiveness of teachers in service. Moreover, the SME has created a

27

rigorous impact evaluation system to make sure a timely and reliable feedback mechanism is

in place (see Section IV.B Implementation, Monitoring and Evaluation for details).

A-3 Public Sector Management

Modernizing and strengthening public-sector management

85. The new administration faces three major challenges related to public sector

management: (a) a weak planning-budgeting system that lacks strategic focus on priorities:

(b) a poor management system that does not efficiently allocate public expenditures or

adequately monitor progress in the implementation of the municipality’s strategic projects: (c)

a lack of performance-based management tools undermines attempts to increase the quality of

expenditures and public-service delivery; and (d) fragmented and less competitive

procurement methods that hinder the government’s ability to achieve greater economies of

scale. In addition, an overly complex organizational structure, cumbersome administrative

procedures, fragmented services, and inadequate instruments to monitor performance

constrain the efficiency of the municipal public administration. As a result, the municipal

government has not been fully successful in meeting the population’s needs and in fostering

development.

86. Addressing these challenges will require transforming the municipal public

administration into a more efficient and results-oriented institution. The new

administration reorganized planning and budgeting in Casa Civil, which is in charge of

implementing and operating a results-based management system. This provides clear political

and technical leadership.

87. Rio can learn from Brazil’s vast and rich federal and state experience in public-

sector management. In the late 1990s, the federal government initiated the modernization of

its planning framework, better linking it to fiscal realities, budgeting, and results-oriented

management of public programs. Since then, a number of states and municipalities have

initiated similar efforts.

88. Rio’s city government has been able to quickly adapt these experiences. Supported by McKinsey & Company consultants, Casa Civil (the office of the chief of staff of

the municipality) developed a strategic plan setting out the priorities for the next four years.

Movimento Brasil Competitivo and Fundação Brava11

sponsored McKinsey’s work. For each

of 10 priority areas, the government identified its main challenges, key projects, outcome

indicators and targets, and important milestones. This strategic plan will serve as a means to

focus both financial and human resources on the government’s priorities. The government

also intends to implement the first steps of a Medium Term Expenditure Framework (MTEF)

as a means to two ends—increasing and ensuring consistency among different planning and

budgeting instruments and fostering a more informed debate over strategic priorities and

resource allocation across and within sectors. As a critical first step, the government would

prepare a comprehensive medium term costing (and projected annual incidence) of planned

expenditures, in particular capital investments, their related operational costs, and other

expected expenditures associated with major sporting events in 2014/16. In tandem, the

government would prepare an associated realistic financing plan including all anticipated

11

Foundations created by the nation’s top business groups to promote improvements in public sector

management in the country.

28

funding sources: own revenues, transfers, borrowing, and any special support modalities,

including from higher levels of government. Put together, these two elements would ensure

medium term sustainability of expenditures, especially as Rio looks to host a series of major

international events. This exercise would ideally be repeated on an annual basis in order to

inform annual budget preparation.

89. Leveraging the lessons of other states and municipalities allowed the

municipality to introduce a results-based management system to foster performance

improvements in public administration and monitor progress towards the strategic

plan’s goals. The city designed new management procedures and tools to provide a

systematic and strategic approach to achieving development goals. For instance, Rio

established a Project Management Unit, modeled on those set up by Brazil’s most innovative

state governments. It provides support to line agencies in planning project execution,

monitoring project execution, and providing project management training. Moreover, the

municipality has implemented some key accountability provisions for management and

execution has been clarified with the designation of a manager for each project. Going

forward, the municipality intends to further develop and introduce procedures for the

evaluation and selection of investment projects, with the goal of increasing their relative

efficiency. The municipality aims to strengthen the quality of project preparation to support

subsequent timely and cost-effective implementation and completion.

90. Rio quickly adopted results agreements to provide both formal and informal

incentives for achieving development goals. Formatted as quasi-contracts, the results

agreements are meant to be a key managerial instrument to focus government agencies on

desired outcomes. In signing the agreements, the mayor commits to providing the secretariats

with sufficient resources to implement the strategic projects, and he grants management

autonomy over how to achieve the results. As a key formal incentive, attainment of targets

triggers the payment of bonuses to public servants. Informal incentives are also in place, such

as peer pressure among secretaries and informed dialogues between the secretary and mayor

on development goals and priorities.

91. Finally, to increase its efficiency, Rio is improving the institutional

arrangements for procurement. Rio’s objective is to better manage and monitor

procurement performance in an environment where procurement operations are highly

decentralized—i.e., each government entity or agency is responsible for its own procurement.

In early 2009, the municipal government decided to expand the use of electronic reverse

auctions as a procurement method (pregão eletrônico) to register prices under framework

agreements for the supply of common goods and services (known as the price registration

system). Decree N° 30.354 mandates that electronic reverse auctions processes should

account for 75 percent of all procurement processes carried out in 2009. At the same time, the

municipal government has been centralizing procurement of common goods and services.

Decree N° 31.539 (3/17/2009) requires all government entities and agencies to provide the

Municipal Secretariat of Administration (SMA) with their annual plans for the procurement of

common goods and services. After review, the SMA will group similar items into packages

and go out to bid these packages on behalf of all entities and agencies. This centralized, more

rational approach to the procurement of common goods and services has the potential to

generate economies of scale. For this approach to be successful, however, good management

of procurement processes and of stocks—a goal supported by the proposed DPL—is essential.

29

Therefore, a necessary next step is for the municipal government to develop a good

management system.

Increasing service provision through Public Private Partnerships

92. Rio is embarking on a vast program over the next seven years to provide

infrastructure and services that will be crucial for economic growth. Public-Private

Partnerships (PPPs) are expected to play an important role by increasing private participation

in the financing and operation of infrastructure, social assets, and public services. The main

planned projects are in the areas of transport (i.e., the expansion of rapid bus transit systems)

and sanitation. The city plans to use the existing federal law for PPPs to govern such

partnerships. The legislative assembly has just passed a municipal law on PPPs that ratifies

the federal law at the municipal level. The city law also creates a PPP Council, defines the

criteria for PPP projects to meet (i.e., being efficient and affordable), and creates a guarantee

fund for PPPs. The municipality’s limited PPP institutional capacity will be an obstacle to

presenting well-designed projects to the PPP Council. There is a need to create a PPP unit to

support the PPP Council. The Bank is supporting the municipality’s efforts.

93. However, the government still faces major tasks in implementing its PPP

program. They are related to defining the details of the institutional framework for PPPs,

including governance structure, and assigning roles and responsibilities. Key issues include

the role of a PPP unit in designing projects and the role of the Treasury as guardian of public

finances and final approver of resources. The government is aware of (a) the importance of

laying out an effective institutional structure and (b) the need to build institutional capacity

within the municipal government to design and manage PPP projects. The governance

structure will also assign responsibility for post-contract award performance monitoring and

will establish the conflict resolution system to be used for PPPs in the city.

B. PARTICIPATORY AND CONSULTATIVE PROCESS

94. Rio de Janeiro’s development priorities, including the policies supported by this

DPL, are embodied in the Multiyear Plan (PPA). They reflect not only rigorous technical

analyses but also the participatory decision-making process defined in the Municipal Organic

Law (Lei Orgânica do Município do Rio de Janeiro) and Municipal Law No. 3189.12

The

PPA, the Annual Budget Law, and related government initiatives are discussed in the

Municipal Assembly, which has the authority to revise and approve the government’s

proposals. The PPA is subject to annual Municipal Assembly review, which includes

government reports on the previous year’s performance in meeting plan objectives.

95. The municipality maintains consultative councils comprised of civil society and

government representatives. The purpose of these councils is to assist the administration in

the analysis, planning, policymaking, implementation, and supervision of government actions

and decisions in their respective areas. Councils created by the organic law include education,

health, human rights, defense of children and teenagers, economic development, science and

technology, environment, and urban policy. The municipal government provides

12

Municipal Law No. 3189 (March 23, 2001) provides for the participation of the community in the preparation,

definition, execution, and monitoring of the multiyear plan and annual budgetary law. Available at:

http://smaonline.rio.rj.gov.br/legis_consulta/17279Lei percent203189_2001.pdf

30

infrastructure and budget to maintain these councils. Usually, participation to these councils is

defined by representatives of civil society organizations. Participation is voluntary and

unpaid. The councils meet regularly.

96. For instance, the Rio de Janeiro Municipal Council on Health is in charge of the

design, strategy, and execution of policies, including the financing and economic aspects. The council comprises users (50 percent), health professionals (25 percent), and government

officials and health-services providers (25 percent). All participants have the right to vote and

affect policy decisions. In addition to the municipal council, the city has 10 health council

districts (Conferências Distritais de Saúde), with the same composition as the municipal

council. All of the secretariat’s important decisions are discussed in these councils, allowing

for broad community participation. For instance, the implementation of family health care

units and emergency care units, an action supported by the proposed DPL, was discussed and

approved at a municipal health conference. The contracting of social organizations as part of

the public sector management reforms, also supported by this DPL, was broadly endorsed by

the Districts’ Health Conference, a representative and deliberative body.

97. The Rio de Janeiro Municipal Council on Education focuses on schools. It is

composed of 12 members—half government officials, half civil society representatives—with

the municipal education secretary as president. A School Community Council (CEC) for each

school is composed of diverse representatives, including school directors, professors,

students, parents, and assistants. Each regional council appoints two representatives—a

primary representative and a substitute—that participate in bimonthly meetings with the

education secretary, assisting in the formulation of strategies to improve the quality of

education.

98. Overall, the policy areas supported by this DPL are part of the government’s

PPA and budget law and undergo discussions in the Municipal Assembly and councils as

part of a participatory budget process defined by Law No. 3189. The policies supported

by the Bank have benefited from the institutional, participatory, and consultative processes.

For instance, private-sector policies to improve the business environment were designed after

consulting key stakeholders, including representatives of commerce and industry,

accountants, staff members of the 19 regional inspection units responsible for licensing and

fiscal oversight, and entities that provide support and technical assistance to micro-

entrepreneurial businesses. The municipal government periodically conducts public opinion

polls that reveal support for measures to improve the use of public space and reduce informal

commerce.

31

IV. BANK SUPPORT FOR THE GOVERNMENT STRATEGY

A. RATIONALE FOR BANK INVOLVEMENT AND LINK TO CURRENT COUNTRY

PARTNERSHIP STRATEGY (CPS) AND FORTHCOMING CPS

99. As a municipal DPL, the proposed operation represents an innovation in terms

of Bank engagement with cities. Municipal governments such as Rio’s are main providers of

essential public services in Brazil, making them critical for promoting economic growth,

reducing poverty, and ensuring an equal quality of service delivery to all citizens. Under the

federal Constitution of 1988, municipal governments are autonomous entities in the same way

states governments are independent from the federal government. To a great extent, policy

reforms cannot be imposed on Rio by higher levels of government. They must be initiated by

the city itself. To support such efforts, the Bank must engage directly with the city

government.

100. The proposed operation responds to a request from the Rio de Janeiro

municipal government and the National Treasury. A strong institutional capacity and

sound and large economy make Rio an ideal place for the Bank to test a new development

model that directly engages with the city while vertically integrating the state and federal

levels.

101. As an example of leveraging lessons of other states and municipalities, Rio has

introduced a results-based management system to foster performance improvements in

public administration and monitor progress towards the strategic plan’s goals. The city

established a Project Management Unit, modeled on those set up by Brazil’s most innovative

state governments. The city learned of the need to have a strategic plan first and follow with a

system of performance management and a monitoring system. This allowed Rio to sign 14

performance contracts with direct administration in the first year. The Bank will bring in the

GET PSP (Global Expert Team in Public Sector Performance) to further support the

municipality in the annual evaluation of the first signed results agreements.

102. The proposed DPL would also allow the Bank to support, for the first time, the

integration and coordination of sectoral policies at different levels of subnational

government. The operation has been designed in conjunction with the State of Rio de Janeiro

Fiscal Sustainability, Human Development, and Competitiveness DPL to support innovative

policies to reform health care delivery, education services and business registration processes.

At least in these areas, the operation will help achieve better integration and coordination of

policies at different levels of government, maximizing their impact on improving the welfare

of Rio’s population. To the extent that this innovative approach proves successful, it could be

replicated in other Brazilian states and large municipalities in other countries.

103. In the health sector, the Bank’s support to the municipality will be leveraged

through a Non Lending Technical Assistance project (NLTA) to the state health

secretary. The project will support activities related to emergency care units that are also

supported in the municipal DPL. The project will strengthen the administrative procedures for

the acquisition and allocation of medicines, introduce a cost-accounting methodology for

UPAs and hospitals, and develop a quality accreditation system for UPAs.

32

104. In the education sector, the municipality is partnering with the Bank as well as

local universities to help them design a monitoring and evaluation system for the crèche

and early childhood program. This is the frontier of best practices, but it is coming from a

municipality that has high institutional capacity and one of the best evaluation systems for

early childhood programs in effect (―crianças marvilhosas”).

105. The proposed operation could become the first of a new generation of policy

loans aimed at supporting fiscal consolidation at the municipal level in Brazil. The

proposed operation closely resembles and embodies a similar rationale as existing and

previous Bank DPLs supporting fiscal consolidation at the federal and state levels in Brazil

and other countries. In supporting the MoRJ, the Bank is also assisting the Federal

Government in implementing the LRF. In these cases, the Bank acts as a credible partner in

supporting corrective policy programs when deviations from LRF may take place.

106. The commitment of the MoRJ to fiscal consolidation and to the LRF is

reflected in a request by the MoRJ and the Federal Government of Brazil to include an

agreement between these two levels of government as a condition of effectiveness of this

DPL. Such an agreement would be fully consistent with the LRF and would represent a

commitment by the MoRJ to further strengthen fiscal consolidation through a prepayment of

at least twenty percent of the Municipality’s debt to the Federal Government.

107. Through the proposed operation, the Bank will support Rio’s efforts to break

the unsustainable trend of increasing current expenditures and make room for needed

investment. The reforms supported in the pension areas, for example, will reduce the NPV of

the actuarial deficit over 50 years by about 17 percent from a baseline of about R$36 billion.

Moreover, the municipality will be able to restructure 20 percent of its debt to the federal

government. This will provide Rio with short-term fiscal space of about R$1 billion for 2010–

12 and will decrease the NPV of the city’s total debt by R$2.8 billion. The prospective

liquidity gain of about R$330 million a year would correspond to 3 percent of the total

municipal revenues and 5 percent of revenues without transfers.

108. The municipal government has the institutional capacity to manage the

additional fiscal space generated by these and other DPL-supported fiscal measures. In

fact, the second and third components of the proposed DPL allow the Bank to help Rio

improve the effectiveness and efficiency in the delivery of public services, especially in poor

and high-crime areas. The components also provide assistance in improving the city’s

capacity to manage public projects and attract private funds for investment through PPPs.

109. The proposed operation is fully consistent with and closely linked to the

objectives of the World Bank Group’s Country Partnership Strategy 2008-2011 (Report

#42677-BR) discussed by the Executive Directors on May 1, 2008, and the Progress

Report (Report #53356-BR) discussed by the Executive Directors on April 20, 2010. In

particular, the policy measures supported by the loan are aligned with the CPS objectives of:

(a) strengthening macroeconomic fundamentals and public-sector management; (b) reducing

poverty, vulnerability, and social exclusion by increasing government efficiency, improving

the quality of spending, and enhancing accountability in the health and education sectors,

especially at the subnational level; and (c) improving competitiveness and the investment

climate. The current partnership strategy was developed in close consultation with the federal

33

authorities that see Bank support to the states as central to their efforts to improve fiscal

management and the provision of public services.

B. CHOICE OF INSTRUMENT AND RELATION TO OTHER BANK OPERATIONS

110. DPL vs. Investment Lending. The operation supports a set of policy reforms to

which the municipal government, an autonomous legal entity, is committed. A DPL is

therefore the appropriate vehicle. The municipality’s reform program is robust and embodies

cross-cutting themes, such as fiscal and public sector management and improving service

delivery. The government’s program and priorities provide a solid ground for confidence that

the operation will contribute to poverty reduction.

111. As bank operational policy does not explicitly provide for DPLs to be extended

to municipalities or cities, approval is sought by the World Bank’s Board of Executive

Directors for a waiver to the definition of the Borrower in Operational Policy (OP) 8.60

for this operation. All other provisions set forth in OP 8.60 would remain applicable to this

operation.

112. One-tranche DPL vs. two-tranche DPL. A single-tranche DPL was unsuitable for

two reasons. It would not allow the bank and the municipality a continuous emphasis on

reforms beyond debt-restructuring. A one-tranche operation would hinder the Bank’s ability

to establish a longer term engagement to support key elements of Rio’s reform agenda. This

consideration takes on added importance with an administration that has been in office for

less than a year and would require our continued support.

113. Two-tranche DPL vs. programmatic DPLs. Brazil’s rigorous fiscal control regime,

which has contributed to fiscal responsibility since the late 1990s, imposes relatively high

transaction costs on processing subnational loans. Each loan would have to go through a

rigorous process of reviews and approvals by federal agencies. This process could take

months or longer and introduces a high degree of uncertainty regarding the timing of loan

approval. The political cycle calls for federal and state elections in November 2010, raising

the possibility of additional uncertainty at the time of a second programmatic operation. Even

though the city’s administration is not running for election in 2010, it is not isolated from the

state political cycle and the presidential election. The two-tranche DPL is sought to avoid

potential delays during a period of political transition.

114. The two-tranche design provides the right incentive scheme because: (a), the

first tranche, presents the reform plan that will be implemented in the second tranche, (b) it

circumvents the long process of internal approval of Bank operations that delays loan

preparation considerably. In Rio’s case, these factors are crucial because the operation will

happen during a period of political transition that potentially adds to the length and risk.

115. The municipal operation is linked with the ongoing Rio State Fiscal

Sustainability, Human Development, and Competitiveness DPL. The US$485 million

DPL aims to provide the state with the financing to smooth its expenditures patterns and to

increase infrastructure investments in the context of the national program for growth

acceleration (PAC) in 2009. The state loan also supports policy actions to strengthen fiscal

consolidation, improve the quality and efficiency of the business registration process, enhance

34

the quality and efficiency of the basic education system, and increase access to health services

and the efficiency of their delivery, especially in disadvantaged areas (see Box 2).

Box 2: Complementarities between Rio State and the Rio Municipality DPLs

For the first time in the history of World Bank policy and investment operations in Brazil, DPL-supported

policies will contribute to aligning policies at different levels of government, achieving better services in health,

education, and the business environment. Policies supported by the city and state DPLs will strengthen the

components that are the responsibilities of each level of government and encourage a more robust system

overall. The figure below illustrates the formal division of responsibilities between municipalities and states in

Brazil.

Education. In the past, policy coordination between Rio state and municipality has been limited, partly because

of the competing political affiliations of previous administrations. Since January 2009, however, dialogue has

developed between the two education secretaries, and the two World Bank DPLs under preparation are

contributing to coordinated and more efficient service delivery in education. The DPLs are tackling the same

problems at different points in the system: the inefficient flow of students due to poor learning outcomes,

excessive grade repetition, and resulting age-grade distortions.

At the municipal level, this involves: (a) expanding early childhood education for low-income children; (b)

strengthening the teaching of basic literacy and numeracy skills in the first two grades (Reforço Escolar), with

special emphasis on remedial instruction for children falling behind their grade levels; and (c) providing targeted

support for schools in high-conflict and high-crime areas, whose students are at greatest risk of repeating grades

and falling behind. Complementing these policies, the state’s DPL-supported program also focuses on reducing

age-grade distortion. Through the innovative Projeto Autonomia, the state is offering over-age students a chance

to graduate on time by following a special compressed curriculum with intensive teacher support. (Despite the

official assignment of education responsibilities, the state and municipality still have some duplication of

provision in grades 6–9, which were historically the responsibility of state government.)

Health. The policies supported by DPLs the Bank is preparing with the two subnational governments have a

mutually reinforcing impact on health-care integration. On one side, the DPL with the Rio state government is

supporting policies to deliver better coverage and quality of medium- and high-complexity health services

through UPAs. These facilities are concentrated in the Rio municipality, where a large proportion of the poor

population lives without access to urgent and emergency care. In a complementary manner, the DPL with the

Rio municipality is supporting policies to increase coverage and quality of primary health care by the expansion

of family health clinics, creating solid mechanisms of cooperation between the state and the municipal health

secretariats to deliver services through structured networks. These networks, organized in administrative health

regions, will be jointly regulated by a clear and enforceable referral and counter-referral system between state

and municipal health units.

Business Environment. Both operations support reforms to the business registration process and follow similar

approaches: first, redesigning and simplifying internal procedures related to either state registration (Inscrição

Estadual) or municipal operating licenses (Alvará de Licença para Estabelecimento); second, joining a

centralized business registration system (Registro Mercantil Integrado, REGIN). REGIN will unify and link

hitherto separate processes that firms are required to follow to fully register with all pertinent agencies (tax,

sanitation, environmental, and fire brigade) at the three different levels of government, creating a one-stop shop

for the registration process. Both the state and municipality have decided to integrate their business registration

systems into the REGIN.

35

116. In health, there is a complementary placement of the UPAs in the Rio

municipality that was coordinated with Rio state UPAs. While the main focus of the

municipality health secretary is primary care (clinicas da familia), the state puts greater

emphasis on urgent and emergency care UPAs. Therefore, there is no duplication of actions or

programs but a sharing of responsibilities in the urgency and emergency programs for

populations in different areas.

117. In education, federal policies drive state and municipal service delivery in two

key areas, and in each of them the current collaboration between the Rio municipal

education secretariat and the federal Ministry of Education is quite good. The areas are:

(a) federal support for the expansion of municipal-level ECD services through FUNDEB

financing reform; and (b) federal support for a stronger focus on learning outcomes through

the IDEB (index of basic education quality). Rio municipality is ―mainstreaming‖ this focus

across its system by translating IDEB performance targets down to the level of each school.

Rio is even going further by introducing a teacher bonus program linked to annual progress on

IDEB outcomes.

118. The proposed operation is related to the Renovating and Strengthening Public

Management (Pró-Gestão) Technical Assistance Project, currently under preparation

with the State of Rio de Janeiro’s Secretariat of Planning. This proposed project has three

objectives: (a) renovation and strengthening of public administration, (b) development of

human capital, and (c) expansion of preventive care and modernization of the health system.

This technical assistance project will finance activities that have synergies with the proposed

DPL. In education, for instance, it will finance, among other things, critical studies in relation

to Projeto Autonomia, which addresses age grade distortion and is supported by the state DPL

and is a benchmark in the municipality DPL. In health, the project will support activities

related to emergency care units, which are also supported in the municipal DPL. The project

will strengthen the administrative procedures for the acquisition and allocation of medicines,

introduce a cost-accounting methodology for UPAs and hospitals, and develop a quality

accreditation system for UPAs.

119. As a subnational, two-tranche DPL, the operation is similar in design and

nature to other Bank operations with Brazilian state governments. The relevant projects

are Alagôas (Fiscal and Public Sector Reform, 2009), Rio Grande do Sul (Fiscal

Sustainability for Growth, 2008), and Minas Gerais (Partnership for Development, 2006).

These experiences with subnational governments have provided strong foundations for this

operation in three ways. First, the preparation and supervision of the three operations gave the

Bank substantial experience in the kind of subnational fiscal and public-sector management

reforms now being used by Rio’s municipal government. Second, the operations’ success

enhanced the Bank’s reputation and led the federal and municipal governments to request a

similar operation for Rio. Third, as part of project preparation and supervision, the Bank has

been fostering increased dialogue on technical issues among civil servants of these

subnational governments. For example, the dialogue has included such topics as subnational

debt management, project monitoring, and public investment management. This initiative

allows for sharing experiences and learning from peers that may be especially helpful to new

reformers.

36

120. Rio has benefitted from several projects financed by the Bank through direct

loans to either the municipality or the federal government. In the 1990s, for instance, the

Bank supported a project for preventing flooding in Rio through a loan to the federal

government. Rio has also benefited from lending operations approved since 2004 related to

family health, AIDS and sexually transmitted disease (STD) control, VIGISUS (health),

Fundescola III (education), the Bolsa Família program, and PARSEP (social security).

C. COLLABORATION WITH THE INTERNATIONAL MONETARY FUND (IMF) AND

OTHER DONORS

Collaboration with IMF

121. IMF collaboration does not apply directly because the proposed operation

involves a subnational government. The consultations between the Bank and Fund teams in

the case of the federal government are consistent with the recommendations of the Joint

Management Action Plan (JMAP), which aims to improve coordination at the country level.13

The plan calls for Bank and Fund staffs to consult at least annually in the preparation of their

work programs.14

Collaboration with Other National and International Partners

122. The actions supported under this DPL are clearly linked to the federal

government’s strategy to improve the overall quality of education in Brazil, given the

role of the municipality in delivering education services. Rio has eight programs supported

by the federal government (see Table 8).

Table 8: Federal Programs in Rio de Janeiro State

13

See ―Enhancing Collaboration: Joint Management Action Plan (Follow Up to the Report of the External

Review Committee on World Bank-IMF Collaboration,‖ September 20, 2007). 14

A February 2008 memorandum from IMF First Deputy Managing Director Lipsky and World Bank Managing

Director Wheeler to IMF Heads of Area Departments and Bank Regional Vice Presidents indicated that,

beginning in April 2008, all Bank country teams and Fund missions preparing CAS/CAS progress reports or

Article IV consultations (whichever came first) should hold annual discussions to pool analytic and diagnostic

work, discuss macro-critical sectoral and other issues, and strategize over how best to sequence needed analytic

work.

Program Main Purpose

National School Feeding Program (Programa Nacional de Alimentação Escolar, PNAE)

Transfer financing resources to the city to support merenda escolar.

Programa Dinheiro Direto na Escola (PDDE) Transfer financing resources directly to each school to improve pedagogical

and physical infrastructure.

Open School Program (Programa Escola Aberta) Transfer financing resources to promote sports, cultural, and arts activities on weekends.

Programma de Desenvolvimento Enfantil (PDE) – Escola

Transfer financing resources to support schools with low

Índice de Desenvolvimento da Educação Básica (IDEB) levels. The schools will be in charge of developing action plans to help low-outcome students.

More Education (Mais Educação)

Transfer resources to extend school time and arts, cultural, sports, and

learning activities.

National Program of Educational Technology (Programa Nacional de Tecnologia Educacional,

PROINFO)

Distribute to schools computers, digital resources, and educational content to promote the use of information technology in public education.

National Textbooks Program (Programa Nacional de

Livro Didático, PNLD)

Distribute textbooks to students and teachers in the following subjects:

Portuguese, mathematics, science, history, geography, and literacy.

National School Library Program (Programa Nacional de

Biblioteca da Escola, PNBE)

Distribute books to build libraries for students in Ensino Fundamental.

37

123. With support from the Municipal Education Secretariat (SME), the United

Nations Educational, Scientific and Cultural Organization (UNESCO), and the Bank’s

DPL, the administration has launched 150 Escolas do Amanhã since January 2009,

serving 108,576 students. Federal programs such as Mais Educação and Escola Aberta will

encourage full-time education through a variety of sport, arts, and cultural activities. The

Escola Aberta program will bring the community to schools on weekends through activities

such as cinema clubs and workshops.

124. The SME in partnership with UNESCO is developing incentives for a reading

program in early childhood education. The program beneficiaries are children aged 3

months to 3 years, 11 months, enrolled in municipal crèches and preschools. The proposed

DPL supports the expansion of municipal crèches and pre-schools. The SME requested

UNESCO technical assistance to implement a pilot program. The agreement has three

immediate objectives: (a) preparing and implementing the pilot program in 10 schools that

participate in the Primeira Infância Completa Program (PIC), (b) implementing reading

strategies in the schools, and (c) disseminating the pilot program’s main results.

125. Rio participates in a national program of technical assistance provided by the

Inter-American Development Bank (IADB) with resources channeled through the

federal government. The purpose of the National Program in Support of Administrative and

Fiscal Modernization (Programa Nacional de Apoio à Modernização Administrativa e Fiscal,

PNAFM), currently in its second phase, is to improve existing fiscal systems in Brazil. It

seeks to do so by supporting the integration of revenue secretariats and the modernization of

Brazilian municipalities’ administrative, fiscal, and financial procedures. In Rio, PNAFM

activities will be in the area of internal and external controls and financial managements. An

initial activity already undertaken has been an audit of the personnel and survivors payroll,

designed to identify fraud or errors that could be causing undue expenditures. This action is a

benchmark for the proposed DPL in the area of creating fiscal space.

126. The private sector is also supporting the municipality in its reforms. The Brazil

Competitive Movement (Movimento Brasil Competitivo, MBC) is dedicated to reducing

Brazil’s tax burden through efficiency in public spending. The MBC has drawn on private-

sector funding to hire consultants to advise subnational governments on how to improve tax-

collection and expenditure management. For instance, MBC has hired the National Institute of

Managerial Development (Instituto Nacional de Desenvolvimento Gerencial, INDG) as well

as McKinsey to help the municipality develop and implement its strategy. The policy reforms

supported under the public sector component of the proposed loan build on the INDG and

McKinsey work.15

15

Sponsored by the MBC, the INDG has been providing advisory services to improve the efficiency of

governmental processes in the states of Minas Gerais and Rio Grande do Sul and the city of Rio de Janeiro. A

July 6, 2009, Financial Times article highlighted the successful experience of private sector support for public

sector reforms (http://www.ft.com/cms/s/0/31a6843a-69c5-11de-bc9f-00144feabdc0.html?nclick_check=1).

38

D. LESSONS LEARNED

127. The design of the proposed operation reflects several lessons from recent

experience with state DPLs in Brazil. Most important is the need for client ownership of the

reform program. Rio’s commitment to reform was established in the initial identification

mission, and it has clearly been in evidence since then. The strongest affirmation is the

sustained progress made in implementing DPL-supported policies since the current

administration took office in January 2009. The commitment is reinforced by the fact that all

DPL-supported reforms are critical parts of the government program.

128. A two-tranche rather than a programmatic approach was chosen to prompt the

Bank and city government to agree on conditions for both tranche disbursements at the

outset, rather than leaving longer-term reforms for a subsequent operation. The current

administration has made progress in important policy areas, including provision of health and

education services and improvements in fiscal discipline that create the conditions for a stable

macroeconomic environment. The project’s time frame and disbursement mechanisms have

been designed to reduce the risk of wavering political commitment in the future. The project

would disburse entirely within the term of the current administration. It focuses on procedural

and administrative reforms that will be self-sustaining.

129. A third lesson from recent experience is the need for in-depth communication

with the municipality during the proposed operation’s preparation and implementation. The project team has worked closely with Rio’s administration to define the reform measures

to be supported by the DPL and to put in place arrangements to assist their implementation

over the medium term. This has been accomplished partly through the Renovating and

Strengthening Public Management Technical Assistance Project, including state and

municipal policies and evaluating their impact. The city government’s proactive role in the

technical preparation phase—defining a policy matrix with measures and policy options that

were both high impact and feasible—has been exemplary. Furthermore, the municipality has

strongly supported the two-tranche design because of the stronger commitment that the

conditions for release of the second tranche would generate.

130. Finally, the Bank’s experience with state DPLs has demonstrated the

importance of coordination with the federal government. The operation was initiated with

the concurrence of the National Treasury and was prepared as a DPL in full coordination

between the state government and the National Treasury. See Box 3 for a discussion of good

practice principles.

39

Box 3: Good Practice Principles on Conditionality

Principle 1 – Reinforce Ownership: The operation has strong ownership at the highest levels of city, state and

federal governments. All municipal secretariats involved in the DPL have shown remarkable commitment to the

government’s medium-term reform program and the policies supported by the DPL. Government commitments

are also clearly stated in the Letter of Development Policy.

Principle 2 – Agree up-front with the government and other partners on a coordinated accountability

framework: The Bank’s support is summarized in a brief and focused policy matrix with observed and expected

results. The Secretariat of Finance, together with Casa Civil and the individual sector monitoring units, will

collect the necessary data to measure the extent to which the results have been achieved.

Principle 3 – Customize the accountability framework and modalities of Bank support to address country

circumstances: Brazil’s rigorous fiscal control regime has contributed much to enforce fiscal responsibility

since the late 1990s and has provided a powerful framework to ensure all borrowing, including from IBRD, is

consistent with a sustainable fiscal environment.

Principle 4 – Choose only actions critical for achieving results as conditions for disbursement: The Bank’s

policy matrix uses a limited number of prior actions. They are part of a comprehensive policy reform plan with a

solid track record. The matrix also uses select benchmarks to track implementation of the government program.

Principle 5 – Conduct transparent progress reviews conducive to predictable and performance-based

financial support: The World Bank is working with IPEA (the Institute for Applied Economic Analysis) and

IETS ( The Institute for Labor and Social Studies) to evaluate the impact of daycare on child development and

parental welfare. The study also aims to design a methodology for monitoring and evaluation of Integrated

Preschool Programs (EDIs).

The World Bank is also carrying out Phase II of the Family Health Program (Programa de Saúde da Família,

PSF). Phase II will support quality improvements, strengthening the capacity of states to: (a) monitor and

evaluate the PSF, (b) introduce a performance-based financing mechanism between the federal government and

participating states and municipalities, and (c) develop and test a results-based management system for PSF

teams.

E. ANALYTICAL UNDERPINNINGS

131. The proposed operation builds on a number of reports and studies produced by

the DPL team in close collaboration with the municipality. These diagnostic studies

include:

Municipality of Rio de Janeiro: Fiscal Sustainability Analysis and Impacts of the

World Bank Program, by Fernando Blanco and Ngoc-Bich Tran (World Bank);

Municipality of Rio de Janeiro: Diagnosis of the Social Security System and

Impact of Proposed Reforms, by Marcelo Abi Ramia Caetano and Mario Rattes

(World Bank consultants);

Municipality of Rio de Janeiro: Strengthening Public Sector Management,

Procurement and Investment Systems, by Juliana Wenceslau, Luciano Wuerzius,

and Tarsila Velloso (World Bank);

Municipality of Rio de Janeiro: Assessment of Debt Restructuring Options, by

Antonio Paulo Medeiros (World Bank consultant);

Municipality of Rio de Janeiro: Poverty and Social Analysis of the Impact of the

DPL, by Alberto Coelho Gomes Costa and Judith Lisansky (World Bank).

40

Other areas of analytical work used to underpin the operation are detailed below.

132. Fiscal sustainability: The analytical underpinnings of specific policy reform areas

are based on a series of technical notes (Notas Técnicas) prepared by SMF. The Nota

Técnica: Administração Tributaria do Municipalidad do Rio de Janeiro—Exercício de 2008 e

Perspectiva para o período de 2009–2011 was used as the basis of the program to strengthen

tax collections and increase revenues. The fiscal projections, the analysis of the operation’s

impact, and the sensitivity analysis of fiscal aggregates to external and internal shocks are

based on the technical note, ―Projeções Fiscais e Análise das Finanças Públicas do

Municipalidad do Rio de Janeiro,‖ which covers the policies adopted on tax administration,

the official decrees, and expected impacts.

133. Public sector modernization: Analytical work in other Brazilian subnational loan

documents will provide input for the loan design. For example, the program documents for

Minas Gerais’ Partnership for Development and Rio Grande do Sul: Fiscal Sustainability for

Growth were fundamental to the operation’s design. In particular, the experience with other

states on results-based management and partnerships with nongovernmental organizations in

the provision of public services will be used in the Rio context.

134. Business environment: The strategies and actions for improving the business

environment build on several documents, including the Bank’s Doing Business in Brazil

(2006), Andre Urani’s analysis of the challenges to Rio’s economic development in Trilhas

para o Rio16

, and such studies as the SMF technical note, Uma avaliação ex-ante de algumas

políticas para melhoria do ambiente de negócios no Estado do Rio de Janeiro (2007) and

McKinsey & Company’s Dinamizando o Crescimento da Economia do Rio de Janeiro

(2006). The focus on supporting the development of an effective institutional structure to deal

with PPPs has analytical backing from a number of studies that have identified the importance

of careful project design and an appropriate regulatory framework for the success of PPP

projects (Guasch 2004; Delmon 2009). Infrastructure neglect in Rio state and municipality is

emphasized by such reports as the National Transport Federation’s Pesquisa Rodoviária,

(2007). The impacts of this deficit in infrastructure investment, common across Latin

America, include much higher logistics costs. They are well documented in Guasch and

Kogan (2005). The importance of investing in infrastructure for developmental outcomes is

more broadly emphasized in Calderón and Servén (2003), while the importance of the role the

private sector can play in helping decrease the deficit in infrastructure investments is

articulated in Andrés and others (2008).

135. Education: An analysis carried out by the SME in partnership with the Ayrton Senna

Foundation (Fundação Ayrton Senna) involved testing 21,000 students in Portuguese. It was

the basis for implementing literacy courses, the Schools of the Future (Escolas do Amanhã)

program, and the new primary care model that integrates crèches and preschool (Espaços de

Desenvolvimento Infantil, or EDIs) and offers health services. The implementation of this new

model for primary care used as background a study conducted by IPEA, IETS, and the Bank.

The study’s objective was to evaluate the impact of daycare on child development and

parental welfare. The study showed that youngsters who received early childhood education

16

André Urani, Trilhas para o Rio: do Reconhecimento da Queda à Reinvenção do Futuro, Elsevier, Rio de

Janeiro, 2008.

41

are more likely to finish school and secure better positions and higher salaries. The study, still

in progress, also aims to design a methodology for monitoring and evaluating EDIs.

136. Finally, the ESW report titled Brazil: Improving Fiscal Conditions for Growth

addresses important policy issues related to budget rigidity and expenditure management. It

contributed to the assessment of the fiscal and public sector management challenges the

municipality faces. The Bank recently produced a report titled Topics in Fiscal Federalism,

which describes the existing system of controls of subnational governments and highlights

their achievements and limitations.

V. THE MUNICIPALITY OF THE CITY OF RIO DE JANEIRO FISCAL

CONSOLIDATION FOR EFFICIENCY AND GROWTH DPL

A. OPERATION DESCRIPTION

137. The proposed DPL is designed to support the Rio city government in its efforts

to reverse economic decline and improve the quality and coverage of social services,

particularly in poor and vulnerable areas. In particular, it supports the government’s

strategy aimed at: (a) generating additional internal resources for capital investment; (b)

improving the quality of social services, particularly in low-income areas; and (c) improving

internal administrative processes to reduce costs and enhance performance. In line with these

objectives, the operation is comprised of three key pillars: fiscal adjustment, service delivery

innovations, and public sector management (see Figure 11). These three components were

selected in partnership with the city government on the basis of a shared assessment of their

relevance to development objectives, feasibility, and the Bank’s value added to the reform

agenda.

Figure 11: The Three Pillars of the Proposed DPL

138. These policies will contribute to fostering a new development cycle in Rio and to

establishing the foundations for improved public-service delivery and equal

opportunities for the city’s young population. The three components are aimed at creating

fiscal space for public investment through measures to improve revenue collection, reduce

staffing, and cut pension costs. They will also support: (a) expansion of innovative approaches

to primary and emergency health; (b) preschool, primary school, and literacy programs in

low-income and violence-prone areas and (c) establishment of a system of results agreements

Service Delivery Innovations

Public Sector Management

Fiscal Adjustment

Improved Social

Services

42

for key municipal functions and rationalizing procurement processes and the management of

stocks (see Table 9).

139. These components are fully consistent with the CPS objective of strengthening

macroeconomic fundamentals and public sector management to support improved

delivery of public services. As a municipal DPL, the proposed operation represents an

innovation for the Bank. Nevertheless, it closely resembles existing Bank DPL operations at

the state level in Brazil and other countries and has much the same rationale. The loan is part

of the Bank’s strategic engagement with Brazil’s federal and subnational governments and is

one of a number of subnational DPLs and SWAPs designed to reinforce public-sector

management as an integral part of the Bank’s strategy for governance in Brazil. This

operation will enable the Bank to provide Rio with the knowledge, expertise, and technical

advice needed to implement the reforms.

Table 9: DPL Policy Pillars and Long Term Vision

Policy Pillar Long-term Vision

Pillar 1: Creating Fiscal Space

Fiscal adjustment: revenue enhancement and

expenditure control.

Improvement of municipal tax collections to achieve

long-run fiscal sustainability and efficient management of

government expenditures.

Pillar 2: Innovations in Public Service Delivery

Improving competitiveness. Reducing administrative barriers and the cost of doing

business.

Improving the coverage and efficiency of primary

care and urgent and emergency health services.

Increased provision of quality health care services.

Improving the quality and coverage of municipal

education services.

Greater equality of opportunities for children and youth.

Pillar 3: Public Sector Management

Strengthening the institutional framework for

sustainable efficient service delivery and the

implementation of the first steps of a MTEF.

Effective public management assured by generalized

results-based systems in the public sector, more efficient

government procurement and a strategy with associated

expenditures plan and financing plan.

Increasing the municipality’s ability to attract new

investments for greater economic growth.

Broad participation of private-sector companies in the

provision of infrastructure services, with improvement in

quality and efficiency.

140. The proposed operation is a two-tranche DPL totaling US$1,045 million. The

first tranche of US$545 million will be disbursed upon completion by the government of the

prior actions. The second tranche of US$500 million will be disbursed when the government

meets the second tranche conditions. These are expected to be met by year-end 2010.

Disbursement of the first tranche would recognize the government's reform efforts since the

current administration took office in January 2009. The prior actions and second tranche

conditions are enumerated in Boxes 4 and 5.

43

Box 4: Prior Actions for First Tranche Loan Disbursement

Policy Pillar 1: Creating Fiscal Space

Objective: Creating fiscal space to expand public investment and lay the foundations for municipal

growth.

Prior Action 1.

Submitting to the legislative assembly a draft law

consistent with the federal Constitutional

Amendments No. 20 of 1998 and No. 41 of 2003

that mandate for new public servants:

(i) the calculation of pension benefits based on the

average wage rather than the last wage;

(ii) the indexation of pension benefits on inflation

rather than wage growth;

(iii) the reduction by 30 percent of survivors

benefits for pensioners above the RGPS

ceiling.

Outcome Indicator

Reduced NPV of the pension system’s actuarial

deficit over the next 50 years by R$3.1 billion or

8.5% stemming from the parametric reforms.

Policy Pillar 2: Innovation in public service delivery

Objective: Reforming public services delivery with (a) improved government processes for registering

businesses; (b) increased access to quality family health care and emergency care services through a

new model for subcontracting social organizations to manage health facilities; and (c) improved early

development of poor children, better quality of primary schools in high-conflict slum areas and system

wide improvements in student learning outcomes.

Prior Action 2

Approval of Decree No. 30.568/2009, which

simplifies the registration process for municipal

business licenses for activities with low

environmental risk.

Outcome Indicator

Reduction in the number of days required to

obtain a municipal business license in Rio from

20 days in 2009 to 12.5 days in 2010.

Prior Action 3

Approval of the Law No. 5026/2009 and Decrees

No. 30.780/2009, No. 30.907/2009 and No.

30.916/2009 to transfer public services

management to social organizations and

implementation of the law with the Municipal

Health Secretariat signing three management

contracts with qualified social organizations to

deliver services in ten family health care clinics

(clínica da família) and three emergency care

clinics (UPA).

Outcome Indicator

Doubling family health care coverage from a

January 2009 baseline of 6 percent to a

projected 12 percent in December 2011.

44

Prior Action 4

Issuing of:

(a) Decrees No. 30.934/2009 and No. 31.022/2009,

establishing the design and budget for

innovative schools (Bairro Educador/Escolas

do Amanhã) in 150 high-conflict slum

neighborhoods; and

(b) Resolution No. 1057/2010 (published in the

official gazette on January 25, 2010) that

establishes a new model of integrated early

child care and pre-school services called EDIs

(Espaços de Desenvolvimento Infantil), with

the first set of centers in targeted low-income

areas.

Outcome Indicators

(a) Annual reductions in student dropout rates

within year and between-year and annual

improvement in IDEB/IDE-Rio for Escolas

do Amanhã from the 2009 baseline; and

(b) Annual expansion by 3,000 new openings

in enrollments in ECD centers and pre-

schools targeted to low-income

communities from the 2009 baselines of

29,921 (crèches) and 77,845 (pré-escolas).

Policy Pillar 3: Public Sector Management

Objective: Developing a framework to improve the efficiency of services delivery (a) in the public

sector through introduction of result-based management (RBM) tools and the implementation of the

first steps of a MTEF and (b) in the private sector through public private partnerships (PPP) in

priority areas.

Prior Action 5

Approval of Decree No. 32214/2010 and the

signing of 16 results agreements with said entities

and secretariats for the implementation of a

monitoring and evaluation system with results-

based management tools.

Outcome Indicator

Implementation of RBM, evidenced by annual

evaluation of the performance contracts.

Prior Action 6

Establishment of a framework to enable PPPs to

invest in infrastructure and service delivery

projects, including:

(a) approval of Law No. 105/2009 on municipal

PPP programs by the Legislative Assembly; and

(b) the issuance of Decree No. 32120/2010

establishing the by-laws of the Municipal

Guarantee Fund for PPPs.

Outcome Indicator

Establishment of a framework to enable PPPs to


projects, evidenced by the at least one project

prepared by the PPP unit.

45

Box 5: Conditions for Second Tranche Loan Disbursement

Policy Pillar 1: Creating Fiscal Space

Objective: Creating fiscal space to expand public investment and lay the foundations for municipal

growth.

Condition 1

Submitting to the Legislative Assembly a draft

law and/or adopting the adequate legislative

framework to allow the following resources

transfers to recapitalize FUNPREVI including

through:

(a) future royalties revenues from the

municipality;

(b) returns (amortizations and interests) from the

portfolio of real estate loans of FUNPREVI;

(c) real estate assets from FUNPREVI;

(d) real estate assets from the municipality; or

(e) other equivalent measures.

Outcome Indicator

Reduced NPV of the pension system’s actuarial

deficit over the next 50 years by R$3.2Billion

equivalent of 8.8% stemming from the

recapitalization measures.

Condition 2

Implementing the Electronic Fiscal Invoice

(Nota Fiscal Eletrônica) for the collection of the

municipal ISS and creating a database system

(Sistema de Inteligencia Fiscal) to facilitate the

identification of ISS tax evasion.

And submitting to the legislative assembly a draft

law to expedite the recourse to judicial measures

to recover tax arrears.

Outcome Indicator

Improved revenue collection, evidenced by a 4

percent increase in ISS tax collections through

NFEs.

Policy Pillar 2: Innovation in public service delivery Objective: Reforming public services delivery with (a) improved government processes for registering

businesses; (b) increased access to quality family health care and emergency care services through a

new model subcontracting with social organizations to manage health facilities; and (c) improved

early development of poor children, better quality of primary schools in high conflict slum areas and

system wide improvements in student learning outcomes.

Condition 3 Continued implementation of the new

management model with the Municipal Health

Secretariat signing 5 new management contracts

with social organizations to implement services

delivery in 10 additional family health care

clinics (clínicas da família) and 4 additional

emergency care clinics (UPA).

Outcome Indicators Family health care coverage will double from a

January 2009 baseline of 6 percent to a projected

12 percent in December 2011.

46

Condition 4 First 10 EDIs (Integrated Early Child

Development Centers) opened and fully

operational in targeted low-income

neighborhoods.

Outcome Indicators (a) Annual reductions in student dropout rates

within year and between year and annual

improvement in IDEB/IDE-Rio for Escolas

do Amanhã from the 2009 baseline; and

(b) Annual expansion by 3,000 new openings in

enrollments in ECD centers and pre-schools

targeted to low-income communities from

2009 baselines of 29,921 (crèches) and

77,845 (pré-escolas).

Policy Pillar 3: Public Sector Management Objective: Developing a framework to improve the efficiency of services delivery (a) in the public

sector through introduction of result-based management (RBM) tools and the implementation of the

first steps of a MTEF and (b) in the private sector through public private partnerships (PPP) in

priority areas. Condition 5 Initiated the implementation of a medium term

expenditures framework as evidenced through a

report presented by the Borrower’s Secretariat of

Finance confirming consistency between said

framework and the Borrower’s budget guideline

draft law of 2012 in form and substance

satisfactory to the Bank

Outcome Indicator Implementation of the initial year of a 3-5 years

strategy with associated expenditures plan and

financing plan.

Condition 6 Monitoring and evaluation system for results

agreements in operation as evidenced by the

publishing of the annual evaluation of the 16

results agreements signed in 2010.

Outcome Indicator Implementation of RBM, evidenced by annual

evaluation of the performance contracts.

Condition 7 Piloting a stock-management system for the

health sector and approval of the schedule for

municipality-wide rollout implementation within

15 months.

Outcome Indicator Improved efficiency in stock management allows

reducing losses in the stock of goods in the health

sector from 20 percent to10 percent.

Condition 8 The PPP unit has been created (decree issued and

published in the Official Journal), is staffed and

operational, and has issued processes approved by

the PPP council for the preparation and

procurement of PPP projects.

Outcome Indicator Establishment of a framework to enable PPPs to


projects, evidenced by the at least one project

prepared by the PPP unit.

47

B. POLICY AREAS

141. The proposed operation would support essential policy reforms within three

broad components: fiscal adjustment, service delivery innovations, and public-sector

management. The policy reforms supported by the proposed operation as well as the expected

results are described in detail below.


142. The actions included in this component support creation of fiscal space through

enhanced efficiency in tax-revenue collections and control of pension-related

expenditures. The fiscal space created for public investments should help finance innovative

public services delivery and modernization of public sector management. In the medium to

long term, the fiscal measures supported by the program should help Rio achieve long-run

fiscal sustainability.

143. As a prior action for the first tranche, the DPL would support submission to the

legislative assembly of three parametric reforms related to the Constitutional

Amendment 41 and applied to new public servants. They are: (a) calculating pensions

benefits based on the average wage rather than the last wage; (b) the indexation of pension

benefits on inflation rather than wage growth; and (c) decreasing the replacement rate of

survivor’s benefits from 100 percent to 70 percent for pension benefits above the RGPS

ceiling.

144. As a second-tranche condition, the proposed loan would support the

recapitalization of the pension fund FUNPREVI including through: (a) future royalties

revenues from the municipality; (b) returns (amortizations and interests) from the portfolio of

real estate loans of FUNPREVI; (c) real estate assets from FUNPREVI; (d) real estate assets

from the municipality, or (e) other equivalent measures.

145. Additional conditions in the fiscal area further support: (a) the implementation of

the Electronic Fiscal Invoice (Nota Fiscal Eletrônica) for the collection of the municipal tax

on services (ISS) and the creation of a database system (Sistema de Inteligencia Fiscal) to

facilitate the identification of ISS tax evasion; and (b) the submission to the legislative

assembly a draft law to expedite the recourse to judicial measures to recover tax arrears. The

expected outcomes of the actions are: (a) reduced NPV of the pension system’s actuarial

deficit over the next 50 years by R$6.3 billion from a current baseline deficit of R$36 billion;

and (b) improved revenue collection, evidenced by a 4 percent increase in ISS tax collections

through NFEs.

Pillar 2: Innovations in Public Services Delivery

146. The DPL supports efforts to bring greater efficiency to the public sector. Reforms seek to improve government processes for registering businesses, increase access to

quality family health care and emergency care services, and establish programs that foster

preschool learning and primary schools in poor and highly violent neighborhoods.

147. Improving the business environment. As a prior action for the first tranche, the

DPL supported approval of Decree No. 30.568/2009, which simplifies the registration process

48

for municipal business licenses for activities with low environmental risk. The expected result

from this component is a reduction in the number of days required to obtain a municipal

business license in Rio from 20 days in 2009 to 12.5 days in 2010.

148. Improving the coverage and efficiency of family health-care services. The

operation’s first tranche will support a new model to manage family health care and

emergency care clinics through social organizations, a strategy sanctioned by Legislative

Assembly approval of Law No. 05026/2009. The first tranche calls for the signing of three

management contracts with a qualified social organization to deliver services in ten family

health care clinics (clínica da família) and three urgent and emergency care clinics (UPA).

Reforms in the second tranche support the continued implementation of the new management

model, with the Municipal Health Secretariat signing five new management contracts with

qualified social organizations to implement services delivery in 10 additional clínicas da

família and four additional UPAs.

149. Strengthening the delivery of urgent and emergency care services. The operation

will support the implementation of urgent and emergence care clinics (UPA). UPAs are health

units that receive, stabilize, and, when necessary, transfer patients in critical medical

conditions to hospitals, providing services that are too serious to be delivered by a family

health-care unit but not serious enough to require hospital care. UPAs are open 24 hours a

day, seven days a week, addressing patient needs that could not be attended by the traditional

basic health-care units or health centers that work only during regular civil service schedule

(8:30 a.m. to 5:00 p.m.). The first tranche of this operation will finance the installation of

three UPAs, which will be managed under a contract signed between the municipality and a

qualified social organization. The second tranche calls for installation of four more UPAs,

also managed under management contracts with qualified social organizations. The municipal

UPAs will complement the UPA network being built and operated by the state government in

the city, integrating state and municipal health networks and collaborating to improve quality

health coverage for the municipality’s poor population.

150. The proposed health-care reforms will produce a range of benefits. The

implementation of contracts between the Municipal Secretary of Health and social

organizations to deliver health services will increase flexibility in acquiring better human

resources and supplies, increasing efficiency, and focusing management on agreed outcomes.

151. The DPL will support improving the quality and coverage of municipal

education services. The proposed operation supports the two core programs established by

the municipal Secretariat of Education (SME): (a) targeted support to schools in the most

disadvantaged areas (Escolas do Amanhã); and (b) expansion of quality early childhood

development services, especially for the poorest families.

152. The DPL will support specific measures in each area. For the first tranche, the

municipality has agreed to implement efforts to improve the quality and equity of education

services. First, it will issue Decree No. 30.934/2009 and No. 31.022/2009, establishing the

design and budget for innovative schools (Bairro Educador/Escolas do Amanhã) in 150 high-

conflict slum neighborhoods, and Resolution No. 1057/2010 (published in the Official

Gazette on January 25, 2010), establishing a new model of integrated early-childhood care

and pre-school services called EDIs (Espaços de Desenvolvimento Infantil), with the first set

of centers in targeted low-income areas. Second, the municipality will implement the Reforço

Escolar, which entails an intensive program of remedial literacy courses for 21,000 students

49

diagnosed as functionally illiterate and special training to upgrade the effectiveness of 3,800

early-grade teachers in imparting basic literacy skills to their students.

153. For the second tranche, the municipality has two aims. First, it will have the first

10 Integrated Early Child Development Centers (EDI) opened and fully operational in

targeted low-income neighborhoods. The government also plans to open additional spaces in

traditional crèche and pre-school centers and continue its collaboration with the Bank on a

rigorous evaluation of the benefits and cost-effectiveness of the municipality’s alternative

ECD models. Second, the municipality will adopt a decree establishing a system of bonus pay

for schools that attain their annual targets for improving student learning outcomes and

student flows and pay the first year’s bonus (expected by September 2010). The latter action

is not a condition for disbursement. The expected outcome of the first- and second-tranche

actions are improved student learning performance on national exams (Prova Brasil and

Provinha Brasil) and reductions in repetition, leading to more efficient student flows and

lower total costs per primary school graduate.


154. This component supports policies to strengthen Rio’s institutional framework

for efficient service delivery and attracting new investments. The DPL will support the

government’s efforts to (a) introduce a medium term expenditures framework as well as

results-based management and increase efficiency in procurement, and (b) establish the

necessary institutional framework for the development of PPP projects in priority areas. This

set of actions is expected to lead to significant improvements in the government’s ability to

effectively and efficiently provide services to the city’s population.

155. The DPL’s first tranche will support introduction of results-based management

systems. This tranche requires the signing of 16 results agreements with the direct

administration and the implementation of a monitoring and evaluation system for the results

agreements. For the second tranche, the city will show the following achievements: (a) the

implementation of the first steps of a medium-term expenditures framework (MTEF) to

inform the preparation of the budget guideline law of 2012-LDO (Lei das Diretrizes

Orçamentárias); (b) the introduction of a monitoring and evaluation system for results

agreements. The latter will be judged on four actions: (a) the publishing of the annual

evaluation for the 16 results agreements signed in 2010 with respect to the year’s targets; (b)

the updating of the IT system with information on progress toward meeting targets for

elaboration of monthly status reports; (c) the maintenance of quarterly meetings on the

progress towards achieving results agreements targets; (d) the preparation of reports on

lessons learned in the first year of implementation of the results agreements and their

monitoring system.

156. An important benchmark for the second tranche is the implementation of a

Public Investment Framework for the municipality to evaluate and select capital

investment projects. Many governments seek to increase fiscal space to boost public

investment in physical assets such as public infrastructure or health facilities; however, the

lack of processes and controls during different phases of the project cycle may undermine the

efficiency of public investment. A well-functioning public investment system could greatly

increase the relative efficiency of public investment as well as its ability to contribute to

enhanced future economic prospects. Such systems include basic processes and controls for

50

project screening, evaluation, selection, funding, and implementation. This benchmark aims to

register the government’s initial efforts towards the development and introduction of basic

processes and controls for public investment projects.

157. Improving procurement process is an important step for increasing economy in

government purchases, thus contributing to overall government efficiency. The second

tranche of the proposed operation will support improvements in the municipal system of

procurement of common goods and services. The municipality will establish a pilot for a

stock management system for the health sector and approve the schedule for municipality-

wide rollout within 15 months.

158. PPPs can enhance the provision of municipal services. As a prior action for the

first-tranche disbursement, the government has agreed to establish a framework to enable

PPPs to invest in infrastructure and service delivery projects. Key actions include: (a)

approval of Law No. 105/2009 on municipal PPP programs by the Legislative Assembly and

(b) the issuance of Decree No. 32.120/2010 establishing the by-laws of the Municipal

Guarantee Fund for PPPs. The DPL’s second tranche will support the implementation of the

PPP program’s institutional structure, with the PPP unit operational and staffed and processes

for the preparation and procurement of PPP projects approved by the PPP council. The goal is

a functioning PPP unit that can prepare projects to attract financing.

C. IMPACT OF THE GOVERNMENT’S PROGRAM ON FISCAL AGGREGATES

159. The debt-restructuring will directly and positively affect the debt dynamics and

the debt-service profile. Rio’s plan to pay down 20 percent of the debt held by the National

Treasury (STN), will reduce the interest rate on the remaining debt from 9 percent plus

inflation to 6 percent plus inflation.

160. The IBRD loan will increase the municipality’s exposure to exchange-rate risk. Dollar-denominated debt will initially rise from 7 percent to 19 percent of the total. However,

several factors mitigate risk—the decreasing size of the debt, the initial low exposure to

dollar-denominated debt, and expectations that the Real will keep appreciating against the

dollar in the medium term. Furthermore, the operation will allow the municipality to diversify

its currency risk by reducing the significant exposure to the retail price index (IGP-DI), which

carries its own exchange-rate risk. Now, almost 90 percent of the debt is indexed to the IGP-

DI.

161. The fiscal impact of the government’s program including the policy reforms

supported by the proposed DPL has been assessed within the debt sustainability analysis

(for details, see Annex 5). On the revenue side, the reforms promise ISS tax revenue

enhancement through the implementation of the electronic fiscal invoice. On the expenditure

side, the government’s program includes: (a) interest payments savings from the debt

restructuring; (b) reduced costs of goods and services due to the implementation of reverse

auction procurement; and (c) reduced pension’s expenditures from rule changes for wages and

survivor benefits. The impact of the reforms is assessed on the evolution of the government

balances, the civil service pension deficit, and the key LFR indicators of total debt, debt

service, and personnel expenditures.

51

162. The analysis indicates that the government’s program will have a strong and

positive impact on the municipality’s fiscal sustainability. The reforms will increase both

the primary and overall balances and reduce the debt indicator expressed in terms of net

current revenue (NCR) (see Figure 12).

Figure 12: Fiscal Impacts of the Government’s Program

Source: World Bank staff projections based on data from the Secretaria Municipal de Fazenda

163. The government’s program will improve the city’s debt sustainability. This is

evidenced by expected further reductions in the city’s net consolidated debt, debt services,

3.00E - 01

2.00E+09

4.00E+09

6.00E+09

8.00E+09

1.00E+10

2009 2010 2011 2012 2013 2014

Reais

Net Consolidated Debt, 2009- 14 -

Baseline Tax Revenue Enhancement Expenditure control Debt Restructuring

0.00E+00

3.00E+08

6.00E+08

9.00E+08

1.20E+09

2009 2010 2011 2012 2013 2014

Reais

Debt Service, 2009-14

Baseline Debt Restructuring

0.00E+00

5.00E+08

1.00E+09

1.50E+09

2.00E+09

2.50E+09

2009 2010 2011 2012 2013 2014

Reais

Primary Balance, 2009-14


0.00E+00

5.00E+08

1.00E+09

1.50E+09

2.00E+09

2.50E+09

2009 2010 2011 2012 2013 2014

Reais

Overall Balance, 2009-14


0.00E+00

1.00E+08

2.00E+08

3.00E+08

4.00E+08

5.00E+08

6.00E+08

7.00E+08

8.00E+08

2009 2010 2011 2012 2013 2014

Reais

Interest Payments, 2009-14

Baseline Debt Restructuring

4.00E+08 9.00E+08 1.40E+09 1.90E+09 2.40E+09 2.90E+09 3.40E+09 3.90E+09 4.40E+09 4.90E+09 5.40E+09

2009 2010 2011 2012 2013 2014

Reais

Investment, 2009-14


52

and personnel expenditures, all of which will fall further below the requirements of the LFR

(see Figure 13).

Figure 13: Evolution of LRF Indicators, with and without Bank Operation

Source: WB Staff Calculations

VI. OPERATION IMPLEMENTATION

A. POVERTY AND SOCIAL IMPACTS

164. The proposed operation is expected to have a significant positive impact on poor

and vulnerable groups. During preparation of the DPL, the Bank undertook a preliminary

poverty and social impact study to determine how it would affect different stakeholder groups

and look for ways to enhance the positive impacts and reduce negative impacts and risks. The

Poverty and Social Impact Assessment (PSIA) focused on policies and programs expected to

have the largest potential impacts on Rio’s poor and vulnerable groups. The analysis

concentrates on activities to improve the business environment and health and education

services. 17

165. Rio de Janeiro’s development priorities, including the policies supported by this

DPL, are embodied in the Multiyear Plan (PPA) and reflect not only rigorous technical

analyses but also the participatory decision-making process defined in the Municipal

Organic Law (Lei Orgânica do Município do Rio de Janeiro) and Municipal Law No.

17

The full PSIA, including a list of stakeholder group meetings, is available in the project files. The report is

based on primary and secondary sources, including municipal research results and statistical data.

0%

20%

40%

60%

80%

100%

2004 2005 2006 2007 2008 2009 2010* 2011* 2012* 2013* 2014*

% oif Net Curre nt Revenue

Impact of the Bank Operation on the LRF indicators, 2004-14

Personnel Expenditure (? 60% of NCR) Personnel Expenditure (with WB operation)

Net Debt Consolidated ( ? 120% of NCR) Net Debt Consolidated (with WB operation)

Debt Services (? 11,5% of NCR) Debt Services (with WB operation)

53

3189.18.

The municipality maintains consultative councils comprised of civil society and

government representatives. The purpose of these councils is to assist the municipal

administration in the analysis, planning, policymaking, implementation, and supervision of

government actions and decisions in their respective areas. The councils created by the

organic law include education, health, human rights, defense of children and teenagers,

economic development, science and technology, environment, and urban policy.

166. For the business environment, operation-supported policies and reforms would

encourage the formal business sector. Alvará Já is simplifying the licensing of low-risk

businesses, and REGIN will facilitate business documentation requirements. These will likely

have positive social impacts on poor and vulnerable groups, now predominantly employed in

the informal economy. These reforms will likely increase the employment opportunities in the

formal economy and improve workers’ access to better labor regimes, higher earnings, and

improved benefits. In addition, it is expected that the two programs’ time and cost savings

will provide incentives for informal entrepreneurs to properly register their businesses and

workers.

167. Operation-supported policies will provide more and better health services to

poor and vulnerable groups, such as women, youths, and the Afro-Brazilian population. Saúde Presente is expected to have positive effects on the poor because it aims to improve

primary care and will target the poorest, fastest growing, remotest, and most poorly serviced

urban neighborhoods, such as Santa Cruz, Paciência, and Sepetiba in the western region.

Currently, these neighborhoods are characterized by the municipality’s highest levels of social

and economic vulnerabilities—the worst health indicators, the most precarious public

transportation, and the highest indicators of crime and violence. One of the main risk factors

is the difficulty of assigning highly skilled medical personnel, and especially physicians, to

poor neighborhoods. The contracts with social organizations are expected to significantly

contribute to better incentives for physicians and other skilled health personnel. In addition,

steps are being taken to enhance security by locating health facilities near major roads, and a

training program for community health agents to accompany home visits is being developed.

168. Low educational attainment closely correlates with poverty and criminal and

violent behavior; hence, the municipality’s main focus is intervening early to ensure high-

risk children’s healthy development and to achieve universal primary school completion, with

improved teacher quality and learning outcomes. Educational indicators—among them,

truancy levels, grade repetition, dropout rates, and test results—are worst in the poorest

neighborhoods. The operation-supported educational programs include the Escolas do

Amanhã, expanded investment in EDIs (Espaços de Desenvolvimento Infantil), crèches and

pre-schools, and system wide support for remedial tutoring and better learning outcomes.

These programs are expected to have significant positive social impacts on poor and

vulnerable groups. Improvements in public educational quality and efficiency generate

relatively greater gains for poor people, who rarely have alternatives to the public school

system. Investments in early childhood development—especially those targeting children

from poor and vulnerable families—have been shown worldwide to have major impacts on

children’s health, nutrition, cognitive abilities, and success in later schooling. They also have

18

Municipal Law No. 3189 (March 23, 2001) provides for the participation of the community in the preparation,

definition, execution, and monitoring of the multiyear plan and annual budgetary law. Available at:

http://smaonline.rio.rj.gov.br/legis_consulta/17279Lei percent203189_2001.pdf.

http://smaonline.rio.rj.gov.br/legis_consulta/17279Lei%20percent203189_2001.pdf

54

long-term positive effects on employability, social interaction, and avoidance of risky

behaviors, crime, and incarceration. One of the main risks faced by Rio youths is a high level

of crime and violence and the temptations to join gangs and engage in illegal activities.

Research indicates that the kinds of ECD and school-quality interventions this operation will

support are some of the most powerful strategies for keeping children in school and away

from violence.

169. The introduction of results-based management (RBM) as well as medium term

expenditures framework will help ensure greater efficiency of public expenditures

including for the poor. These new public sector management tools will help ensure that Rio

municipality’s public expenditures are efficiently used to address the issues of the entire

population, including the poor and to help better plan the major events that Rio will be hosting

in the medium term. Results based management will further create increased accountability on

the quality of public services delivered to the poor. Medium Term Expenditures elements will

help increase Rio municipality’s forward costing and planning of capital as well as recurrent

expenditures and as such lower the probability of fiscal slippages that could affect key social

expenditures.

170. On pensions, the reform proposed is focused on new public servants and as such

is not expected to have an impact on the poor. The reform supports the application of

constitutional guidelines in effect since 2004, which Rio has yet to adopt. These are across-

the-board reform applied, or in the process of being applied, in all states and municipalities in

Brazil. Those reforms supported by the operation are not targeted to poor people; rather, they

affect future municipal servants who, in most cases, will be in the high-income brackets. For

instance, the reform on reducing survivor benefits from 100 percent to 70 percent only applies

to those that receive benefits above the RGPS ceiling (about RS 3.416,54, which is equivalent

to 2.5 times the average wage in the metropolitan area). As a result, the reform will only

affect the 10 percent richest pensioners. The second reform supported by the operation

determines benefits based on the average wage rather than the last wage. It is more generous

than the private-sector rules, which provide only a portion of the average salary. The reform

will curtail artificially generous and unsustainable benefits and better align public servants’

benefits to those received in the private sector.

B. IMPLEMENTATION, MONITORING AND EVALUATION

171. The Secretary of Finance, with support from the Secretary of Planning and the

individual sectors, will be responsible for the overall implementation of the proposed

operation and for reporting progress and coordinating actions. Two tasks are essential:

(a) providing evidence justifying the first and second tranches; and (b) overseeing and

reporting progress toward completion of the second-tranche conditions, including tracking

individual conditions and facilitating the timely completion of the studies and activities

required for meeting these conditions.

172. The Bank will vet the prior conditions for the first tranche. The timing of this

disbursement will depend upon the city’s ability to provide the Bank with satisfactory

evidence that the conditions have been met. While most of these conditions have already been

addressed during project preparation, the Secretary of Finance still has the responsibility to

present the information in a timely manner and in a format satisfactory to the Bank.

55

173. Similarly, the Secretary of Finance will be responsible for marshalling the

information necessary to demonstrate that Rio has satisfactorily met the second-tranche

conditions and covenants. In the event that one or more conditions is not met or only partly

met, the Secretary of Finance will take the lead in identifying and explaining causes and

determining what, if anything, can be done to mitigate the corresponding risks.

174. A Project Implementation Committee of officials from the agencies directly

involved in the DPL-supported reform agenda will monitor implementation, including

all essential technical assistance activities. In addition to monitoring and management

systems, this project will support a number of evaluation activities that will generate data to

inform city policies and—by informing policies—strengthen a culture of evidence-based

policymaking. Several activities present opportunities for significant learning, both for the

municipality itself and for other governments in Brazil. The major initiatives for evaluation

activities are taking place within the human development sectors, namely in education, and

health.

175. In education, the SME is taking advantage of several learning opportunities. First, the SME is collaborating with the Bank and researchers from the Catholic University of

Rio (PUC-Rio) to evaluate merit pay for teachers in schools that achieve key goals, seeking to

determine the impact on subsequent efforts and teaching methods and—most important—

student outcomes. Second, the SME is collaborating with the Bank and IPEA researchers to

evaluate the effectiveness of municipal crèches relative to alternative options sought out by

parents—whether private crèches or home care. This evaluation will provide data on

children’s learning outcomes, parents’ involvement in schools, and parents’ labor market

participation. Third, the SME is collaborating with the Bank and University College London

researchers to evaluate a Saturday-only crèche option, which includes parenting classes at the

end of the day. A pilot is underway, and the program will be expanded in January 2010.

Finally, the Bank is discussing with the SME a plan to evaluate the new Escolas do Amanhã

program, which provides well-resourced schools in crime-ridden areas.

176. In health, the State Secretariat of Health and Civil Defense (SESDEC) will be

carrying out an evaluation of patient risk assessment in one hospital to work out the

details of implementation and gauge patients’ reactions and the impact on hospital

efficiency. The evaluation will be critical to improving the program and implementing it in

hospitals throughout the municipality.

C. FIDUCIARY ASPECTS AND DISBURSEMENTS

Foreign exchange control environment

177. The IMF Safeguards Assessment of the Central Bank of Brazil, first done in

October 2002 and updated in March 2004, concluded that the Central Bank does not

present widespread vulnerabilities that could compromise the safeguarding of Fund

resources. In particular, the Central Bank audit is conducted by an internationally recognized

audit firm, while the Central Bank’s internal audit function contributes effectively to internal

control systems. Since the IMF Safeguards Assessment of the Central Bank has not been

updated in recent years, the Bank also reviewed the year-end Central Bank financial

statements for 2006, 2007, and 2008, including the Explanatory Notes to the financial

56

statements and the independent auditors’ report that included an unqualified opinion on the

financial statements for all years.

178. The Explanatory Notes, audited as an integral part of the financial statements,

provide an extensive explanation of the Central Bank’s risk management policies,

including those related to financial instruments held to manage the international

reserves. In relation to operational risks, the audited Notes state that the Central Bank ―uses

internal control systems, which are considered adequate for its activities.‖ Based on the IMF

Safeguards Assessments and the review of the Central Bank’s financial statements, the control

environment, procedures, and regulations governing the Central Bank’s operations through

which the foreign exchange from the operation would flow are considered adequate.

Public financial management of budget resources

179. The Bank’s review of the municipality’s key public financial management

(PFM) institutions, systems, processes, and policies, indicates that the municipality’s

PFM system, including budgeting, accounting, financial reporting, control and cash and

debt management is considered to be functioning adequately. Management has also

demonstrated a clear commitment to strengthening municipal PFM. Planning and budgeting

processes are timely and produce realistic budgets and reasonably strong budget execution

controls are spearheaded by the independent Office of the Controller General. The

management of cost data is possibly a ―good practice‖ in the Brazilian public sector. Some

PFM systems are aging but still provide reasonable control.

180. Upon taking office, the new administration found a planning and budgeting

system that lacked strategic focus on priorities and a poor management system that

undermined government effectiveness. The municipal public administration also suffered

from an overly complex organizational structure, cumbersome administrative procedures, and

a lack of instruments to monitor performance. In response to this situation, the new

administration has strengthened its PFM by: (a) reorganizing planning and budgeting in Casa

Civil and putting it in charge of preparing a strategic plan and implementation and operation

of a results-based management system; (b) strengthening debt and cash management by

creating a function to analyze the portfolio financial risks; designing and implementing

integrated systems for debt recording and cash management; and training staff to undertake

risk analysis, quantify cost-risk tradeoffs, and manage the municipality’s financial assets and

liabilities;(c) tightening controls over spending on active staff; (d) defining a strategy to

streamline administrative procedures; (e) passing Municipal Law Nº 5026 authorizing the

municipal government to establish management contracts with private nonprofit institutions;

and (f) enhancing accountability through the implementation of results agreements.

D. DISBURSEMENT

181. Once the Bank formally notifies the borrower that the loan is available for

withdrawal, the borrower may submit a withdrawal application so that the proceeds of the

loan would be deposited by the Bank. The Bank will disburse the two tranches of the loan

proceeds. All withdrawals from the Loan Account shall be deposited by the Bank into a

defined account as found acceptable to the Bank. The Borrower shall ensure that upon each

deposit of an amount of the Loan into this account, an equivalent amount is accounted for in

the Borrower’s budget management system, in a manner acceptable to the Bank. The

57

Municipal Secretary of Finance will then provide the Bank a written confirmation of the

transaction.

E. ENVIRONMENTAL ASPECTS

182. The proposed operation is not expected to have a significant environmental

impact. An analysis of the environmental implications reveals no likely environmental impact

from the DPL-supported policies. In particular, streamlining the registration process for

businesses should in fact free up Environmental Secretariat resources to focus licensing

efforts on the economic activities that do have environmental impacts. The expected increase

in formal-sector businesses will increase demand for environmental monitoring, and the

secretariat has already requested additional funds to hire more personnel. A few months into

implementation of the Alvará Já, the experience so far has shown that the majority of

companies that have used the program to register do not need environmental licensing to

operate—for example, service providers. While rising demand for environmental monitoring

is expected, the actual increase in personnel capacity need may not be large. Finally, firms

that tend to benefit the most from these types of reforms are micro and small enterprises,

either new firms or previously informal ones. Given the scope of these companies’ activities,

and the fact that these reforms are not expected to increase large companies’ economic

activity in mining and other sectors, the expected environmental impact is low.19

F. RISKS AND RISK MITIGATION

The proposed operation is considered of moderate to substantial risk.

183. Implementation of the government’s reform program: The main risk is related to

the fact that the city’s administration is relatively new and may overestimate the pace of

reforms or may not have sufficient support from civil servants with longer experience in the

public sector. As a result, weak implementation of the agreed measures could result in delays

in the second-tranche disbursement. This risk is mitigated as follows. First, the Bank is

supporting the municipality’s efforts to reinforce implementation capacity—including a

technical assistance loan in the areas of public-sector management, pensions, education, and

health; close supervision during implementation; and knowledge exchanges with other

countries and other subnational governments in Brazil. Second, the government has shown a

strong commitment to its reform program and has made progress in some areas, establishing a

solid track record since taking office.

184. Upcoming presidential and gubernatorial elections: The main political risk is

related to the presidential and state elections in November 2010. Though the municipal

government is not up for election, the administration may have limited political space to

implement deep reforms because it may face a complex political situation and groups with

entrenched political interests may oppose the proposed reforms. However, the municipality’s

19

The Alvará Já reform has been facilitating the registration process for micro and small companies that

typically do not need environmental licenses to operate. Prior to the Alvará Já, every company had to go

through the same registration procedures, regardless of their potential environmental impact or their need for an

environmental license. The Alvará Já now simplifies the licensing for companies with a low environmental

impact or without a need for such an environmental license. However, this streamlined licensing process does

not mean that companies will not be monitored for possible environmental impacts; in fact, it frees up resources

that, coupled with the additional personnel, should make the municipality more effective in its monitoring tasks.

58

political leadership enjoys support from both of the main candidates for elections presidential

and state levels, and the outcome of the elections should not affect the municipality’s

development programs. In addition, the preparation of the World Cup and the Olympics

implies that the federal and state government will support and foster continuity of the

municipality’s strategic programs.

185. Fiscal and Public Sector: There is a risk that preparations for the Olympics

may burden the municipality’s finances and the capacity to implement its reform

program. Previous Olympics ended up costing much more than initially planned and

temporarily hijacked government resources to complete hosting infrastructure in time. The

Olympics are in 2016, and the second-tranche disbursement is planned for July 2011. The

reforms supported by this DPL should not be affected by the Olympics planning. However,

there is a risk of fiscal burden from the Olympics that would occur beyond the loan’s

implementation period. This risk is mitigated in three ways. First, the federal and state

governments will be working with the municipality to share the implementation and financial

burdens related to the games. Second, this DPL supports a set of institutional reforms geared

to improve the institutional capacity to manage projects and strengthen the efficiency of

resource allocation in the medium term. Third, the technical assistance loan will have a strong

public-sector component that will support capacity building in public investment

management, medium-term financial planning, and results-based management. The bank will

also share with the municipality the experiences of other countries and subnationals in

implementing public-sector management reforms, partnering with the GET-PSM (Global

Expert Team on Public Sector Management).

186. Pensions: There is a moderate risk that the government does not take advantage

of the full range of pension reform measures. Each reform implies a loss in benefits for one

political constituency or another and is likely to face resistance from unions or retiree

associations. The operation’s design is a mitigating factor because the reforms are focused on

future public servants, implying lower political risk.

187. The proposed pensions reforms are mandated by the federal constitutional

amendment and have already being undertaken in Rio and in other municipalities and

states since 2004. Although the reforms are ―prescribed by the federal constitution,‖ there is a

chance that the legislative assembly will not approve them. However the team deems that risk

as limited, given the high political support for the current administration and the fact that the

measures target new public servants. The fiscal implications of a potential delay in pension

reform would be increased pensions expenditures and inconsistency with current federal

legislation, which could affect federal transfers to the municipality.

188. PPPs: The main risks center on the institutional capacity to manage a PPP

program and the generation of financial contingent liabilities. Institutional capacity risks

can be mitigated by a well-planned and executed capacity-building program, including the

hiring of key advisors for the transactions. The municipality is aware of the need to ensure

institutional capacity to manage its PPP program effectively. City officials are thinking

carefully about the structure of such a program and the expertise they will need to manage it.

189. The municipality is also moving to mitigate contingent-liability risks. Rio’s PPP

program entails a number of projects that are not fully financially viable. The municipality

will have to enhance the project through financial contributions and guarantees. This may

59

generate contingent financial liabilities, creating the need to manage them appropriately and

track them trough a register. The potential risks from these liabilities are limited and will be

mitigated because the municipality is setting up a fund with liquid assets to guarantee

committed financial payments for PPP projects. The city's Treasury is establishing a process

to adequately assess the need for guarantees in projects. The Treasury is also aware of the

need to properly report and budget for contingent liabilities, and it has committed to do so in

accordance with best practices. The municipality’s recurrent payments will be assigned yearly

through the budget; in the event of a failure to pay, the guarantee will be triggered and the

guarantee fund will be used to cover payments. Two issues are critically important—ensuring

allocated funds are exclusively used for the appropriate purpose and ensuring the guarantee

fund has adequate resources. The municipality’s intentions are set out in their draft by-laws

for the guarantee fund, greatly reducing the usual risk associated with contingent liabilities.

The issue of termination remains, but in that case assets will be recovered. On balance, the

fiscal costs of termination should be minimal, leaving just an issue of liquidity at the time of

paying termination compensation.

190. As part of the operation preparation, the Rio DPL team has received advice

from the Bank’s Global Expert Team for PPP (GET-PPP) in advising the municipality

on its PPP program. This support has included several consultations on the guarantee fund

that will be established for PPPs and an initial assessment of the municipality's institutional

structure and capacity to manage a PPP program. The GET-PPP team has provided

recommendations on the guarantee fund and its by-laws and produced a draft document with

recommendations for the institutional framework and capacity-building activities. The Bank

team would continue to provide the municipality with the technical support needed to develop

its PPP Program.

191. Education: Rio is implementing the Escolas do Amanhã program in high-crime,

drug-infested areas. Due to the unstable environment in these neighborhoods, there is some

risk that it will be difficult to implement all elements of the ambitious program at all sites.

Plans calls for ―cinema clubs‖ at the schools on weekends, skills training centers, and one-

stop shops at schools for all types of municipal services, including birth and marriage

certificates, car registrations, and pension claims. To achieve the goal of full integration and

community acceptance of the Escolas do Amanhã, the SME has created new positions—an

educador comunitário, responsible for the link between each school and the community, and a

mães comunitárias, responsible for monitoring attendance and assisting at school events.

The program is off to a good start, but it is likely to face greater implementation challenges in

some communities than others. To mitigate these risks, the SME has assembled a strong and

experienced team that is working closely with the municipality’s social services branches.

192. Implementing and operating the Espaços para Educação Infantil program

requires the development of a strong analytical framework with results-based evidence. Without this framework, it would be hard to improve the EDIs. To mitigate this risk, SME in

partnership with UNESCO is already developing a pilot program in 10 schools to test and

adapt the model before full implementation. The SME is also joining with IPEA, IETS and

the Bank to implement a rigorous, randomized controlled trial to evaluate the developmental

benefits and costs of the SME’s new models and traditional crèche and pre-school services,

comparing them to situations with no access to ECD services. Sovereign repayment risks.

The team feels confident that the sovereign repayment risk for Brazil is very low. Portfolio

investment flows have been increasing, but they are currently at the same as 2007 and well

60

below levels that can constitute a vulnerability for the country as a whole. The accumulation

of reserves up to US$239 billion and the consistent application of sound macro policies in the

past 10 years more than offset the short-term increase in portfolio investments in making an

assessment of low vulnerability.

61

ANNEX 1: LETTER OF DEVELOPMENT POLICY

66

ANNEX 2: OPERATION POLICY MATRIX – RESULT INDICATORS

Actions in bold are the core prior actions and conditions for this DPL

Programs Long Term Vision Prior Actions

(First Tranche)

Conditions

(Second Tranche)

Outcome Indicators


Creating Fiscal Space

Creating fiscal space

to expand public

investment and lay the

foundations for

municipal growth.

Submitting to the legislative

assembly a draft law consistent with

the federal Constitutional

Amendments No. 20 of 1998 and No.

41 of 2003 that mandate for new

public servants:

(i) the calculation of pension

benefits based on the average

wage rather than the last wage;

(ii) the indexation of pension

benefits on inflation rather than

wage growth;

(iii) the reduction by 30 percent of

survivors benefits for

pensioners above the RGPS

ceiling.

Approval by the legislative

assembly of the draft law on

pensions that was submitted as a

prior action for the first tranche.


assembly a draft law and/or

adopting the adequate

legislative framework to allow

the following resources transfers

to recapitalize FUNPREVI

including through:

(f) future royalties revenues from

the municipality;

(g) the returns (amortizations

and interests) from the

portfolio of real estate loans of

FUNPREVI;

(h) real estate assets from

FUNPREVI;

(i) real estate assets from the

municipality; or

(j) other equivalent measures.

Implementing a set of legal and

administrative measures to

improve the corporate governance

of the pension fund and the

institutional capacity to manage

Reduced NPV of the pension

system’s actuarial deficit over

the next 50 years of 17% (from

a current baseline of R$36

billion) or R$6.3 billion of

which R$3.1 billion from

parametric reforms and

R$3.2Billion from the

recapitalization measures.

Improved revenue collection,

evidenced by a 4 percent

increase in ISS tax

collections through NFEs.

Rationalized current

expenditures as evidenced by a

reduction in the growth of

personnel expenses.

67


(First Tranche)

Conditions

(Second Tranche)

Outcome Indicators

Decree No 30.345 (01/01/09)

mandating the reduction of 30 percent

of commissioned positions in the direct

and indirect municipal administration

and the reduction of the incorporations

of benefits earned in the private sector.

Approval of the draft law to introduce a

user charge tax on public illumination

by the legislative assembly.

the pension funds’ assets.

Issuing an administrative decree

(Decreto Interno) setting up the

organizational restructuring and

the institutionalizing of the cash

management function performed

by the Treasury.

Implementing the Electronic

Fiscal Invoice System (Nota

Fiscal Eletrônica) for the

collection of the municipal tax

on services (ISS) and creating a

database system (Inteligência

Fiscal) to facilitate the

identification of ISS tax evasion.


assembly a draft law to expedite

the recourse to judicial

measures to recover tax arrears.

Completion of the municipality

payroll audit including

compensation for active

employees, pensioners, and

survivors benefits.

Pillar 2: Innovation in public service delivery

Reforming Public Services

Delivery

(a) Improved

government

processes for

registering

businesses.

(b) Increased access to

quality family health

care and emergency

Approval of Decree No. 30.568/2009,

which simplifies the registration

process for municipal business

licenses for activities with low

environmental risk.

Approval of the Law No. 5026/2009

and Decrees No. 30.780/2009, No.

30.907/2009 and No. 30.916/2009 to

REGIN (one stop shop for business

registration) is implemented at the

municipal level.

Continued implementation of the

new management model with the

Municipal Health Secretariat

signing five new management

contracts with qualified social

Reduction in the number of

days required to obtain a

municipal business license in

Rio from 20 days in 2009 to

12.5 days in 2010.

Family health care coverage

will double from a January

2009 baseline of 6 percent to a

projected 12 percent in

68


(First Tranche)

Conditions

(Second Tranche)

Outcome Indicators

care services.

(c) Improved early

development of poor

children, better

quality of primary

schools in high

conflict slum areas

and system wide

improvements in

student learning

outcomes.

transfer public services management

to social organizations and

implementation of the law with the

Municipal Health Secretariat signing

three management contracts with

qualified social organizations to

deliver services in ten family health-

care clinics (clínica da família) and

three emergency care clinics (UPA).

Issuing of (a) Decrees No.

30.934/2009 and No. 31.022/2009

establishing the design and budget

for innovative schools (Bairro

Educador/Escolas do Amanhã) in 150

high-conflict slum neighborhoods;

(b) Resolution No. 1057/2010

(published in the Official Gazette on

January 25, 2010), establishing a new

model of integrated early child care

and pre-school services called

Espaços de Desenvolvimento Infantil

(EDIs), with the first set of centers in

targeted low-income areas.

Establishment of a Partnership

agreement with Ayrton Senna Institute

for delivery of remedial classes during

2009 for 21,000 students diagnosed as

functionally illiterate and training of

1,736 teachers in literacy teaching

skills.

organizations to implement

services delivery in 10 additional

family health-care clinics

(clínicas da família) and four

additional emergency care clinics

(UPA).

(a) First 10 EDIs (Integrated

Early Child Development

Centers) opened and fully

operational, in targeted low-

income neighborhoods.

(b) Issuance of Decree No.

30.860/2009, establishing a system

of bonus pay for schools that attain

annual targets for improvements in

student learning and student flows.

December 2011.

(a) Annual reductions in

student within year and

between-year dropout rates

and annual improvement in

IDEB/IDE-Rio for Escolas do

Amanhã from the 2009

baseline; and

(b) annual expansion by 3,000

new openings in enrollments

in ECD centers and pre-

schools targeted to low-

income communities from

29,921 (crèches) and 77,845

(pré-escolas) from 2009

baseline.

The share of municipal Grade 2

students meeting national

reading proficiency standards

on Provinha Brasil rises by at

least 1 percentage point

annually from 73 percent in

2009.

The share of children more than

two years behind grade level at

grade 8 or 9 (atrasados)

decreases by at least 1

percentage point annually from

14.3 percent in 2009.


Strengthening the Public

Institutional Framework

for efficient service

Developing a

framework to improve

Approval of Decree No. 32214/2010

and the signing of 16 results

agreements with said entities and

Initiating the implementation of a

medium term expenditures

Implementation of the initial

year of a 3-5 years strategy

with associated expenditures

69


(First Tranche)

Conditions

(Second Tranche)

Outcome Indicators

delivery the efficiency of

services delivery (a)

in the public sector

through introduction

of a MTEF and result-

based management

(RBM) tools and (b)

in the private sector

through public private

partnerships (PPP) in

priority areas.

secretariats for the implementation

of a monitoring and evaluation

system with results based

management tools.

Development of an IT system for

results monitoring.

Establishment of a Project Unit to

monitor a portfolio of 46 priority

projects linked to the Strategic Plan of

the Municipality.

Establishment of a framework to

enable PPPs to invest in

infrastructure and service delivery

projects, including:

Approval of Law No. 105/2009 on

municipal PPP programs by the

Legislative Assembly and

The issuance of Decree No.

32120/2010 establishing the by-laws

of the Municipal Guarantee Fund

for PPPs.

Decree Nº 30.539 (of March 17, 2009)

institutionalizing yearly procurement

planning for the centralized purchase

of general consumption goods and

services.

framework as evidenced through a

report presented by the

Borrower’s Secretariat of Finance

confirming consistency between

said framework and the

Borrower’s budget guideline draft

law of 2012 in form and substance

satisfactory to the Bank

Monitoring and evaluation

system for results agreements in

operation as evidenced by (a)

the publishing of the annual

evaluation of the 16 results

agreements signed in 2010; (b)

the updating of the IT system with

information on progress towards

achievement of targets for

elaboration of monthly status

reports; (c) the maintenance of

quarterly meetings on the progress

towards achieving results

agreements targets; (d)

preparation of report on lessons

learned in the first year of

implementation of results

agreements and their monitoring

system.

Implementation of a Public

Investment Framework for the

municipality to evaluate and select

capital investment projects.

The PPP unit has been created

(decree issued and published in

the Official Journal), is staffed

and operational, and has issued

plan and financing plan used

for the preparation of the

budget guideline law of 2012 -

LDO (Lei das Diretrizes

Orçamentárias).

Implementation of RBM,

evidenced by annual

evaluation of the

performance contracts.

Establishment of a

framework to enable PPPs to

invest in infrastructure and

service delivery projects,

evidenced by the at least one

project prepared by the PPP

unit.

Average savings of 20 percent

through centralized

procurement of general

consumption goods and

services and the estimated cost.

Improved efficiency in stock

management allows reducing

losses in the stock of goods in

the health sector from 20

percent to10 percent.

70


(First Tranche)

Conditions

(Second Tranche)

Outcome Indicators

processes approved by the PPP

council for the preparation and

procurement of PPP projects.

Publication in the Official Journal

of the call for expressions of

interest for one PPP project.

Piloting a stock management

system for the health sector and

approval of the schedule for

municipality-wide roll-out

within 15 months.

71

ANNEX 3: FUND RELATIONS NOTE

Bank and Fund country teams for Brazil meet regularly. Economist teams have been

meeting once every three months on average, and lead economists/sector leaders have been

meeting twice yearly. During the IMF yearly surveillance mission—Article 4 mission—in

Brazil, the Fund team meets with the Bank team’s lead economist in Brasília. The Bank

representative participates in the presentation of the Brazil Article 4 board document. The

IMF country resident representative is in regular contact with the Bank team. He serves as a

peer reviewer for the Rio de Janeiro State Fiscal Sustainability, Human Development, and

Competitiveness DPL. The primary objective of the consultations is to inform each institution

of the other’s ongoing projects and studies. The IMF work on Brazil includes one staff visit

and a yearly surveillance mission (also referred to as Article 4 mission), which are the basis

for preparation of the Article 4 documents and the Selected Issues Papers. The secondary

objective is to share views about the direction and effectiveness of macroeconomic policies

being considered by the government and to articulate and influence each other’s sectoral and

macroeconomic priorities. The Bank also shares with the Fund the progress and findings of

Bank economic studies. Because of its engagement at the subnational and sectoral levels, the

Bank brings this perspective to the discussion. The outcome of consultations is a short joint

memorandum and ―action matrix‖ that summarizes the main issues discussed and the work

program for the next 12 months. The memorandum and matrix include: (a) identification of

analytical work of joint interest; (b) tentative mission dates; and (c) expectations for main

programs, projects, technical assistance, and lending operations for the period ahead.

74

ANNEX 4: STATEMENT OF LOANS AND CREDITS

BRAZIL: Municipality of Rio de Janeiro Fiscal Consolidation for Efficiency and Growth DPL

Original Amount in US$ Millions

Difference between

expected and actual disbursements

Project

ID

FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Frm. Rev’d

P118410

P106703

P106390

P113540

P108443

P099469

P101508

2010

2010

2010

2010

2010

2010

2010

BR Mato Grosso do Sul Roads

BR São Paulo Water Reagua

BR São Paulo Metro Line 4-Phase 2

BR AIDS-SUS

BR SP Sust. Rural Dev. & Access to

Markets

(APL 2) 2nd National Environment

BR-RJ Sustainable Rural Development

300.0

64.5

130.0

67.0

78.0

24.30

39.50

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.00

0.00

0.0

0.0

0.0

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

300.0

64.5

130.0

67.0

78.0

24.30

39.40

0.00

0.00

0.00

0.00

0.00

0.0

1.83

0.00

0.00

0.00

0.00

0.00

0.00

0.00

P119215 2010 BR AF Minas Gerais Swap 461.0 0.00 0.00 0.00 0.00 461.00 0.00 0.00

P116170 2010 BR São Paulo Metro Line 5 650.0 0.00 0.00 0.00 0.00 650.00 0.0 0.00

P108654 2010 BR Pernambuco Sustainable Water 190.00 0.00 0.00 0.00 0.00 190.00 0.00 0.00

P106663 2010 BR Sao Paulo Feeder Roads Project 166.65 0.00 0.00 0.00 0.00 55.73 -110.50 0.00

P103770 2010 BR ALAGOAS Fiscal & Public Mgmt Reform

195.45 0.00 0.00 0.00 0.00 74.96 -120.00 0.00

P104995 2010 BR Municipal APL5: Santos 44.00 0.00 0.00 0.00 0.00 44.00 0.00 0.00

P111996 2010 BR RJ Mass Transit II 211.70 0.00 0.00 0.00 0.00 210.67 -0.50 0.00

P006553 2010 BR SP APL Integrated Wtr Mgmt 104.00 0.00 0.00 0.00 0.00 104.00 3.78 0.00

P117244 2010 BR Rio State DPL 485.00 0.00 0.00 0.00 0.00 485.00 0.00 0.00

P104752 2009 BR Paraiba 2nd Rural Pov Reduction 20.90 0.00 0.00 0.00 0.00 20.90 0.00 0.00

P099369 2009 BR Ceara Regional Development 46.00 0.00 0.00 0.00 0.00 45.89 0.07 0.00

P095205 2009 BR 1st Prog. DPL for Sust. Env

Mgmt

1,300.00 0.00 0.00 0.00 0.00 1,300.00 1.30 0.00

P094315 2009 BR Municipal APL4: Sao Luis 35.64 0.00 0.00 0.00 0.00 33.49 -1.90 0.00

P106208 2009 BR Pernambuco Educ Results& Account.

154.00 0.00 0.00 0.00 0.00 97.84 -55.77 0.00

P106765 2009 BR Ceara Inclusive Growth (SWAp II)

240.00 0.00 0.00 0.00 0.00 137.05 27.29 0.00

P106767 2009 BR RGS Fiscal Sustainability DPL 1,100.00 0.00 0.00 0.00 0.00 450.00 0.00 0.00

P107146 2009 BR Acre Social Economic Inclusion

Sust D

120.00 0.00 0.00 0.00 0.00 104.00 -0.70 0.00

P107843 2009 BR Fed District Multisector Manag. Proj.

130.00 0.00 0.00 0.00 0.00 129.68 29.23 0.00

P110614 2009 BR: Sergipe State Int. Proj.: Rural Pov

20.80 0.00 0.00 0.00 0.00 17.55 2.81 0.00

P088716 2009 BR Health Network Formation &

Quality Im

235.00 0.00 0.00 0.00 0.00 234.41 4.07 0.00

P106038 2008 BR Sao Paulo Trains and Signalling 550.00 0.00 0.00 0.00 0.00 307.04 34.30 0.00

P083997 2008 BR Alto Solimoes Basic Services and Sust

24.25 0.00 0.00 0.00 0.00 21.59 5.04 0.00

P101324 2008 BR-Second Minas Gerais Dev't Partnership

976.00 0.00 0.00 0.00 0.00 235.40 6.34 0.00

P088966 2008 BR Municipal APL3: Teresina 31.13 0.00 0.00 0.00 0.00 28.64 4.42 0.00

P095626 2008 BR (APL2)Family Health Extension

2nd APL

83.45 0.00 0.00 0.00 0.00 83.24 26.15 0.00

75

P089013 2008 BR Municipal APL: Recife 32.76 0.00 0.00 0.00 0.00 32.68 13.96 0.00

P094199 2008 BR-(APL) RS (Pelotas) Integr. Mun. Dev.

54.38 0.00 0.00 0.00 0.00 39.36 5.42 0.00

P089929 2008 BR RGN State Integrated Water Res Mgmt

35.90 0.00 0.00 0.00 0.00 31.20 20.73 0.00

P082651 2007 BR APL 1 Para Integrated Rural Dev 60.00 0.00 0.00 0.00 0.00 51.20 45.20 0.00

P089793 2007 BR State Pension Reform TAL II 5.00 0.00 0.00 0.00 0.00 4.99 3.17 0.00

P095460 2007 BR-Bahia Integr.Hway Mngmt. 100.00 0.00 0.00 0.00 0.00 87.90 24.43 0.00

P089011 2007 BR Municipal APL1: Uberaba 17.27 0.00 0.00 0.00 0.00 13.05 9.49 0.00

P050761 2006 BR-Housing Sector TAL 4.00 0.00 0.00 0.00 2.70 0.96 3.66 -0.29

P090041 2006 BR ENVIRONMENTAL SUST.

AGENDA TAL

8.00 0.00 0.00 0.00 0.00 4.88 4.85 0.69

P089440 2006 BR-Brasilia Environmentally Sustainable

57.64 0.00 0.00 0.00 0.00 21.22 19.30 0.00

P093787 2006 BR Bahia State Integ Proj Rur Pov 84.35 0.00 0.00 0.00 0.00 30.72 0.22 0.00

P092990 2006 BR - Road Transport Project 501.25 0.00 0.00 0.00 0.00 228.70 209.95 0.00

P081436 2006 BR-Bahia Poor Urban Areas Integrated Dev

49.30 0.00 0.00 0.00 0.00 38.96 38.96 0.00

P083533 2005 BR TA-Sustain. & Equit Growth 12.12 0.00 0.00 0.00 0.00 7.70 7.70 0.00

P069934 2005 BR-PERNAMBUCO INTEG DEVT:

EDUC QUAL IMPR

31.50 0.00 0.00 0.00 0.00 9.15 9.15 0.00

P087711 2005 BR Espirito Santo Wtr & Coastal Pollu

107.50 0.00 0.00 0.00 0.00 31.06 -40.26 -17.93

P076924 2005 BR- Amapa Sustainable Communities 4.80 0.00 0.00 0.00 0.23 2.35 2.58 1.99

P060573 2004 BR Tocantins Sustainable Regional Dev

60.00 0.00 0.00 0.00 0.00 18.19 18.19 0.00

P076977 2003 BR-Energy Sector TA Project 12.12 0.00 0.00 0.00 0.00 5.63 5.63 0.00

P049265 2003 BR-RECIFE URBAN UPGRADING PROJECT

46.00 0.00 0.00 0.00 0.00 8.13 8.13 0.00

P066170 2002 BR-RGN Rural Poverty Reduction 45.00 0.00 0.00 0.00 0.00 15.49 -6.95 15.55

P060221 2002 BR FORTALEZA METROPOLITAN TRANSPORT

PROJ

85.00 0.00 0.00 0.00 62.60 9.79 65.37 13.65

P051696 2002 BR SÃO PAULO METRO LINE 4 PROJECT

304.00 0.00 0.00 0.00 0.00 27.67 -67.10 27.90

P006449 2000 BR CEARA WTR MGT PROGERIRH SIM

239.00 0.00 0.00 0.00 0.00 96.74 -6.00 1.00

Total: 10,235.16 0.00 0.00 0.00 65.53 7,042.94 253.04 42.56

76

BRAZIL

STATEMENT OF IFC’s

Held and Disbursed Portfolio

In Millions of US Dollars

Committed Disbursed

IFC IFC

FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic.

2005

ABILLION AMRO REAL 98.00 0.00 0.00 0.00 15.77 0.00 0.00 0.00

2005 ABILLION AMRO REAL 98.00 0.00 0.00 0.00 15.77 0.00 0.00 0.00

2001 AG Concession 0.00 30.00 0.00 0.00 0.00 30.00 0.00 0.00

2002 Amaggi 17.14 0.00 0.00 0.00 17.14 0.00 0.00 0.00

2005 Amaggi 30.00 0.00 0.00 0.00 30.00 0.00 0.00 0.00

2002 Andrade G. SA 22.00 0.00 10.00 12.12 22.00 0.00 10.00 12.12

2001 Apolo 6.04 0.00 0.00 0.00 3.54 0.00 0.00 0.00

1998 Arteb 20.00 0.00 0.00 18.33 20.00 0.00 0.00 18.33

2006 BBM 49.40 0.00 0.00 0.00 49.40 0.00 0.00 0.00

2001 Brazil CGFund 0.00 19.75 0.00 0.00 0.00 18.15 0.00 0.00

2004 CGTF 54.01 0.00 7.00 65.12 54.01 0.00 7.00 65.12

1994 CHAPECO 10.00 0.00 0.00 0.00 10.00 0.00 0.00 0.00

1996 CHAPECO 1.50 0.00 0.00 5.26 1.50 0.00 0.00 5.26

2003 CPFL Energia 0.00 40.00 0.00 0.00 0.00 40.00 0.00 0.00

1996 CTBC Telecom 3.00 8.00 0.00 0.00 3.00 8.00 0.00 0.00

1997 CTBC Telecom 0.00 6.54 0.00 0.00 0.00 6.54 0.00 0.00

1999 Cibrasec 0.00 3.27 0.00 0.00 0.00 3.27 0.00 0.00

2004 Comgas 11.90 0.00 0.00 11.54 11.90 0.00 0.00 11.54

2005 Cosan S.A. 50.00 5.00 15.00 0.00 50.00 5.00 15.00 0.00

Coteminas 0.00 1.84 0.00 0.00 0.00 1.84 0.00 0.00

1997 Coteminas 1.85 1.25 0.00 0.00 1.85 1.25 0.00 0.00

2000 Coteminas 0.00 0.18 0.00 0.00 0.00 0.18 0.00 0.00

1980 DENPASA 0.00 0.52 0.00 0.00 0.00 0.48 0.00 0.00

1992 DENPASA 0.00 0.06 0.00 0.00 0.00 0.06 0.00 0.00

Dixie Toga 0.00 0.34 0.00 0.00 0.00 0.34 0.00 0.00

1998 Dixie Toga 0.00 10.03 0.00 0.00 0.00 10.03 0.00 0.00

1997 Duratex 1.36 0.00 3.00 0.57 1.36 0.00 3.00 0.57

2005 EMBRAER 35.00 0.00 0.00 145.00 35.00 0.00 0.00 145.00

1999 Eliane 14.93 0.00 13.00 0.00 14.93 0.00 13.00 0.00

1998 Empesca 1.33 0.00 2.67 0.00 1.33 0.00 2.67 0.00

2006 Endesa Brasil 0.00 50.00 0.00 0.00 0.00 50.00 0.00 0.00

2006 Enerbrasil Ltda 0.00 5.50 0.00 0.00 0.00 0.00 0.00 0.00

2006 FEBR 12.00 0.00 0.00 0.00 12.00 0.00 0.00 0.00

2000 Fleury 0.00 0.00 6.00 0.00 0.00 0.00 6.00 0.00

1998 Fras-le 4.00 0.00 9.34 0.00 4.00 0.00 6.04 0.00

2006 GOL 50.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

2005 GP Capital III 0.00 14.00 0.00 0.00 0.00 0.14 0.00 0.00

GP Cptl Rstrctd 0.00 2.22 0.00 0.00 0.00 2.16 0.00 0.00

2001 GPC 0.00 0.00 9.00 0.00 0.00 0.00 9.00 0.00

77

GTFP BIC Banco 44.91 0.00 0.00 0.00 44.91 0.00 0.00 0.00

GTFP BM Brazil 4.22 0.00 0.00 0.00 4.22 0.00 0.00 0.00

GTFP Indusval 5.00 0.00 0.00 0.00 5.00 0.00 0.00 0.00

1997 Guilman-Amorim 18.08 0.00 0.00 14.37 18.08 0.00 0.00 14.37

1998 Icatu Equity 0.00 5.46 0.00 0.00 0.00 4.16 0.00 0.00

1999 Innova SA 0.00 5.00 0.00 0.00 0.00 5.00 0.00 0.00

1980 Ipiranga 0.00 2.87 0.00 0.00 0.00 2.87 0.00 0.00

1987 Ipiranga 0.00 0.54 0.00 0.00 0.00 0.54 0.00 0.00

2006 Ipiranga 50.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

2006 Itambe 15.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

2000 Itau-BBA 12.86 0.00 0.00 0.00 12.86 0.00 0.00 0.00

2002 Itau-BBA 70.61 0.00 0.00 0.00 38.47 0.00 0.00 0.00

1999 JOSAPAR 7.57 0.00 7.00 0.00 2.57 0.00 7.00 0.00

2005 Lojas Americana 35.00 0.00 0.00 0.00 35.00 0.00 0.00 0.00

1992 MBR 0.00 0.00 10.00 0.00 0.00 0.00 10.00 0.00

2006 MRS 50.00 0.00 0.00 50.00 0.00 0.00 0.00 0.00

2002 Microinvest 0.00 1.25 0.00 0.00 0.00 0.82 0.00 0.00

Net Servicos 0.00 10.93 0.00 0.00 0.00 10.93 0.00 0.00

2002 Net Servicos 0.00 1.60 0.00 0.00 0.00 1.60 0.00 0.00

2005 Net Servicos 0.00 5.08 0.00 0.00 0.00 5.08 0.00 0.00

1994 Para Pigmentos 2.15 0.00 9.00 0.00 2.15 0.00 9.00 0.00

1994 Portobello 0.00 0.59 0.00 0.00 0.00 0.59 0.00 0.00

2000 Portobello 4.28 0.00 7.00 0.00 4.28 0.00 7.00 0.00

2002 Portobello 0.00 0.90 0.00 0.00 0.00 0.90 0.00 0.00

2000 Puras 0.00 0.00 1.00 0.00 0.00 0.00 1.00 0.00

2003 Queiroz Galvao 26.67 0.00 10.00 0.00 26.67 0.00 10.00 0.00

2004 Queiroz Galvao 0.60 0.00 0.00 0.00 0.08 0.00 0.00 0.00

2006 RBSec 22.83 1.51 0.00 0.00 0.00 1.51 0.00 0.00

Randon Impl Part 2.33 0.00 3.00 0.00 2.33 0.00 3.00 0.00

1997 Sadia 2.55 0.00 2.33 3.28 2.55 0.00 2.33 3.28

1997 Samarco 3.60 0.00 0.00 0.00 3.60 0.00 0.00 0.00

1998 Saraiva 0.00 1.24 0.00 0.00 0.00 1.24 0.00 0.00

2000 Sepetiba 26.24 0.00 5.00 0.00 11.24 0.00 5.00 0.00

2002 Suape ICT 6.00 0.00 0.00 0.00 6.00 0.00 0.00 0.00

1999 Sudamerica 0.00 7.35 0.00 0.00 0.00 7.35 0.00 0.00

2006 Suzano petroq 50.00 0.00 10.00 140.00 39.50 0.00 10.00 110.50

2001 Synteko 11.57 0.00 0.00 0.00 11.57 0.00 0.00 0.00

2006 TAM 50.00 0.00 0.00 0.00 17.00 0.00 0.00 0.00

1998 Tecon Rio Grande 3.55 0.00 5.50 3.71 3.55 0.00 5.50 3.71

2004 Tecon Rio Grande 7.87 0.00 0.00 7.76 7.59 0.00 0.00 7.48

2001 Tecon Salvador 2.95 1.00 0.00 3.10 2.95 0.77 0.00 3.10

2003 Tecon Salvador 0.00 0.55 0.00 0.00 0.00 0.55 0.00 0.00

2004 TriBanco 10.00 0.00 0.00 0.00 10.00 0.00 0.00 0.00

2006 TriBanco 0.35 0.00 0.00 0.00 0.35 0.00 0.00 0.00

2002 UP Offshore 9.01 9.51 0.00 23.29 0.00 2.51 0.00 0.00

2002 Unibanco 16.89 0.00 0.00 0.00 16.89 0.00 0.00 0.00

Total portfolio: 1,164.15 253.88 144.84 503.45 703.91 223.86 141.54 400.38

78

Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Partic.

2000 BBA 0.01 0.00 0.00 0.00

1999 Cibrasec 0.00 0.00 0.00 0.00

2006 Ipiranga II 0.00 0.00 0.00 0.10

2002 Banco Itau-BBA 0.00 0.00 0.00 0.10

Total pending commitment: 0.01 0.00 0.00 0.20

79

ANNEX 5: FISCAL AND DEBT SUSTAINABILITY ANALYSIS

A5-1 Fiscal Analysis: Municipality of Rio de Janeiro, 2004–09

Evolution of Fiscal Balances, 2004–09

A5.1 The municipality of Rio de Janeiro’s fiscal revenues experienced a turning point in

2005 with increases that allowed for more investment. Revenues rose sharply from R$8.7 billion

in 2004 to R$10.78 billion in 2008, driven mostly by higher receipts from the Imposto Sobre

Serviços (ISS), the municipal tax on services. Nevertheless, the municipality was less successful

in controlling current expenditures, particularly those related to wages and salaries and purchases

of goods and services. From 2004 to 2006, current expenditures grew a mere 1.3 percent, but

they ballooned from 2006 to 2008, growing 21.6 percent. Despite the lack of control over

expenditures, the city’s gross operating balance grew from R$834 million in 2005 to R$1.2

billion in 2008. This has allowed the municipality to reverse the pre-2005 decreasing trend in

investment, with a 70 percent increase from 2005 to 2008. As a result, the primary balance

decreased from R$137 million in 2004 to R$95 million in 2008. During 2005–08, interest

expenditures also increased by 13 percent. As a result, the modest overall fiscal balances have

decreased and fallen into negative territory, going from R$99 million in 2004 to -R$23 million in

2008. In 2009, current expenditures decreased during the financial turmoil, the city maintained

increasing revenues and drastically cut the capital investments. This resulted in an extraordinary

fiscal primary surplus of R$1.394 billion that contrasts with an average primary surplus of

R$363 million generated in the previous year (see Figure A5.1).

Figure A5.1: Rio de Janeiro’s Fiscal Balances, 2004-09


Evolution of Fiscal Revenues, 2004-2009

A5.2 On the revenue side, tax revenues and transfers are the main drivers, representing on

average 39 percent of total revenues (see Figure A5.2). From 2004 to 2008, current revenue

increased by 18 percent, with taxes rising 44 percent, led by increases in collections from the ISS

and the Imposto sobre Transmissão de Bens Imóveis (ITBI), the tax on real estate conveyance.

Together, these two levies accounted for more than 65 percent of revenues. Transfers increased 5

percent from 2004 to 2008, led by Fund for Maintenance and Development of Primary Education

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

2004 2005 2006 2007 2008 2009

Tho

usa

nd

R$

Rio de Janeiro's Fiscal Balances, 2004-09

Primary Balance Overall Balance Public Investment

2.4

80

and of Teacher’s Valorization (FUNDEB) transfers, which increased by 31 percent and

represented 26 percent of the total transfers in 2008. State transfers, which accounted for 42

percent of total transfers in 2008, increased 2 percent during the period. Federal transfers

decreased 13 percent. In 2009, despite the financial crisis, the government of Rio recorded

increasing revenues, although at a slower pace than 2004-08. The driving factors were the strong

tax revenues and transfers.

Figure A5.2: Evolution of Current Revenues and expenditures from 2004 to 2009


Evolution of Expenditures, 2004–09

A5.3 From 2006 to 2008, rapid growth in expenditures for wages and salaries, goods and

services, and interest expenses tightened fiscal adjustment. Current expenditures increased by 22

percent in the past four years. Personnel expenditures, including pensions, are the largest part of

current expenditures, increasing by 26 percent from 2004 to 2008. Goods and services (custeio),

the second largest component on the expenditure side, rose by 17 percent during the period.

Despite declining indebtedness, the accumulation of debt service payments in the short run

prevents Rio from contracting credit operations to finance investment expenses—a consequence

of borrowing restrictions coming from the debt renegotiation agreement under the MP2185.

Nevertheless, the municipality should be commended for managing to increase investment

expenditures. In 2009, due to the global crisis, current expenditures decreased. Only interest

payments and the pensions spending increased during the same period.

Evolution of net consolidated debt, 2003–09

A5.4 The good revenue performance and consistent fiscal adjustment over the past five years

lowered the debt-to-revenue ratio from 79 percent in 2004 to 48 percent in 2008. The decline

allows Rio to comply with Fiscal Responsibility Law (LRF) requirements. In 1999, Rio’s

refinanced debt amounted to R$3 billion, representing 19 percent of the total debt refinancing

package for municipal governments. Despite strict observance of the debt renegotiation contract,

Rio’s stock of refinanced debt has been growing, reaching R$8.3 billion in December 2008 and

R$7.5 billion in 2009, or more than 82 percent of Rio’s total debt. The net consolidated debt has

drastically decreased from 2008 to 2009 due to extraordinary sales of financial assets (see Figure

A5.3)

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

2004 2005 2006 2007 2008 2009

Tho

usa

nd

R$

of

20

09

Evolution of Revenue, 2004-09

Taxes Social Contributions Other Current Revenues Transfers

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

2004 2005 2006 2007 2008 2009

Tho

usa

nd

R$

of

20

09

Evolution of Expenditure, 2004-09

Compensation of employees Goods and Services

Interest Payments Pensions

Investments

81

Figure A5.3: Evolution of Gross and Net Consolidated Debts, 2004-09


A5.5 The outstanding debt stock is composed mainly of domestic debt, averaging 92 percent

of total debt for 2004–09. Both the share of external and domestic debt has decreased since 2004.

In 2009, refinanced, or intralimite, debt represented more than 82 percent of the total debt stock

(see Figure A5.4).

Figure A5.4: Consolidated Debt Composition, 2008-09


-

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

2004 2005 2006 2007 2008 2009

R$

Th

ou

san

d o

f 2

00

9

Evolution of Gross and Net Consolidated Debts , 2004-09

Consolidated Debt (I) Financial Assets (II)

Net Consolidated Debt (I)-(II)

External Debt5%

Domestic Debt47%

National Treasury (STN)42%

Banks1%

Other Debts5%

Domestic Debt95%

Debt Decomposition as of 2009

2008 2009

Consolidated Debt 10,055,560 9,094,454

Total Intra-limite Debt 8,334,781 8,680,481

Intra-limite Debt (R$) 7,970,237 8,443,705

Of which MP 2.185 - Normal 7,841,240 7,188,233

Intra-limite Debt (US$) 364,544 236,776

Total Extra-limite Debt 1,720,779 413,973

Extra-limite Debt (R$) 1,322,630 146,262

Extra-limite Debt (US$) 398,149 267,711

82

A5.6 Debt service has been growing modestly, mainly from interest payments. Under the

Fiscal Responsibility Framework, debt service is capped at 11.5 percent of net current revenues.

The ratio of debt service to net current revenues remained below the threshold during 2004-09

(see Figure A5.5).

Figure A5.5: Evolution of Debt Service, 2004-09


Evolution of Fiscal Responsibility Indicators, 2004-09

A5.7 Since 2004, the municipality has improved in all indicators monitored by the National

Treasury under the LRF. By 2008, all indicators were well below their prudential limits,

indicating a comfortable situation on the fiscal and debt sides.

A5-2 Fiscal and Debt Sustainability of the Municipality of Rio de Janeiro, 2009–13

Fiscal Assumption

A5.8 The following assumptions underlying the fiscal projections. Under the baseline

scenario, Rio’s revenues and expenditures will broadly grow in line with IPCA consumer-price

inflation, the GDP growth rate, and specific components of the IGP inflation rate. The

outstanding stock of debt is indexed to the projected IGP inflation. The fundamental

macroeconomic variables that are affecting the paths of fiscal projections and debt—most

importantly, inflation rates, the nominal GDP growth rate, and the fiscal assumptions—are

detailed in the Table A5.1. The Secretaria Municipal de Fazenda recommended those

assumptions. A set of alternative scenarios has also been run to assess the vulnerability of the

fiscal situation to risks linked to macroeconomic variables. The baseline case does not include

any policy reforms. Alternative scenarios simulating the impact of the fiscal reforms, the debt

restructuring, and the impact of royalties and the Olympic Games will also be discussed.

A5.9 On the revenue side, we assume that tax receipts, including the ISS and ITBI, grow in

line with real GDP and the IPCA inflation rate. The Imposto sobre Propriedade Predial e

Territorial Urbana (IPTU), the tax on urban land and property, and the Imposto de Renda Retido

na Fonte (IRRF), the withholding income tax, are expected to increase with the IPCA inflation

rate. Social security contribution revenues are assumed to follow IPCA inflation and the

personnel growth. Current transfers, such as FUNDEB, grow in line with IPCA inflation, while

8.8%

9.2%

9.6%

10.0%

10.4%

10.8%

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

2004 2005 2006 2007 2008 2009

Tho

usa

nd

R$

of

20

08

Evolution of Debt Service, 2004-09

Debt Amortization Interest payments Debt Service / NCR (right axis)

83

capital transfers are increasing with the real GDP growth. Interest revenues, nonfinancial assets,

and other current revenues are assumed to grow with IPCA inflation. Net current revenue (NCR)

is derived from current revenue and capital transfers, less transfers to the municipality and social

contribution revenues. This variable is used to standardize the fiscal and debt outcomes in

compliance with LRF requirements. The net real revenue (NRR)20

is used to calculate the debt

service ceiling—13 percent of NRR—is expected to growth with nominal GDP.

A5.10 On the expenditure side, personnel expenses follow IPCA inflation and the personnel

growth rate. The latter is mainly driven by an automatic residual growth (crescimento

vegetativo), estimated at 1 percent a year. Goods and services purchases (custeio) are increasing

in line with IPCA inflation. Pension expenditure projections follow actuarial calculations. Rio’s

finance secretariat provided the amortization and interest-payment profiles. The fiscal space left

for further investment will be defined by the gross operating balance’s surplus. This fiscal

account classification follows the Government Finance Statistics (GFS) system recommended by

the IMF.

A5.11 On the debt side, the outstanding stock of debt is indexed to projected IGP inflation. Net

consolidated debt is defined as consolidated debt less financial assets. The fundamental

macroeconomic variables affecting the paths of the debt and fiscal projections, such as the

inflation and nominal GDP growth rates, are detailed in Table A5.1. Regarding the

macroeconomic variables, the baseline projections for the exchange rate are based on the

FOCUS Survey forecast from the Central Bank of Brazil (BCB). The medium term projections

for the baseline real GDP growth and the IGP and IPCA inflation rates follow FOCUS survey

estimates and afterward their long-run equilibriums. For 2010, we expect real GDP growth of 5.5

percents and to reach the long-run equilibrium in 2011. The inflation rates will rise in 2010, with

IPCA reaching its equilibrium in 2011 and the IGP in 2012. The macroeconomic projections

used in this document are conservative. Brazil’s potential GDP growth has been estimated at 4.5

percent to 5 percent. The assumptions for the baseline and the alternative scenario are

summarized in Table A5.2.

20

Net real revenue is sum of current and capital revenues excluded: FUNDEF transfers, credit operation revenues,

asset sales revenues, capital transfers, constitutional transfers to municipalities and the SUS revenues.

84

Table A5.1. Assumptions for Fiscal Projections

Variables Assumptions

Base year figures – 2008

REVENUES

Tax Revenues

ISS, IRRF, impostos Increase with real GDP growth and IPCA inflation

IPTU, IRRF Increase with IPCA inflation

ITBI Increase with real GDP growth and IGP inflation

Social Contributions Increase with personnel growth and IPCA inflation.

Transfers

Current Transfers Federal transfers Increase with IPCA inflation and real GDP growth State transfers Increase with real GDP growth and IPCA inflation

Of which ICMS Increase with real GDP growth and IGP inflation

IPVA Increase with real GDP growth and IPCA inflation

FUNDEB Increase with IPCA inflation

Royalties Increase with IPCA inflation

Capital Transfers Increase with real GDP growth

Other Current Revenues

Non financial assets and Admin. Fees Increase with IPCA inflation

Interest revenue Increase with IPCA inflation.

Sales and miscellaneous Increase with IPCA inflation

Deduction to Net Current Revenue FUNDEB transfer revenues

Net Real Revenue Increase with real GDP growth and IPCA inflation

EXPENDITURES

Wages Increase with personnel growth and IPCA inflation.

Goods and Services Increase with IPCA inflation.

Interest payments Obtained from Debt Department of SMF Rio Municipality

Social Benefits (Pensions) Actuarial calculations

Investment 81 percent of fiscal space left by the gross operating balance

(four-year moving average)

Amortizations Obtained from Debt Department of SMF Rio Municipality

Financial assets 47 percent of the consolidated debt which is the historical

average. (four-year moving average)

IBRD Loan Approximately US$1,045 million disbursed in two tranches.

Source: Secretaria Municipal de Fazenda and World Bank staff.

A5.12 The baseline scenario is described in Section II-C. The alternative scenarios have their

meaning in the risk assessments. We have simulated pessimistic scenarios to assess the potential

risks to the municipal government. In particular, we will discuss possible effects on main fiscal

and debt indicators, including the LRF indicators.

85

Table A5.2. Assumptions for Macroeconomic Variables

(Baseline and Alternative scenario)

Source: Secretaria Municipal de Fazenda, BCB

Fiscal and Debt Projections, 2010–14

A5.13 The projected fiscal accounts of the Rio municipality suggest a sustainable trend in the

medium term; that is, the macro framework is adequate. The trajectory of revenues in the

medium term is largely driven by sales taxes and current transfers. On the expenditures side, the

main determinants are personnel expenditures, pensions, and purchases of goods and services.

The resulting fiscal balances—the primary fiscal balance, the overall balance and the gross

operating balance—are all expected to record surpluses for the projected period, thus creating

fiscal space for increased city investments.

A5.14 On the revenue side, the key tax receipts and current transfers are mainly subject to the

volatility of inflation and the real GDP. On the expenditure side, salary increases are the main

driver of government expenses, suggesting the importance of controlling current expenditures

and salary adjustments to strengthen fiscal balances. The 2016 Olympic Games are not expected

baseline

alternative

(lower) baseline

Alternativ

e baseline

alternative

(higher)

2009 -0.20% -0.2% 1.74 1.74 -0.3% -0.3%

2010 5.50% 4.7% 1.76 1.65 6.0% 6.8%

2011 4.50% 4.0% 1.80 1.60 5.0% 5.2%

2012 4.50% 4.0% 1.90 1.60 4.5% 4.5%

2013 4.50% 4.0% 1.99 1.50 4.5% 4.5%

2014 4.50% 4.0% 2.07 1.50 4.5% 4.5%

2015 4.50% 4.0% 2.17 1.45 4.5% 4.5%

2016 4.50% 4.0% 2.27 1.45 4.5% 4.5%

2017 4.50% 4.0% 2.37 1.50 4.5% 4.5%

2018 4.50% 4.0% 2.47 1.50 4.5% 4.5%

baseline

alternative

(higher)

2009 4.3% 4.3%

2010 5.0% 5.5%

2011 4.5% 4.8%

2012 4.5% 4.5%

2013 4.5% 4.5%

2014 4.5% 4.5%

2015 4.5% 4.5%

2016 4.5% 4.5%

2017 4.5% 4.5%

2018 4.5% 4.5%

Year

Real GDP growth

rate

Exchange rate

(R$/US$)

IGP inflation

Year

Population growth

rate

Personnel growth IPCA inflation

baseline baseline

1.1% 2.0%

1.1% 2.0%

1.0% 2.0%

1.0% 2.0%

1.0% 2.0%

0.9% 2.0%

0.8% 2.0%

0.9% 2.0%

0.9% 2.0%

0.9% 2.0%

86

to have a detrimental effect on the municipal financial position. On the debt side, the

consolidated debt remains well below the limits set by the federal government.

Table A5.3. Debt Amortization and Interest Payments Schedule, 2010-2014


Figures adjusted by the General Price Index (IGP-DI)

Fiscal Responsibility Law Indicators Projections

A5.15 The fiscal and debt sustainability analysis shows a sustainable path for the main LRF

indicators for 2010-14. Hence, personnel expenditures as a share of net current revenue (NCR),

net consolidated debt per NCR, and debt service as a share of NCR will remain below the limits

set by the federal government. Personnel expenditures per NCR, which are assumed to grow in

line with the personnel growth rate and IPCA inflation, increase slightly in 2010 but remain

below the limit of 60 percent of NCR. The net consolidated debt to NCR indicator is expected to

decrease from 2010 to 2014, driven by the projected surpluses in the overall fiscal balance. This

projection includes the net interest payments and a NCR growth rate higher than the IGP

inflation that adjusts the outstanding stock of debt. Given the amortization and the interest

payment profiles, the debt service per NCR is following a sustainable path with no major debt

principal repayments expected for the next five years (see Figure A5.5).

Risk Analysis

A5.16 The risk analysis assesses the impact on the fiscal and debt projections of uncertainties

surrounding fundamental macroeconomic variables, such as the exchange rate, the GDP, oil

revenues, and inflation. The analysis consists of adding stochastic shocks to the fundamental

economic variables and assessing their impacts on projected fiscal and debt aggregates. We also

assess the impact of simultaneous random shocks on the fiscal and debt aggregate by performing

Monte Carlo simulations, which draw shocks from specific probability distributions.

A5.17 The risk analysis finds that the fiscal situation of Rio state is sustainable, and the impact

of the proposed Bank operation is positive and sustainable. Since the portion of foreign-

denominated debt is small, the impact of the exchange rate on debt dynamics is not significant.

The municipal government is likely to remain below LRF requirements, even when subject to a

combination of stochastic shocks (see Figure A5.6).

Unit: R$ Thousand of 2009

2010* 2011* 2012* 2013* 2014*

Consolidated debt 7,587,474 7,339,573 7,261,155 7,172,899 7,096,889

Intralimite Debt 7,598,159 7,487,551 7,609,159 7,674,126 7,712,717

Extralimite Debt (10,686) (147,978) (348,004) (501,227) (615,828)

Net Consolidated Debt 7,587,474 7,339,573 7,261,155 7,172,899 7,096,889

Debt Amortization 529,790 514,069 243,201 267,071 294,854

Intralimite Debt 483,157 478,993 208,051 233,177 261,332

Extralimite Debt 46,633 35,076 35,150 33,894 33,522

Interest payments 602,315 649,612 674,371 684,403 690,802

Debt Services 1,132,105 1,163,681 917,572 951,474 985,656

87

Figure A5.6: Risk Analysis


A5-3 Fiscal Impact of the Policy Reforms and Debt Restructuring, 2010-14

A5.18 We simulated the impact of policy reforms undertaken by the municipal government in

expenditure control (payroll audit, pension, and procurement process for common goods and

services) and tax revenue enhancement (efficiency gain collection and NFE for ISS taxes). We

also estimated the effects of the debt restructuring on fiscal aggregates.

A5.19 The assumptions under the two scenarios are as follows:

a. ISS revenue collection efficiency measures such as the adoption of the system of

database integration to detect evasion and the electronic invoice system should lead to tax

receipt increases that would be 5 percent higher than the baseline scenario, which projects

an ISS growth rate that follows GDP growth and IPCA inflation.

88

b. Payroll census, audit, and the new HR system will generate a one-time decrease of 1

percent of the payroll registered in 2010 under the reform scenario. The baseline scenario

implies that payroll will grow with GDP and inflation.

c. Social security reforms consist of indexing pension benefits to the average wage rather

than the final wage and reducing survivors’ benefits from 100 percent to 70 percent for

those above RGPS. The baseline scenario implies that pensions grow with population,

national GDP, and inflation.

d. Reforms in procurement with expansion of the use of electronic reverse auction and

rationalization and centralization of procurement of common goods and services will

generate savings of 10 percent in 2010 on government purchases of goods and services.

Thereafter, expenditures on goods and services will grow at the same rate as inflation and

GDP in both scenarios.

e. The World Bank loan of US$1,045 million would have the following financial

conditions: 30 years, a five-year grace period, and LIBOR + 1.4 percent.

89


Net Consolidated Debt / NCR 2009 2010 2011 2012 2013 2014

Basel ine 25.37% 66.41% 58.95% 53.58% 48.64% 44.24%

Tax Revenue Enhancement 25.37% 65.02% 56.35% 49.86% 43.90% 38.65%

Expenditure control 25.37% 63.65% 58.40% 53.10% 48.22% 43.88%

Debt Restructuring 25.37% 67.01% 60.76% 55.20% 49.90% 45.18%

Debt Service/ NCR 2009 2010 2011 2012 2013 2014

Basel ine 10.46% 9.27% 9.15% 6.77% 6.45% 6.14%


Primary Balance / NCR 2009 2010 2011 2012 2013 2014

Basel ine 13.40% 15.96% 9.40% 7.95% 8.26% 8.22%




Overall Balance / NCR 2009 2010 2011 2012 2013 2014

Basel ine 11.18% 14.81% 8.14% 6.77% 7.26% 7.41%




Interest Payments 2009 2010 2011 2012 2013 2014

Basel ine 6.54% 5.27% 5.22% 4.98% 4.64% 4.31%


Investment 2009 2010 2011 2012 2013 2014

Basel ine 3.85% 7.73% 17.08% 21.21% 23.23% 23.76%




90

ANNEX 6: BRAZIL AT A GLANCE

BRAZIL: Municipality of Rio de Janeiro Fiscal Consolidation for Efficiency and Growth

DPL

92

ANNEX 7: THE DECENTRALIZING EFFECTS OF THE CONSTITUTION OF 1988: SERVICE

PROVISION, INTERGOVERNMENTAL TRANSFERS TO MUNICIPALITIES, AND THE

SMALL-MUNICIPAL-SIZE BIAS

A7.1 After two decades of centralization during the period of the military regime, increasing

social demands resulting from political openness created pressures to expand social expenditures.

As a reaction to the centralism of the military regime, democratization also fueled a strong

decentralization movement both in the fiscal and political spheres. These forces were

institutionalized in the 1988 Constitution.

A7.2 The constitution guarantees free access to social services and establishes higher social

security benefits and entitlements for rural workers, the elderly, and the disabled. Since states

and municipalities provide most of these benefits, the constitution greatly increased their

expenditure obligations and expanded public-sector employment benefits by providing

employment tenure, higher compensation, and a generous social security system. In exchange,

the constitution increased revenue-sharing transfers to states and municipalities and revenue

earmarking to guarantee the financing of social expenditure responsibilities. To reduce regional

disparities, however, the increase in intergovernmental transfers did not benefit large states and

municipalities such as Rio; rather, they favored small municipalities with low expenditure needs

because of low population density, low population growth, and low urbanization levels (see

Figure A6.1).

Figure A6.1: Intergovernmental Transfers: Revenue-sharing Mechanisms, 2006 (As percent of corresponding tax revenue)

Source: Secretariat of Economic Policy (SPE). Ministry of Finance.

A7.3 The fiscal conditions of large subnational governments deteriorated in the early 1990s.

The end of the inflationary period worsened the fiscal situation of all levels of government due to

CIDE Tax on fuels

FCO Regional development funds for the development of Center-West ICMS State Value-Added Tax

FNE Regional development funds for the development of Northeast IOF - Ouro Tax on Financial Operations on Gold

FNO Regional development funds for the development of North IPI Tax on Industrial Goods

FPE States’ participation fund IPVA State Motor Vehicle Tax

FPEX Compensation Fund for Exports IR Income Tax

FPM Municipalities’ participation fund ITR Federal rural property tax

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the decline of the ―inflationary tax,‖ which allowed a reduction of public expenditures in real

terms and payment of negative real interest rates on the public debt. High interest rates resulting

from the price stabilization effort also exacerbated debt accumulation. The social obligations

imposed by the constitution, coupled with fiscal revenue stagnation due to Brazil’s slow growth

and ineffective controls for indebtedness, led to successive subnational debt crises.

A7.4 The signing of the debt renegotiation contracts with the National Treasury in 1997 and

enactment of the LRF in 2000 obligated subnational governments to adopt fiscal adjustment

efforts by incorporating hard budget constraints into a single, unifying framework. Under Law

9496 of September 1997 and the Provisional Measure 2185 of 2000, the Treasury refinanced the

bond debt of 25 states and 180 municipalities over 30 years. Strict observance of the debt

renegotiation contracts and the LRF resulted in a significant improvement in subnational

governments’ fiscal performance and significant declines in subnational indebtedness from 18

percent of GDP in 2003 to 14 percent of GDP in 2003, the same figure as 2008.

A7.5 The subnational fiscal adjustment has been realized mainly through a considerable

reduction of investment expenditures. Facing high expenditure rigidity from increasing personnel

expenditures and debt service obligations, new earmarking schemes in social sectors, and poor

revenue performance at least until 2004, subnational governments cut investment expenses to

obtain increased primary balances and reduce indebtedness.

A7.6 Consequently, domestic credit operations to municipalities were drastically reduced,

further affecting municipal investment expenditures and amplifying the gap between municipal

investment needs and resource availability. In addition, the overall public-sector fiscal

adjustment forced federal and state governments to reduce capital transfers to municipalities,

deepening the gap and making current-expenditure savings the main financing source for

municipal investments.

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ANNEX 8: BRAZIL: IMPACT OF THE GLOBAL CRISIS

A8.1 The global financial crisis has affected Brazil through contagion in financial markets, a

fall in commodity prices, exchange-rate depreciation, and external and domestic credit

curtailment. Effects on the real economy were felt immediately, with two consecutive quarters of

negative growth suggesting a recession.

A8.2 Effects on the external sector were also sharp—but again, temporary. The fall in

commodity prices and the worldwide economic slowdown led to declines in exports from a

monthly average of US$18 billion in third quarter 2008 to less than U$S10 billion in first quarter

2009. For the first time in seven years, the trade balance was negative in January 2009.

Nonetheless, the domestic economy’s deceleration reduced imports and the trade balance quickly

became positive again. The nominal and real exchange rates and terms of trade experienced a

temporary depreciation that was reversed with the increase in commodity prices and the

reduction of risk aversion in financial markets. The current account balance and foreign direct

investment (FDI) also suffered during the global crisis. However, economic activity contraction

and improving market sentiment have helped stabilize the current account balance while FDI

flows into the country have resumed.

A8.3 The government acted promptly to restore foreign-exchange markets’ confidence,

alleviate the liquidity squeeze, and avoid sharper declines in economic activity. The central bank

adopted various measures to inject liquidity into domestic markets and provide foreign exchange

to Brazilian corporations facing obligations abroad. A wide range of policies were used to

alleviate private-sector difficulties in raising resources in domestic and foreign markets and

avoid deeper exchange rate depreciation, They included: Reductions in reserve requirements,

liquidity provision to small financial institutions facing difficulties, incentives to large financial

institutions to buy smaller ones with liquidity problems, repo-credit line auctions in dollars for

exporters, and sales of international reserves to irrigate the spot exchange rate. In addition, public

banks massively increased their lending to industry and agriculture to compensate for the fall in

private credit supply. The government’s quick response was successful in normalizing credit

market conditions in a short period. A year after the crisis, both domestic credit and access to

foreign credit have returned to their pre-crisis levels.

A8.4 On the monetary side, the economic slowdown and the fall in commodity prices also

lessened inflationary pressures and opened space for central bank easing. Twelve-month

accumulated inflation fell from 6.3 percent in September 2008 to 5.5 percent in March 2009, hit

the center of the central bank target zone at 4.5 percent in July, and fell to 4.2 percent in August.

Inflation expectations for 2009 fell from 5.5 percent in September 2008 to 4.5 percent in March

2009 and to 4.3 in September 2009. Consistent with the inflation-targeting regime, and drawing

on the credibility earned in the last decade, the central bank cut interest rates by 500 basis points

to 8.75 percent in July 2009—its lowest historical level. Rates were 13.75 percent in December

2008.

A8.5 On the fiscal side, the government adopted a countercyclical stance. Nonetheless, there

are reservations about measuring the actual size of the fiscal stimulus and the countercyclical

nature of the government’s fiscal impulse because part of the primary surplus is not associated

with expansionary fiscal policy but with decisions taken before the global crisis’ emergence.

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Indeed, prior to the crisis, the Brazilian government had been increasing its expenditures,

especially expanding current expenses through increases in operating costs, public employees’

wages, and social protection transfers. With the arrival of the crisis, the countercyclical fiscal

stimulus consisted of tax breaks, acceleration of capital investment, and expansion of federal

banks’ credit supply.

A8.6 Another important component of the government’s expansionary policy was the

significant increase in credit supply from public financial institutions. It is estimated that the

quasi-fiscal stimulus associated with increased lending from public banks reached 3 percent of

GDP. In fact, credit by public banks grew 25 percent in the year since September 2008, while

credit from private institutions grew only 3 percent. The expansion of finance from public banks

included credit to exporters, the agricultural sector, and housing and durable-goods consumption.

As a result, the share of public banks in total outstanding credit grew to 39 percent in June 2009,

compared with 34 percent in September 2008. In addition, the government has stimulated large

private banks to increase their participation in the market.

A8.7 Strong monetary easing, expansionary fiscal policy, increases in credit supply from

public banks, and the recovery of commodity prices have allowed a quick and strong economic

activity recovery. Indeed, Q2-2009 GDP growth achieved an impressive quarter-over-quarter

rate of 1.9 percent. Information on industrial production, job creation, unemployment in

metropolitan areas, and labor income provides clear signals of an ongoing consolidation of GDP

recovery in Q3-2009, indicating that GDP decline in 2009 will be less accentuated than expected

and should be followed by a strong acceleration of growth in 2010.21

21

Market forecasts for growth in 2009 rose from -1.5 percent in April to 0 percent in September. For 2010, the

improvement in market growth-rate projections went from 3 percent in April to 4.5 percent in September.

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