Document of The World Bank

Report No: 32489

IMPLEMENTATION COMPLETION REPORT(FSLT-72100)

ON A

LOAN

IN THE AMOUNT OF US$30 MILLION

TO THE

REPUBLIC OF PARAGUAY

FOR AN

ECONOMIC RECOVERY STRUCTURAL ADJUSTMENT LOAN

June 27, 2005

Poverty Reduction and Economic Management DepartmentCountry Management Unit 7Latin America and the Caribbean Region

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY EQUIVALENTS

(Exchange Rate Effective June 2005)

Currency Unit = Guarani (G$) G1 = US$ 0.00016

US$ 1 = G 6150

FISCAL YEARJanuary 1 December 31

ABBREVIATIONS AND ACRONYMS

CAS Country Assistance StrategyCGR Comptroller General

(Contralor General de la República)CISNI Consejo Impulsor del Sistema Nacional de IntegridadCY Calendar YearDGCP Directorate General of Public Procurement

(Dirección General de Compras Públicas)ERL Economic Recovery LoanFSAL Financial Sector Adjustment LoanGDP Gross Domestic ProductIDB Inter-American Development BankIMF International Monetary FundISC Excise tax

(Impuesto Selectivo al Consumo)NGO Non-Governmental OrganizationSBA Stand-By ArrangementSIAF Integrated Financial Management Information System

(Sistema Integrado de Administración Financiera)SINARH National Human Resource Information System

(Sistema Nacional de Recursos Humanos)UCIP Central Public Investment Unit

(Unidad Central de Inversión Pública)UNDP United Nations Development ProgrammeUNICEF United Nations Children's FundVAT Value-Added Tax

Vice President: Pamela CoxCountry Director Axel van Trotsenburg

Sector Manager/DirectorLead Economist

Mauricio Carrizosa/Ernesto MayJames Parks

Task Manager: Zeinab Partow

PARAGUAYPY Economic Recovery Loan

CONTENTS

Page No.1. Project Data 42. Principal Performance Ratings 53. Assessment of Development Objective and Design, and of Quality at Entry 64. Achievement of Objective and Outputs 115. Major Factors Affecting Implementation and Outcome 216. Sustainability 237. Bank and Borrower Performance 268. Lessons Learned 289. Partner Comments 3110. Additional Information 33Annex 1. Key Performance Indicators/Log Frame Matrix 35Annex 2. Project Costs and Financing 43Annex 3. Economic Costs and Benefits 45Annex 4. Bank Inputs 47Annex 5. Ratings for Achievement of Objectives/Outputs of Components 49Annex 6. Ratings of Bank and Borrower Performance 51Annex 7. List of Supporting Documents 53

Project ID: P086543 Project Name: PY Economic Recovery LoanTeam Leader: Zeinab Partow TL Unit: LCSPEICR Type: Core ICR Report Date: June 27, 2005

1. Project DataName: PY Economic Recovery Loan L/C/TF Number: FSLT-72100

Country/Department: PARAGUAY Region: Latin America and the Caribbean Region

Sector/subsector: Central government administration (75%); Compulsory pension and unemployment insurance (15%); Banking (10%)

Theme: Debt management and fiscal substainability (P); Public expenditure, financial management and procurement (P); Tax policy and administration (P); Administrative and civil service reform (S); Other accountability/anti-corruption (S)

KEY DATES Original Revised/ActualPCD: 10/08/2003 Effective: 12/24/2003 12/24/2003

Appraisal: 10/27/2003 MTR:Approval: 12/16/2003 Closing: 12/31/2004 12/31/2004

Borrower/Implementing Agency: REPUBLIC OF PARAGUAY/MINISTRY OF FINANCEOther Partners:

STAFF Current At AppraisalVice President: Pamela Cox David de FerrantiCountry Director: Axel van Trotsenburg Axel van TrotsenburgSector Manager/Director: Mauricio Carrizosa Mauricio CarrizosaTeam Leader at ICR: Zeinab Partow Zeinab PartowICR Primary Author: Cecilia Zanetta

2. Principal Performance Ratings

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible)

Outcome: S

Sustainability: L

Institutional Development Impact: SU

Bank Performance: HS

Borrower Performance: S

QAG (if available) ICRQuality at Entry: HS

Project at Risk at Any Time: No

3. Assessment of Development Objective and Design, and of Quality at Entry

3.1 Original Objective:

Context: The objectives of the Economic Recovery Structural Adjustment loan need to be assessed in the context of a long-term decline in economic performance and poverty indicators and the election of a reformist Administration in 2003. From the late 1990s onward, Paraguay’s economy experienced a sustained decline, with per capita incomes falling from US$1,810 to US$1,170 between 1998 and 2002 (World Bank Atlas methodology) and poverty reaching 46 percent of the population in 2002. Worsening economic conditions were the result of lagging reforms, political instability and the inefficiencies of a highly informal and corrupt system. Poor domestic performance was also exacerbated by unfavorable international events, such as declining export prices for soybeans and cotton and adverse economic developments affecting Paraguay’s main trading partners, including the Brazilian devaluation in 1999 and the collapse of Argentina’s economy in December 2001. Economic conditions continued to decline in 2002, with GDP falling by 2.3 percent and inflation rising to double digits. Public accounts deteriorated sharply, with a deficit reaching 3.1 percent of GDP and the stock of public external debt rising to nearly 50 percent of GDP from 33 percent the year before, largely as a result of the devaluation of the guarani. Given Paraguay’s almost complete lack of access to domestic or international financing, the country’s economic outlook was grim. With a financial gap of almost US$200 million looming in 2003, the possibility of default was becoming increasingly real.

The election of President Nicanor Duarte Frutos in April 2003 opened a window of opportunity to reverse Paraguay’s economic decline and the ongoing deterioration of social indicators. Recognizing the need to address Paraguay’s long-entrenched problems, the new administration articulated a clear reform agenda that focused on five key areas: (i) correcting fiscal imbalances; (ii) restoring confidence in the state and its institutions; (iii) fostering economic growth with social and fiscal responsibility; (iv) reducing poverty; and (v) promoting greater civic participation. After its electoral victory, the new administration moved swiftly, successfully building a coalition of support for its reform agenda. It also sought the active support of the international financial community, including the IMF, IDB and the World Bank, to help it implement its agenda and ease the strong financial pressure that endangered the country’s ability to meet its financial obligations in the short term.

Working in close coordination with its partners, the Bank responded promptly to the newly elected administration’s request by preparing a Policy Options Report (Report No. 25894-PA) that analyzed the sectors and themes in which the Bank had previously worked on and formulated policy recommendations for the new administration; this report was presented to the recently elected administration in June 2003, prior to its formal inauguration. As there was significant coincidence between the views presented in this report and those of the administration, the Bank proceeded to the preparation of a new Country Assistance Strategy (Report No. 27341-PA; CAS) and the Economic Recovery Structural Adjustment Loan (Loan No. 72100-PA; ERL). Demonstrating agility and responsiveness on the part of the Bank, the new CAS and the ERL were presented to the Board and received approval on December 16, 2003, exactly four months after the new administration took office.The ERL was intended to support a package of key actions and reforms aimed at bringing the fiscal accounts to a sustainable path in order to enable the attainment of higher growth rates, a return to positive per capita economic growth and a significant reduction in poverty. Specifically, the operation provided financial support to the government’s short and medium-term program of actions and policy reforms in the areas of fiscal stabilization and deficit reduction, tax policy, public administration and anti-corruption measures, financial sector reforms and pension reform (see Annex 1.a: Matrix of Policy Actions).

- 2 -

Prepared in conjunction with the new 2003 CAS, the operation was fully consistent with its objectives. By supporting reforms in the areas of taxes, pension and improved governance, the ERL provided direct support to two of the four principal objectives identified in the CAS: (i) fiscal and financial sector stabilization and (ii) improved governance and transparency in public administration. In turn, by supporting these objectives, the operation laid the foundations to achieve the other two objectives identified in the CAS: (iii) achieving sustained growth, particularly in rural areas where poverty is most concentrated and deepest; and (iv) fostering social inclusion. The first operation in the Bank’s new strategy, the ERL set the stage for renewed Bank involvement in Paraguay, as a ‘door opener’ in the sequence of operations envisaged in the framework of the new CAS.

3.2 Revised Objective:

The loan’s objectives remained unchanged during its implementation.

3.3 Original Components:

The operation focused on five main components of the government’s short and medium-term reform program: (a) fiscal stabilization; (b) tax policy; (c) public administration and anti-corruption; (d) financial sector; and (e) public-sector pension fund. The operation was conceived as a structural adjustment loan for US$30 million to be disbursed in a single tranche. A set of policy actions was identified as conditionality for loan effectiveness. A second set of benchmark indicators was identified to assess the continuing progress made in the implementation of the various components after the loan’s formal closing (see Annex 1.a: Matrix of Policy Actions and Annex 1.b: Key Performance and Monitoring Indicators).

The main components were defined as follows: a. Fiscal Stabilization: The deterioration of Paraguay’s macroeconomic conditions was clearly reflected in the chronically high public deficits—reaching up to 4.3 percent of GDP in 2000—and the rising stock of external public debt—from US$1.6 billion in 1999 (26.9 percent of GDP) to US$2.3 billion in 2002 (42.9 percent of GDP), equivalent to a 42.8 percent increase in dollar terms in only four years. The lack of fiscal stability, in turn, translated into rising interest rates, making it increasingly difficult for Paraguay to meet its financial obligations, including the timely payment of public sector salaries. As reflected in the government’s Letter of Development Policy, the new administration recognized the urgency to revert the deterioration of the country’s fiscal situation, assigning it a top priority. In this framework, the ERL supported a set of immediate actions taken by the new administration aimed at stabilizing the country’s fiscal accounts as a first step towards medium-term fiscal sustainability. Specifically, these measures included a freeze on public sector wages, the withdrawal of budgetary supplements presented to Congress by the previous administration and the presentation to Congress of a budget for 2004 consistent with the objectives of narrowing the fiscal deficit and attaining a primary surplus (see Annex 1.a: Matrix of Policy Actions). At the same time, the IDB’s operation included provisions to ensure that expenditure cuts did not affect social spending.

b. Tax Policy: Increasing tax revenues was a central pillar in the strategy adopted by the new administration to achieve financial stability in the medium term. At the operational level, the administration embarked upon an all-out war on tax evasion and corruption. With evasion estimated at over 50 percent of actual collections, the rewards from improving tax and customs administration without increasing tax rates were potentially substantial. At the policy level, the administration built support among the country’s main economic interest groups for a tax policy reform aimed at reducing the level of informality in the economy, expanding the tax base and eliminating the web of loopholes and exceptions that plagued the old tax code.

- 3 -

In this context, the ERL supported the presentation to Congress of the government’s tax reform bill. It also supported an increase in the excise tax (Impuesto Selectivo al Consumo, ISC) on diesel fuel (gasoil) from 14 percent to 26 percent, a rate more in line with those of other Mercosur countries, where taxes on diesel are in the range of 30 percent (see Annex a.1: Matrix of Policy Actions).

c. Public Administration and Anti-Corruption: Promoting greater transparency, accountability, and effectiveness in the public sector was another key objective of the government’s reform program. In this context, the ERL provided support for important measures aimed at enhancing transparency and fighting corruption, such as the implementation of a new public procurement law and a financial management action plan that strengthens independent reviews and audits (for details, see Annex 1). Likewise, this component supported measures aimed at promoting greater efficiency and effectiveness in the management of public resources, including the shift to a national budget using the programs-and-results methodology and the adoption of a new Customs Code (see Annex 1.a: Matrix of Policy Actions). These measures constitute important steps toward creating a climate of improved governance and greater public sector credibility, essential for a well-functioning state.

d. Financial Sector: Paraguay’s financial system exhibited increasing vulnerability from the mid-1990s onward, which, in turn, eroded fiscal stability and the availability of credit for the private sector. Between the mid-1990s and early 2000s, the government and the Central Bank intervened in four banking crises, during which a number of financial institutions—accounting for approximately 35 percent of the financial system—were liquidated. The government’s intervention caused the guaraní to weaken, as the Central Bank used its reserves to rescue insolvent banks. Overall outlays amounted to almost 12 percent of GDP. In addition, the financial sector's problems have resulted in a reduction of credit available to the private sector. As a result, strengthening Paraguay’s financial sector became a top priority for the new administration, which embarked upon an ambitious program to reform and modernize the laws regulating private and state-owned banks. In the framework of the government’s program, the ERL supported the approval of a law creating the Deposit Guarantee and Bank Resolution Fund, aimed at increasing the use of market-oriented risk-sharing methods while reducing the fiscal cost to the state in the event of turbulence or crisis in the sector (see Annex 1.a: Matrix of Policy Actions). This reform corrects a crucial structural weakness of Paraguay’s financial system and paves the way for a stronger financial system that can play a key role in resource allocation and private sector development.

e. Public Sector Pension System: Paraguay’s public pension system—the Caja Fiscal—covers contributing pension plans of public-sector employees, including those in the central administration, teachers, university professors, police officers, army officers and judicial employees, as well as the non-contributory pension benefits to Chaco war veterans and their survivors. This institution, which operates on a pay-as-you-go basis, has been a central factor contributing to fiscal instability, generating chronically large deficits, equivalent to 1.9 percent of GDP in 2002. Unrealistic benefits, such as retirement ages as low as 40, and widespread fraud have been key factors contributing to the chronically high deficits. To address the lack of sustainability of the public sector pension fund, the ERL’s conditionality included the presentation to Congress of a reform of the Caja Fiscal aimed at reducing its cash deficit and fostering more homogeneity with the benefits and parameters of other existing pension funds. The reform of the Caja Fiscal, together with a set of actions aimed at improving its administration, were intended as a first step in the development of a financially sustainable and equitable pension system (see Annex 1.a: Matrix of Policy Actions).

3.4 Revised Components:

The components did not change during project implementation.

- 4 -

3.5 Quality at Entry:

Quality at entry was not assessed by the Quality Assurance Group. Quality at entry is considered highly satisfactory as the operation's objectives were highly responsive, both in substance and opportunity, to government priorities and fully in line with the longer term objectives of the Bank's assistance strategy for Paraguay. The design of the operation responded effectively to those objectives with due consideration of external factors and risks; the Bank's safeguard policies did not apply.

The loan objectives were consistent with the government’s priorities as reflected in its Letter of Development Policy as well as the Bank’s policy objectives as articulated in the 2003 CAS. The approach embedded in the ERL reflects many of the characteristics of the Bank’s newly adopted Development Policy Lending (World Bank, 2004a). Specifically, the new CAS and the ERL are closely aligned with Paraguay’s priorities, fully supporting the reform program of the administration instead of trying to ‘purchase’ reforms deemed important to the Bank’s staff. While the ERL is a rather complex operation that includes several key reforms and a myriad of government actions aimed at enhancing the public sector performance and transparency, it does not follow a prescriptive approach; rather, it includes those reforms and actions that had been assigned top priority by the incoming administration. The new CAS also takes a long-term perspective towards solving Paraguay’s structural problems, with the ERL being the first in a series of operations designed to tackle individual sectors, along the lines of programmatic lending. Likewise, the ERL reflects a comprehensive approach toward development, taking into consideration the myriad challenges facing Paraguay, which include not only fiscal stability and public sector reform but social issues as well. In addition, the ERL has a strong emphasis on ensuring broader participation in government policy making. Finally, the ERL has been fully consistent with the new emphasis on the faster processing of operations, high client responsiveness and the provision of timely financing. Drawing from the Bank’s previous operational and sector work in Paraguay and elsewhere, the Bank’s team provided substantial technical assistance in the design of the reforms, particularly in the development of procurement procedures and financial sector reform.

Tranching was the subject of lengthy discussions during project preparation and appraisal, as well as during the Board’s meeting, when the advantages and disadvantages of adopting a one-tranche versus a two-tranche format for the operation were analyzed in detail. On the one hand, a one-tranche format permitted the timely influx of financial resources—key in helping Paraguay overcome its large financing gap for 2003—at the expense of relatively higher risk in ensuring the implementation of the newly adopted policy measures. On the other hand, a two-tranche operation would have permitted a better linkage between policy measures and actual performance, although sacrificing crucial expediency in the provision of financial resources. In the end, a single-tranche operation was considered more appropriate, placing a premium on providing early and rapid support to the new administration in its efforts to restore fiscal stability. As the ERL was to be followed by a Financial Sector Adjustment Loan, ensuring further action on key financial sector issues, it was considered that this provided some comfort regarding the likely continuity and implementation of the government's reform program. Moreover, the ERL’s Matrix of Policy Actions was expanded to include a set of well-defined implementation benchmarks to measure progress on the implementation of the operation’s policy actions and laws. In turn, these benchmarks replicated closely the performance criteria included in the CAS, effectively linking future lending to satisfactory progress in the implementation of the key reforms supported under the ERL.

In terms of the operation's design and timing, the strategic conception embedded in the design of the ERL was key in enhancing its effectiveness. Specifically, the operation focused on a well-defined set of actions that were identified as pre-conditions for further progress in the reform program. The Bank also identified

- 5 -

the need to move swiftly, ensuring the timely influx of resources—both technical and financial—to enhance the chances of success for the government’s reform program by helping it achieve tangible results during the first 100 days of its administration. The strategic conception of the new operation was coupled with an agile response on the part of the Bank, which promptly embarked on analytical policy work, followed almost immediately by a lending operation. This approach resulted not only in economies of scale in time and other inputs, but also in full internal consistency between the policy framework and the supporting lending operation.

During project design, the main risk factors, including the potential backtracking on the reform efforts due to vested interests, weak implementation capacity and vulnerability to regional shocks, were correctly identified and candidly discussed in the Program Document (Report No. 27172-PA). At the political level, Paraguay’s lack of a record of accomplishment in implementing high-quality reforms was identified as a significant risk, particularly since the government’s reform strategy was an ambitious one, including major reforms to be approved by Congress within a short time period. Likewise, efforts to tackle corruption and increase efficiency in the public sector had the potential to ignite strong resistance, weakening the reform agenda. The new administration’s concerted efforts to reach a wide-ranging political consensus for its reform program was considered a key factor in mitigating these risks.

At the implementation level, the weak capacity of Paraguay’s public sector was identified as a factor that could endanger the sustainability of the reforms in the medium term. The administration’s understanding and demonstrated willingness to act on public sector strengthening and reform were considered mitigating factors, as was the assistance it sought from the Bank, the IDB and others for advice, lending and technical assistance in key areas of the reform agenda.

At the macroeconomic level, regional shocks and weak economic growth were seen as a threat to the sustainability of the reform program, particularly since the government’s strategy for restoring fiscal stability depended heavily on increased tax revenues. This risk was mitigated by the improving regional conditions—particularly in Brazil and Argentina—as well as the rise in prices of Paraguay’s commodity exports, all of which pointed to improved growth prospects for Paraguay’s economy. Likewise, the newly signed IMF Stand-By agreement and the new financial support from the Bank and the IDB, including the ERL itself, were seen as key risk-management measures to help Paraguay weather regional shocks from a stronger fiscal position.

4. Achievement of Objective and Outputs

4.1 Outcome/achievement of objective:

By the time the new administration took office in August 2003, Paraguay was experiencing serious difficulties in meeting its debt obligations, with mounting arrears on debt service having reached almost 3 percent of GDP by the end of 2002. Given Paraguay’s almost complete lack of access to financing at the time, both domestic and international, the fiscal gap was largely financed by a combination of delays in public sector salary payments, postponment of public investment expenditures, the drawing down of deposits at the Central Bank and the accumulation of arrears to creditors and suppliers. With an estimated fiscal gap of US$200 million for 2003, equivalent to over 3 percent of GDP, the country was on the brink of default.

By providing early support to the administration’s economic and institutional reform agenda, the ERL helped the government avoid a severe financial crisis, meet its short-term debt obligations and gain time to restore fiscal balance. After several years of fiscal deficits, tight spending policies and improved tax

- 6 -

administration improved primary balances from -1.7 percent of GDP in 2002 to 0.9 percent of GDP in 2003, and to an estimated 2.8 percent of GDP in 2004 for the central administration, and from -1.3 percent of GDP in 2002 to 2.4 and 4.0 percent of GDP, in 2003 and 2004, respectively, for the consolidated public administration. Other macroeconomic policy indicators also improved. The annual inflation rate declined from 14.6 percent in 2002 to 9.3 percent in 2003, and to 2.8 percent in 2004. After a 40 percent decline in 2002, the Guaraní appreciated by close to 15 percent with respect to the dollar in 2003 and enjoyed broad stability in 2004. Arrears in external debt servicing obligations have been eliminated and international reserves have increased by almost 40 percent, from US$786 million in June 2003 to US$1.2 billion in 2004.

From a more stable fiscal position, the administration was then able to concentrate on its program, undertaking long-needed reforms aimed at achieving sustained fiscal stability, restoring confidence in state institutions, reducing corruption and improving public sector management in the medium term. With ERL support, a package of key legislative actions was presented and approved by Congress, resulting in major reforms of the tax code, the public-sector pension system, the customs code and the banking system. The ERL also supported numerous actions aimed at improving public sector administration, including the implementation of enhanced budgetary procedures, a new public procurement system, censuses of public sector employees and of beneficiaries of the public pension scheme, and the adoption of a financial management action plan. The first stage of the reform program has been highly successful, as evidence by the positive evolution of the main economic indicators. After a decline of 2.3 percent in GDP in 2002, economic growth was restored, with 2.6 percent growth in 2003 and a 2.9 percent growth in 2004. This constitutes a significant improvement with respect to the 0.4 percent average growth rate during the period 1996-2002. Higher economic growth rates allowed per capita GDP to reverse its annual decline, and poverty to fall from its 2002 peak of 46.4 to 41 percent in 2003.

The reforms supported under the ERL have also laid the foundations to restore economic growth and fight poverty. The early successes of the economic reform program have helped restore investor confidence, as evidenced by the increase in economic activity in various sectors of the economy, including the construction, agriculture and industrial sectors. From an enhanced fiscal position, the administration is now better positioned to address poverty, with budgeted social spending, including education, health, social protection and housing, having increased by 4 percent, in real terms, with respect to 2003. The government has also reached agreements with the United Nations—i.e., UNDP and UNICEF—to provide information on social spending to monitor progress toward the achievement of the Millennium Development Goals. Nevertheless, continued concerted action is needed if Paraguay is to make significant inroads in the fight against poverty, both to ensure more substantial per capita growth rates and that public resources effectively reach the neediest sectors of the population.

In summary, the ERL played an important role in providing early support to the improvements in Paraguay’s economic and social conditions. By providing timely financial backing to the incoming administration, the operation helped prevent a major economic crisis and the consequent social costs on the more vulnerable sectors of the population. It also helped capitalize on the window of opportunity that opened with the new administration which has been effective in setting in motion an ambitious set of structural reforms aimed at restoring economic growth in a framework of social and fiscal responsibility.

The achievement of objectives in each of the individual components is as follows:

a. Fiscal Stabilization: Achievement of objectives under the fiscal stabilization component has been

- 7 -

highly satisfactory. Because of the government’s commitment to fiscal responsibility and economic reform, together with a more stable external environment, Paraguay’s fiscal performance has improved substantially. The overall deficit in public accounts was reduced from 3.1 percent in 2002 to 0.1 percent in 2003, a significant improvement considering preliminary estimates projected a deficit of 3 percent of GDP for 2003. A surplus of 3.2 percent of GDP was achieved in 2004, a significant overperformace with respect to the fiscal surplus target of 0.3 percent of GDP established in the IMF Stand-By Arrangement. The total public debt-to-GDP ratio declined from 49.6 percent in 2002 to 45.6 percent in 2004.

The improvement in Paraguay’s fiscal accounts has been the result of a remarkable increase in public revenues and tight control over public spending. In 2004, current revenues increased by 27 percent relative to 2003, while current expenditures increased by only 8 percent (in nominal terms) during the same period. The number of permanent employees has remained almost constant and no salary increases have been given - with the exception of increases for the judicial sector in 2004 - and a review of public employees to reduce multiple jobs held by the same person was completed. As a result, expenditure on wages and salaries in the central administration declined from 8.1 percent of GDP in 2002 to an estimated 7 percent in 2004. Other important measures have been taken to limit public spending and improve its rationality, including pension reform (see Section 4(e)), reduced interest payments on public debt through domestic debt restructuring, improved budgetary procedures and enhanced procurement procedures.

b. Tax Policy: Achievement of objectives under the tax policy component has been satisfactory. During 2004, tax revenues—including customs—increased by 36 percent with respect to the previous year, a growth of over 2 percentage points of GDP. The increase in tax revenues has been the result of the government’s efforts to reduce evasion, increase efficiency and reduce corruption in tax and customs administration. Personal leadership from the top of the administration was a key factor in increasing awareness and the perceived risk of evasion and corruption both among the general population and within the agency, resulting in the remarkable increase in tax collections.

In addition to the improvements in tax and customs administration, the approval of a Tax Reform Law (Ley de Reordenamiento Administrativo y Adecuación Fiscal) in July 2004 constitutes a significant breakthrough in tax policy, as it introduces new revenue instruments, including a personal income tax, broadens the value-added tax (VAT) and company income tax base -- extending it to agriculture and ranching -- eliminates exemptions and strengthens tax administration. The Law also gradually, in two stages, reduces the company tax rate from 30 to 10 percent. The revenue impact of the new tax bill is estimated at 1.5 percent of GDP once it is fully effective in 2011. However, the increase in the diesel fuel (gasoil) tax from 14 to 26 percent, which was one of the ERL conditionalities, was not ultimately maintained. While the increase took place as originally envisioned, the tax rate was later reversed to the original level, reportedly as a temporary measure to ameliorate the negative impact of the record-high oil prices registered in 2004.

c. Public Administration and Anti-Corruption: Achievement of objectives under the public administration and anti-corruption component has been satisfactory. With the support of the ERL, the administration has implemented a series of important measures aimed at improving efficiency in the management of public resources, enhancing transparency and reducing corruption. The achievements in the area of procurement are particularly noteworthy, and follow the passage of a new law and regulation to modernize public procurement. An informational public procurement portal has been launched on the Web as a first step in a full-fledged electronic procurement system. In addition, a public process for the competitive selection of the head and key staff of the DGCP (Dirección General de Contrataciones Públicas, General Directorate General of Public Procurement) has taken place, as have public hearings on the newly designed standard public bidding documents. Progress on these measures and the increased

- 8 -

transparency of public procurement practices has already led to reductions in spending on goods and services and to more efficient public investment. Equally significant has been the adoption of a new Customs Code, which modernizes procedures, curtails corruption and grants financial independence to the customs administration. The recently completed census of public employees holds promise as an ingredient to help rationalize human resources within the public sector. The establishment of a unit responsible for coordinating externally financed projects, the partnership with Transparencia Paraguay and other NGOs, as well as the implementation of a financial management plan are also significant, as they begin to pave the way for a modern and more credible public sector.

d. Financial Sector: Achievement of objectives under the financial sector component has been satisfactory. Although the level of non-performing loans remains high (although it declined in 2004), the passage of the Deposit Guarantee and Bank Resolution Fund Law has eased banking system risks. The new law has introduced a deposit-guarantee system financed by the commercial banks. In the event of a bank collapse, the deposit guarantee fund will facilitate the purchase of the assets by solvent banks and ensure that depositors are compensated. Previously, the state was required to bail out depositors of collapsed banks; thus, this reform effectively reduces the public sector’s contingent liabilities. This is no minor accomplishment, given that the fiscal cost of bank rescues in Paraguay during the 1990s was estimated at over 12 percent of GDP.

e. Public Sector Pension System: Achievement of objectives under the public sector pension system component has been satisfactory. In December 2003, Congress approved a new law reforming the Caja Fiscal, which has reduced the financial deficit of the system and fostered consistency across pension plans. Some of the specific modifications included: increasing the contribution rate from 14 to 16 percent; increasing the retirement age from between 40 and 50 years, depending on occupation, gender and years of service, to 62 years and making retirement mandatory at this age; modifying the base wage used to compute the pension benefit from the last wage to average wage over the last five years of service; significantly reducing the replacement rate from 93 percent of the base wage to 20 percent of the base wage plus 2.7 percent per year of service, applicable only after ten years of service; eliminating the aguinaldo—i.e., thirteenth-month bonus; and linking pension indexation to CPI inflation rather than public wage increases. Although Congress granted some exceptions to these rules, particularly for teachers, the new law constitutes a significant improvement over the previous one. In addition, the Caja Fiscal reform law has generated savings from the Chaco war pensions—which generated 45 percent of the overall deficit of the Caja Fiscal in 2003—by reducing survivor pensions from 100 to 75 percent of the original pension, making eligibility criteria somewhat more stringent and abolishing the aguinaldo(there has been some back-tracking on this measure, however, with a recent law reintroducing the aguinaldofor 2005). Notably, the law has made explicit the subsidy embedded in the non-contributing Chaco-war pensions by separating their administration from the contributing pensions and requiring that they be fully financed in the annual budget law. Estimates indicate that the new reform law has reduced the actuarial deficit (i.e. the present value of the future stream of surpluses/deficits) over the period 2003-2050 by approximately half, from almost 90 percent of GDP in 2003. To increase efficiency, enhance transparency and reduce corruption within the Caja Fiscal, the government has embarked on an in-depth review of the registry of the beneficiaries to identify and eliminate illegitimate claims.

4.2 Outputs by components:

Progress toward the implementation of the various policy reforms has been generally positive, with the majority of benchmark indicators either having been achieved or being well advanced (see Annex 1.b: Key Performance and Monitoring Indicators). All the reform laws supported by the operation have been approved by Congress. In addition, the operation has effectively supported the implementation of a

- 9 -

substantive set of actions aimed at enhancing rationality, efficiency and transparency in public sector management in key areas, such as tax revenues, budgetary procedures, procurement practices and public pensions. The main exceptions are the failure to maintain a freeze on the nominal wage bill of the central administration (although the number of permanent employees remained basically constant, as did payroll spending as a proportion of GDP) and the exclusion from the budget by Congress of the provision to create a compensation fund to ameliorate the social impact of measures reducing public sector staffing. Likewise, after having increased from 14 to 26 percent, the gasoil tax was lowered again to its 2003 level as a temporary measure to ameliorate the negative impact of record world oil prices.

The specific outcomes corresponding to the individual components are the following:

a) Fiscal Stabilization

Maintenance of an acceptable macroeconomic framework: Achieved. The Stand-By Arrangement signed with the IMF in December 2003 is on track, with the first four reviews having been completed. A fifth review is scheduled for June 2005. The SBA has been extended by six months to allow more time to fulfill the structural reform agenda. At the fourth program review in March 2005, IMF Directors commended the authorities for Paraguay's strong economic performance with GDP growth coming in higher than projected, the lowest inflation in a decade, and a shift in fiscal position from deficits back into surplus. They noted that the fiscal outlook has improved, partly reflecting the congressional passage of the tax reform as well as the significant improvements in tax administration in the internal revenue service and customs.

Withdrawal of budgetary supplements from 2003 budget: Achieved. To quickly halt the growth of spending, the new administration withdrew all the budgetary supplements that had been presented during the previous administration, with the exception of those targeting priority social and agricultural areas. The fiscal effect of this was approximately US$32 million, about 0.5 percent of GDP. The number of requests for budgetary supplements was further reduced in 2004, with only 12 supplements being requested compared to 117 in 2003.

Maintenance of the nominal wage bill freeze for permanent employees and a reduction of wage bill for contracted employees: Partially achieved. While the wage bill of the central administration in 2003 amounted to G2.724 billion (7 percent of GDP), the 2004 wage bill stood at G2.984 billion (also 7 percent of GDP), equivalent to a 6 percent increase in real terms. These figures correspond to all payroll obligations of the central administration, as it is not yet possible to differentiate between permanent and contracted employees.

The availability of additional resources as a result of the larger than projected tax revenues increases moderates the fiscal impact of wage growth. It is also important to note that increases in public sector employment have responded primarily to the need for public services to keep up with the demands arising from population growth—especially in terms of teachers, healthcare and security workers—and the normal increases associated with staff promotions. With the exception of salary increases granted to the judicial sector, there have been no salary increases in the rest of the central administration, although some ministries have re-categorized staff in order to increase their salaries. Other measures to circumvent the freeze on wages include the charging of overtime as well as other extraordinary remuneration.

Review of all public employees completed, identifying those with multiple salaries: Achieved. Significant progress has been made in the effort to identify public employees who unduly received more than one

- 10 -

salary. Approximately two-thirds of the 90 institutions covered in the review (including the central administration, the Banco Nacional de Fomento, the Instituto de Previsión Social, and the Municipality of Asunción) have supplied the required information—i.e., a complete list of permanent and contract employees—to the Secretaría de la Función Pública. To date, 1,650 employees receiving more than one salary have been identified. Of these, a significant number are health and education personnel, some of whom are legally entitled to hold more than one public-sector job. Approximately 170 of the identified employees have resigned. The estimated savings resulting from this exercise so far amount to G 106 million per month, or US$ 220,000 per year. This figure is expected to increase as the process proceeds. Follow-up actions include informing employees and institutions of the need to regularize their status. Detailed information—including personal identification data, education and terms of the appointment—is also being incorporated into employee databases in order to simplify the process of identifying those who are permitted to hold more than one (non-simultaneous) public post. The process calls for administrative reviews for those cases where the employee cannot demonstrate a justification and does not resign. Audits aimed at detecting irregularities are currently being carried out in three key sectors—i.e., health, education and defense—as required by the 2004 Budget Law. Three additional sectors are expected to be audited during 2005.

Approval of the 2004 budget, including the following measures:

i. Reduction of administrative personnel of the central administration from 2003 levels: Partially achieved. The number of positions in the central administration remained almost constant between 2003 and 2004. The 2004 budget identified 152,271 positions, equivalent to a 1 percent increase with respect to 2003. Some ministries reduced their staff, including the Ministry of Finance, with a net reduction of reduction of 244 positions (equivalent to a reduction of 306 permanent positions and an increase of 62 contracted positions). Other entities also made smaller reductions. In addition, about 3,600 employees were identified as eligible for automatic pensions in 2004 (all public employees are obliged under Law No. 2344 of 2004 to retire upon reaching 62 or 57 years of age, for men and women, respectively). Approximately 700 of these positions are expected to be suppressed upon the retirement of the incumbents.

ii. Reduction of central administration personnel contracts from 2003 levels: Information not available. There is no data available on contractual staff, which makes it impossible to determine the 2003-2004 variation.

iii. Creation of a Compensation Fund (Fondo de Inserción Laboral): Not achieved. The 2004 budget provided for the creation of Compensation Fund aimed at ameliorating the social impact of measures reducing public sector staffing. The provision for creating this fund was deleted from the 2004 budget by Congress. However, it is important to note that there has not been a significant reduction in public sector staffing except for those eligible for automatic retirement and the elimination of illegitimate positions, such as multiple appointments with overlapping schedules.

iii. 100 percent financing of counterpart funds for projects with external funding: Partially achieved. The original 2004 budget did not include 100 percent counterpart funds for externally funded projects. A budgetary supplement was approved in the second semester of 2004 with an increase in the total amount budgeted for counterpart funding, from G 151 billion to G 264 billion.

b) Tax Policy

Increase in the excise tax on gasoil from 14 percent to 26 percent: Not achieved (Reversed). One of the

- 11 -

ERL's policy conditions was to increase the excise tax on diesel (gasoil) from 14 percent to 20 percent by Board presentation. A second increase in the gasoil tax to 26 percent was identified as a benchmark indicator. While the excise tax on gasoil was indeed raised from 14 to 20 percent in August 2003 and, again to 26 percent in January 2004, it was later reversed to the original 14 percent level. The reduction is supposedly a temporary measure to release some of the pressure generated by record-high oil prices on the economy.

Approval by Congress of the Tax Reform Law: Achieved. The new tax bill — the Administrative Restructuring and Fiscal Adjustment Law (Ley de Reordenamiento Administrativo y Adecuación Fiscal) — was approved by Congress in July 2004. It introduces significant modifications to the tax code designed to increase revenues and unify rates, largely through a widening of the tax base and the elimination of exceptions and loopholes. The fiscal impact of this reform is estimated to reach 1.5 percent of GDP per year once it is fully effective.

c) Public Administration and Anti-Corruption

Congress to approve program and results budget, with ten central ministries developing detailed financial plans for implementation of the 2004 budget, linking disbursements to program objectives: Partially Achieved. For the first time, the 2004 budget was prepared using a programs-and-results methodology. Upon consultations with technical experts from neighboring countries, the government decided that the process of evaluating the achievement of program objectives should not be incorporated into budget execution at this stage, but instead should run in parallel to the budget process until a sound methodology is developed. An evaluation tool will be tested in five entities during 2005 as a pilot experience.

Approval by Congress of a new Customs Code: Achieved. A new Customs Code was approved in July 2004. The Code modernizes and simplifies administrative procedures, stiffens sanctions, provides for the professionalization of the staff of the customs administration and grants it financial autonomy by assigning resources equivalent to 0.5 percent of the value of imports. The fiscal impact of the new Code is expected to be substantial, equivalent to a 100 to 200 percent increase in revenues over the already record-high levels currently being achieved.

Progress in the implementation of a Procurement Action Plan: Achieved. The Government has made important progress in implementing Paraguay's Procurement Action Plan in accordance to the recently approved Public Procurement Law and the resolution creating the Directorate General of Public Procurement (DGCP). An online procurement portal has been launched, which posts the annual procurement plans for state institutions, bidding documents, the bulk of invitations to bid and contract awards as well as a list of ineligible and black-listed contractors. This is seen as the first step in a full-fledged electronic procurement system. A public process for the competitive selection of the head and key staff of the DGCP has taken place, as have public hearings on the newly designed standard public bidding documents. The DGCP is implementing a comprehensive training program for public sector employees, potential contractors and civil society on the new Procurement Law and its implementation. Progress on these measures and the increased transparency of public procurement practices has already led to reductions in spending on goods and services, such as a 37 percent reduction in procurement costs in the health area for the period January-April 2004 compared to the previous year. The new procurement portal has also resulted in savings for the private sector—for example, bidding documents that cost US$10,000 in 2003 can now be downloaded at not cost from the portal. The success of the actions implemented in procurement is illustrated by the opinions expressed by public sector users—many of whom had resisted the implementation of the new procedure—with 78 and 82 percent of respondents reporting that the new

- 12 -

procedures have resulted in enhanced transparency and significant savings, respectively.

Report from Transparency Paraguay on implementation of the agreement with the Ministry of Finance: Achieved. A report on Transparency Paraguay’s activities with the Ministry of Finance has been provided as agreed. Transparency Paraguay has been particularly active in the area of public education with regard to tax obligations and in the Procurement Directorate’s training program. They have also been involved with the newly established Citizen Participation Unit within the Ministry of Finance.

Finalization of the public sector employee census: Achieved. Data collection for the public sector employee census was completed in April 2004, including among others the executive, legislative and judicial branches, public financial institutions, autonomous and decentralized entities, IPS, Petropar, armed forces, national police, departmental and municipal governments, and national universities. A report of the census results has been published, and the digitalization of the information has taken place and will be incorporated into the national human resources management system (Sistema Nacional de Recursos Humanos, SINARH), where individual employee files will be generated. The next step is the transfer of employee files to the respective public sector entities and data verification. This new database will set the foundation for the eventual rationalization of human resources in the public administration as well as stringent controls linking salary payments with up-to-date, reliable human resources information.

Staffing and operation of the Unit of Public Investment: Achieved. The Unit of Public Investment has been created and staffed and is in operation. The Unit, which until recently reported directly to the Minister of Finance although it has now been merged into the Vice-Ministry of Economy, is responsible for the coordination of externally funded programs with the ultimate objective of avoiding overlaps and duplication, incorporating lessons learned in project preparation, design and implementation, and increasing the administrative capacity of project units.

Progress on the adopted Financial Management Action Plan: In progress. Substantial advances have been made toward the implementation of Paraguay’s Financial Management Action Plan. With IDB support, an integrated financial management system (SIAF) has been implemented in the central administration and in some decentralized agencies. A peer review of the Comptroller General's (CGR) audit procedures is underway and an internal audit manual for the CGR is being prepared. The government is fulfilling its commitment to require independent audits of public enterprises, which will also be subject to increased data publishing requirements to improve transparency. This is part of an effort to improve efficiency and governance in Paraguay's public enterprises, which, despite having a strong presence in key economic activities of the country, have been plagued by inefficient operations, lack of transparency and inadequate financial management.

d) Financial Sector

Completion of the financial sector measures and reforms as included in the proposal Financial Sector Adjustment Loan (FSAL): In progress. The Deposit Guarantee and Bank Resolution Fund Law (Ley de Garantía de los Depósitos y Resolución de Entidades Financieras) was approved by Congress in late 2003. The Executive submitted a General Banking reform to Congress in December 2004, and the reform of the public sector banks -- split into a second and a first tier public banking law -- in November 2004 and February 2005, respectively. The public banking reforms would restructure and consolidate state-owned financial institutions in order to contain their potential fiscal costs, eliminating duplication of activities and increasing transparency and accountability. The first tier public bank system would focus on loans to small-scale borrowers who have difficulty obtaining commercial credits. The second tier would channel foreign credits for economic development through the private banking system to medium and large-scale

- 13 -

borrowers. A new Anti-Money Laundering Law has also been presented to Congress and would modernize and strengthen procedures and systems of the detection and prevention of money laundering. It would expedite judicial and penal action on detected money laundering activities, create a single intelligence unit in charge of overseeing all anti-money laundering activity, require reporting requirements according to international standards to allow for quicker verification of information, and enhance transparency in the procedures for seizure and decommissioning of assets.

e) Public Sector Pension Fund (Caja Fiscal)

Updating of the database of public sector pension and progress in the reorganization of the unit in charge of affairs related to the Caja Fiscal, and the submission of a preliminary report, by the contracted firm, on the status and issues related to current management of the Caja Fiscal: Partially achieved/In progress. The digitalization of the files corresponding to about 55,000 beneficiaries of the Caja Fisca—32,000 pensioners and 23,000 veterans and their survivors—and the creation of the new information system is expected to be completed by the end of November 2004 with support from IDB. A preliminary diagnosis has been prepared by Price Waterhouse—the firm contracted to help reorganize the pension administration and computerize its databases. The corresponding report has been submitted to the Bank, as agreed in the framework of the ERL. A new payment system is under preparation, centering on the non-contributory plans of the Caja Fiscal, as most public sector retirees already receive their pensions through the banking system.

Beneficiary files are being reviewed to verify their accuracy and identify illegitimate and phantom pensioners. As a result of this effort, 3413 beneficiaries have been eliminated since August 2003, resulting in estimated annual savings of G26.7 billion (US$4.5 million). These efforts should eventually generate even larger savings, as fraudulent claims are believed to be widespread, particularly in the administration of Chaco war pensions. Actions are also being taken to improve the functioning of the Caja Fiscal, increasing its efficiency and transparency. For example, as a result of the simplification of bureaucratic procedures, the time required to process a pension has been reduced from three months to 15 days.

Table 1. Evolution of the Operational Deficit of the Caja Fiscal, January-July 2003, 2004

Categories 2003 2004 2003-04 2003 2004 2003-04 2003 2004 2003-04

(G billion) (G billion) % (G billion) (G billion) % (G billion) (G billion) %

Contributory Pensions Public administration 134 157 17.0% 105 116 10.1% 28 40 42.2% University teachers 17 25 47.9% 13 16 24.4% 4 10 114.1% Judicial employees 12 21 70.3% 10 11 4.3% 2 10 427.1% Police force 33 40 21.7% 91 95 4.6% (58) (56) 4.9% Teachers 152 172 13.4% 211 225 6.7% (59) (53) 10.4% Armed forces 22 25 14.9% 168 171 1.9% (146) (146) 0.1%

Non-Contributory Pensions 0 0 0 344 306 -11.0% (344) (306) 11.0%Veterans and heirs of the Chaco War

Total Caja Fiscal 369 440 19.0% 943 940 -0.2% (573) (501) 12.6%Percent of GDP 1.0 1.0 7.6% 2.4 2.2 -9.8% -1.5 -1.2 21.0%

Source: Sistema de Contabilidad (SICO), Ministry of Finance. 2004 figures are preliminary.

Contributions Disbursements Balance

Approval by Congress of a law reforming the Caja Fiscal: Achieved. As mentioned earlier, the reform of the Caja Fiscal was approved by Congress in late 2003, in a form largely similar to its original version

- 14 -

apart from some exceptions granted to teachers and, to a lesser degree, police and the armed forces. The fiscal impact of the reform has been substantial, with the evolution of the cash flow of the Caja Fiscal during 2004 showing a favorable trend with respect to 2003, particularly among contributing plans. While contributions have increased by 19 percent relative to 2003, benefits paid in the form of contributory pensions have remained roughly constant (see Table 1). As a result, the cumulative operational deficit (i.e., the difference between annual contributions and annual disbursements) which amounted to G 501 billion at the end 2004, experienced a reduction of more than 12 percent with respect to the previous year. Performance has been less impressive for non-contributory pensions, with benefits for war veterans and their survivors decreasing by only 1 percent during 2004 relative to the same period in 2003.

4.3 Net Present Value/Economic rate of return:

N/A

4.4 Financial rate of return:

N/A

4.5 Institutional development impact:

The project’s institutional development impact has been substantial. With the support of the ERL, the administration has initiated an ambitious reform process aimed at addressing the country’s long-standing governance problems and improving the efficiency and transparency of government operations. With the support of the ERL, key economic reform laws have been approved by Congress imposing limits on current expenditures, tackling key fiscal drains on public accounts, enhancing tax and tariff revenues and addressing urgent vulnerabilities of the economy such as those associated with the financial sector. As discussed in detail in previous sections, these bills include:

§ 2004 Budget Law (Ley de Presupuesto General de la Nación 2004; 2.344/2003), which introduces several key provisions aimed at limiting fiscal deficits and improving the quality of public spending.

§ Tax Reform Law (Ley de Reordenamiento Administrativo y Adecuación Fiscal, Law No. 2.421/04), which expands the tax base and eliminates exemptions.

§ Customs Code (Ley de Reforma del Códico Aduanero, Law Nº 2.422/2004), which modernizes and strengths the customs administration, optimizes revenue collection, reduces user costs, and grants financial autonomy to the customs administration.

§ Government Pension Reform Law (Ley de Reforma de la Caja de Jubilaciones, Law Nº 2.345/2003), which reforms the government employees’ pension plan, a chronic drain on public finances

§ Deposit Insurance and Bank Resolution Law (Ley de Garantía de Depósitos y Resolución de Entidades Financieras, Law No. 2.334/03), which strengthens the banking system through improved bank resolution and deposit insurance as a safeguard against potential losses on non-performing loans.

In addition to legislative advances, the administration has embarked on a far-reaching program to modernize and reform public sector management by enhancing its transparency, reducing widespread corruption and increasing its overall efficiency. These actions include steps to improve the efficiency in tax and customs administration and to eliminate pockets of corruption within these agencies. A census of public sector employees has been completed which, in addition to potentially playing a key role in rationalizing resources and enhancing the performance of the public sector, is being used to audit employee rolls in order to eliminate phantom workers and those collecting more than one salary. Similarly, the government pension rolls are being cleansed, with 3,400 non-justified pensions having been eliminated. The

- 15 -

government has also made significant progress in the implementation of public procurement and financial administration action plans, enhancing the efficiency and transparency in the use of public funds. Agreements have been subscribed with non-government organizations, such as Transparency Paraguay, the National Integrity Council (Consejo Impulsor del Sistema Nacional de Integridad, CISNI) and the Network of Citizen Controllers (Red de Contralorías Ciudadanas) to develop mechanisms for citizen participation with the ultimate objective of eliminating corruption.

5. Major Factors Affecting Implementation and Outcome

5.1 Factors outside the control of government or implementing agency:

The interplay of several factors, both within and outside the government’s control, has contributed in creating a favorable environment for Paraguay’s economic recovery and the implementation of the government’s reform agenda.

Overall, factors outside the government’s control have been generally quite positive, contributing to the initial success of the reform program. On the positive side, the rise in international prices for soybean and cotton, as well as improved economic conditions in Brazil and Argentina, have contributed to Paraguay’s economic recovery. As a result, both agricultural and non-agricultural output has increased, generating modest economic growth. Likewise, higher economic activity in Brazil and Argentina has resulted in higher royalties from Yacyretá and Itaipú, which, during the period of January-July 2004, increased by 30 percent relative to the previous year. On the negative side, record-high oil prices, reaching over the US$50 per barrel mark in 2004, have had a negative impact, particularly given Paraguay’s full dependence on oil imports, as well as the price distortions introduced by the Paraguayan oil company, Petropar. Likewise, a late-season drought depressed the output of soy, the largest export crop, reducing expected agricultural output growth to nearly zero. Robust economic activity is, of course, an important condition for the success of the reform program, particularly given the prominence of increased tax revenues in the administration’s strategy to achieve sustained fiscal stability.

5.2 Factors generally subject to government control:

The rapid deterioration of economic and social conditions, and the strong mandate received by the incoming administration, opened a window of opportunity for reform, generating wide support among both the general population and political parties. The administration succeeded in capitalizing on this opportunity and successfully built a coalition of support for its stabilization and reform program involving multiple stakeholders. On the domestic financial front, it successfully negotiated an agreement with 14 domestic financial institutions to voluntarily renegotiate the repayment of US$138 million in internal debt. It also gained the support of the country’s main economic groups to reform the tax structure. Likewise, as part of the Acuerdo Político, the President obtained the support of the heads of both houses of Congress as well as opposition party leaders for the government's ambitious reforms and their corresponding legislative approval. Finally, the administration was also very effective in seeking the backing of international financial institutions. By the end of 2003, considerable advances in core economic laws enabled the administration to reach an agreement with the IMF for a precautionary 15-month Stand-By Arrangement, and allowed the approval of adjustment lending totaling a combined US$60 million by the Bank and IDB. The experience of Paraguay points to the importance of building coalitions across broad sectors of society to support far-reaching reform programs.

5.3 Factors generally subject to implementing agency control:

- 16 -

With the full support of the President, the Ministry of Finance articulated a clear reform strategy, identifying both immediate actions to be implemented during the first 100 days of the administration, as well as a medium-term strategy. It also demonstrated a high capacity for implementation, relying on top-notch professionals from both inside and outside the public administration. In areas that required strong technical expertise, such as fiscal policy, debt management and pension reform, in-house resources were key in determining the overall reform strategy. In contrast, positions that required strong implementation skills and the introduction of modern management models were filled by outsiders, such as in the areas of tax administration and procurement. In this way, a good balance was achieved between key in-house expertise and innovative ideas grought by newcomers from outside government. Strong political support on the part of the President and the Ministry of Finance was a key ingredient in fostering leadership at different levels of the administration and attaining tangible results early in the reform process.

5.4 Costs and financing:

A single tranche for a total amount of US$30 million was disbursed in December 2003, as originally envisioned.

6. Sustainability

6.1 Rationale for sustainability rating:The sustainability of the achievements of the ERL is deemed likely, as the reforms supported under the ERL constitute an integral part of the government’s agenda and enjoy strong government ownership, and the relevant law have already been approved. Consistent with the experience of reform programs worldwide, Paraguay’s early success was the result of the positive alignment of various factors: a strong willingness to reform on the part of the incoming administration, multi-partisan political support for the reform program fueled by the urgency to avert an impending economic crisis, and the designation of key actors in strategic posts. Capitalizing on this window of opportunity, the President provided strong backing to the Ministry of Finance to implement key components of the reform agenda. In turn, a small group of individuals, many of whom were new to the public sector, was given responsibility for the implementation of individual reforms within the Ministry of Finance. With strong technical skills and a reputation of integrity, these ‘champions’ have made important advances, including addressing chronic pockets of corruption in areas such as tax and customs administration and developing modern management tools, such as the new procurement procedures.

However, the sustainability of the significant achievements to date continues to depend on individual actors, as the reforms have not yet been—nor could have they been in such a short period—institutionalized. Thus, in the short term, the sustainability of the reforms strongly depends on the ability of the President to continue to provide strong political backing to the Ministry of Finance and the champions responsible for the reforms in individual sectors

1. In the medium term, the sustainability of the reforms depends on the

ability to institutionalize the various reforms—that is, to develop and implement operational systems that ensure the effective, efficient and transparent day-to-day management of the public administration with the full support of the public bureaucracy and civil society. This introduces an important element of vulnerability to the reforms and to the progress achieved thus far.

As the initial enthusiasm for the reform program wears off, with congressional elections approaching and the threat of an economic collapse becoming less real, the administration may be pressured to slow down and even reverse some of its reforms. There continues to be strong resistance to change within the government. Mounting social pressure, as evidenced for example by the demonstrations of landless

- 17 -

campesinos, is also likely to generate additional pressure on the administration to increase spending and/or take actions that may be perceived as a threat by strong interest groups. As identified during project preparation, the absence of dialogue and actions on inequality, rural poverty and insecurity of tenure for indigenous groups can potentially lead to a large social backlash, which would be a risk to further implementation of the overall reform program. So far, the administration has demonstrated a capacity for building and maintaining complex political alliances around its ambitious program. Its commitment toward reform has been firm. In view of this track record, the government's ability to ensure the sustainability of the achievements attained so far is considered likely, although by no means easy.

a. Fiscal Stabilization: Sustainability of the actions supported under the fiscal stabilization component is deemed likely. The prospects for continued fiscal stabilization are encouraging, as external conditions are more stable, economic growth is moderately rising and the government continues to be committed to fiscal responsibility. Efforts to improve the quality of public spending need to be further deepened. For example, while inroads have been made in identifying illegitimate public sector employment and fraudulent pensions, much more can still be done. These efforts can potentially generate significant savings, which, in turn, can be redirected to increase social spending. Institutionalizing responsible fiscal behavior is a much-needed, though long-term process, as sustainability cannot depend on the enthusiasm and commitment of a small, reform-minded team.

b. Tax Policy: Sustainability within the tax policy component is deemed likely. At the policy level, the new tax law is an important first step toward widening the tax base and helping reduce the level of informality in the economy. While there is a fragile equilibrium between political feasibility and the scope of the reforms, it is important to note that there is still ample room for improvement in Paraguay’s tax policy, particularly in terms of redistribution. Likewise, taxes on diesel fuel—now back at their 2003 level of 14 percent—continue to be significantly lower than in all other Mercosur countries.

At the operational level, by reaching record levels in tax revenues, both the tax and customs administrations have demonstrated that significant improvement in performance is possible. As of today, however, the strong performance in the tax and custom administrations depends on the presence of key individuals—the Vice-Minister of Tax Administration and the Customs Director. Ultimately, the sustainability of the improvements in tax and customs administration will depend on their successful institutionalization. In this regard, adequate human and financial resources are key inputs in the institutionalization process. The new custom code provides financial independence to the customs administration, ensuring it has adequate financial resources and embedded incentives that are conducive to high performance. However, the same financial independence was not granted to the tax administration, potentially making it more vulnerable during times of political volatility.

e. Public Administration and Anti-Corruption: The sustainability of the progress attained under the public administration and anti-corruption component is deemed likely, with further progress in these areas is being supported under other IDB and World Bank operations. Broad dissemination of the new tools can be effective in helping to ensure their sustainability, as they generate higher expectations in the public, making their elimination more politically costly. For example, the number of users subscribed to an electronic procurement newsletter increased from 1,200 to 3,200 within a few days after a dissemination campaign featuring the new procurement portal.

d. Financial Sector: The sustainability of the progress achieved under the financial sector component is deemed likely. The Programmatic FSAL approved by the Board in April 2005 will support further reforms in Paraguay’s financial sector.

- 18 -

e. Public Sector Pension System: The sustainability of the reform of the Caja Fiscal is deemed likely. At the policy level, the newly introduced modifications to the public sector pension system have resulted in important savings. However, further reforms are still needed to achieve financial equilibrium over the long run, particularly in eliminating large unfunded liabilities in the three largest contributing plans—teachers, the army and the police. Moving ahead with the reform of the Caja Fiscal—and avoiding reversals—will require strong political committment on the part of the government, as yielding to pressures to increase benefits would jeopardize the incipient financial sustainability of the Caja Fiscal. For example, a legislative proposal to restore the aguinaldo has already been presented to (and rejected by) Congress. A similar request has recently been presented to the President by representatives of the Chaco war veterans, demanding both an increase in their pensions and the restoration of the aguinaldo.

At the operational level, steps are being taken to continue with the purging of beneficiary rolls, including subscribing agreements to coordinate the systematic exchange of information with the national registry (Registro Civil) and voter registration (Justicia Electoral) files. In addition, the census of public employees that has recently been completed will provide the foundations for the development of a detailed database of contributors to the pension system. At a later stage, the government plans to conduct a census of the recipients of war pensions, further deepening the depuration of the Caja Fiscal. These continuing efforts will be needed to break institutional inertia and pockets of corruption still existing within the Caja Fiscal. While considerable progress has been made toward the identification of phantom and illegitimate pensioners, corruption is still considered widespread within the public sector pension system, with anecdotal evidence suggesting that up to 30 to 40 percent of claims might be fraudulent, particularly among non-contributory pensions.

6.2 Transition arrangement to regular operations:N/A

1 The recent resignation of Finance Minister Dionisio Borda is a case in point. The new Minister of Finance,

Ernst Bergen, is also perceived as a reformer and has stated his intention to maintain existing policies of economic prudence and structural reform. Nevertheless, the continuation of the reform process will depend on the continued strong support of the President for the reform agenda.

7. Bank and Borrower Performance

Bank7.1 Lending:The performance of the Bank’s team in assisting the Borrower in identifying, preparing and appraising the operation was highly satisfactory. Recognizing a window of opportunity for reform with the election of the Duarte Frutos administration, the Bank’s team took the initiative and proceeded to identify policy options open to the new administration. In this way, the Bank’s team was able to transmit to the new administration the in-depth knowledge that the Bank had accumulated over years of sector work and operational experience in Paraguay. At the request of the new administration and with full support from upper management, the Bank’s team prepared the ERL within four months of the inauguration of the new administration. During the interviews conducted as part of the ICR preparation, government officials repeatedly praised the performance on the part of the Bank’s team and the personal level of commitment exhibited by its members.

7.2 Supervision:The Bank’s supervision has been highly satisfactory. As the loan was fully disbursed upon Board approval and formally closed just a week after becoming effective, no supervision missions were formally required. However, there was close oversight of the progress being made on the various reforms by the

- 19 -

Bank’s field office in Paraguay and the task manager, who is also Paraguay’s country economist. At the same time, sector task managers were responsible for the follow-up of the progress being made in individual sectors, including financial sector reform, procurement and financial administration, providing valuable sector-specific knowledge. There has been good coordination within the Bank’s Paraguay team, including the field office, the project task manager and the task managers working in individual sectors, which permitted the balancing of sector expertise with a comprehensive view of the operation. The Bank has maintained a close working relationship with top government officials as well as with individual government agencies, maintaining fluid communication at both the policy and operational levels.

7.3 Overall Bank performance:Overall Bank’s performance is rated highly satisfactory as it illustrates the central concepts embedded in the newly adopted Development Policy Lending approach. The rapid processing of the operation points to high responsiveness to the client’s needs, both in terms of providing timely financing and technical assistance as well as in supporting reforms and actions that had been assigned top priority by the incoming administration. The performance of the Paraguay team has helped strengthen the Bank’s presence in Paraguay and make a substantial contribution toward the success of the country’s reform program.

Borrower7.4 Preparation:The government’s performance during preparation was highly satisfactory. The preparation of the loan was in the hands of qualified professional staff within the Ministry of Finance, which, in turn, was responsible for coordinating actions with individual areas within the government. Given the large number of participating agencies and the complex nature of the operation, such coordination required a substantial effort on the part of the government’s preparation team. Throughout the project preparation, top officials and government staff worked closely with the Bank’s project team, contributing high motivation and sound technical proficiency to the process and, most importantly, demonstrating a high level of ownership of the reforms and actions being included as part of the operation.

7.5 Government implementation performance:The government’s implementation performance was satisfactory. Nearly two years after taking office, the administration boasts a strong record of accomplishments. Not only was the administration able to avert a major economic crisis, but it also succeeded in making substantial progress towards achieving fiscal sustainability and improving public sector performance. These strides have been the result of a commitment to correcting Paraguay’s longstanding problems. The reforms and actions supported under the ERL are central components of the government’s agenda and, hence, have its full support. The high level of ownership on the part of the government of the policy actions supported under the ERL has been perhaps the single most important factor contributing to the operation’s success. There have been a few reversals in policy over time and some elements of the program that have not been fully implemented, however. The excise tax on diesel, after having been increased to a level comparable to that of Paraguay's neighbors, was again reduced, largely as a result of political pressures. Measures to reduce the public sector staffing and to create an associated compensation fund were not fully implemented, and there are still problems with inadequate counterpart funding. The presentation to Congress, and the approval by the legislature, of financial sector reforms have been delayed.

7.6 Implementing Agency:The performance of the Ministry of Finance as the government counterpart for the operation has been satisfactory. With strong support from the President, the Ministry of Finance exhibited strong leadership skills, delineating a clear reform strategy. In turn, responsibility for engineering and implementing individual reforms has been assigned to first-rate professionals. Some of them come from within the public

- 20 -

bureaucracy, contributing their valuable in-house expertise; others are outsiders who bring in a dose of enthusiasm and strong implementation capacity. Together, these individuals have challenged vested interests, shaken institutional inertia and dismantled pockets of corruption, first steps towards a more efficient and transparent public sector in Paraguay. Nearly two years after the launching of the government reform program, the Ministry has maintained much of the early momentum, although as noted in the previous paragraph, there have been some lapses and delays.

7.7 Overall Borrower performance:The overall performance of the Borrower is rated satisfactory for the reasons outlined above.

8. Lessons Learned

There are several lessons that can be learned from this operation, particularly in terms of the elements needed to ensure the success and sustainability of economic reform programs: q Economic crises often open windows of opportunity for reform. Since their adverse impact is likely to be felt across all segments of society, crises often galvanize diverse interest groups, helping them come together in their desire to avert or overcome such crises. q Timely assistance on the part of the Bank and other international financial institutions can help reform-minded leaders capitalize on such windows of opportunity. In the case of Paraguay, the expedient intervention of the Bank and its partners effectively helped the incoming administration prevent Paraguay’s default, giving it enough breathing space to be able to take immediate and medium-term actions aimed at restoring fiscal stability and implementing long-needed reforms.

q Strong ownership on the part of national authorities is a necessary condition for the success of any reform program. In this regard, the early success of Paraguay’s reform program, with a strong ownership on the part of the administration, echoes the experience of reform programs worldwide (see, for example, the main conclusions of the Assessing Aid report).

q Bank sector work and operations can contribute substantial value-added to economic reform programs. While the World Bank’s operations cannot ‘buy’ policy improvements, they can contribute not only financial support but also other valuable ingredients—such as ideas, technical expertise and credibility—to countries with a genuine commitment toward reform, as illustrated by the experience of the ERL.

q The excellence of the Bank depends on the commitment, motivation and high quality of its staff. The performance of the Bank’s team in Paraguay can be considered best practice, as it promptly recognized the opening of a window of opportunity for reform with the election of the new administration, proceeded to identify policy options open to the new administration leveraging the Bank’s previous work in the country, obtained the support of management, and prepared and obtained Board approval for both a new CAS and the ERL within four months of the inauguration of the new administration. This level of performance on the part of the Bank’s team was key to reestablishing an important Bank presence in Paraguay and contributing toward the success of the country’s reform program in general and the ERL in particular.

q Valuable synergies can arise from preparing lending operations while simultaneously conducting policy and sector work. The ERL was conceived as an intrinsic component of the new CAS, providing both substantial financial incentives and a clear roadmap for the administration’s immediate and

- 21 -

medium-term reform strategy. The preparation of the ERL in conjunction with the CAS not only ensured full conceptual consistency between the policy and operational levels but also resulted in considerable economies of scale in time and financial inputs.

q The ability to build and maintain complex coalitions of support is key to ensuring the success of any reform program. In this regard, the administration has demonstrated a remarkable ability in building support from multiple stakeholders for its ambitious reform program, including parties from a wide political spectrum, economic interests, domestic investors and the international community.

q There is a delicate balance between the political feasibility and the depth of the reform efforts. The need to maintain coalitions of support often sets limits on the depth of the reforms, particularly in terms of the impact that new legislation can have on powerful interest groups. In the case of Paraguay, this is illustrated by the exceptions granted to teachers, the army and the police in the context of the reform of the Caja Fiscal. The same is true in the case of the new tax law, which includes a staged implementation—with several years for the tax law to be fully effective—and tax rates significantly lower than other countries in the region. However, both the reform of the Caja Fiscal and the tax law constitute a considerable improvement over the past; moreover, the reform of the Caja Fiscal in particular also paves the way toward further, more comprehensive reforms in the future. This, in turn, points to the complex nature of reform processes, which, to be successful, have to foster change, either drastically or incrementally, and sustain it over time.

q To assert its credibility, a reform-minded administration needs to demonstrate a critical mass of achievements during the initial stage of its mandate—the proverbial first 100 days of an administration. The Duarte Frutos administration moved swiftly after its electoral victory, appointing its ministers, developing its reform strategy and building coalitions of support well before its inauguration. Because of the intense preparatory work, the new administration was able to submit to Congress a package of key pieces of legislation and set in motion far-reaching reforms shortly after it took office, effectively capitalizing on the initial enthusiasm and consolidating the momentum of its reform program. Likewise, the identification of a set of key actions to be taken during the first 100 days of the administration was an important consideration of the Bank’s Policy Options Report and the CAS.

q Strong political determination on the part of government officials needs to be sustained over the long haul. So far, the Duarte Frutos administration and Congress have exhibited their continuous commitment toward the reform process. However, as the initial enthusiasm wears off, elections draw nearer and pressure from interest groups continues to mount, strong political determination will be required on the part of both the President and Congress to maintain a steady reform course and avoid reversals. The recent reversal of the increase in the gasoil tax as well as the delays in presenting the banking reform law to Congress signals that Paraguay’s reform program is likely to encounter an icreasingly complex political environment in the future.

q Obtaining tangible results from improved public sector management can contribute to the success of a reform program. As demonstrated by the considerable financial gains resulting from improved tax and customs administration, the elimination of fraudulent public-sector pensions and enhanced procurement procedures, actions aimed at increasing efficiency and reducing corruption in public sector management can generate considerable fiscal surpluses without affecting legitimate interest groups. Early tangible results also help boost the government’s credibility.

q Top-down strong political support is necessary to foster leadership on the various fronts of

- 22 -

the reform efforts. In the case of Paraguay, the strong support given to the Minister of Finance by the President and, in turn, that given by the Minister to those responsible for the implementation of individual reforms was key in generating leadership synergies at various levels. Highly capable individuals with a reputation for personal integrity were given responsibility for engineering and implementing key reforms within the Ministry of Finance. With full support from top officials, these individuals were able to assume leadership roles, implementing difficult actions aimed at restructuring and modernizing the public sector apparatus, challenging vested interests, shaking institutional inertia and dismantling pockets of corruption. The initial success of Paraguay’s reform program suggests that successful reform programs depend on not just one but many leaders. In turn, strong political backing from the top is a necessary condition to unfold the leadership potential of those responsible for the implementation of the reforms on the various fronts.

q Increasing the ‘subjective risk’, both within agencies and among the public, can be an effective strategy to improve performance in the short term. As illustrated by the experience of the tax administration agency, exemplary actions, such applying stiff sanctions for tax evasion to well-known companies, can be effective in triggering a spontaneous increase in tax collections, as contributors’ perception of risk is heightened. Exemplary actions, such as the dismissal of corrupt tax inspectors, can also be effective in reducing corruption within agencies.

q To sustain the improved performance in the medium and long term, it is necessary to ‘institutionalize’ the reforms within individual agencies. Specifically, it is necessary to develop and implement effective, efficient and transparent procedures and information systems that help identify non-compliance.

q Adequate human and financial resources are key inputs in the ‘institutionalization’ of reforms within individual agencies. In this regard, the new customs code has been highly successful, as it provides financial independence to the customs administration, ensuring it has adequate financial resources and embedded incentives that are conducive to high performance. Unfortunately, the same financial independence was not granted to the tax administration, potentially making it more vulnerable during volatile political environments.

q Bringing on board reputable non-government organizations (NGOs) can add transparency and, hence, credibility to the reform process. In the case of Paraguay, agreements have been reached with local NGOs, such as Transparencia Paraguay, to facilitate citizen participation as a way to eliminate corruption.

q The wide dissemination of new management tools and their impact can be an effective strategy to ensure their sustainability. As illustrated by the new procurement portal and electronic tax filing capabilities, modern management tools result in greater convenience and reduced costs to users. The ample dissemination of the availability of such tools can be effective in maximizing their use and generating a new level of expectations among the public, thus, making their future elimination more unlikely.

q Balancing fiscal and social objectives is one of the most difficult challenges facing reformers. Having succeeded in averting a major economic crisis, achieving a more stable fiscal environment and setting in motion far-reaching reforms aimed at enhancing public sector management, the administration is now better positioned to address Paraguay’s structural social problems, including widespread poverty and a highly skewed income distribution. The lack of a dialogue and tangible actions addressing these issues could potentially lead to widespread social unrest, threatening the stability of the overall reform program.

- 23 -

9. Partner Comments

(a) Borrower/implementing agency:

The Bank worked in close coordination with the IMF and the IDB to help the incoming administration confront the lack of liquidity and to support its medium-term program. As discussed above, the government negotiated a Stand-By Arrangement with the IMF that has been crucial in helping restore fiscal and monetary stability. In addition, the government negotiated two structural adjustment operations with the Bank and IDB for a total of US$60 million. The three institutions have also worked closely in providing technical assistance and monitoring the progress being made on the various fronts of the reform program. Below are the comments from IDB and the IMF on the progress being made on the IDB loan and the overall reform program, respectively.

On 17 December 2003, IDB approved the Emergency Social Expenditure Protection Loan (Loan No. 1520/OC-PR), for US$30 million to be disbursed over a period of up to 18 months in two tranches of US$20 million and US$10 million, respectively. The loan was designed to help the administration mitigate the effects of the economic crisis on the poorest and most vulnerable segments of the population and prevent setbacks in modernization efforts in an adverse economic climate. Loan conditionality focused on three areas: (i) good standing on the macroeconomic program agreed with the IMF; (ii) budgetary protection for programs targeted to the poor and important to the modernization of the country; and (iii) support for modernization efforts in the social sectors. The first tranche of US$20 million was disbursed in December 2003. The second tranche has not yet been disbursed. As reported by the IDB, the main objective of the project, protecting social expenditures, has been already achieved.

The IMF’s assessment of the achievements of the administration are described in the chairman's remarks following the completion of the Fourth Review under the Stand-By arrangement conducted in March 2005. The IMF commended the authorities for Paraguay's strong overall performance. Prudent macroeconomic policies and structural reforms have been maintained. According to the IMF, Paraguay's macroeconomic situation was been better than envisaged under the program, with real GDP growth accelerating to almost 3 percent in 2004, the highest growth rate in a decade, while inflation fell below 3 percent, the lowest inflation rate in three decades. The overall fiscal position of the central government was brought back into surplus, confidence in the banking system returned, and the foreign exchange market has broadly stabilized. The fiscal outlook has improved, partly reflecting the congressional passage of the tax reform bill. The IMF praised the government’s efforts at improved tax administration in the internal revenue service and customs which, in the future, should be consolidated through institutional strengthening. The chairman also pointed to important pending challenges, such as maintaining fiscal discipline and moving forward with the structural reform agenda. Unemployment and poverty levels remain high, underscoring the importance of pressing ahead with the reform agenda. It was also noted that the structural reform agenda remains ambitious but feasible. Looking ahead, the authorities will need to reinforce their commitment to reform by further advancing with the difficult task of restructuring the National Development Bank (BNF). It will also be important to strengthen governance and the climate for private investment to allow the economy to reach its full growth potential.

(b) Cofinanciers:

- 24 -

N/A

(c) Other partners (NGOs/private sector):

N/A

10. Additional Information

The individuals interviewed in the course of the preparation of this report include:Government BankManuel Alarcón Peter HansenMargarita Díaz de Vivar Zeinab PartowPedro Espínola Vargas Peña John PollnerSergio ForteFernando Masi Other OrganizationsBernardo Navarro Luis Durán (IMF)Andreas Neufeld Jorge Domínguez (IDB)Francisco Ogura Pilar Callizo (Transparencia Paraguay)Juan Max RejalagaCarlos RíosCésar Talavera

- 25 -

Annex 1. Key Performance Indicators/Log Frame Matrix

Outcome / Impact Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

NA NA NA

Output Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

NA NA NA

1 End of project

- 26 -

Annex 1.a: Log Frame Matrix

MATRIX OF POLICY ACTIONS Policy Objectives Policy Actions Required by Board Date Result a. Fiscal Stabilization To reduce the fiscal deficit of the public sector in 2003-2004, attaining a primary surplus and narrowing the financing gap.

Existence of an acceptable macroeconomic framework. Withdrawal of supplemental budget requests presented to Congress during calendar year 2003, with the exception of requests for the purpose of external debt payments and social sectors expenditures. No increase in central administration salaries by the new administration during 2003. Sixty percent of all public employees in the central administration checked for duplicative salary payments. Of a total of 125,000 reviews, 1,650 have been identified as holding more than one job and a system has been set up to regularize their situation via elimination of extra positions. A draft-law for the annual budget for CY 2004 (Presupuesto General de la Nación – Ejercicio Fiscal 2004) consistent with the attainment of a primary surplus in the central administration to be submitted to Congress.

Accomplished

Accomplished

Accomplished

Accomplished

Accomplished

b. Taxes To rationalize and improve the quality of the tax code, widening of tax bases increasing equitability of taxes and promoting the generation of greater revenues.

Increase in the excise tax on diesel oil (gasoil) to 20 percent. A draft law on administrative and tax reform (Reordenamiento Administrativo y Adecuación Fiscal) submitted to Congress, including the following measures: (i) widening of the VAT base through generalization of VAT to agriculture, services, and current contributors to the Tributo Unico; (ii) reduction of exemptions; (iii) increase in the excise tax on alcohol and cigarettes; (iv) reduction of the income tax rate on firms; and (v) a widening of the income tax base. Adoption of measures to combat tax evasion, including: (i) the removal of all non-customs employees from customs areas; (ii) the elimination of ad-hoc checkpoints along transport routes; (iii) the creation of a special technical unit combining staff from the Public Prosecutor’s Office (Ministerio Público) and the ministries of the Interior, Finance and Industry and Commerce to improve coordination of efforts on combating tax evasion and informality of the economy; and (iv) the launching of an educational and awareness-raising campaign for tax compliance.

Accomplished but later reversed

Accomplished

Accomplished

- 27 -

MATRIX OF POLICY ACTIONS (cont.) Policy Objectives Policy Actions Required by Board Date Result c. Public Administration and Anti-Corruption To address the problems of widespread corruption, lack of transparency, high levels of waste and low efficiency and effectiveness in the public sector, increase fiscal revenue.

A draft-law for the annual budget for calendar year 2004 (Presupuesto General de la Nación – Ejercicio Fiscal 2004) submitted to Congress, with a shift to program-and-results format. A draft law for a new Customs Code submitted to Congress, including measures for renewal and simplification of administrative procedures, promotion of selective audits, the granting of financial autonomy to the Customs Administration and the professionalization of its staff. Enactment of a decree regulating the new Public Procurement Law and a resolution creating the Directorate General of Public Procurement (DGCP), as well as dissemination of the contents of the regulation. Adoption of a Procurement Action Plan that includes development and implementation of: (i) the institutional and operational framework for the DGCP and the agency procurement units; (ii) a human resources development plan; (iii) an electronic information and procurement system; and (iv) strengthened contract management. Agreement with Transparency Paraguay for a set of actions to improve the transparency in the use of public resources in the Ministry of Finance. Launching of a census of employees in the public sector to determine the number of public employees and their positions. Creation of the Central Unit of Public Investment (Unidad Central de Inversión Pública) in the Ministry of Finance. Adoption of a financial management action plan, including the following measures: (i) introduction of accrual accounting in the Integrated System of Financial Management (Sistema Integrado de Administración Financiera- SIAF); and (ii) implementation of SIAF in the public decentralized agencies of the non-financial sector.

Accomplished

Accomplished

Accomplished

Accomplished

Accomplished

Accomplished

Accomplished

Accomplished

d. Financial Sector To strengthen the government’s capacity to manage potential weaknesses and stresses in the financial system and prevent crisis contagion by using market oriented risk-sharing methods while reducing losses to the state.

The Deposit Guarantee and Bank Resolution Fund (Fondo de Garantía de Depósitos y Resoluciones Bancarias) law approved by Congress and in effect.

Accomplished

- 28 -

MATRIX OF POLICY ACTIONS (cont.) Policy Objectives Policy Actions Required by Board Date Result e. Public Sector Pension Fund (Caja Fiscal) To gradually reduce the deficit of the Caja Fiscal, increasing the harmonization of benefits and contributions with existing pension funds.

Public bidding launched to hire technical assistance to: (i) design a database for the Public Sector Pension System (Caja Fiscal); (ii) digitalize contributor and beneficiary files; and (iii) design a process for the restructuring of contributory and non-contributory pensions. Public bidding launched to hire technical assistance to design a process for the restructuring of contributory and non-contributory pensions of the Public Sector Pension System (Caja Fiscal). A draft law for reforming the Public Sector Pension System (Caja Fiscal) submitted to Congress, including the following measures: (i) increase of the retirement age; (ii) lengthening of the time period over which the salary base for pension benefits is calculated; (iii) reduction in replacement rates for mandatory and early retirement; (iv) raising of the age and years of contribution required for early retirement; and (v) harmonization of contributions and benefits Caja Fiscal with those of other existing pension funds.

Accomplished

Accomplished

Accomplished

- 29 -

Annex 1.b: Performance and Monitoring Indicators

- 30 -

PERFORMANCE AND MONITORING BENCHMARKS Implementation

Benchmarks Expectations by May 2004 Actual Performance

a. Fiscal Stabilization Reduction of the fiscal deficit of the public sector

§ Maintenance of an acceptable macroeconomic framework

• Achieved: The overall public deficit was reduced from 3.1% in 2002 to 0.1% percent in 2003, and to a surplus of 2.4% of GDP in 2004.

• The government overperformed with respect to the fiscal target as established in the IMF Stand-By agreement (0.2% of GDP), attaining a surplus of 1.5% of GDP.

Freeze of central administration salaries

§ Maintenance of the nominal wage bill freeze for permanent employees;

§ Reduction of wage bill for contracted employees

• Partially Achieved: The wage bill of the central administration increased by about 9% for the period 2003-2004.

• With an inflation rate of 2.8% in 2004, the wage bill budgeted for 2004 reflects an increase of 9% with respect to 2003.

• With the exception of salary increases in the judiciary, there have been no salary increases in the rest of the Central Government. The growth in the wage bill responds primarily to the need to cover the growth of the population in education, health and security services.

Identification of illegitimate public sector employment

§ Review of all public employees completed, identifying those with multiple salaries; follow-up actions taken.

• Partially Achieved: 1,650 employees receiving more than one salary have been identified by the review, with 2/3 of central government entities providing the required information.

• Approximately 170 of the identified employees have resigned. The estimated savings resulting from this exercise so far amount G$106 million per month, or US$ 220,000 per year.

2004 Budget that includes the following provisions:

§ Reduction of administrative personnel of the central administration from 2003 levels

§ Reduction of central administration

personnel contracts from 2003 levels § Creation of a compensation fund

(Fondo de Inserción Laboral) to ameliorate the social impact of measures reducing public sector staffing

§ 100% financing of counterpart funds for projects with external funding

• Partially Achieved: The number of positions in the central administration has remained almost constant, with a 1 percent increase in the positions budgeted in 2004 with respect to 2003.

• No Data Available • Not Achieved: The provision for

creating this fund was deleted from the 2004 budget by Congress.

• Partially Achieved: A request has been

presented to Congress to increase to $G264 billion the amount budgeted for counterpart funding in 2004. According to the Central Public Investment Unit (UCIP), this amount, which is less than the anticipated counterpart financing needs, reflects the implementation capacity of the various project implementation units for 2004.

- 31 -

PERFORMANCE AND MONITORING BENCHMARKS (Cont.)

Implementation Benchmarks Expectations by May 2004 Actual Performance

b. Tax Policy Tax on diesel fuel (gasoil)

§ Increase in the excise tax on gasoil from 20% to 26%.

• Not Achieved: The excise tax on diesel oil was increased from 14% to 20%first and later to 26%, as agreed in the framework of the ERL. However, this tax has been recently lowered to the original 14%, reportedly as a temporary, measure until international oil prices come back down.

Tax reform § Approval by Congress of Tax Reform Law (Ley de Reordenamiento Administrativo y Adecuación Fiscal)

• Achieved: A new tax bill was approved by Congress in July 2004.

• It includes significant improvements, such as the widening of the tax base, the unification of tariffs and a considerable reduction of exemptions.

• The estimated fiscal impact amounts to about 1.5% of GDP when it becomes full effectiveness—2013 is the time limit for full effectiveness.

c. Public Administration and Anti-Corruption Program-and-results budget

§ Congress to approve program-and-results budget.

§ Ten central ministries develop detailed financial plans for implementation of 2004 budget, linking disbursements to program objectives.

• In Progress: The 2004 Budget was prepared using the program-and-results methodology. For the time being, the evaluation of results runs in parallel to the budget.

• Five entities will fully implement the newly adopted methodology in 2005 as a pilot experience.

New Customs Code

§ Approval by Congress of a new Customs Code.

• Achieved: A new Custom Code was approved in July 2004.

• It results in the modernization and simplification of administrative procedures, stiffer sanctions, lower user costs and the financial autonomy of the customs administration.

Procurement procedures

§ Progress in the implementation of a Procurement Action Plan.

• Achieved: A new online procurement portal is now in place, which posts the annual procurement plans for state institutions, bidding documents, all public procurement notices and a list of ineligible and black-listed contractors.

Transparency Paraguay

§ Report from Transparency Paraguay on implementation of the agreement with the Ministry of Finance.

• Achieved: A report has been submitted describing the involvement of Transparency Paraguay in public education campaigns in the areas of procurement and taxes.

Census of public sector employees

§ Finalization of the public sector employee census.

• Achieved: The census was completed in April 2004.

Public Investment Unit

§ Staffing and operation of the Central Public Investment Unit (UCIP).

• Achieved: The new UCIP, responsible for the coordination of externally financed projects, is now in place.

Financial Management Plan

§ Progress on the adopted Financial Management Action Plan.

• In Progress: Considerable advances are being made in this area, including the implementation of an integrated financial management system (SIAF).

- 32 -

PERFORMANCE AND MONITORING INDICATORS (cont.) Implementation

Benchmarks Expectations by May 2004 Actual Performance

d. Financial Sector Financial Sector Reform § Completion of the financial

sector measures and reforms as included in the proposal Financial Sector Adjustment Loan (FSAL).

• In Progress: Two financial sector reform laws—the Restructuring and Consolidation of State-Owned Banks Law and the Anti-Money Laundering Law—have been presented to Congress..

e. Public Sector Pension Fund (Caja Fiscal) Census of public sector pension system beneficiaries

§ Updating of the database of public sector pension and progress in the reorganization of the unit in charge of affairs related to the Caja Fiscal, and the submission of a preliminary report, by the contracted firm, on the status and issues related to current management of the Caja Fiscal.

• In Progress: Substantial progress has been made in the digitalization of digitalization of the files of 55,000 beneficiaries of the Caja Fiscal—32,000 pensioners and 23,000 veterans and their survivors.

• Ongoing efforts to purge the registry of beneficiaries have resulted in the elimination of 3, 413 beneficiaries since August 2003, resulting in estimated annual savings of G26.7 billion (US$4.5 million).

• The firm Price-Waterhouse has submitted a preliminary report that includes a diagnosis for the restructuring of the Caja Fiscal and the computerization of its databases.

Public Sector Pension Reform

§ Approval by Congress of a law reforming the Caja Fiscal.

• Achieved: A Law reforming the Caja Fiscal was approved in December 2003, lengthening the time period over which the salary base for pension benefits is calculated, increasing the rate of contribution and the salary base over which contributions are made, reducing replacement rates, eliminating the aguinaldo and gradually raising the age and years of contribution required for early retirement.

• The fiscal impact of the reform has been substantial. At the end of 2004, the fiscal deficit of the contributing pensions for 2004 had decreased by 15 percent with respect to 2003.

- 33 -

Annex 2. Project Costs and Financing

N/A

N/AN/AN/A

- 34 -

Annex 3. Economic Costs and Benefits

N/A

- 35 -

Annex 4. Bank Inputs

(a) Missions:Stage of Project Cycle Performance Rating No. of Persons and Specialty

(e.g. 2 Economists, 1 FMS, etc.)Month/Year Count Specialty

ImplementationProgress

DevelopmentObjective

Identification/Preparation9/2003 2 2 economists10/2003 4 2 economists, 1 public sector

spec., 1 pension spec.,

Appraisal/Negotiation10/2003 3 2 economists, 1 lawyer

Supervision5/2004 2 informal "supervision" - 1

economist, 1 procurement spec.

ICR9/2004 2 2 economists

(b) Staff:

Stage of Project Cycle Actual/Latest EstimateNo. Staff weeks US$ ('000)

Identification/Preparation 6.375 24288.10Appraisal/Negotiation 3.85 13648.4Supervision 3.122 13247.73ICR 3.5 11015.29Total 19.2 62199.52

"Staff" does not include consultants' time or cost which amounted to $21,435.63 in total.

- 36 -

Annex 5. Ratings for Achievement of Objectives/Outputs of Components(H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable)

RatingMacro policies H SU M N NASector Policies H SU M N NAPhysical H SU M N NAFinancial H SU M N NAInstitutional Development H SU M N NAEnvironmental H SU M N NA

SocialPoverty Reduction H SU M N NAGender H SU M N NAOther (Please specify) H SU M N NA

Private sector development H SU M N NAPublic sector management H SU M N NAOther (Please specify) H SU M N NA

- 37 -

Annex 6. Ratings of Bank and Borrower Performance

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory)

6.1 Bank performance Rating

Lending HS S U HUSupervision HS S U HUOverall HS S U HU

6.2 Borrower performance Rating

Preparation HS S U HUGovernment implementation performance HS S U HUImplementation agency performance HS S U HUOverall HS S U HU

- 38 -

Annex 7. List of Supporting Documents

Inter-American Development Bank (2003), Social Protection Program for Paraguay (Pr-0147) - Loan Proposal, Washington, D.C.

Ministry of Finance (2004), Código Aduanero: Ley No. 2.422/04, July 2004, Dirección Nacional de Aduanas, República del Paraguay, Asunción.

Ministry of Finance (2004), Rendición de Cuentas: Informe de Gestión 2003/2004, 15 August 2004, Republic of Paraguay, Asunción.

Ministry of Finance (2004), Paraguay: Informe de Coyuntura Fiscal: Situación Financiera de la Administración Central, Julio 2004, Republic of Paraguay, Asunción.

Ministry of Finance (2003), Paraguay: Informe de Coyuntura Fiscal: Situación Financiera de la Administración Central, December 2003, Republic of Paraguay, Asunción.

Ministry of Finance (2003), Paraguay: Informe de Coyuntura Fiscal: Situación Financiera de la Administración Central, Julio 2003, Republic of Paraguay, Asunción.

International Monetary Fund (2004), Article IV Consultation with Paraguay, Public Information Notice (PIN) No. 04/103, 16 September 2004, Washington, D.C.

International Monetary Fund (2004), IMF Executive Board Completes Second Review Under Paraguay Stand-By Arrangement, Press Release No. 04/165, 2 August 2004, Washington, D.C.

International Monetary Fund (2004), IMF Executive Board Completes First Review Under Paraguay Stand-By Arrangement, Press Release No. 04/74, 12 April 12 2004, Washington, D.C.

Price-Waterhouse-Cooper (2004), Reingeniería del Sistema de Gestión de Jubilados y Pensionados de la Dirección General de Jubilaciones y Pensiones del Ministerio de Hacienda: Informe de Diagnóstico, Febrero 2004 Asunción, Paraguay.

World Bank (2004a), From Adjustment Lending to Development Policy Lending: Update of World Bank Policy, 16 August 2004, Operations Policy and Country Services, Washington, D.C.

World Bank (2004b), Draft Program Document for a Proposed Financial Sector Adjustment Loan, Report No. 23996-PA, 29 July 2004, Washington, D.C.

World Bank (2003), Program Document for a Proposed Economic Recovery Structural Adjustment Loan, Report No. 27172-PA, 2 December 2003, Washington, D.C.

World Bank (2003), Paraguay: Country Strategy Assistance, Report No. 27341-PA, 26 November 2003, Washington, D.C.

World Bank (2003), Paraguay: Policy Options for the New Administration: Creating Conditions for Sustainable Growth, Report No. 25894-PA, Vol. I and II, 6 June 2003, Washington, D.C.

World Bank (1998), Assessing Aids: What Works, What Doesn’t, and Why, World Bank Policy Research Report, Oxford University Press: New York.

- 39 -

- 40 -