Document of The World Bank

FOR OFFICIAL USE ONLY

Report No. 52146-BR

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT

FOR A PROPOSED LOAN

IN THE AMOUNT OF US$485 MILLION

TO

THE STATE OF RIO DE JANEIRO, BRAZIL

WITH THE GUARANTEE OF THE FEDERATIVE REPUBLIC OF BRAZIL

FOR A

FISCAL SUSTAINABILITY, HUMAN DEVELOPMENT AND COMPETITIVENESS DEVELOPMENT POLICY LOAN

December 16,2009

Human Development Department Brazil Country Management Unit Latin America and Caribbean Region

This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not otherwise be disclosed without World Bank authorization.

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BCB BRL CFAA

CGU CPS CPAR

DPL

ERJ FDI FPE FRL FRM FUNDEB

GDP GFS GORJ HDI IGP IGP-DI

IADB IASB

IBRD

ICE1 RJ

ICMS

IDEB

IFRS

IMF IPCA

IPVA

Brazil - GOVERNMENT FISCAL YEAR January, 1 -December, 31

CURRENCY EQUIVALENTS (Exchange Rate Effective as of November 4, 2009)

Currency Unit Real (R$) US$1 .oo R$ 1.728

Weights and Measures Metr ic System

ABBREVIATION AND ACRONYMS

Central Bank o f Brazil Brazilian Real Country Financial Accountability Assessment Controller General’s Office o f the Republic Country Partnership Strategy Country Procurement Assessment Report

Development Policy Loan

State o f Rio de Janeiro Foreign Direct Investment State Participation Fund Fiscal Responsibility Law Roberto Marinho Foundation Fund for Maintenance and Development o f Basic Education Gross Domestic Product Government Finance Statistics Government o f Rio de Janeiro Human Development Index General Price Index

Inter-American Development Bank International Accounting Standards Board

International Bank for Reconstruction and Development

Brazilian State Value Added Tax

Basic Education Development Index

International Financial Reporting Standards

International Monetary Fund Consumer Price Index

Tax on Motor Vehicle Property

Banco Central do Brasil Real Brasileiro Avaliaqdo da Gestdo Financeira do Pais

Controladoria Geral da Unido Estratkgia de Parceriapara o Pais Relatdrio da Avaliap7o do Sistema de Aquisiq6es do Pais Emprhtimo para Politicas de Desenvolvimento Estado do Rio de Janeiro Investimento Externo Direto Fundo de Participaqdo dos Estados Lei de Responsabilidade Fiscal Fundaqdo Roberto Marinho Fundo de Manutenqdo e Desenvolvimento do Ensino Bcisico Produto Interno Bruto Estatisticas Financeiras do Governo Governo do Estado do Rio de Janeiro indice de Desenvolvimento Humano indice Geral de Preqos indice Geral de Preqos Disponibilidade Interna Banco Interamericano de Desenvolvimento Diretoria de Normas de Contabilidade Internacional Banco Internacional para Reconstruqdo e Desenvolvimento indice de ConJianGa do Emprescirio Industrial Fluminense Imposto sobre Circulaqdo de Mercadorias e Serviqos Indice de Desenvolvimento da Educaqdo Bdsica Normas de Relatdrios Financeiros Internacionais Fundo Monetcirio Internacional indice Nacional de Preqos ao Consumidor Amplo Imposto sobre a Propriedade de Veiculos Automotores

FOR OFFICIAL USE ONLY

JUCERJA

NCR OCOG

os PAC PACS

PAF PAHI

PEFA

PISA

PGE PNAFE

PPA PROESF

PSF PSIA REGIN QUALISUS

SAERJ

SEEDUC SFC SEFAZ SESDEC SEPLAG SHF S I L S T N sus SWAP TCU UPA V A T

Chamber o f Commerce o f State o f Rio de Janeiro Net Current Revenue Organizing Committee for the Olympic Games Social Organization Program o f Accelerated Growth Community Health Agents

Program o f Fiscal Adjustment Program to Support Municipal Hospitals

Public Expenditure and Financial Accountability Program for International Student Assessment State’s General Attorney Office National Program in Support to Fiscal Management for the Brazilian States

Multi-year Plan Family Health Project

Family Health Program Poverty and Social Impact Assessment Centralized Business Registration System Health Network Formation and Quality Improvement Project Evaluation System o f Basic Education o f the State o f Rio de Janeiro State Secretariat o f Education Federal Secretariat o f Internal Control State Secretariat o f Finance State Secretary o f Health and Civi l Defense State Secretary o f Planning State Health Foundation Specific Investment Loan National Treasury Secretariat National Health System Sector Wide Approach Court o f Accounts o f the Nation Urgent and Emergency Care Unit Value Added Tax

Junta Comercial do Estado do Rio de Janeiro Receita Corrente Liquida Comitt Organizador dos Jogos Olimpicos

Organizaqrio Social Programa de Aceleramento do Crescimento Programa de Agentes Comunitririos de Salide Programa de Ajuste Fiscal Programa de Apoio aos Hospitais do Interior Mgtodo de despesap2ibIica e responsabilidade financeira Programa de Avaliaqrio Internacional de Estudantes Procuradoria Geral da UnicSo Programa Nacional de Apoio d Administraqrio Fiscal para os Estados Brasileiros Plano Plurianual Programa de Apoio a Estratbgia de Sazide da Familia Programa de Salide da Familia AvaliaqCo de Impactos Sociais e de Pobreza Registro Mercantil Integrado Programa de FormaqCo de Redes de Salide e Melhoria da Qualidade do SUS Sistema de AvaliaqcSo da Educaqrio Bhica do Estado do Rio de Janeiro Secretaria de Estado de EducaqcSo Secretaria Federal de Controle Interno Secretaria de Estado da Fazenda Secretaria de Estado de Salide e Defesa Civil Secretaria de Estado de Planejamento Fundaqrio Estatal de Sazide Projeto de Investimento Secretaria do Tesouro Nacional Sistema Unico de Sazide Abordagem Setorial Ampla Tribunal de Contas da Unirio Unidade de Pronto Atendimento Impost0 sobre o Valor Agregado (IVA)

Vice President: Pamela Cox Country Director: Makhtar Diop

Sector Manager: Chingboon Lee Task Team Leader: Michele Grannolati

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties. I t s contents may not be otherwise disclosed without Wor ld Bank authorization.

BRAZIL FISCAL SUSTAINABILITY, HUMAN DEVELOPMENT AND COMPETITIVENESS

DEVELOPMENT POLICY LOAN

TABLE OF CONTENTS

LOAN AND PROGRAM SUMMARY ................................................................................... 3 I . INTRODUCTION .................................................................................................... 5 I1 . COUNTRY AND STATE CONTEXT ................................................................... 5

A . ECONOMIC DEVELOPMENTS IN BRAZIL (UP TO THE CRISIS) .......................... 5 B . CURRENT MACROECONOMIC OUTLOOK .............................................................. 9 C . RECENT SOCIOECONOMIC DEVELOPMENTS IN THE STATE OF RIO DE

JANEIRO ......................................................................................................................... 13 D . MACRO ECONOMIC OUTLOOK AND DEBT SUSTAINABILITY IN THE STATE

OF RIO DE JANEIRO ..................................................................................................... 15

THE GOVERNMENT’S PROGRAM AND PARTICIPATORY PROCESSES18

BANK SUPPORT TO THE GOVERNMENT STRATEGY. .............................. 20 A . RATIONALE FOR BANK INVOLVEMENT AND LINK TO CPS ............................. 20 B . CHOICE OF INSTRUMENT AND RELATIONSHIP TO OTHER BANK

OPERATIONS ................................................................................................................. 21 C . COLLABORATION WITH THE IMF AND OTHER DONORS .................................. 24 D . LESSONS LEARNED ..................................................................................................... 26 E . ANALYTICAL UNDERPINNINGS ............................................................................... 27

THE PROPOSED LOAN ........................................................................................ 29 A . OPERATION DESCRIPTION ........................................................................................ 29 B . POLICY AREAS ............................................................................................................. 30

OPERATION IMPLEMENTATION ..................................................................... 45 A . POVERTY AND SOCIAL IMPACTS ............................................................................ 45 B . IMPLEMENTATION, MONITORING AND EVALUATION ...................................... 46 C . FIDUCIARY ASPECTS .................................................................................................. 47 D . DISBURSEMENT AND AUDITING ............................................................................. 49 E . ENVIRONMENTAL ASPECTS ..................................................................................... 49 F . R I S K S AND RISK MITIGATION .................................................................................. 50

I11 . I V .

V .

V I .

ANNEX 1: LETTER OF DEVELOPMENT POLICY ......................................................... 52 ANNEX 2: OPERATION POLICY MATRIX . RESULTS INDICATORS ...................... 57 ANNEX 3: MACRO ECONOMIC OUTLOOK AND DEBT SUSTAINABILITY IN THE

STATE OF RIO DE JANEIRO ........................................................................... 62 ANNEX 4: BRAZIL AT A GLANCE ..................................................................................... 63

List of Figures

Figure Figure Figure

1 . Sovereign Spreads. Exchange Rate. Ibovespa Stock Market Index ..................... 2 . GDP Growth. Industrial Production. Unemployment and Inflation., .................. 3 . GDP Growth Decomposition. 2003-20 10 (quarterly figures). ..........................

9 11 12

List of Tables

Table 1 . Brazil Macroeconomic Indicators. 2002.08 ................................................. 7 Table 2 . Macroeconomic Outlook. 2008-201 1 ........................................................ 13 Table 3 . School Completion Rates, 2007 ............................................................... 15 Table 4 . Percent o f Population Covered by Basic Health Care Programs, 2002-2007 ........... 15 Table 5 . OCOG Cash Flow Forecast, 2010-201 8 ..................................................... 18

List o f Boxes

Box 1 . Brazilian Fiscal Federalism and the Control o f Sub-National Fiscal Performance ...... 8 Box 2 . Fiscal Impact o f the Olympic Games in Rio de Janeiro in 2016 ........................... 18 Box 3 . Complementarities between the Rio State Fiscal Sustainability, Human Development and

Competitiveness DPL and the Rio Municipality Public Sector Efficiency. Human Development and Competitiveness DPL ...................................................... 23

Box 4 . Good Practice Principles on Conditionality ................................................... 27 Box 5 . Prior Actions for Loan Disbursement ......................................................... 30 Box 6 . Enhancing Budget Predictability in the State o f Rio de Janeiro ........................... 35

Fiscal Sustainability. Human Development and Competitiveness Development Policy Loan was prepared by an IBRD team led by Michele Gragnolati and consisting o f Erica Amorim. Fernando Blanco. Barbara Bruns. Tito Cordella. Regis Cunnigham . David Evans. Pablo Fajnzylber. Maria Isabel Junqueira Braga. Evelyn Levy. Judith Lisansky. Andre Medici. Mariana Montiel. Albert0 Ninio. Daniela Pena de Lima. Gunars Platais. Catarina Isabel Portelo. Luis Prada. Tatiana Proskuryakova. Cristian Quijada Torrres. Jose Guilherme Reis. Romero Rocha. Yaye Seynabou Sakho. Ricardo Silveira. Ngoc-Bich Tran. Juliana Wenceslau Biriba. Carla Zardo . Marize dos Santos and Mariane Brito .

2

FISCAL SUSTAINABILITK HUMAN DEVELOPMENT AND COMPETITIVENESS DEVELOPMENT POLICY LOAN

LOAN AND PROGRAM SUMMARY

Borrower Implementing Agency Amount Terms

Operation Type

Main Policy Areas

Key Outcome Indicators (by December 3 1 , 20 10)

State o f Rio de Janeiro, Brazil State Secretariat o f Finance o f R io de Janeiro US$485 Mil l ion 29.5-year IBRD flexible loan with variable spread over LIBOR denominated in US dollars. Front-end fee o f 0.25 percent of the loan capitalized and financed under the loan. Single tranche Development Policy Loan to be disbursed upon loan effectiveness. The proposed loan will support policy actions in the following areas: 0 Strengthening fiscal consolidation. 0 Improving quality and efficiency o f business registration process. 0 Increasing quality and efficiency o f basic education system. 0 Increasing access and efficiency o f health services, especially in

disadvantaged areas and for poor people. N e t asset position o f the pension fund i s increased and i s not subiect to executive discretion 0

Increased tax collection 0

Pension fund assets totaling R$50,495 mill ion on Dec. 3 1, 2010 [baseline: R$16,229 in 20081

Value o f tax collected increases to R$26,438 mill ion in 2010 [baseline: R$22,920 mill ion in 20081

Improved financial management 0 Financial revenue from cash flow management increases to R$550 million

in 2010 [baseline: R$500 mill ion in 20081 0 Net financial position (cash less current liabilities) increases to R$1,233 in

20 10 [baseline: R $ l , 140 million in 20081

Share o f payments made in less than 30 days increases to 84.0 percent in 2010 [baseline: 82.0 percent in 20091

More efficient business registration process 0 Average number o f days to register a firm i s reduced to 30 in 2010

[baseline: 63 in 20081

Program to reduce age-grade - distortion in basic education (Projeto Autonomia) developed 0

0

Increased predictability and transparency o f expenditure 0

Number o f teachers trained for Projeto Autonomia increases to 1363 in 2010 [baseline: 0 in 20081 Number o f students enrolled in Projeto Autonomia increases to 43,000 in 2010 [baseline: 0 in 20081

Program Development Objectives and Contribution to CPS

Risks and Mitigation

Operation ID Number

New school management information program (Conexiio Educacdo) developed to increase accountability among teachers and students and efficiency o f resource use 0 Number o f students receiving Conexiio EducapTo smart cards increases to

600,000 in 2010 [baseline: 0 in 20081

Urgent and emergency care services delivered according to a more efficient organizational model 0 Number o f services at UPAS increases to 3.7 mill ion in 2010 [baseline: 1.3

million in 20081

Incentive scheme i s created leading to better health outcomes Number o f municipalities with signed PAHI performance agreements increases to 50 in 2010 [baseline: 0 in 20091

The objective o f the proposed operation i s to assist the Government o f Rio de Janeiro (GORJ) in strengthening i t s policies to improve fiscal management, competitiveness and social service delivery and covering the projected fiscal gap during 20 10 resulting from a temporary fall in revenues associated with the recent global financial crisis and economic slowdown. The proposed operation i s fully consistent with and closely linked to the objectives o f the Brazil CPS, 2008-20 1 1. Sound macroeconomic management, fiscal consolidation, efficient public sector management, quality o f education and health expenditures, especially at the sub-national level, and better investment climate are key pillars o f the 2008-201 1 CPS for achieving inclusive economic growth in Brazil. The operation i s subject to two main risks: 1 .Economic risk: ongoing global financial crisis can affect the State’s fiscal position. This risk i s mitigated by the commitment and capacity o f GORJ’s financial and economic team, which indicates that fiscal repercussions o f the global crisis will be managed prudently so as not to offset the gains made in the last three years. In case the crisis turns to be more prolonged or more severe than expected GORJ may have to readjust expenditures to reflect the corresponding decrease in revenues. 2.Political and institutional risk: political situation in the State o f Rio de Janeiro remains complex and reforms can be opposed by groups with entrenched political interests, such as public employee unions. Moreover, with the exception o f top public officials in key positions, the technical capacity o f the State administration i s weak. These risks are mitigated by the rapid and decisive pace o f reforms, by the broad popular consensus behind them, as well as by their irreversible nature. The Bank wi l l continue supporting the Government by providing the necessary technical assistance under forthcoming Rio de Janeiro State Renovating and Strengthening Public Management Technical Assistance Proiect. P117244

4

IBRD PROGRAM DOCUMENT FOR A PROPOSED

FISCAL SUSTAINABILITY, HUMAN DEVELOPMENT AND COMPETITIVENESS DEVELOPMENT POLICY LOAN TO THE STATE OF RIO DE JANEIRO WITH

THE GUARANTEE OF THE FEDERATIVE REPUBLIC OF BRAZIL

I. INTRODUCTION

1. This document presents a proposed Development Policy Loan (DPL) for US$485 mi l l ion to the State o f Rio de Janeiro, Brazil. This Fiscal Sustainability, Human Development and Competitiveness Development Policy Loan i s designed to assist the Government o f the State o f Rio de Janeiro (GORJ) in sustaining its strategic efforts to improve fiscal management, competitiveness and social service delivery in the context o f a temporary fa l l in revenues associated with the recent global financial crisis and economic slowdown. Rio de Janeiro State and Federal Government o f Brazi l requested a single-tranche stand-alone D P L to help with the projected 2010 financing needs deriving from reduced projected revenues, mainly due to lower o i l royalties, state taxes and intergovernmental transfers and increased expenditures on infrastructure associated with the Program o f Accelerated Growth (PAC).

2. Although financing needs are related to the current global and financial crisis, the policies supported by the proposed DPL are part o f GORJ’s medium-term reform program. Specifically, the loan supports measures that: (a) strengthen fiscal consolidation through reduced long-term fiscal risk, improved efficiency o f tax administration and strengthened budget procedures and financial management; (b) improve quality and efficiency o f the business registration process; (c) increase quality and efficiency o f the basic education system; and (d) increase access to and efficiency o f health services, especially for urgent and emergency health care in disadvantaged areas and for low-income populations.

3. The proposed operation and associated Bank support meet the criteria for engagement with sub-national governments as agreed under the World Bank Group’s Country Partnership Strategy (CPS) 2008- 10 1 1 (Report No. 42677-BR) discussed by the Executive Directors on May 1, 2008. As specified in the CPS, the level o f Bank lending must be consistent with the credit ceilings specified in each State’s Program o f Fiscal Adjustment (PAF) and must be approved by the National Treasury Secretariat (STN). The proposed operation has been prepared based on the following key principles o f engagement: (i) a shared understanding o f the fiscal and sectoral challenges o f the State; (ii) State ownership o f the program, with pol icy measures emerging from the authorities’ own initiatives; and (iii) political commitment at the highest level.

11. COUNTRY AND STATE CONTEXT

A. ECONOMIC DEVELOPMENTS IN BRAZIL (UP TO THE CRISIS)

4. The combination o f sound macroeconomic management and the favorable external environment o f the last decade prior to the on-going global crisis allowed Brazi l to maintain macroeconomic stability, increase growth, reduce poverty and enhance its resilience to external shocks (see Table 1 below). This framework consisted in the adoption o f a strong fiscal discipline, an inflation targeting regime and a flexible exchange rate. O n the fiscal side,

5

the Government pursued a policy o f primary fiscal balance targets to reduce public debt. Primary surpluses o f about 4 percent o f GDP achieved annually since 1999 resulted in a declining public debt path and contributed to continuous improvement in credit ratings and the achievement o f investment grade in 2008. In addition, through effective debt management, the Brazilian Government also improved the composition o f public debt thereby lessening vulnerabilities associated with exchange rate and interest rate shocks.

5. Fiscal discipline was also pursued by sub-national Governments after the federal bailout o f 25 o f the 27 States in 1997 (see Box 1). Fiscal Responsibility Law (FRL) that was introduced in 2000 as a direct result o f the bailout has lead to immediate and impressive results. Sub-national Governments have accompanied the adjustment efforts o f the Federal Government and generated robust primary surpluses, which have in turn contributed to the overall improvement in Brazil’s fiscal accounts and debt sustainability.

6. The inflation targeting regime has been very successful in anchoring inflation expectations. Operationally independent, the Central Bank o f Brazil (BCB) has been able to control inflation and progressively reduce interest rates. Inflation fe l l from 12.5 percent in 2002 to 5.9 percent in 2008. Thanks in part to this regime the BCB reduced the headline interest rate from a peak o f 26.50 percent in 2003 to 13.75 percent at the end o f 2008.

7. Brazil’s flexible exchange rate policy has helped cushion external shocks while supporting the country’s strong external sector performance. Benefiting from high commodity prices, exports grew from US$60 billion in 2002 to US$198 billion in 2008. The Brazilian trade surplus grew fiom US$13 billion in 2002 to more than US$40 billion in 2005- 07. The strong trade surpluses resulted in a decisive improvement o f the current account balance. After more than a decade o f deficits, Brazil obtained current account surpluses from 2003 to 2007l.

8. Such robust external performance led to strong accumulation o f international reserves, which grew to US$206 billion in December 2008 from US$37 billion in 2002. The growing strength o f Brazil’s external position allowed the country to make an early repayment o f i t s outstanding obligations to the International Monetary Fund (IMF) in December 2005 and to the Paris Club in 2006, as well as to retire i t s Brady Bonds in 2006. As a result, Brazilian public sector net external debt i s now negative, and Brazil’s external debt sustainability indicators have improved noticeably. Strong exports reduced the interest payments-to-exports ratio from 24 percent in 2002 to 7.1 percent in 2008. Similarly, there was a significant decrease in the debt-to-exports ratio from 350 percent in 2002 to 100 percent in 2008.

9. GDP growth rates have also increased. Between 2004 and 2008 the economy grew on average by 4.7 percent a year, well above the average annual rate o f just below 2.5 percent o f the previous two decades. The increase in growth was driven by domestic consumption and more recently by the acceleration o f capital formation, both fostered by vigorous credit expansion.

In 2008, strong economic activity and exchange rate appreciation led to 25 percent increase in imports which, together with an increase o f prof i t remittances l ed t o a current account deficit o f 1.8 percent o f GDP.

6

Table 1: Brazil Macroeconomic Indicators, 2002-08

1.1 -0.3 -4.6 15.3 2.6 12.7 16.0

24.8 4.2 0.7 10.1 49.3 290.0 72.5 19.4 2.89

3.9 -4.6 52.3 76.5

9.3 7.7 16.5 12.3

I Source: IMF, BCB, IBGE, /PEA

5.7 3.9 9.1 16.1 3.2 12.9 18.5

33.7 11.7 1.8

18.1 52.9

210.0 53.7 14.8 2.65

4.2

47.0 69.2

7.6 12.1 17.8 11.5

-2.4

3.2 3.9 3.6 15.9 3.3 12.6 17.3

44.7 14.0 1.6

15.1 53.8 143.2 55.8 12.2 2.34

4.4 -3 .O 46.5 64.2

5.7 1.2

19.5 9.8

4.0 4.5 9.8 16.4 3.3 13.1 17.6

46.1 13.6 1.3

18.8 85.8 125.2 41.3 10.8 2.14

3.9 -3 .O 44.7 64.8

3.3 3.8 13.3 10.0

5.7 5.9 13.5 17.5 3.3 14.2 17.5

40.3 1.6 0.1

34.5 180.3 120.3 32.4 9.5 1.77

3.9 -2.2 42.0 68.8

4.1 7.9 11.3 9.3

5.1 5.4 13.8 19.0 3.3 15.7 16.9

24.8 -28.2 -1.8 45.1

206.8 100.2 19.0 7.1 2.3

4.1

36.0 58.6

5.9 9.1 13.8 7.9

-1.5

10. Higher growth coupled with improvements in social policies resulted in pronounced poverty and income inequality reduction. The poverty rate dropped to 21.6 percent in 2008 from 32.9 percent in 2002. The drop was due mainly to higher economic growth, real increase in the minimum wage, wel l targeted conditional cash transfer programs (such as Bolsa Familia), increases in labor income and a decline in unemployment f rom over 12 percent in 2003 to below 9 percent in 2008. The Gini index also f e l l to 0.55 in 2008 from 0.59 in 2002.

1 1. Thanks to these remarkable improvements, the overall macroeconomic management framework in Brazil i s robust. Remaining structural challenges include l o w capital formation (under 20 percent o f GDP), which may be an obstacle to more sustained growth. High taxation and government consumption also limit Brazil’s growth potential.

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Box 1. Brazi l ian Fiscal Federalism and the Cont ro l of Sub-National Fiscal Performance

With 27 State Governments and more than 5,500 municipalities, Brazil i s a highly decentralized federation. Distribution o f tax collection responsibilities i s broadly consistent wi th economic principles that suggest that mobile tax bases need to be taxed by the central government while immobile bases by sub-national governments. Indirect taxes are shared between central and sub-national levels. As a result o f these tax assignments, central government collects two thirds o f total tax revenues and sub-national governments collect one-third o f them.

Expenditure assignments also follow fairly closely the economic theory principles on decentralization with exclusive responsibility for certain expenses and the three levels involved in the provision o f public goods and services in other areas. Sub-national governments account for more than 50 percent o f total government primary expenditures by being the most important providers o f education, health and infrastructure services in the country.

To equilibrate revenue and expenditure responsibilities and reduce regional disparities, Brazilian federalism embraces an extensive system o f constitutional intergovernmental transfers. As a result, when compared with other federal countries, lower levels o f government enjoy a relatively high degree o f autonomy as their revenue structure i s mainly comprised o f own taxes and constitutional intergovernmental transfers.

The fiscal stance o f the States has always been an important element in macroeconomic management in Brazil. Until the late 199Os, the expansionary fiscal policies by the States and the lack o f effective controls over their indebtedness resulted in frequent sub-national debt crises. In three different occasions (1989, 1993 and 1997) the Federal Government had to assume and reschedule the debts o f the States. The largest operation occurred in 1997, under Law 9496, when the Federal Government restructured R$200 bi l l ion (12 percent o f national GDP) o f the debts owed by the States.

In the 1997 refinancing operation, the debts were refinanced for 30 years. This refinanced debt, so called intra-limite debt, carries a real interest rate o f 6 percent, wi th the nominal value o f the debt rising with inflation. However, the debt service i s capped at 13 percent o f States’ net current revenues; anything above that i s recapitalized and added to the intra-limite debt stock. At the end o f the contracts (in 2028), if there are residual debt balances, the State must pay o f f the remainder within 10 years.

The 1997 bailout was conditioned upon the State’s compliance with medium-term fiscal adjustment and structural reform programs. Debt renegotiation contracts mandate the implementation o f three-year rolling Programs o f Fiscal Adjustment (PAFs) to be agreed upon by the National Treasury Secretariat and the 25 States that had their debt rescued by the S T N during the period o f the contract. The PAFs set annual targets on indebtedness, primary balances, personnel spending, tax revenue and public investment, in order to guarantee a gradual decline in indebtedness. In addition, the PAFs include structural reforms such as privatization or other public sector modernization initiatives.

The controls on sub-national fiscal performance were further strengthened by the approval o f the Fiscal Responsibility Law (FRL) in 2000. The FRL institutionalized fiscal discipline at al l levels o f government, incorporating hard budget constraints into a single unifying fi-amework. I t explicitly prohibits debt refinancing operations between different levels o f government, thereby addressing the moral hazard problem in intergovernmental fiscal relations caused by sequential bailouts. Complementary Senate resolutions also prohibit borrowing if: (i) the net consolidated debt exceeds double net current revenue (NCR) (ii) new credit operations exceed 16 percent o f NCR, and (iii) debt service exceeds 11.5 percent o f NCR. Borrowing i s also prohibited if it violates debt reduction schedules set by the contracts under the Law 9496. Finally, emission o f sub-national Governments bonds i s generally prohibited through 2016; however, States whose net debt i s less than net current revenue can issue bonds after 201 1, although even then the Federal Government retains the power to veto the bond issue.

This system o f controls has resulted in a substantial macroeconomic adjustment as evidenced by repeated State and municipal surpluses-an adjustment that has continued through four federal administrations. In addition, this system has also favored the adoption o f appropriate expenditure programs by sub-national Governments. Besides the controls on indebtedness, FRL requirements improved transparency, strengthened budgetary practices and encouraged the application o f the “golden rule” limiting the amount o f new loans to the amount o f the capital expense. In practice, it means that any loans contracted w i l l only be destined to expenses related to investments.

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B. CURRENT MACROECONOMIC OUTLOOK

12. Despite i ts increased resilience, the global financial crisis has hit Brazi l hard. First round effects encompassed contagion in financial markets, fa l l in commodity prices, exchange rate depreciation, external credit curtailment and a liquidity squeeze for Brazilian f i rms . From September through December, 2008 the S5o Paul0 Stock Market Index (Ibovespa) fe l l by 32 percent, sovereign spreads increased by 78 percent, the main Brazilian commodity exports prices fel l by more than 30 percent and the Brazilian Real (BRL) depreciated by 35 percent (see Figure 1 below).

13. Access to external and domestic credit markets was severely constrained, especially for small financial institutions and medium and small f i rms. External credit for exporters and small banks practically vanished. Domestically, the overall volume o f credit to the private sector fe l l sharply. The Government reacted promptly to alleviate the liquidity squeeze. The Central Bank (BCB) adopted various measures to inject liquidity into domestic markets and provide foreign exchange to Brazilian corporations facing obligations abroad. Reductions in reserve requirements, liquidity provision support to small financial institutions in difficulties, incentives to large financial institutions to buy smaller ones with liquidity problems, repo- credit l ine auctions in dollars for exporters, sales o f international reserves to irrigate the spot exchange rate were al l used to alleviate private sector difficulties in raising resources in domestic and foreign markets and avoided deeper exchange rate depreciation. In addition, public banks increased massively their lending to industry and agriculture to compensate for the fal l in private credit supply. The Government's quick reaction was successful in normalizing credit market conditions in a short period o f time. A year after the crisis both, domestic credit and access to foreign credit have returned to their pre-crisis levels.

Figure 1: Sovereign Spreads, Exchange Rate,

800 700 600

500 400

300

200

100

62000

52000

42000

32000

- EMBl + Sovereign Spread .. .. .. Exchange Rate

14. Effects on the external sector were also sharp but again temporary. The fall in commodity prices and the worldwide economic slowdown led to a decline in exports from a monthly average o f US$18 bi l l ion in 43, 2008 to less than U$S10 bi l l ion in Q1, 2009. As a consequence, for the first time in seven years, the trade balance was negative in January, 2009. As domestic economic deceleration reduced imports, the trade balance returned to positive. The nominal and real exchange rates and terms o f trade experienced a temporary depreciation that was reverted with the increase in commodity prices and the reduction o f risk aversion in financial markets. The current account balance and foreign direct investment also suffered the impact o f the global crisis. However, the economic activity contraction and the

9

improvement in market sentiment have helped stabilize the current account balance while Foreign Direct Investment (FDI) flows to the country have resumed.

15. Second round effects were also quite strong and were felt immediately in the real economy. The financial turmoil interrupted 21 consecutive quarters o f GDP expansion (from Q2, 2003 to 43, 2008). Indeed, Brazilian GDP contracted in Q4, 2008 by 3.6 percent (qoq) and in Q1, 2009 by 0.9 (qoq), driven by a strong drop in investment. Consumption continued to grow while the external sector had a neutral contribution to growth. Industrial production plummeted (especially capital goods and car vehicle production), falling by 16 percent f rom September 2008 to March 2009. Industrial capacity utilization fe l l from 87 to 78 percent in the same period, while unemployment rose from 7.6 to 9 percent. Market GDP growth forecasts for 2009 were revised downward from a positive 2 percent in December-January to a negative 0.5 to 1.5 percent in May-June. (see Figure 2 below)

16. Economic slowdown and the fal l in commodity prices lessened pressures o n inflation and opened space for monetary easing. Twelve month accumulated inflation f e l l f rom 6.3 percent in September 2008 to 5.5 percent in March 2009 and hit the center o f the B C B target zone at 4.5 percent in July 2009. Inflation expectations for 2009 fel l f rom 5.5 percent in September 2008 to 4.5 percent in March and to 4.3 in July 2009. The B C B consecutively reduced interest rates f rom 13.75 percent in December 2008 to 1 1.25 percent in March 2009 to 8.75 percent in July 2009 (its historical lowest level).

17. Third round effects are related to the accentuated deterioration o f public finances and Government pol icy reactions. The sharp fal l in revenues during the first semester o f 2009 and the aggressive expansion o f Government expenditures - especially social security and public sector salaries - resulted in the reduction o f the Consolidated Public Sector’s primary surplus, which decreased to 2.4 percent o f GDP in January-June 2009 from 5.9 percent o f GDP in the same period in 2008. Total deficit increased to 3 percent o f GDP in the first semester o f 2009 and net public debt grew from 41 percent o f GDP in June 2008, to 43 percent in June 2009.

18. An important component o f the Government’s expansionary pol icy was the significant increase in credit supply from public financial institutions. It i s estimated that the quasi-fiscal stimulus associated with increased lending from public banks reached 3 percent o f GDP. Credit by public banks grew by 25 percent in the year since September 2008, while credit from private institutions grew by only 3 percent. The expansion o f finance from public banks included credit to exporters, the agricultural sector, for housing and for durable goods consumption. As a result, the share o f public banks in total outstanding credit grew to 39 percent in June 2009 from 34 percent in September 2008. In addition, the Government has also stimulated large private banks to increase their participation in the market.

10

Figure 2: GDP Growth, Industrial Production, Unemployment and Inflation

_ - ~ ' Quarterly GDP Growth and Demand Components Contributions, 2002-09

- 8.0 I ma%-- ....... I fin .....................................................

W -4.0

-8.0 Q l 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 201

U C o n s u m p t l o n I=llnveStment M E I i e m a l Sector -GDP GroWth Rate - - 4

i Unemployment Rate (%), 2002-09

1 1 4

i Industrial Actlvlty Index and Capacity Utilization, 1 135 2002-09 84

95 76 m 75

- - * lndustnal Production Index - CNI Percentage of Total Capacity

12 - Month Accumulated Inflation, 2002-09

-2

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

19. Strong monetary easing, expansionary fiscal policy, the expansion o f credit supply f rom public banks, and the recovery o f commodity prices have allowed economic activity to recover quickly. Indeed, 4 2 2009 GDP growth achieved an impressive 1.9 percent (qoq). Information o n industrial production, j o b creation, unemployment in metropolitan areas and labor income provides clear signals o f an ongoing consolidation o f GDP recovery in Q3 2009 indicating that GDP decline in 2009 will be less severe than expected and should be followed by a strong recovery in 2010:2 projections for the coming quarters indicate GDP growth between 4.5 percent and 5.5 percent3. Figure 3 shows that the initial recovery would be driven by the increase in capacity utilization followed by the resumption o f total factor productivity growth. Increases in capital accumulation and labor are expected to begin in 2010.

2 Accordingly, market forecasts for growth in 2009 increased to 0 percent in September (from -1.5 percent in April). For 2010 there was also an improvement in market projections that in September indicated a growth rate o f 4.5 percent (from 3 percent in April).

There i s an statistical carry out effect on these numbers as 4 4 2008 and Q1 and 4 2 2009 levels are low, therefore the comparison base w i l l favor Q 4 2009 and 2010.

11

Figure 3: GDP Growth Decomposition, 2003-2010 (quarterly figures)

20. Financial markets are also exhibiting a robust recovery. From March to September, the Ibovespa stock market index grew 48 percent, sovereign spreads returned to their pre-crisis levels o f about 250 basis points and the BRL appreciated by 23 percent, also returning to its pre-global crisis level. Capital inflows resumed their earlier trend and the country’s international reserves reached US225 bi l l ion in September, level wel l above the pre-crisis highest level o f US$205 bi l l ion recorded in August 2008.

21. In t h i s context, two scenarios with growth rates o f 0 percent (scenario A) and -1.5 percent (scenario B) in 2009 are presented in Table 2 below. Growth assumptions for 2010 and 2011 are the same and depict a gradual growth recovery to 3.5 percent in 2010 and 4 percent for 20 1 1.

22. In summary, the country’s macroeconomic framework is deemed appropriate for this proposed DPL in that solid macroeconomic fundamentals built in the last decade have allowed the country to smooth the effects o f the financial turmoil with relative speed. The Government has been using i t s increased fiscal and external solvency and i t s enhanced credibility to adopt expansionary fiscal and monetary policies.

12

Table 2: Macroeconomic Outlook, 2008-2011

Indicator

National Accounts Real GDP Growth (%) Consumption Growth (%) Investment Growth (“h) Investment (% o f GDP) Public sector Private sector Gross National Savings

External Sector Trade Balance (US$ bi) Current Account Balance (US$ bi) Current Account Balance (YO o f GDP) Foreign Direct Investment International Reserves (US$ bi) Debt Service to Exports (“h) Interest Payments to Exports (“h) Nominal Exchange Rate (eop)

PS. Primary Balance (“? o f GDP) PS. Overall Balance (?h o f GDP) Net Public Sector Debt (% of GDP) Gross Gen. Gov. Debt (“76 o f GDP)

Consumer Inflation (“h) Wholesale Inflation (%) Headline Interest Rate (% eop) Unemployment (YO) Industrial Cap. Utilization (%)

Public Sector

Prices and Economic Activity

2008

5.1 5.4 13.8 19.0 3.3 15.7 16.9

24.8 -28.2 -1.8 45.1 207 19.0 7.1 2.3

4.1

36.0 58.6

-1.5

5.9 9.1 13.8 7.9 82.6

0.0 3.5 -6.5 17.7 3.8 13.9 16.3

22.4 -22.3 -1.3 30.0 219 18.1 4.3 1.9

2.0 -3.0 42.5 64.0

4.4 3 .O 8.8 8.5

78.5

-1.5 2.5

17.0 3.8 13.2 16.1

-1 1.5

28.9 -13.5 -0.8 25.0 220 18.0 4.3 1.8

1.5 -3.4 44.0 65.5

4.0 2.5 8.8 9.0

76.6

3.5 3.2 4.7 17.9 3.5 14.4 16.4

24.2 -28.9 -1.8 35.0 223 11.8 4.3 2.09

3.5 -1.8 41.0 62.2

4.5 4.5 8.5 8.2

79.5

3.5 3.9 4.7 17.2 3.5 13.7 15.7

20.0 -26.1 -1.5 30.0 227 12.0 4.4 2.05

3.2

42.5 63.6

-2.5

4.5 4.5 8.5 8.7

79.0

4.0 5.4 8.1 18.6 3.6 15.0 16.3

11.8 -44.8 -2.7 40.0 234 12.9 4.1 2.2

3.5 -1.5 39.5 61.2

4.5 4.5 9.0 8.0

81.5

4.0 4.7 8.2 17.9 3.6 14.3 16.5

19.0 -31.1 -2.0 40.0 232 13.5 4.3 2.2

3.5 -1.8 41.0 62.5

4.5 4.5 9.0 8.5

80.5

Source: IMF, BCB, IBGE, Bank Staff Calculation

C. RECENT SOCIOECONOMIC DEVELOPMENTS IN THE STATE OF RIO DE JANEIRO

23. The State o f Rio de Janeiro i s among Brazil’s smallest states in land area but has the third largest population and the second highest GDP in the nation. About 96 percent o f the State’s population resides in urban areas, with the greatest part (75 percent) concentrated in the metropolitan region o f the municipality o f Rio de Janeiro. In 2007, the State’s Gross Domestic Product (GDP) was US$222 bi l l ion - or about 12 percent o f national GDP. The Rio de Janeiro economy i s smaller than Siio Paulo’s, but roughly equivalent in size to that o f Portugal or Venezuela. The State’s productive capacity i s dominated by industries in the machinery and pharmaceutical sectors, and by services. Rapid growth in the petroleum

The state holds Brazil’s largest o i l reserves (90% o f the total) and i s responsible for 84% o f the country’s o i l

13

production.

industry has brought the State o f Rio de Janeiro back from a decline which reached i t s nadir around 1990. This rapid growth has also fed industries with heavy petroleum reliance such as the naval industry and the petrochemical sectors. This economic growth has also reduced the importance o f the capital ci ty and i t s metropolitan region in the State e ~ o n o m y . ~

24. In comparison with the nation as a whole, the State performs wel l on both economic and educational indicators for adults. Rio de Janeiro ranks second among states for per capita household income, with the State average 20.4 percent higher than the national one. The proportion o f poor people in i t s population i s smaller than in the country (22 percent versus 29 percent). Nearly one mi l l ion new jobs have been created in the State in the last decade. The State’s adult population holds the highest level o f school education in the country and the highest adult literacy rate (outside the federal district). R i o is also characterized by better access to basic public infra-structures (electric power, water supply, sanitation, and garbage collection) than the national averages.

25. However, the State continues to struggle with various social and economic challenges. Income inequality i s high and has remained consistent despite falling inequality for the nation as a whole. Most o f the jobs created in the last decade have been in the informal economy, leading the informal sector to comprise nearly 44 percent o f the existing employment opportunities in the State.6 Within the capital city, the population o f favelas (urban slums) has increased at a rate three times higher than the growth rate o f the city’s p ~ p u l a t i o n . ~ The State is also characterized by the fourth-highest homicide rate in the country. These rates are even higher in the Rio de Janeiro metropolitan region. Violence and criminality are widely recognized as the main social issues and the key obstacles to economic and social development.

26. Despite excellent adult outcomes in education, children currently in school perform far f rom the top in the nation. On the main indicator o f education performance for Brazi l state schools (the Basic Education Development Index - IDEB), Rio f e l l f rom ninth place in 2005 to fourteenth place in 2007 for 4th grade students and from seventeenth place to twentieth place for 8‘h grade students during the same period. In secondary education, between 2005 and 2007 the performance o f schools in R io de Janeiro State also worsened in comparison with other Brazilian states (from seventeenth to eighteenth place), while the IDEB score remained the same - 2.8. Education outcomes in Rio de Janeiro State are the lowest in the Southeast Region. Table 3 shows Rio wel l below the national average for secondary school completion and close to the national average in primary school completion.

The metropolitan region has lost a great proportion o f its participation in the state gross national production,

Two-thirds o f the one mil l ion jobs created in the State and three-quarters o f the 600,000 jobs created in the Rio

In 2008, there were at least 784 favelas, comprising an area o f 45.8 square kilometers (7% higher than a decade

14

which fe l l f iom 86% to 53%, within one decade.

de Janeiro metropolitan region were in the informal economy.

before).

6

Brazil (BR) Southeast (SE) Rio de Janeiro (RJ)

27. In the health sector Rio de Janeiro’s performance i s also disappointing relative to the State’s level o f economic development. Health outcomes in R io de Janeiro trail wel l behind other States in Brazil’s Southeast Region. These deficiencies are most apparent in two key areas: (i) the coverage o f basic health programs (including PSF - family health program - and PACS - community health agents program); and (b) the delivery o f services related to urgent and emergency care. Table 4 presents comparative data on the on the coverage o f basic health programs through 2007.

49.3 52.6 54.5 55.9 58.3 58.1 28.8 32.7 34.8 37.0 40.1 40.5 18.6 20.5 23.1 25.2 27.9 27.7

Espirito Santo (ES) Sao Paulo (SP) Minas Gerais (MG)

54.3 58.1 61.4 65.0 68.5 67.5 20.1 23.9 26.3 27.9 30.9 31.8 50.8 56.5 57.2 60.6 64.2 64.2

28. . Rio de Janeiro’s poor social indicators are not simply a consequence o f l o w public expenditures. In 2007 R io State ranked slightly higher than the average for Brazil as a whole in per student expenditures (R$2,284 vs. R$2,061).* In per capita health expenditures, Rio State ranked 20th in 2007.’ However, expenditure increases have not been accompanied by commensurate improvements in either the coverage or quality o f public services. lo

D. MACRO ECONOMIC OUTLOOK AND DEBT SUSTAINABILITY IN THE STATE OF RIO DE JANEIRO

Fiscal Situation

29. Prior to the current crisis, the fiscal situation o f the State o f Rio de Janeiro has improved dramatically since 2006 thanks both to rapidly growing public revenues, driven by increasing commodity prices and relatively high GDP growth rates, and by the fact that the Government has implemented a number o f complementary measures to curb current expenditures and increase tax collection. A s a result, primary surpluses quadrupled between

* Secretaria do Tesouro Nacional. “Dados Contabeis dos Municipios” (2007) e “Execuqlo Orqamenthria dos Estados” (2007). The state ranks 8” on the Ministry o f Education’s index o f educational performance. See Ministerio da Educaqlo - INEP e Censo Escolar (2007).

Ministerio da FazenddSTN-COREM; IBGE/Censo 2000 and PNAD. Nominal expenditures by the Secretariats o f Education and Health increased by 12% and 20%, respectively,

15

10

between 2007 and 2008. [Source: Sistema de Informaq6es Gerencias]

2006 and 2008 and overall fiscal balances soared from a deficit o f R$65 mi l l ion to a surplus o f R$2.8 bi l l ion during the same period.

30. The State’s revenues benefited from a favorable economic environment in Brazil and worldwide, a boom in commodity prices which increased royalties from the o i l sector, as well as significant improvements in tax collection efforts. Between 2003 and 2008, tax revenues (which represented on average 56% o f total revenues during the period) increased by 25 percent thanks largely to increases in the collection o f the ICMS”; o i l and gas sector revenues (which represented on average 12% o f total revenues) grew by 80 percent; and federal transfers (which represented o n average 9% o f total revenues) doubled.

31. Fiscal adjustment efforts from 2003 to 2008 consisted to a large extent in limiting the growth o f current expenditures, including salaries as wel l as goods and services (custeio). As a result, while current expenditures grew, they did so at a slower pace than capital expenditures, and both o f them were modest in comparison to revenue growth (see Annex 3)

32. The State strictly adhered to the debt renegotiation contract o f 2007, but the stock o f i t s refinanced debt continued growing and reached almost R$50 bi l l ion in the f i rs t quarter o f 2009, or 94 percent o f the total debt o f Rio de Janeiro. The accumulation o f debt was largely due to the automatic rollover o f the interest above the 13 percent cap and the effect o f wholesale price movements that are used to correct the value o f the debt stock. At the same time, thanks to the State’s good revenue performance and consistent fiscal adjustment, the net consolidated debt to revenue ratio has fallen from 202 percent in 2003 to 160 percent in 2008. As a result, Rio de Janeiro is in compliance with the Fiscal Responsibility L a w that requires the ratio o f net consolidated debt to net current revenue to be below the ceiling o f 200 percent.

33. W h i l e the economy o f Rio de Janeiro was not immune to the effects o f the global turmoil, the State’s fiscal revenues were initially very resilient. This was due to the State’s relatively l imited dependence on federal transfers and the dominance o f services and o i l extraction in i t s economy, sectors that were relatively less affected by the global crisis. Production and investments in the o i l sector, in particular, are recovering at a rapid pace and offer bright prospects for the State’s economy. During the second quarter o f 2009, however, revenue collection has deteriorated and is limiting the Government’s ability to keep pace with planned investments and other expenditures. The proposed loan i s expected to partially compensate for this fal l in revenues and help sustain the implementation o f the Government’s development program described in Section 111. In the medium term, the State’s fiscal accounts are projected to maintain a sustainable trend, with positive fiscal balances allowing for considerable increases in public investments even as net consolidated debt i s substantially reduced over the next decade. See Annex 3 for detailed analysis o f fiscal trends and debt sustainability projections.

Macroeconomic Outlook

34. The global crisis has hit the industrial sector but did not affect the booming extractive industry. In June 2009, the State’s Production Index increased 0.5 percent month on month. This was the second consecutive increase, indicating that the effects o f the crisis are

I‘ Impost0 estadual sobre circulacao de mercadorias e prestacao de servicios, or State tax on circulation o f goods and services

16

bottoming out. However, this Index s t i l l remained 7.4 percent below and industrial production 10 percent below the level o f June 2008. This i s in contrast with the dynamism o f production in the extractive industry, which increased 11.4 percent in M a y 2009 compared to the previous year, and 3.9 percent compared to the previous month. Similarly, in June 2009 capacity utilization surpassed the level o f 80.4 percent reached a year earlier. Confidence indexes based on enterprise surveys performed in the State also suggest a strong recovery starting in the second quarter o f 2009.

35. Looking forward, even under the most pessimistic scenario, and without assuming any revenues from the l ikely exploitation o f the newly discovered “Pre-Sal” reserves, projected revenues from o i l royalties are expected to offer a comfortable situation to the State o f Rio during the coming decade. To a large extent, this i s due to the fact that production i s expected to benefit, starting in 2010, from the exploitation o f the “Tupi” field, which i s the largest field discovered in the Americas since Mexico’s Cantarell o i l f ield in 1976. The new revenues from “Tupi” are l ikely to compensate for any foreseeable decline in revenues derived from further reduction in o i l prices.12

Outlook for 2010-2013

36. State revenues are expected to get back to their pre-crisis level during the second hal f o f 2010. O n the expenditure side, however, the increase observed in the previous years i s expected to persist due to intrinsic rigidities mainly related to personnel expenditures. As such, fiscal balances are expected to record a fal l in 2009 and begin to recover in 2010 reaching positive figures and showing a comfortable fiscal situation f rom 201 1 onwards.

37. In the medium term the projected fiscal accounts o f the State o f Rio de Janeiro show a sustainable trend13. Primary fiscal balance, overall balance and gross operating balance are al l expected to record a surplus during the projected period. The risk o f a deterioration o f fiscal balances in the medium term i s moderate and related to the volatility o f o i l and gas revenues and growth o f personnel expenditures. O n the revenue side, the revenues from the oi l and gas sector are transferred to the State social security fund - Rio P r e v i d z n ~ i a ’ ~ - and are protected from executive discretion. However, funding o f Rio Previdzncia i s sensitive to price and quantity fluctuations in the o i l and gas sector. The production o f the newly discovered o i l f ield o f “Tupi” will increase the quantity o f o i l produced and mitigate the risk associated with volatility o f o i l prices. O n the expenditure side, salary increases are the main driver o f government expenses, suggesting the importance o f controlling current expenditures and salary adjustment to strengthen fiscal balances. Upcoming Olympic Games in R io de Janeiro are not expected to have a detrimental effect on the State’s financial position (see B o x 2).

l2 It i s important to remember that, as noted above, revenues from the o i l and gas sector on average represented only 12% o f total revenues between 2003 and 2008. l3 See assumptions for the fiscal projections in Annex 3. l4 A description o f Rio Previdincia i s found in Section V.B.

17

Box 2. Fiscal Impact o f the Olympic Games in Rio de Janeiro in 201615

The financing of the 20 16 Olympic Games i s covered by two budgets: one for the Organizing Committee for the Olympic Games (OCOG), which includes all expenditures directly related to the games such as financing for the opening and closing events; and the non-OCOG budget which i s the responsibility o f the three levels o f government (Federal, State and Municipal Governments). The non-OCOG budget covers public and private investments to build new sports venues and infkastructure works, including airport expansion, transport improvements and other operations.

The total OCOG budget i s US$2.8 billion, o f which 31% will be financed by the International Olympic Committee (IOC) contribution, 45% by private sources (e.g. marketing, ticket sales and licensing) and 24% by the three levels o f government. Hence, the State, Federal Government and Municipality need to cover a total o f US$672 million or US$224 million each. The total non-OCOG budget i s US$l 1.6 billion, 34% allotted to projects already under way, 35% to work already planned, and 31% to new projects. In particular, already committed and ongoing investments in the non-OCOG budget amount to USD3.9 billion for projects such as airport and subway expansion.

The three levels of Brazilian government have guaranteed to (i) to finance the OCOG and non-OCOG budgets, (ii) to cover any potential economics shortfall o f the OCOG and (iii) cover any refunds to the IOC of advances in payments or other contribution made by the IOC to the OCOG.

Thus, the expected total cost for the State i s approximately US$4 billion for the period of 2010-2016, which represents approximately 1% annual increase o f total expenditures. Financing o f this cost wi l l be covered by loans from the Federal Government. Given the comfortable fiscal situation of the State in the medium term, the fiscal impact o f the Olympic Games wi l l not affect the sustainability o f Rio State finances.

Table 5: OCOG Cash Flow Forecast 2010-2018 (in thousand USD) 2010 2011 2012 2013 2014 2015 2016 2017 2011

Beginning of the year) 12,270 10,856 13,186 18,706 14,080 15,345 19,839 4,459 Cash position

TOP sponsorship 22,973 22,973 22,973 22.973 Country, State and City 29,627 46,312 58,259 3,356 74,167 110,746 606,548

Source: http:llwww.rio20 16.org.brlenl

111. THE GOVERNMENT’S PROGRAM AND PARTICIPATORY PROCESSES

The Government Program

38. The Government o f the State o f Rio de Janeiro has launched a comprehensive reform program to improve the effectiveness and efficiency o f public services. Public administration worldwide has been undergoing significant changes in the past two decades. The performance o f the State i s being increasingly pressured by comparisons with the private sector and the third sector, especially with regard to the quality and cost o f services rendered. The intensification o f globalization has changed the parameters o f competitiveness and accelerated the need for a greater efficiency in the delivery o f public services. The combination o f this set

Items quoted in U S Dollar (USD) have been converted to the Brazilian Real (BRL) at the exchange rate of 1

18

15

USD= 2BRL.

o f factors has led to progressive changes in the model o f public administration, replacing a model o f bureaucratic routines by one that is focused on results.

39. The present administration has taken some important steps to achieve “quick wins” to improve public expenditures. For example, to remove unproductive personnel expenditures, the Government cut 1,756 employees from the State’s direct and indirect administration, and removed the names o f 2,587 people who had died but remained on the State payroll. The resulting savings are R$204 mi l l ion per annum. GORJ also has underway a project to install a biometric registry for a l l public employees and pensioners (Identidade Funcional). To improve Government procurement GORJ has launched the development o f an Integrated Procurement Management System (Sistema Integrade de Gestao de AdquisiqCes - SIGA).

40. To tackle the more difficult management challenges, GORJ announced a comprehensive reform program in 2007 aimed at improving the effectiveness and efficiency o f public services. The program i s to develop new results-based management tools, and focus these on a set o f priority “Areas o f Results”: (a) development o f human capital; (b) expansion o f preventative actions and modernization o f the health system; (c) economic development, attraction o f investment and technological innovation; (d) renovation and strengthening o f public administration; (e) social development, productive inclusion and citizenship; (0 restoration o f public safety; (g) environmental sustainability; (h) expansion and improvement o f urban infrastructure and transportation logistics; and (i) promotion o f culture and integration through sports. The D P L will support the f i rs t four o f the nine Areas o f Results the 2007-20 10 Government Strategic Plan.

Participatory and Consultative Process

41. Rio de Janeiro’s development priorities, including the policies supported by this DPL, are embodied in the Multi-year Plan (PPA) and reflect not only rigorous technical analyses but also a participatory process o f decision-making, which i s defined in the State’s constitution. The PPA, Annual Budget Law, and related Government initiatives are regularly and extensively discussed at the State Assembly, which has the authority to revise and approve the Government’s proposals. The PPA i s the subject o f an annual review by the State Assembly, at which time the Government reports on the previous year’s performance in meeting the objectives o f the Plan.

42. By law (Rio de Janeiro State Constitution, Article 286 and Complementary Laws 71/1991, 76/1993 and 82/1996), a l l State health policies are discussed and approved at the monthly meeting o f the State Health Council. The Council is composed o f 28 members (50 percent are users, 25 percent are health workers and 25 percent are health services providers). There i s also a Bipartite Commission o f Health Managers which i s composed o f 10 representatives o f the Municipal Health Secretaries and 10 members designated by the State Secretary o f Health. The Commission has a consultative and technical role on al l matters related to the Unif ied Health System (SUS), including the UPAs and the financial transfers f rom the State to municipalities under special programs such as the Program to Support the Municipal Hospitals (PAHI). In particular, the proposals and normative rules related to location, construction, and operation o f the UPAs are discussed and approved by both boards.

43. Policies o f the education sector supported by the Bank operation are an integral part o f the Multi-Annual Plan o f State Education that i s presently being discussed at the State

19

Assembly. To define this Plan, municipal consultations and seven regional meetings were held, and hundreds o f teachers, principals and representatives o f parent-teacher associations were heard. In November 2007, the Plan was evaluated at the Second State Congress on Education with the participation o f dozens o f institutions, representatives o f c iv i l society, universities and education professionals. In addition, the implementation strategy o f the acceleration program (Projeto Autonornia) requires the voluntary participation o f interested schools, teachers, and students. Since its ince t ion by a resolution o f the State Secretary o f Education (Resolution SEEDUC 4295, June 4 , 2009), Projeto Autonomia has carried out a dissemination and mobilization campaign that includes school meetings, regional workshops, a website and a telephone line. The education M I S Program (Conex80 Educaq8o) has also made extensive use o f videos, websites and school meetings to disseminate and obtain feedback on the Program. The State Secretariat o f Education i s building a virtual environment on its website to exchange information with stakeholders o f both programs and to mobilize school principals, teachers, and students to organize a forum that will function as a consultative board for the programs. Finally, these programs have been reviewed by the State Council o f Education, which i s composed o f 21 recognized experts in education (eight o f them designated by the State Governor, eight by the State Legislative House and five representatives o f institutions that represent education workers).

E

44. Policies related to the business environment are also part o f the PPA and have benefitted f rom the institutional, participatory and consultative processes. Moreover, business environment policies have been discussed with representatives o f the State Accountants Association, representative organizations o f small entrepreneurs, the Commercial Board o f Rio de Janeiro State, and c iv i l servants.

IV. BANK SUPPORT TO THE GOVERNMENT STRATEGY

A. RATIONALE FOR BANK INVOLVEMENT AND LINK TO CPS

45. The proposed operation responds in a timely fashion to the needs o f the State Government o f Rio de Janeiro and to requests by the National Treasury. I t helps GORJ reinforce fiscal discipline, strengthen policies in the education and health sectors to deliver better services and improve the competitiveness and growth o f the State economy through a more dynamic business environment.

46. The proposed loan would provide financing to the State o f Rio de Janeiro to sustain the implementation o f i t s Multi-Annual Plan. State capacity to finance these expenditures has been strained for two major reasons. First, State resources devoted to investment in infrastructure through the Program o f Accelerated Growth (PAC) have doubled compared to what was originally budgeted. Second, State revenues have fallen relative to projection. The rise in infrastructure investment i s due to higher costs o f works compared to what was originally estimated and delays in the execution o f works; the impact i s amplified by the fact that although the Federal Government co-finances programs under the PAC, the State alone bears any burden associated with increased costs. As a result o f these three factors, State investment spending grew by 63 percent in the f i rs t ha l f o f 2009 (January-June) compared to the same period in 2008 against the backdrop o f falling revenues due to the financial crisis.

20

47. The proposed operation i s fully consistent with and closely linked to the objectives o f the Brazil CPS, 2008-201 1. This operation i s one o f a number o f sub-national DPLs and S WAps designed to reinforce fiscal discipline, public sector management and service delivery as an integral part o f the Bank’s Country Partnership Strategy in Brazil.16 By focusing on a State with such a large economy and high inequality as Rio de Janeiro, the DPL will address both the Growth and Equity pillars o f the CPS. In particular, the policy measures supported by the loan are aligned with the CPS objectives o f (i) strengthening macroeconomic fundamentals and public sector management; (ii) reducing poverty, vulnerability and social exclusion by increasing efficiency, quality o f spending and accountability o f the health and education sectors, especially at the sub-national level; and (iii) improving competitiveness and the investment climate. The current partnership strategy was developed in close consultation with the Federal authorities, who see Bank support to the States as central to their efforts to improve fiscal management and the provision o f public services. B y supporting policies to increase the Index o f Basic Education and reduce the time and steps required to open a new business in the third most populated State with the second largest economy in the country the DPL will contribute improve such CPS outcome indicators for Brazil as a whole.

48. It i s also worth noticing that, although average socioeconomic indicators in the State o f Rio de Janeiro are above the Brazilian average, more than 2.5 million poor people live in the State, i.e. only 6 states in Brazil have a larger number o f the poor: Bahia, Sao Paulo, Pernambuco, Ceara, MaranhZio and Minas Gerais. Most policies supported by the DPL, and especially those in the areas o f education and health have positive distributional impact and will contribute to improving important socioeconomic indicators, such as educational attainment and health status that have been resistant to change among the most disadvantaged groups o f the population.

B. CHOICE OF INSTRUMENT AND RELATIONSHIP TO OTHER BANK OPERATIONS

49. A single tranche stand-alone DPL was chosen as the preferred instrument to reinforce GORJ’s key reforms and to provide necessary financing to smooth the State’s expenditure pattern protecting core expenditures against a projected temporary fall in revenues in 2009. A DPL series has not been pursued for the following reasons: (i) all resources the DPL would make available are needed to cover the 2010 projected financing gap; (ii) GORJ does not have space in i ts PAF for a larger multi-year borrowing program; (iii) the political cycle ahead (with Federal and State elections in November 2010) does not allow any State Government to sign new loans after June 30, 2010 and (iv) it was preferred not to bind the next administration to specific policy triggers agreed with the current one.

50. Nevertheless, this operation i s strongly linked to the State’s medium term development program, which gives confidence that the policies supported by the DPL will be sustained and will have a long-lasting impact. In addition, the 2014 World Cup (to be hosted in Brazil) and the 2016 Olympic Games (to be hosted in the Municipality o f Rio de Janeiro) will bring additional financial, political and logistical resources to GORJ’s efforts to promote economic

Ongoing Bank support for public sector management in Brazil’s sub-national governments includes the states of Minas Gerais (Partnership for Development I (DPL) and I1 (SWAP), Rio Grande do SUI (Fiscal Sustainability for Growth (DPL), Ceara (Multi-sector SWAps I and 11), Pemambuco (Education SWAP), Alagoas (DPL under preparation) and the municipality of Rio de Janeiro (DPL under preparation).

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development and improve delivery o f services and overall living conditions in the State o f Rio de Janeiro, founded on those policies supported by this DPL.

5 1. Until recently, IBRD support to the State o f Rio de Janeiro was limited to investment projects in Rural Development and Transport. The Rio de Janeiro Sustainable Rural Development Project and Second Rio de Janeiro Mass Transit Project provide support to increase the adoption o f integrated and sustainable farming systems and improve livelihoods in rural communities, and to improve services provided by the rai l transport system in the metropolitan region respectively. Both projects were approved by the Board o f Executive Directors o f the World Bank in July 2009.

52. More recently, however, IBRD’s focus in Brazil has shifted towards supporting public sector management reform and structural programs to improve fiscal management, the business environment and the delivery o f education and health services with special attention on improving articulation and synergy o f State and municipal policies. The proposed operation has strong l i n k s with the Renovating and Strengthening Public Management Technical Assistance Project, currently under preparation with the Secretariat o f Planning o f GORJ. The objective o f this proposed project i s to strengthen the Government’s managerial capacity, including promoting results-based management in key l ine sectors. I t will also provide GORJ with the resources to finance the technical assistance needed to sustain and monitor implementation o f i t s medium-term education and health sector reform programs and to evaluate the impact o f key policies and programs, including Projeto Autonomia, Conex& EducaqCo, the UPAS and PAHI, al l o f which are supported by the this DPL. The Renovating and Strengthening Public Management Technical Assistance Project i s the instrument the Bank will use to enable implementation and continuity o f the reforms supported by the Fiscal Sustainability, Human Development and Competitiveness DPL.

53. The proposed operation has especially strong l i n k s with the Public Sector Efficiency, Human Development and Competitiveness DPL, which is being prepared in parallel with the Municipality o f Rio de Janeiro (see Box 3). This i s a debt restructuring DPL in the amount o f US$l.05 billion, which would allow the Municipality to refinance 20 percent o f the renegotiated debt with the National Treasury, thus creating fiscal space for much needed investment. The operation i s expected to be in two tranches with the f i r s t disbursement in February 2010 and full disbursement by early 201 1. The first tranche will restructure 10 percent o f the debt, lowering the interest rate by 1.5 percentage points; the second tranche will restructure an additional 10 percent, lowering the interest rate by another 1.5 percentage points.

54. The main objective o f the municipal operation i s to support the Municipality o f Rio de Janeiro’s reforms for medium term fiscal sustainability, which would lead to greater investment in health and education and to enhanced economic growth and development. The loan would have five main pol icy areas: (i) fiscal adjustment - through actions in revenues and expenditures (debt service, personnel costs, and pension expenditures); (ii) public sector management - especially to introduce results-based management; (iii) private sector development; (iv) education; and (v) health.

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Box 3. Complementarities between the Rio State Fiscal Sustainability, Human Development and Competitiveness DPL and the Rio Municipality Public Sector Efficiency, Human Development and

Competitiveness DPL

In the early 1980s, the Brazilian state had a very centralized system o f decision-making and control o f public finance, a legacy o f the time o f military dictatorship. The Constitution o f 1988 greatly expanded the importance o f State and, especially, municipal government in social service provision, establishing that provision o f essential services (education, health, social assistance and public works) would be the primary responsibility of municipalities, wi th secondary roles for State Governments. The role o f the Federal Government, then, l ies in the definition o f ru les and guidelines for policies and also the transfers o f funds. The figure below illustrates the

municipalities and the States.

ow o f policy and investment operations

formal division o f re -

:sponr sibilities between the

For the f i s t time in the World Bank’s hist in Brazil, the policies supported by the DPLs with the Governments of: the State and the Municipality-of Rio de Janeiro w i l l contribute to the alignment o f policies at different levels o f government to achieve better services in the areas o f health, education and business environment. The policies supported by each D P L both strengthen the components for which that level o f government i s responsible and encourage a more robust system overall.

Education. Policy coordination between Rio State and Rio Municipality has been limited in the past, given the competing political affiliations o f previous administrations. Since January 2009, however, a dialogue between the two education secretaries has developed, and the two World Bank DPLs under preparation are contributing to better coordinated and more efficient service delivery in education by tackling the same problems at different points in the system: the inefficient f low o f students through the system due to poor learning outcomes, excessive grade repetition, and resulting age-grade distortions. This i s tackled at the municipal level by expanding early child education for low-income children; strengthening the teaching o f basic literacy and numeracy sk i l l s in the f i s t two grades o f primary school (Reforqo Escolar) with special emphasis on remedial instruction for children falling behind grade level; and providing targeted support for schools in high conflict and crime areas, whose students are at highest risk o f repeating grades and falling behind. Complementing these policies, the State’s own DPL supported program also focuses on reducing age-grade distortion. Through the innovative Projeto Autonomia, the State i s offering over-age students a chance to graduate on time by following a special compressed curriculum with intensive teacher support. (Despite the official assignment o f education responsibilities, in Rio there is s t i l l duplication o f provision in grades 6-9, which were historically a responsibility o f state governments.)

Health. The policies supported by the DPLs the Bank i s preparing with subnational Governments have a mutually-reinforcing impact on such integration. On one side, the D P L with the Rio de Janeiro State Government i s supporting policies to deliver better coverage and quality o f medium- and high-complexity health services by the UPA’s, which are mostly concentrated in the Rio de Janeiro Municipality where a large proportion o f the poor population i s l iv ing without access to urgent and emergency care. In a complementary manner, the D P L with the Rio de Janeiro Municipality i s supporting policies to increase coverage and quality o f primary health care by the expansion o f the family health clinics, creating solid mechanisms o f cooperation between the State and the Municipal Secretariats o f Health in order to deliver health services through structured health networks. These networks, organized in administrative health regions, w i l l be joint ly regulated by a clear and enforceable referral and counter-referral system between state and municipal health units.

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Business Environment. Both operations are supporting reforms to the business registration process and are following a similar approach: first, redesigning and simplifying the internal procedures related to either the state registration (ZnscriqCo Estadual) or the municipal operating license (Alvarri de Licenqa para Estabelecimento), and subsequently, choosing to enter a centralized business registration system (REGIN or Registro Mercantil Zntegrado). This latter system wi l l unify and link hitherto separate processes that f m s are required to follow in order to fully register with all o f the pertinent government agencies (tax, sanitary, environmental and f i re i brigade) at the three different levels (federal, state and municipal), creating a one-stop shop for the process o f

1 fm registration. Both the State and the municipality o f Rio have decided to integrate their business registration systems to the REGIN.

55. A few current federal projects, including the Health Network Formation and Quality Improvement Project (QUALISUS) and the Second Family Health Project, have direct impacts on the health reforms supported by the proposed operation in the State of Rio de Janeiro, by helping to strengthen the health network and improve access and quality o f primary health care services in the Rio de Janeiro Metropolitan Region respectively. The recently completed Third School Improvement Project with the Ministry o f Education (FUNDESCOLA) s t i l l significantly impacts the reforms prepared by the State Government to improve basic education services by providing references and standards to increase school performance.

56. Finally, GORJ i s interested to learn o f oil-revenue management systems that can be used for the large flow or resources expected from the “Pre-sal” oi l fields recently discovered in the Atlantic Ocean along the Brazilian coast spanning from Espirito Santo to Santa Catarina, which has Rio de Janeiro as the main extraction center. As a follow up o f the Regional Flagship Report on “Commodity Dependence: Policy Challenges and Opportunities for Latin America and the Caribbean”, which i s currently under preparation, the Bank i s planning to prepare an analytical piece to present best practices in oil-revenue management, which can be used by the Government o f the State o f Rio de Janeiro and other States in Brazil.

C. COLLABORATION WITH THE IMF AND OTHER DONORS

Collaboration with IMF

57. Since the loan i s to a sub-national Government rather than the Federal Government and the IMF does not work directly with State Governments, there has been no direct collaboration with the IMF on this specific operation. However, the Bank and Fund teams work very closely on the overall Brazil program. This i s consistent with the recommendations o f the Joint Management Action Plan (JMAP)”, which, in order to improve coordination at the country level, called for Bank and Fund staff to consult at least annually in the preparation o f their work programs. l8

l7 See “Enhancing Collaboration: Joint Management Action Plan (Follow Up to the Report o f the External Review Committee on World Bank-IMF Collaboration”, September 20, 2007.

A February 2008 memorandum from the IMF First Deputy Managing Director Lipsky and World Bank Managing Director Wheeler to IMF Heads o f Area Departments and Bank Regional Vice Presidents indicated that, beginning in April 2008, all Bank country teams and Fund missions preparing CASKAS progress reports or Article IV consultations (whichever came first) should hold annual discussions to pool analytic and diagnostic work, discuss macro-critical sectoral and other issues, and strategize over how best to sequence needed analytic work.

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58. Bank and Fund Brazi l country teams have been meeting regularly. Economists’ teams have been meeting on average once every three months and Lead Economists/Sector Leader twice yearly. During the IMF Article IV mission to Brazil, the Fund team met with the lead economist o f the Bank team in Brasilia. The World Bank PREM Sector Leader participated to the Board presentation o f the Brazi l Article I V Board document. The IMF country resident representative i s in regular contact with the World Bank team. H e serves as a peer reviewer for the Rio de Janeiro State Fiscal Sustainability, Human Development and Competitiveness DPL.

59. The primary objective o f such consultations i s to inform the other institution o f ongoing projects and studies. The IMF work on Brazil includes one staff visit and an Article IV mission which are the basis for the preparation o f the Article IV documents and the Selected Issues Papers. The secondary objective i s to share views about the direction o f macroeconomic policies considered by the Government and their effectiveness and to articulate and influence each other’s sectoral and macroeconomic priorities. During Bank- Fund consultations, country teams share views on the country overall macroeconomic situation and discuss recent economic policies. The Bank also shares with the Fund progress with and findings o f the Bank economic studies. Because o f i t s engagement at the sub- national level and at the sectoral level the Bank brings this perspective to the discussion.

60. The outcome o f consultations i s a short joint memorandum and “action matrix” summarizing the main issues discussed and the work program for the next 12 months. The memorandum and action matrix include: (i) the identification o f analytical work o f jo int interest, (ii) tentative mission dates and (iii) expectations for main programs, projects, technical assistance, and lending operations for the period ahead.

Work Financed by Other Donors

61. The other donor that i s active in the State o f Rio de Janeiro is the Inter-American Development Bank (IADB). Currently GORJ has plans to borrow US$l 10 mi l l ion from the IADB for the promotion o f the tourism sector (Programa de Desenvolvimento do Turismo - PRODETUR). PRODETUR has become a key piece to finance the investments needed to prepare the State o f Rio de Janeiro to host the 2014 World Cup and the 2016 Olympic Games. In addition, the State o f Rio de Janeiro participates in two national programs o f technical assistance provided by the IADB with resources being channeled through the Federal Government. The first i s the National Program for the Support o f State Finance Secretariats (Programa Nacional de Apdio h Administraqfio Fiscal para os Estados Brasileiros, PNAFE) and the second is the forthcoming National Program for Fiscal Modernization (Programa Nacional de Modernizaqfio Fiscal - PROFISCO). The State has been using the funds from the PNAFE program, available to al l States, to promote improvements in the State tax administration. Along the same lines, the PROFISCO program will finance technical advisory services and IT systems to support the implementation o f the Electronic Invoice (Nota Fiscal EletrGnica) for the collection o f the State VAT - ICMS and for general improvements in the State’s financial management systems. I t i s worth noting that there is strong complementarity between the Bank’s proposed D P L and the PROFISCO program financed by the IADB.

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D. LESSONS LEARNED

62. The design o f the proposed operation reflects several lessons from the recent experience with State DPLs in Brazil. Most important i s the need for client ownership o f the reform program. The strongest evidence o f GORJ’s commitment to the policies supported by the DPL is the progress itself in their implementation, which has been sustained since they were designed after the current administration took office in January 2007. Most such policies have reached a mature phase o f formulation and the DPL i s supporting the final steps o f their implementation.

63. A second lesson is the need for strong leadership in order for fiscal adjustment and deep public sector reforms to succeed. In this respect, the current administration has been able to make progress in pol icy areas, including the provision o f health and education services, where no or l i t t l e progress was observed during the past decade. Even more impressive has been the record o f reforms and consequent results to improve fiscal discipline and create the conditions for a stable macroeconomic environment.

64. A third lesson from recent experience is the need for close dialogue with the State during the preparation o f the proposed operation. The project team has worked in close partnership with the State administration to define the reform measures to be supported by the D P L and to put in place arrangements to assist in their implementation over the medium-term, mostly through the Renovating and Strengthening Public Management Technical Assistance Project, including strengthening the articulation o f state and municipal policies and evaluating their impact.

65. Finally, the Bank’s experience with State DPLs has demonstrated the importance o f coordination with the Federal Government. The operation was initiated with the concurrence o f the National Treasury and was prepared as a D P L in full coordination between the State Government and the National Treasury.

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Box 4. Good Practice Principles on Conditionality

Principle 1 - Reinforce Ownership: The operation has strong ownership at the highest levels o f the Rio State and Federal Governments. Al l State secretariats involved in the D P L have shown remarkable commitment to the Government’s medium-term reform program and the policies supported by the DPL, which are an integral and priority part o f the State Multi-Annual Plan. Government commitments are also clearly stated in the Letter o f Development Policy.

Principle 2 - Agree up front with the Government and other financial partners on a coordinated accountability framework The Bank’s support i s summarized in a brief and focused policy matrix wi th observed and expected results. The Secretariat o f Finance, together with the Secretariat o f Planning and the individual sector monitoring units, w i l l collect the necessary data to measure the extent to which the results indicators have been achieved. A comprehensive review o f the reforms supported by the DPL i s going to be organized during 43 o f 20 10 by the Bank and GORJ in support to the preparation o f the ICR.

Principle 3 - Customize the accountability framework and modalities of Bank support to address country circumstances: Brazil’s rigorous fiscal control regime has contributed much to sustenance o f fiscal responsibility since the late 1990s and has provided a powerful framework to ensure al l borrowing, including from IBRD, i s consistent with a sustainable fiscal environment. Given the temporary financing needed to cover the fiscal gap projected for 2010 and the upcoming political election during the second hal f o f 2010, the Bank concurred that a single-tranche stand alone DPL would be the most appropriate instrument to support the ongoing policy reform program.

Principle 4 - Choose only actions critical for achieving results as conditions for disbursement: The policy matrix uses a limited number o f prior actions. These actions are part o f a comprehensive policy reform plan with a solid track record o f implementation.

Principle 5 - Conduct transparent progress reviews conducive to predictable and performance-based financial support: The World Bank and SEEDUC are collaborating on a rigorous impact evaluation o f the secondary school accelerated learning program, Projeto Autonomia, partially funded under the Rio de Janeiro Public Sector Modernization Project. The World Bank and SEEDUC are also discussing an evaluation within the context o f the new system for monitoring student and teacher attendance, ConexZo EducaqZo, o f using text messages to parents to reduce absenteeism. The Rio de Janeiro Public Sector Modernization Project w i l l also finance strengthening o f monitoring and evaluation systems within the health sector in the following areas: (a) development o f accreditation and cost systems for the UPAS and (b) development o f an information system for state financial transfers to and performance agreements wi th municipalities.

E. ANALYTICAL UNDERPINNINGS

66. The proposed operation builds on a series o f discussions and analysis o f policy in Brazil. The analysis includes studies carried out by the World Bank, both formal and informal, and studies carried out by in-country partners, including the “The State o f Rio de Janeiro Strategic Plan 2007-2010” prepared by GORJ after i t took office in January 2007.

67. Fiscal sustainability: The State Government fiscal reforms are based on the State’s Multiyear Plan and the Fiscal Adjustment Program with the Federal Government for 2007 and 2008, which set the objectives and targets o f the State’s fiscal policy. The analytical underpinnings o f specific policy reforms areas are based on a series o f technical notes (Notas Te‘cnicas) prepared by the Subsecretaria de Politica Fiscal o f SEFAZ. The “Nota Te‘cnica: Administraqlio Tributaria do Estado de Rio de Janeiro- Exercicio de 2008 e Perspectiva para o period0 de 2009-2011” was used as the basis o f the program to strengthen tax collection and increase tax revenues. The fiscal projections, the analysis on the impact o f the operation and the sensitivity analysis o f fiscal aggregates to external and internal shocks are based on two technical notes. The f i rs t one “Projeqi7es Fiscais e Andlise das Finanqas Pziblicas do Estado

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do Rio de Janeiro” details the policies adopted on tax administration, the official decrees and the expected impact. The second one “ Me‘todo de Projeqiio de Arrecadaqiio de Royalties e ParticipaqGes Especiais ate 2008 and de 2009 a 2024” presents a methodology to forecast oil production and oi l revenues based on different scenarios o f o i l production that incorporate the “Tupi” and “Pre-Sal” oi l fields. The Fiscal and Debt Sustainability Analysis i s based on a detailed background document from the World Bank team, “Macroeconomic Outlook Fiscal and Debt Sustainability in the State o f Rio de Janeiro” (2009). The analysis therein highlights the impact o f different shocks on the fiscal and debt paths o f the State, including shocks related to the production o f o i l and to oi l revenues. The analysis also considers the impact o f a combination o f negative shocks on the Fiscal Responsibility Law Indicators for the State.

68. Business Environment: Recent work by Urani (2008)19 discusses the main challenges to economic and social development in Rio de Janeiro, specifically highlighting the importance o f improvements to the business environment. The World Bank’s Doing Business 2010 (2009)20 highlights Brazil’s poor ranking o f 129th out o f 183 ranked countries in the ease o f doing business, with 16 procedures required to start a business. The business registration system and the centralized government service centers established by GORJ directly respond to these concerns by streamlining procedures for both opening and operating a business in the State.

69. Education: The World Bank team prepared a background document to highlight the key strengths and needs (Amorim 2009)2’ in the education sector. The policy actions related to Conexiio EducaqGo build on recent research from Bursztyn & Coffman (2009)22. Using a sample o f children from 2 14 families in Brazil - specifically, from the slums outside Brasilia - the researchers show that parents consistently underestimate their children’s school absenteeism. When 52 parents were offered the option o f receiving a text message on their cell phone when their children were not present in school, all accepted except for the two parents without phones. This implies that parents have imperfect information about children’s school attendance and that they value better information. ConexGo Educaqiio allows the school to gather attendance data in a more systematic way; it also opens the door to automated text messages to parents when students are absent. The other element o f the education program, Projeto Autonomia, addresses a clearly identified problem in Brazilian education. In 2000, 32 percent o f children age 10-14 in Rio de Janeiro were more than one year older than the typical age for their grade in school; this age-grade distortion contributes to higher dropout rate and i s concentrated in the poor who have higher repetition rates (Schwartzman 2004)23. Projeto Autonomia seeks to dramatically reduce this distortion among children in the last years o f primary education and in secondary education.

70. Health: The health strategy has been built upon the federal Ministry o f Health’s National Policy for Urgent Care (2007)24. The Secretary o f Health for Rio carried out a study

l9 Urani, Andre, Trilhas Para o Rio, Campus: 2008. 2o IBRD, Doing Business 2010: Brazil, 2009.

Amorim, E, “Diagn6stico do Estado do Rio de Janeiro na &ea de educaqlo”, World Bank project background gaper, 2009.

Bursztyn, Leonardo, and Lucas Coffman, “The Schooling Decision: Parental Control, Intergenerational Contracting, and Family Preferences in the Brazilian Favelas,” working paper, September 2009. 23 Schwartzman, Simon, A educaqZo no Rio de Janeiro. Anhlise do Rio de Janeiro a partir do Atlas de Desenvolvimento Humano. 2004. 24 Brazil Ministry o f Health, Politica Nacional de Atenqao bs Urgzncias, 2004.

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indicating that hospitals are the principal entry point to the health system for urgent and emergency care, especially after normal working hours. Further, about 70 percent o f cases presented at hospitals are at a low level o f complexity. These factors form the basis for the new strategy for providing urgent and emergency care through UPAs (Secretaria de Saude 2009)25. Further, recent research has highlighted the difficulty in managing and coordinating the complex health needs in the Rio de Janeiro metropolitan area, resulting in reduced quality o f care (Camargo 2009)26. The UPA model uses a modified version o f the Manchester Triage System for Emergency Care (Mackway-Jones 2005)27, which i s a system to classify patients at the emergency gate o f a health unit or a patient transportation system according to their health risk in order to prioritize the use o f specific emergency interventions to save lives and minimize the possibility o f care mismanagement. The Manchester Triage System i s the most widely used triage system in the UK, Europe and Australia. Both UPAs and PAHI are also consistent with a recent World Bank study (La Forgia & Coutelenc 2008)28, which indicates the need to improve hospital performance, in part through improved accountability, contracting and coordinating across providers, which an enhanced referral system will enable.

V. THE PROPOSED LOAN

A. OPERATION DESCRIPTION

7 1. The Fiscal Sustainability, Human Development and Competitiveness DPL i s designed to support the implementation o f GORJ’s medium-term strategy to promote economic development and improve social welfare. The primary development objective o f this DPL i s to assist GORJ in sustaining i ts strategic efforts to improve fiscal management, competitiveness and social service delivery in the context o f a temporary fall in revenues associated with the recent global financial crisis and economic slowdown.

72. GORJ has prepared and started implementing a medium-term program to modernize the State in a sustainable manner. State governments in Brazil are responsible for executing many areas o f public policy, from public safety to education and health. Bank support o f effective public management o f State Governments i s therefore critical to support economic growth and poverty reduction at the State level as well as to create incentives for sound policy making by State Governments. The disbursement o f the Fiscal Sustainability, Human Development and Competitiveness DPL would signal recognition o f GORJ’s strong fiscal discipline and reform-minded policies to improve delivery o f social and business services since taking office in January 2007. Such disbursement would, in turn, allow GORJ cover the projected 2010 fiscal gap, which i s due to lower than originally expected revenues during the second semester o f 2009 and the first semester o f 2010.

73. The four DPL policy areas are described in the next section and in more detail in Annex 5. These policy areas are: (i) Fiscal Consolidation; (ii) Business Environment; (iii) Quality and Efficiency of Basic Education; and (iv) Coverage and Efficiency of Health

25 Secretaria de Saude e Defesa Civil, Nota Tbcnica: Projeto UPA 24 Horas, 2009. 26 Camargo, Ana Tereza da Silva Pereira, Health regionalization vs metropolitan reality: analysis of hospital admissions in Rio de Janeiro metropolitan region from 1995 to 2005, Rio de Janeiro: Doctoral dissertation for the Institute for Social Medicine at the University o f the State o f Rio de Janeiro.

28 L a Forgia & Coutelenc. Hospital performance in Brazil: the search for excellence. Washington, D.C.: World Bank; 2008

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Kevin Mackway-Jones (Editor), Emergency Triage - Manchester Triage Group. Wiley Chichester, 2005. 27

Services. They are intended to consolidate fiscal sustainability, facilitate opening o f new businesses and improve delivery o f health and education services. The World Bank and GORJ have agreed upon the prior actions listed in Box 5 below as conditions for presenting the DPL to the Bank’s Board for approval.

Box 5. Prior Actions for Loan Disbursement

Prior Action 1: Capitalization o f the Social Security System for State public servants wi th oil-based revenues and protection o f transfers from executive discretion to secure financing o f the social security system, reduce pressure o f social security expenditures on State finances and minimize pro-cyclicality o f State expenditures.

Prior Action 2: Enhancement o f tax collection measures, including: (i) recruitment o f qualified staff and upgraded training for existing staff o f the State Revenue Sub-secretariat and (ii) adoption of Electronic Invoices [Nota Fiscal EletrGnica] to increase tax compliance and oversight

Prior Action 3: Reorganization o f budget processes, including redefining financial programming requirements, defining precise budget execution and financial management procedures and introducing a public timetable for invoice payments.

Prior Action 4: Implementation o f streamlined business registration process that modifies the current business registration procedure wi th SEFAZ in order to provide a more uniform procedure and decrease the need for businesses to take documents or questions to SEFAZ, thereby expediting the registration process.

Prior Action 5: Implementation o f Integrated Service Centers (Rio Poupa Tempo units) that w i l l provide services such as company registration, licensing and permits, among other services, in one location. An important commitment o f the Rio Poupu Tempo project i s also to significantly improve the quality o f the services that are provided within these units.

Prior Action 6: Implementation o f accelerated learning program (designed by the FundupTo Roberto Marinho) to reduce age-grade distortion in last years o f fimdamental education in a significant subset o f State schools.

Prior Action 7: Development and implementation o f a new school management information system (Conexio Educap70) to increase accountability among teachers and students and efficiency o f resource use.

Prior Action 8: Expansion o f a more efficient model o f provision o f urgent and emergency care in poor areas o f the Rio de Janeiro Metropolitan Areas and as an element o f a rational referral and counter- referral system o f the health care network in the State.

Prior Action 9: Establishment o f a performance-based transfer system between the State and municipalities based on improvements in mother-child health and hospital care to create incentives for municipalities to deliver more efficient and higher quality health care services.

B. POLICY AREAS

Policy Area 1: Strengthening Fiscal Adjustment, Improving Tax Administration and Controlling Public Expenditures in State Operations

74. Description o f the Government’s pol icy obiectives. The central mission o f the Secretariat o f Finance o f the Government o f the State o f Rio de Janeiro (SEFAZ) since the current administration took office has been to maintain positive fiscal balances. Since early 2007, SEFAZ has been developing and putting in place the structural and institutional organization, as wel l as developing fiscal and fiscal management procedures needed to effectively fulfill this mission. The objective o f this reorganization and these procedures i s to

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maintain a stable macroeconomic environment in the State to foster economic growth and to provide it with the fiscal capacity to invest in key sectors, such as health, education and public security and deliver quality public services. To achieve this objective the strategy o f the Government has been three-pronged:

a

a

First, enforcing fiscal austerity and respect o f budgetary limits to create fiscal space for the State’s priority investments and provision o f services. Second, increasing revenue collections as wel l as rationalizing expenditures related to goods and services to reach a balanced budget. Third, developing the institutional framework, processes and procedures to effectively and efficiently conduct fiscal management on a day-to-day basis.

75. GORJ chose increased transparency, predictability and credibility as the thrusts o f i t s fiscal consolidation efforts. The success o f this effort can be seen in the fiscal adjustment brought forth by the strict compliance with the targets set in the 2008-2010 Fiscal Adjustment Program (PAF)29 in terms o f the following parameters measured at the end 2008:

(i) (ii) (iii)

(iv) (v)

(vi)

State debt relative to net current revenues -target: 2.38; actual: 2.26 Primary balances - target R$2.1 billion; actual R$4.2 billion Personnel expenditures relative to net current revenues - target: 50.40 percent; actual: 48.17 percent Revenue collection - target: R$20.66 billion; actual: R$22.15 bi l l ion Current expenditures relative to net current revenues - target: 36.15 percent; actual: 3 5.5 8 percent Investment expenditures - target: 12.22 percent; actual: 6.00 percent

76. The fiscal pol icy area o f the DPL supports some specific reforms in al l three dimensions. They are related to: (i) reducing long term fiscal risk by transferring o i l revenues to the pension fund; (ii) improving the efficiency o f tax administration; and (iii) strengthening the institutional framework for budget management.

77. fiscal and \ were

Challenves. When the current administration took office at the beginning o f 2007, the situation was characterized by several roblems, including highly volatile o i l revenues

rery limited tax administration capacit$. Financial management and budget processes also deficient o n many fronts, including (i) accumulated arrears to providers o f goods

and services and creditors o f different kinds, the full extent and details o f which was not known, (ii) limited capacity to align planned expenditures with projected revenues, (iii) a weak internal control system, (iv) a practice o f overestimating revenues and approving inflated budgets, (v) no culture o f enforcing hard budget constraints and preparing sectoral budgets that reflect reform and investment programs and credible financing plans and (vi) an obsolete information system made o f disconnected pieces. The overall challenge was therefore to put in place an institutional framework conducive to conducting sound fiscal and financial management that would be able to generate the fiscal space necessary to invest in key sectors.

29 The State o f Rio de Janeiro signed a contract with the National treasury (No. 004/99-STN/COAFI within the Law N o 9.496/97 and the Senate Federal Resolution N o 65/99) as part o f the National Treasury plan o f October 1999 to absorb and refmance sub-national debt.

The last public exam to hire staff in the State Revenue Sub-secretariat was held in 1990. 30

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78. Government actions to date and goals for the future. The f i rs t action taken by the Government in 2007 was to freeze expenditures to be able to pay past arrears and to establish a system that would be able to align future expenditures with expected revenues. The government also initiated its f i rs t multi-annual budget. From then on, the focus o f GORJ has been on developing an institutional framework for efficient and sustainable fiscal management based o n simple principles, such as controlling expenditures, monthly financial programming to match the planned f low o f expenditures with the projected f low o f revenues, and executing payments o f goods and services by the State Treasury efficiently.

79. In 2008 the State Government’s improved financial management resulted in a positive net financial position for the f i rs t time, which was invested profitably and yielded significant returns. The Government also initiated a program to clear its balance sheet o f carry-over debts to providers o f goods and services, or Restos a Pagar. This involved renegotiating with creditors using criteria for prioritization (for example, creditors for health, education and public security were the f i rst ones to receive payments). By April 2008, 86 percent o f the creditors who signed an agreement with the State were paid.

80. Since 2008, the Government has put in place the Rio de Janeiro State Fiscal Transparency Bullet in (Boletim de Transparzncia Fiscal), a bimonthly publication that analyzes risks for the Government to reach i t s fiscal target as per the Fiscal Responsibility Law. In addition, al l the fiscal data used in the analysis i s published, as wel l as information on al l the payments made by the State treasury to State providers o f goods and services. The objective i s to increase accountability to the population o f the State, to create an oversight mechanism so the public can review the Government’s use o f public funds and to curb corruption or illegal activities on the part o f public servants or creditors o f the State. Finally, the government is modernizing and integrating the four systems that control and manage budgetary execution, which were developed independently, to be able to evaluate and improve the quality o f public expenditures. The State Government aims to sustain these efforts and put in place a complete Medium Term Expenditures Framework, which i s expected to be tested by end 20 10.

81. In 1999, the State o f Rio de Janeiro created the Single Social Security Fund o f the State o f Rio de Janeirw Rio Previdzncia. I t serves around 500,000 employees, retirees, survivors o f deceased employees and former employees o f the State o f R io de Janeiro. The total assets o f the fund are projected to be R$5 1 bi l l ion for 201 0. Rio Previdincia i s the most important public servants’ social security system o f Brazil in terms o f assets. The present value o f future royalties revenues represent about 70% o f the assets o f the pension fund. Brazilian treasury bonds and cash reserves constitute the rest (at R$4 bi l l ion and R$1.4 bi l l ion respectively). The liabilities o f the fund stand at R$98 billion; as such the actuarial deficit o f the fund i s about R$47 billion. Despite this long term actuarial deficit, the fund’s short run operations are entirely covered by contributions from the State and from employers and employees as wel l as f rom oi l and gas revenues and income from National Treasury bonds. In particular, monthly expenses amount to R$500 mi l l ion and are met with revenues o f R$300 mi l l ion from contribution and more than R$200 mi l l ion from o i l and gas revenues and income from National treasury bonds. Since 2007, the State has implemented many institutional reforms to adapt i t s pension system to the requirements o f the Federal Constitution. For instance, in 2007, the entities responsible for managing the State Employees’ pensions were unified (law NO 5 109/2007). In 2008, the different pension regimes existing in the State were

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unif ied (law N05260/2008). Many additional measures were adopted to improve the governance, compliance (with Federal dispositions) and transparency o f the pension fund’s management.

82. measures that the State has taken to achieve the three objectives outlined above:

Specific measures supported under the DPL. The operation supports a set o f specific

e Strengthening Fiscal Adjustment through reducing long-term fiscal risk. O i l revenues are a sizable but volatile part o f State revenues (12-16 percent). L a w 3 18911999 gives Rio Previdzncia legal status with the objective o f collecting and administering the financial resources and assets necessary to operate the pension system o f the State to meet the payment o f current and future social benefits o f al l state public employees. Law 4.23 7/2003 explicitly includes royalties and special participations as part o f the funding sources o f the Fund. However, the provisions o f such law did not specify which portion o f royalties should be transferred to Rio Previdzncia. As such, royalties were used to pay part o f State debt f i rs t and only the residual would be transferred to the Fund. As a result Rio Previdzncia was undercapitalized and used to run high deficits. Decree 37.571/2006 partly addresses such issue by excluding debt payments f rom royalties to be transferred to the Fund. As a result from 2006 to 2008 the share o f revenues transferred to the Fund increased from 39 percent to 64 percent. However those resources were not completely secured since the State Government could use them for other purposes by decree. Decree 42.011/2009, i.e. the specific pol icy supported by this DPL, addresses this issue by establishing royalties as assets o f Rio Previdt?ncia, which therefore cannot be used for other purposes and are protected from executive discretion. More importantly, the law allows recapitalizing Rio Previdzncia by providing future flows o f o i l revenues as assets, which represent 70% o f the assets o f the fund, thus providing a hedge against liabilities and considerably strengthening its financial position.

e Improving the efficiency o f tax administration. Increasing tax collection was the main objective o f the reforms implemented by SEFAZ during 2008. On the one hand, the State recognized that by increasing fiscal control through more agents working on the ground, revenues increased by 13.5 percent between 2007 and 2008. On the other hand, there was an urgent need for more fiscal agents to replace retirees31. As such, the State sponsored two public exams recruiting 159 new qualified staff to help meet the increased tax collection objective. The loan supports the policy o f increasing the number qualified staff through hiring new staff with selective public exams (concursos) and retraining o f existing staff o f the Revenue Sub-secretariat o f SEFAZ. Retraining included using modern IT equipment to support fiscal audits as wel l as training o f tax inspectors in inspection-based tax collection management. As an additional effort to increase tax collection, the Sub-secretariat o f Revenues also decided to combat tax evasion more aggressively. As a result, the number o f fines issued increased significantly between 2007 and 2008 and i s continuing to increase in 2009. In this area many measures were adopted, including strengthened control o f fiscal incentives, credit card information and issuance o f fiscal receipts. The loan also supports the specific action related to the adoption o f Electronic Fiscal Invoices, which

3 1 The last public exam to hire staff in the State Revenue Sub-secretariat was held in 1990.

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were made compulsory in 2008, to increase the efficiency o f tax collection and reduce evasion.

e Strengthening budget procedures, financial management and purchasing system. One o f the main focuses o f SEFAZ during the current administration has been to increase budget predictability with the objective o f aligning planned expenditures with expected revenues in daily and monthly programming activities. The State has introduced a number o f measures which reduce the costs associated with uncertainty related to operations within public entities as well as those with external contractors. The new financial controls are already helping to better manage the payment process, while enhancements in investment management are generating additional revenue for the State. The loan supports measures introduced by Decrees 41.682/09 and 41.880/09 (see Box 6) related to: (i) reorganizing the budget and annual financial programming processes; (ii) defining precise budget execution and fiscal and financial management procedures; (iii) introducing a public timetable for invoice payments; and (iv) improving fiscal transparency in state operations. The loan also supports the introduction o f Price Registry and Preg6o EZetrGnico in 2008 as preferred procurement methods.

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I Box 6. Enhancing budget predictability in the State of Rio de Janeiro

Government cash management i s about ensuring that sufficient funds are available to meet the Government’s daily cash needs, or to manage daily cash surpluses, in the most cost-efficient manner. Good cash management helps to promote efficient expenditure management, by giving spending agencies greater predictability over their resources and by allowing greater flexibility in the timing o f expenditures. Additionally, greater predictability for suppliers can significantly reduce the costs to the Government, as the potential “cost-of carry” for payments and idle balances are reduced and cash holdings can be better invested for a greater return. Starting in 2007, the State o f Rio de Janeiro has introduced a number of measures to enhance its cash management. These include:

I

Enhancingjnancial and cashplanning: a fmancial program was introduced in 2007 that publically sets out the monthly and quarterly receipts and spending limits for each public agency (see decrees 40.567/07 and 4 1.162/08). In accordance with the FRL, this i s reviewed every two months, particularly with regard to the flow of receipts, to ensure compliance against the balanced budget objective.

New rules for payment processing: Along with the financial plan, a more routine monthly disbursement schedule was also introduced that sets the monthly payment dates for operating and capital costs (Decree 41.162/08). Measures were also introduced to ensure the timely flow of resources to operating expenses, utilities and the priority spending areas of health, education and public safety (Art. 11). These measures are designed to reduce delays and discretion and increase the predictability over payments.

Improving commitment controls: Controlling expenditure commitments i s an essential component of cash management. New quarterly commitment limits have been introduced, consistent with the FRL (Art. 8). Prior to 2007, the carry-over of expenditures which has committed in one year but not yet paid (Restos a Pagar, RAP) had grown significantly, fiom R$458 million in 2004, to a peak of R$2,143 million in 2006. This represents an often unpredictable State liability. New control and payment procedures, including a scheme to encourage creditors to register with the Treasury for quick disbursements of small amounts or tranches for larger amounts (sometimes with discounts), successfully reduced the RAP to around R$730 million at the start of 2009 (see various Decrees, e.g. 40974/07 or more recently 4 1625/09).

Strengtheningfinancial management: During 2008, the Treasury has been restructured to enhance its investment management capability (including risk management) and a new Investment Committee i s to be established to oversee the investment strategy. State investments are now regularly benchmarked against the interbank CD rate and recently yields have risen above the benchmark, due to closer monitoring.

New “rules of the game” - greater transparency and accountability: Since April 2008, much of the above information on the payment process i s available to public agencies, the public and with secure access to confidential-client information for certified suppliers on the SAFAZ’s website. This i s helping to promote a culture of transparency as well as improving the predictability of resource flows.

Source: SEFAZ, www.fazenda.ri.gov.br

83. Expected results. The expected results in this pol icy area are the following:

The Social Security System for State public servants (Rio Previdincia) i s recapitalized with the present value o f future o i l and gas revenues representing 70% o f the fund’s assets, reducing considerably i t s long te rm actuarial deficit by providing increased and more predictable revenues that are secured from the risk o f appropriation from the executive discretionary power. A secondary result i s that volatile oil revenues can no longer finance budget expenditures, thus eliminating the temptation o f counting on those resources to finance permanent expenditures. An expected result o f the action i s that assets o f Rio Previdzncia free from risk o f executive discretion are increased from R$16,229 mi l l ion in 2008 to R$50,495 mi l l ion by 201 0.

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Efficiency gains in tax administration will lead to more revenues collected by the State, more efficient handling o f tax claims and enhanced tax compliance and oversight. The value o f tax collected i s expected to increase from R$22,920 in 2008 to R$26,438 mi l l ion in 2010. Electronic Fiscal Invoices are expected to be used for 95 percent o f al l receipts issued in 20 10. Financial revenues from better cash flow management are expected to increase from R$500 mi l l ion in 2008 to R$550 million in 2010. The State’s Net Financial Position (cash less current liabilities) i s expected to increase as well. The predictability and transparency o f expenditures is expected to improve as evidenced by the percentage o f payments made in less than 30 days, which i s expected to increase from 86.6 percent in 2009 to 95 percent o f a l l payments in 2010. The number o f services contracted using the Pregdo EletrGnico procurement method i s also expected to increase from 90 percent in 2009 to 95 percent o f al l contracts in 2010.

Policy Area 2: Improving Quality and Efficiency of the Business Registration Process.

84. Description o f the Government’s pol icy obiectives. This policy area supports the Government’s strategy to achieve economic diversification and growth. The improvement o f the business environment in Rio will help the Government to increase the State’s ability to attract new investments and to improve i t s competitiveness, thereby achieving greater economic diversification and growth.

85. Challenges. The economic recovery that the State o f Rio de Janeiro has experienced since the late 1990s has come after a long process o f economic decline, which saw the State’s share o f real GDP in Brazi l fal l f rom 14.2 percent in 1980 to 12.8 percent in 1985, and to 10.9 percent in 1990. This process o f de-industrialization and economic stagnation resulted in a region afflicted by social problems, including rising unemployment, crime, and a diminished capacity to attract new investments. Despite recent economic revival, the State s t i l l has difficulty diversifying its economic base and investments are concentrated in only a few sectors.

86. Excessive bureaucracy and executive discretion are recognized as constraints to better business environment in the State. While it is not one o f the worst performing States, Rio de Janeiro could do much more to improve its business environment to make it a more attractive location for businesses. In a Doing Business survey conducted at the sub-national level in Brazil in 2006, Rio ranked 8 out 13 states in terms o f the ease o f doing business locally. In particular, company registration is one o f the areas where the State could improve. Excessive delays in the processing o f documentation and frequent opportunities for subjectivity in the evaluation o f documents create conditions for abuses and possibilities o f informal payments to be required to “speed things along”. Partly as a consequence o f this excessive bureaucracy and high costs o f registering businesses, informality i s high. In the State o f Rio de Janeiro, there are more workers in the informal market (3.4 million, in 2005) than there are in the formal labor market (3.2 million, in 2005). When company registration records are analyzed, the State has 900 thousand companies that are not formalized (2003).

87. Government actions to date and goals for the future. The Government’s objective i s to reduce the State’s reliance on oil. In order to do so, the State i s striving to improve Rio’s competitiveness and to promote the attraction o f new investments. The Government’s strategy

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includes tackling the security issue, in al l i t s many facets, as wel l as increasing infrastructure investments, and improving the business environment. The latter effort includes the easing o f bureaucratic processes and a greater integration o f organizations that deal with businesses at different levels o f government (national, State and municipal).

88. The State Government, through the Finance Secretariat and the Commerce Board (Economic Development Secretariat), has been moving on a number of projects aimed at: i) easing the bureaucratic processes related to the registration and operation o f businesses, ii) decentralizing the provision o f services to businesses, iii) improving the efficiency o f tax collection and allocation o f personnel resources in SEFAZ and iv) improving the targeting o f fiscal incentives. Some o f these include:

e

e

e

e

e

e

e

e

e

89.

Cadastro Fdci l (Facilitation o f Firm Registration), which will provide a more uniform procedure and decrease the need for businesses to take documents or questions to SEFAZ, thereby expediting the registration process. Rio Poupa Tempo: Integrated Service Centers that will provide services such as company registration, licensing and permits, among other services, in one location. An important commitment o f the Rio Poupa Tempo project i s to significantly improve the quality o f the services that are provided within these units. EscrituraGclo Fiscal Digital (Digital Tax Archive), which will require companies to generate in digital format documents related to payment o f taxes and sales and purchases, among others. The aim i s to improve quality o f information and the operation o f tax authorities. Nota Fiscal EletrGnica (Electronic Invoices), which will improve the performance o f the tax collection system (supported under this operation). Redesign and implementation o f processes related to key interactions between SEFAZ and businesses. Transfer to Electronic Form and Digital Certification o f Processes and Documents at the Commerce Board (Junta Comercial). Expansion o f Commerce Board Regional offices, to reach regions of the State until now unattended by the services provided by the Board. Implementation o f the Use o f Incentives Document, which will provide information on the use o f fiscal incentives, allowing for an analysis o f the fiscal impact o f such incentives and improved targeting o f these incentives in the future. Implementation o f REGIN, which will centralize the many other documents and requirements needed to register and operate a business in Brazil. This new system will provide for a single window where information will be entered that i s needed by federal, state and municipal level tax authorities to register a business, as well as by agencies related to environmental, sanitary and Fire Brigade licenses, among others.

Specific measures supported under the DPL. Out o f the universe o f initiatives and reforms that the Government i s undertaking to improve the business environment in the State, the proposed operation will support two initiatives that have a direct impact on the ease o f doing business. These are: the implementation o f the Cadastro Fdci l and Rio Poupa Tempo units.

90. For the Cadastro Fdci l , the following steps are being taken that will lead to the implementation o f the new system: signing o f an agreement between SEFAZ and the

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Chamber o f Commerce o f State o f Rio de Janeiro (JUCERJA), publication o f modifications made, development and testing o f new software, writing o f operating manual for the new system, training o f personnel and bringing online the new Cadastro Fdcil web portal. The main modifications to the business registration system relate to the simplification o f State business registration, including: (i) reduction in the number o f documents required; (ii) minimization o f the need for direct interaction with SEFAZ inspectors; and (iii) reduction in the time needed to verify accuracy o f information and documentation being provided by the firm.

91. For the Rio Poupa Tempo, the decree establishing these centers was passed on April 17, 2009 (Decree No. 41.832). The f i rst Rio Poupa Tempo was opened in July in the western part o f the city o f Rio de Janeiro. The second unit was opened in November in the Baixada Fluminese region o f the State.

92. Expected results. The expected results o f these two initiatives are:

0

0

More efficient business registration process, as measured by a decrease in the number o f days needed to obtain the State business registration (InscriqTo Estadual). Two Rio Poupa Tempo units that are operational, specifically for the services related to businesses.

Policy Area 3: Increasing Quality and Efficiency of the Basic Education System.

93. Description o f the Government’s policv obiectives. GORJ recognizes the need for action to improve education quality and efficiency, as part o f Brazil’s overall strategy o f reaching OECD PISA level learning outcomes in al l states by 2021. The DPL supports a f i rst set o f actions the government has taken in relation to two o f its major goals:

a Increasing primary and secondary school completion rates and reducing age- grade distortion, through large-scale implementation o f a high quality “accelerated learning” program (Projeto Autonomia) that enables overage students to complete the curriculum in reduced time Modernizing system information and resource management through a major investment in computers and wireless internet to provide electronic learning resources and digital skills training in al l schools and introduce smart cards to monitor student and teacher attendance and access to school lunches and transport

a

94. Challenges. Education outcomes in the state system o f E o de Janeiro are the lowest in the Southeast Region, and in several key areas, such as secondary school learning and graduation rates, seriously below the average for al l o f Brazil. As in other parts o f Brazil, the principal responsibility o f the State education system i s secondary, vocational and adult education (accounting for about 80 percent o f enrollments at those levels) while enrollments in State-managed primary schools are less than 25 percent o f the total at that level, with municipalities being the main provider. Thus, issues o f l o w learning performance and age- grade distortion in the State system are to some extent inherited from poor quality education provided by municipalities. The State manages 1,500 schools, enrolling 1.34 mi l l ion students (out o f 10,000 schools and 4 mi l l ion students in total in the State).

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95. currently grappling with 4 major challenges:

Due to combined failings o f the State and municipal school systems, the State is

Low primary and secondary school completion - Less than hal f o f students enrolled in secondary school graduate (44.5 percent), compared with 60 percent for the rest o f the Southeast region and 50 percent for Brazi l as a whole. Lack of management information at the school level and among administrators - Spending per student i s not l o w in the RJ State education system, and administrators are concerned with several sources o f waste and inefficiency in resource use. Inadequate physical conditions in schools - 12% o f secondary schools operate in municipal primary school buildings at night and 47% o f secondary students attend night shift schools. Poor learning outcomes - Student learning performance on national and international (PISA) tests is also the lowest in the Southeast region. At the secondary level, Rio State’s outcomes are below the national average and stagnant. While the Brazilian average Basic Education Development Index (IDEB) score (reflecting Ma th and Portuguese and graduation rates) for secondary state schools rose from 3.9 to 4.3 (on a 10 point scale) from 2005 to 2007, Rio’s score remained at the same value o f 2.8.

96. Government actions to date and goals for the future. These four challenges have deep roots and to some extent reflect weaknesses in municipal schools that are beyond the State’s control. The current administration i s working on comprehensive policies in al l four areas but it will take some time to develop these fully and even longer to implement, especially in the last two areas. Actions taken to date represent key, but relatively limited, steps in some o f the needed directions. These actions include recruitment o f skilled technicians in some key positions and plans, under the parallel Rio de Janeiro Public Sector Modernization Project, for a small core team o f economists to help develop evidence-based policies to address system challenges and closely monitor implementation.

97. The State’s strategy i s centered on four major goals: i) improving primary and secondary school completion rates; ii) modernizing system management and the efficiency o f resource use; iii) building new, full-day secondary schools and upgrading physical conditions in al l schools, and iv) improving learning outcomes. The DPL-supported program i s delivering progress on the f i rst two o f these goals. Significant progress towards goals three and four will take longer, and will need to draw on preparatory work planned under the R io State TA loan.

98. To improve completion rates at both primary and secondary levels, the Government i s focusing on the large number o f students in the system who are more than two years behind grade level, due to having repeated grades several times. Education research in Brazi l and elsewhere shows that these students have a high chance o f dropping out o f school, both as their opportunity costs o f staying in school rise with age and as frustration sets in. Teachers also find it difficult to address the needs o f these students. The Fundaqlio Roberto Marinho (FRM), which pioneered televised education in Brazil, has developed a highly regarded accelerated curriculum - currently being implemented in Pernambuco, Acre, and Maranhgo among other States -- which enables overage primary students to complete 8th and 9th grades in a single school year and secondary students to complete the 3 year high school curriculum in 1.5 years. As one o f the DPL prior actions, SEEDUC has contracted with FRM to offer the

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accelerated program, called Projeto Autonomia, to 7,000 primary and 6,000 secondary students beginning in the 2009 school year. In 2010, SEEDUC expects to expand the program to cover 14,000 primary and 21,000 secondary students. SEEDUC and FRM have also agreed to carry out a rigorous impact evaluation o f the cohort o f students entering the secondary level program in 2010, with technical support from World Bank impact evaluation experts.

99. Modernization o f system management i s receiving a big boost in 2009 through the introduction o f the innovative Conexao Educaqfio, the second prior action supported by the DPL. This program i s equipping all schools with wireless internet, laptops for al l teachers and smart cards for all teachers and students. In addition to promoting access to digital teaching and learning resources, Conexfio Educaqfio wi l l allow for real-time monitoring o f student and teacher attendance and students’ lunch and transport consumption. SEEDUC expects to establish accurate baseline data for these four variables by the end o f the 2009 school year (December 31) and to monitor these on a monthly basis throughout the 2010 school year. It expects electronic monitoring and transparent, real-time reporting on teacher and student absence rates, lunch and transport consumption to produce measurable improvements in these indicators from the December 2009 baseline values over the course o f the 2010 school year.

100. Full-day secondary schools are a priority o f SEEDUC’s which can only be achieved gradually over the next several years. With support under the Rio de Janeiro Public Sector Modernization Project, SEEDUC i s working on a set o f padrces minimos or minimum standards for physical conditions in all schools (similar to those implemented under the federally-supported FUNDESCOLA program). The Rio de Janeiro Public Sector Modernization Project will also support a census o f the system’s existing infrastructure, to identify all buildings below minimum standards, which would be the basis for a multi-year program o f Expansfio, Reforma e Reaparelhamento da Rede de Ensino, designed to upgrade all schools to the minimum standards by 201 3. Acquiring land on which to build new, fully adequate secondary schools has been a difficult issue to date, but the multi-year upgrading/construction program would tackle this problem systematically.

10 1. The most important challenge, however, i s improving learning outcomes. With support from the Rio de Janeiro Public Sector Modernization Project, the Government i s laying the ground for three key reforms that hold long-term promise for improving learning: i) improving the quality o f school leadership by professionalizing the process through which school directors are appointed and held accountable for results; ii) introducing annual, school- level targets (metas) for improving student learning outcomes and student flows, based on SAERJ (annual state learning assessment) results; and iii) reforming the system o f in-service teacher training through an innovative model called the “Casu do Educador”. These are probably the most important o f the state’s proposed policies, but will need to be phased in gradually over the 20 10 and 20 1 1 school years, after considerable technical background work.

102. The Secretaria recognizes the critical importance o f school-level leadership and would l i ke to make the appointment o f school directors more transparent and objective, by introducing clear criteria for director positions, and a technically-managed certification process for all new and sitting school directors. This type o f reform i s politically sensitive in a l l school systems, however, and the State plans to proceed in a gradual manner. In 2010, the technical assistance resources will be used to commission a review o f the criteria and

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processes (technical screening, competitive appointment, direct election, etc) used in other states in Brazil (and other countries) and to use this as a basis for developing proposals for Rio State.

Setting annual school-level targets (metas) for learning outcomes i s something an increasing number o f other Brazilian states are doing, in order to stimulate a stronger focus on results focus and learning at the level o f individual schools. The State Secretary o f Rio de Janeiro plans to introduce school level targets over the next two school years. With support under the TA loan, the State wi l l take the first step o f developing a feedback system to communicate the state’s annual student assessment results (SAERJ) back to individual schools on a timely basis and to provide technical support from the district offices in analyzing results and planning improvement programs.

103. following measures:

Specific measures supported under the DPL. The proposed operation supports the

0 To improve primary and secondary graduation rates and reduce age-grade distortion: -

To improve the quality o f management information in state schools -

Contract with FRM for the implementation o f the Projeto Autonomia during 2009 and 2010

Introduction o f the Conexao EducaqGo in all schools by the end o f 2009 0

104. Expected results. Over 7,000 primary and 6,000 secondary students were enrolled in the FRM Projeto Autonomia classes during the 2009 school year. Based on FRM experience in other states, it i s expected that a significantly higher share o f primary students wi l l successfully graduate from the program in December 2009 than from the SEEDUC’s regular programs, and that completion rates for Projeto Autonomia’s secondary students (who will finish the 18 month curriculum in July 201 0) will be similarly higher than regular secondary completion rates. However, both completion rates and learning outcomes for these cohorts (measured on the State’s annual assessments and the federal ENEM secondary school leaving exam) will be monitored closely by SEEDUC as part o f a rigorous impact evaluation o f the program being carried out by the Secretaria’s new evaluation studies, with support under the Rio de Janeiro Public Sector Modernization Project. A larger wave o f 14,000 primary and 16,000 secondary students are expected to enter the program as it moves to scale at the beginning o f the next school year (March 201 0).

105. Expected results o f the ConexiTo EducaqGo program in the first instance will be the availability for the f i rs t time o f robust, real-time, school-by-school data on student and teacher attendance, and consumption o f school transport and school meals. The production o f these data are an essential f i rs t step in eliminating waste, improving efficiency through reallocation, and responding swiftly to problems in student and teacher attendance. The program allows the possibility o f sending text messages to students or to parents to address student absenteeism. In other areas, such as health, this strategy has significant improved service delivery. A rigorous impact evaluation o f the use o f text messaging to curb student absence i s among the studies the Secretaria’s proposed analytical unit would carry out.

Policy Area 4: Increasing Access to and Efficiency of Health Services, Especially in Disadvantaged Areas and for Poor People.

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106. Government to achieve two main objectives:

Description o f the Government’s policy obiectives. This pol icy area supports the State

e Providing quality coverage for urgent and emergency health care by implementing specialized health units (UPAS - see description below) and mobile health units (ambulances) in low-income urban neighborhoods. These health un i t s fill a significant gap in the referral and counter-referral system o f the State health networks and significantly contribute to improving the outcomes o f the health services financed by the State and municipalities. Increasing efficiency of health spending and accountability of health service provision by creating incentives for health units and municipalities to deliver more efficient and higher quality services through additional resources tied to performance.

e

107. Challenges. The health system in the State o f Rio de Janeiro faces two major challenges: (i) the lack o f coverage and quality o f health services to respond to urgent and/or emergency needs o f populations living in the poorest neighborhoods; and (ii) poor management, which leads to inefficient use o f resources.

108. Lack of coverage and quality of urgent and emergency care. When it took office in 2007, the new State Government faced problems o f coverage and quality throughout the State’s health system. Weak prevention strategies and lack o f access to basic and medium- complexity care affected the poorest populations. National health strategies implemented by Brazil’s Unified Health System - such as the Family Health Program (PSF) and the Community Health Agents (PACS) - only covered 27 percent o f the State’s population (1 1 percent in the Rio Municipality) in 2007, compared with a national coverage o f 58 percent.

109. Most non-hospital health units only provided services during working hours, making it dif f icult for poor families that faced urgent health needs at other times o f the day. These non- hospital units cannot handle more complex cases because they lack qualified human resources, equipment, diagnostic facilities, transportation and/or supplies. Such units are unable to resolve issues beyond basic care in a way that would avoid unnecessary transfers to hospitals. As a consequence, the urgent care and emergency hospital services are overwhelmed with too many patients and no prioritization o f cases by severity levels. Frequently, patients needing urgent care have died from inadequate care or because they did not reach the hospital in time.

110. Low efficiency and lack of good management in health services. The State Government identified several critical management-related issues in the health system and especially in the budget transfers to the municipal health departments including: (i) lack o f coordination between primary care and hospitals due to the non-existence o f sound referral mechanisms; (ii) lack o f resources in small municipalities necessary to keep public and private non-profit hospitals operational and efficient; (iii) lack o f management tools and processes associated with state budget transfers such as performance agreements and systems for monitoring and evaluation; (iv) inadequate incentives for personnel that result in absenteeism and l o w productivity; (v) uneven distribution o f human resources by skill levels and among different areas and functional structures; (vi) poor managerial skills and lack o f

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trained hospital managers; and (vii) constant breakdowns in supply chains and insufficient access to diagnostic facilities.

111. Government actions to date and goals for the future. In order to address these challenges the State Secretariat o f Health and C iv i l Defense (SESDEC) adopted the following actions since the current administration took office:

0

0

a

112.

Implement 24-hour Rapid Service Units (Unidades de Pronto Atendimento - UPAs) in low-income areas to provide treatment options that are less expensive than hospital care but with more capacity to attend complex medical cases than family health clinics. Increase coordination within the urgent and emergency care network through referral and counter-referral mechanisms. A State agency (Central de Regula@o) has been established to address the referral and counter-referral system o f al l urgent and emergency care within the State. Implement a system o f performance-based State financial transfers to municipalities to increase resources and improve efficiency and quality o f health services at the municipal level. Implement medical protocols starting with the more costly and prevalent diseases. The first medical protocol for chest pain has been implemented with defined referral and counter-referral mechanisms. Establish State Health Foundations to introduce flexibility and strengthen performance orientation and accountability in the system.

Specific measures supported under the DPL. Two specific health policies are included in the proposed operation:

113. Expansion of the new delivery system of urgent and emergency care (the UPA model) in the State: The State’s f i rs t UPA was established in May 2007 in the Favela da Mare‘, one o f the biggest slums in the Rio de Janeiro Municipality. Since then, 21 additional UPA’s were established by the State Secretary o f Health and C iv i l Defense (SESDEC) in some o f the State’s poorest c o m m u n i t i e ~ ~ ~ . UPAs are designed to be ambulatory care facilities equipped to perform low- and medium-complexity surgeries as well as to treat some severe cases. They apply a model o f patient risk classification to prioritize interventions and patient transportation needs that i s based on an adapted version o f the Manchester Protocol. Because UPAs are always open, they can serve the poorest populations at any hour o f the day. Each UPA has medical teams specialized in pediatrics, general medicine, orthopedic care and dentistry. They also have rooms equipped to treat respiratory infections and for minor surgeries. Complementing this are services for imaging exams, drug prescriptions and lab work. Besides observation beds, UPAs have a “red room” for stabilization o f severe cases before hospital transfer. The UPA model works on an integrated basis, providing and receiving referrals and counter-referrals for a l l health facilities and programs.

114. The UPAs fill a huge gap in the State’s health network, improving referral and counter-referral mechanisms between al l complexity levels which i s going to improve

32 These UPAs are placed in the following neighborhoods: Iraja, Santa Cruz, Bangu, Campo Grande, Belford ROXO, Tijuca, Duque de Caxias Ricardo de Albuquerque, Botafogo, Cabuqd, Marechal Hemes , Vila Sarapui, Ilha do Governador, Barra Mansa, Jacarepagua, Penha, Campo Grande 11, Realengo e Engenho Novo.

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network integration and coordination. Because UPAs can avoid unnecessary hospital visits, they will take a large burden coming from primary care and PSF units, which did not have the ability to refer patients to the right level o f care or to fo l low up after medium-complexity care or intervention. To replicate the successful experience o f Rio de Janeiro other states in Brazil, including Bahia and Pernambuco, have started establishing UPAs as strategic components o f their state health care delivery network, especially in urban and densely populated areas.

115. Establishment of a performance-based transfer system between the State and municipalities based on improvements in maternal and child health and hospital care. Since 2007 SESDEC has put in place financial transfers to support municipalities to improve health care management and increase coverage and quality o f health services for the poorest population. In September 2009, in order to increase the responsibility and accountability o f al l government levels in the provision o f health services and to provide incentives to municipalities to strengthen their health service delivery strategies and programs, the State Government established the Program to Support Municipal Hospitals (PAHI). The main characteristics o f this program are described below:

0

0

The hospitals included in the program can be public and private non-for-profit and have to be located in municipalities with less than 100,000 inhabitants; Hospitals must have 100 percent o f their beds available to be used by the referral agencies (Centrais de Regulaqclo) as part o f the State referral and counter-referral system; Financial transfers will be directed to the municipalities and will be defined according the size o f the hospitals and the characteristics o f the municipalities; The participation in the program i s voluntary for municipalities and for hospitals. Municipalities without hospitals are also eligible to participate by financing referrals to hospitals located in other municipalities that belong to the program; The financial transfers will be made up o f two components: a fixed transfer and a variable transfer. In this way, base financing i s ensured at al l times also for the poorer municipalities with weaker capacity. The value o f the variable transfer can be as high as 85 percent o f the fixed transfer depending o n performance related to hospital management and maternal and child health outcomes; and Additional technical support i s planned to help the poorest municipalities achieve their targets.

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0

0

0

116. Expected results. The expected outcomes in the area o f providing coverage for urgent and emergency care are an improved distribution o f urgent and emergency care services across the health services network, a reduction o f hospital-based services and an increased coverage and reduced wait times for medical services, especially for the immediate needs o f the poorest populations. The main indicator in this area i s the number o f people receiving services at the UPAs, which i s expected to increase from 2.4 mi l l ion in 2009 to 3.7 mi l l ion in 2010.

117. In the area o f increasing efficiency in delivering municipal health services, the expected outcomes are significant improvements in a range o f adverse health outcomes including reduction o f maternal and child mortality, reduction o f hospital infection rates and increases in prenatal medical visits. The main indicator for this area i s the following: o f the 69

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identified municipalities at least 50 municipalities will sign performance agreements with the SESDEC related to the P A H I by December 30,20 10.

VI. OPERATION IMPLEMENTATION

A. POVERTY AND SOCIAL IMPACTS

118. The specific policies supported by this DPL are expected to have significant positive social impacts. During preparation, the Bank undertook a poverty and social impact analysis to explore the disaggregated social impacts o n different stakeholder groups to enhance the positive impacts and minimize and reduce negative impacts and r isks associated with the operation.33

1 19. The policies and reforms supported by this operation include consolidating fiscal sustainability, facilitating opening o f new businesses, and improving the delivery o f health and educational services. Each o f these policies has a l ikely overall positive poverty and social impact. Reforms in health and education are expected to generate the most rapid positive gains for poor people and vulnerable populations. These potential impacts, along with the potential risks and mitigation recommendations are discussed below.

120. Fiscal Sustainability. Improved fiscal sustainability and expansion o f fiscal space for investment would l ikely have positive social impacts due to government's ability to improve public services and public investments. When public services improve, l o w income groups with a history o f very low access to these services experience relatively larger gains. More investments are also l ikely to benefit lower-income groups via increased j o b opportunities in construction and related activities.

121. Business Environment. The policies and reforms supported by this operation would facilitate the formal business sector. Cadastro Fdcil i s facilitating firm registration, and Rio Poupa Tempo is providing integrated business services in one location. These projects are expected to contribute over time to a decrease in the informal sector. Since the poor are overrepresented in the informal economy which i s characterized by illegality and precarious labor regimes, the formalization o f businesses i s expected to expand access o f workers to the formal market economy. This i s expected to expand access o f workers, and especially the poor, to improved labor regimes with benefits. Legalized workers are also more likely to gain improved access to public services and redistributive programs. The main caveat i s that the informal economy has sometimes served as a route for escaping poverty, and for some vulnerable groups, especially those with l o w educational levels and few skills, as an important source o f low-level jobs. This risk is mitigated by the fact that transition will not completely eliminate the informal economy, and other Government programs, particularly in education, are addressing the educational disparities.

122. Basic Education. Since poverty and extreme poverty i s closely correlated with lower- levels o f education, the Government's program to improve education quality and efficiency is expected to have highly positive social outcomes with markedly greater gains for poor people

33 The full PSIA report i s available in the project files. The report i s based on primary and secondary sources, including social and economic analyses utilizing demographic and census data, ethnographic studies, as well as meetings held with stakeholders.

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and vulnerable groups who usually have no alternative to the public school system. Projeto Autonomia with its accelerated learning program i s an example o f an initiative with positive social and distributional impact. It is reducing the age-grade distortion and increasing the completion rates for high school, especially among the poor. As a consequence, poor young people have better opportunities to continue on for advanced training, and more options for better jobs, improved labor conditions, and higher incomes. Conex80 Educa@o also has positive social impacts as it i s contributing to reducing rates o f class absences by both teachers and students and hence i s contributing to reducing age-grade distortion, grade repetition and improving the quality o f instruction in regular classrooms. The main risks to these programs are the need for: (i) better dissemination to diverse publics (including teachers and students) about the value o f these programs; (ii) ongoing evaluation so any needed adjustments can be made in a timely fashion; and (iii) sufficient support and training to teachers some o f whom have resisted innovative programs and especially new technologies they have not mastered. These are being addressed by more information campaigns to diverse audiences; the creation o f a robust monitoring and evaluation system which i s being put into place; and providing additional training to teachers.

123. Health. Increasing access and efficiency o f health services in disadvantaged areas and for poor people are expected to have overall positive social impacts, especially for the poor and more vulnerable groups who must rely on public health services. The U P A model for urgent and emergency care i s already demonstrating its effectiveness, especially for the poor in Metropolitan Rio. The main risks include the need for: (i) better inter-institutional coordination o f health services overall; and (ii) better informed consumers and positive interactions between the UPA and the community where it i s located. The first i s being addressed by the introduction o f an inter-institutional and interagency cybernetic system to improve coordination among services, as wel l as implementation o f a real-time information monitoring system for UPAs. The community issues are being addressed by public awareness campaigns, as well as consultations with and involvement o f communities in their local UPAs. The P A H I i s also expected to produce positive social and distributional impact due to improvements in the delivery o f maternal and child care in the smaller municipalities, which would benefit disproportionately poorer people. The main risk associated with the program i s a possible lack o f interest from a few municipalities in signing performance agreements due lack o f specialized staff and managerial skills. To mitigate this risk, SESDEC (with support o f technical assistance from the Bank) will develop toolkits and provide direct technical assistance to improve hospital management and help smaller municipalities to get the right staff skill-mix, both o f which are needed to reach the agreed performance targets.

B. IMPLEMENTATION, MONITORING AND EVALUATION

Implementation

124. The preparation o f this operation was led by the State Secretariat o f Finance (SEFAZ), which i s also responsible for the fiscal consolidation and reforms related to business environment. The Secretariat o f Health and C iv i l Defense (SESDEC) is in charge o f the reforms associated with the quality o f urgent and emergency care, and the efficiency o f state health services. The Secretariat o f Education (SEEDUC) i s conducting reforms to improve the quality and efficiency o f basic education, mainly through the improvement o f education services in State schools, and reduction o f age-grade distortion.

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Monitoring and Evaluation

125. The Secretariat o f Finance, together with the Secretariat o f Planning (SEPLAG) and the individual sector monitoring units, will collect the necessary data to indicate that the results indicators have been achieved. SEPLAG has implemented a new monitoring tool for certain strategic programs, called SigeRio, which allows real-time monitoring o f the status o f the program implementation through a web-based interface. Other programs are monitored within the purview o f the sectors.

126. Further, the World Bank and SEEDUC are collaborating on a rigorous impact evaluation o f the secondary school accelerated learning program, Projeto Autonomiu, partially funded under the Rio de Janeiro Public Sector Modernization Project. The World Bank and SEEDUC are also discussing an evaluation within the context o f the new system for monitoring student and teacher attendance (among other things), Conex6o Educaq6o, o f using text messages to parents to reduce absenteeism. The same Project will also finance strengthening o f monitoring and evaluation systems within the health sector in the following areas: (a) development o f accreditation and cost systems for the UPAS and (b) development o f an information system for state financial transfers to and performance agreements with municipalities.

C. FIDUCIARY ASPECTS

Financial Management

127. Public financial management (PFM) systems in Brazil are adequate for DPL lending.

Foreign Exchange Control Environment

128. The IMF Safeguards Assessment o f the Central Bank o f Brazil done in October 2002 and updated in March 2004 concluded that Central Bank does not present widespread vulnerabilities that could compromise the safeguarding o f Fund resources. As the IMF Safeguards Assessment o f the Central Bank has not been updated in recent years, the Bank also reviewed the comparative Financial Statements o f the Central Bank for the years ended December 31, 2006, 2007 and 2008, including the Explanatory Notes to the financial statements and the independent auditors’ report that included an unqualified opinion on the financial statements for all years. The Explanatory Notes, an integral part o f the Financial Statements, provide an extensive explanation o f the Central Bank’s risk management policies, including those related to financial instruments held to manage the international reserves. In relation to operational risks, the Notes state that the Central Bank “uses internal control systems, which are considered adequate for i t s activities.” Based on the above, the control environment governing the Central Bank’s operations within which the loan’s foreign exchange would flow i s considered adequate.

Public Financial Management

129. Planning and budget are housed in the Secretary o f Planning and Management (SEPLAG). Norms, processes and procedures are well documented. Preparation o f the PPA, the medium-term plan, and LOA, the annual budget, adheres to the timetable established by law and share the same structure. Preparation o f the PPA and L O A follow the methodology o f

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the Federal government based on program budgeting. Distortions arise however between the PPA and L O A as budget execution does not adhere to priority plans and goals, possibly reflecting weaknesses in planning, an imbedded short-term culture, and long-standing weakness in the human resource management. The budget management information system functions adequately and budget carryovers are limited to primarily unpaid bills from the prior budget year. Budget revenue estimates are also relatively realistic and the executive branch maintains veto power over proposed legislative amendments to the budget.

130. Treasury and public debt are housed in the Secretary o f Finance (Fazenda). The State uses o f single treasury account (that includes a large number o f segregated bank accounts required by contract), complemented by tax collection and payment accounts. Cash flow, despite the financial crisis, has been strong and there are no late payments. Cash flows projections are updated monthly and payments are scheduled three times per month. The current administration has reduced staff but increased professionalism and motivation.

13 1. Accounting and Internal Audit are also both within the Fazenda. Accounting produces the consolidated financial statements o f the State government, LRF reports and other management information on a timely basis. SIAFEM, the state’s integrated financial management system, i s functional but based on an outdated technological platform. The State is studying i t s replacement but has made a number o f innovative enhancements, such as the use o f bar coding, in partnership with private banks and companies. Fixed assets are not integrated and control in this area could be improved. A new fixed asset system has been acquired and i s expected to come on l ine in 2010. Internal Audit staffing has lagged far behind growth in the state and therefore demands on audit. Hierarchically it has occupied a relatively l o w level in Finance but i s being elevated, reflecting the increased importance given to the function by the current Administration. A longer-term plan for Internal Audit to report directly to the Governor is under study. Both Accounting and Internal Audit have suffered, particularly in the sectors, from weak HR management. Improvement efforts have had modest success to date in these areas. Attempts at implementing automated audit tools have similarly had l imited to modest success.

132. Based on this review o f the State o f Rio de Janeiro’s PFM institutions, systems, processes and policies, it appears that the State’s PFM system i s functioning and management has demonstrated a clear commitment to an adequate program o f PFM evidenced by substantive improvements over the past several years. The State Government has also shown a strong interest in carrying out a joint PEFA PFM assessment with the Bank that would provide it a strong tool to monitor i t s progress in the future.

133. The project team’s review o f the significant PFM areas (planning, budget, treasury, accounting, public debt, internal controls, internal audit and external audit identified key demonstrations o f improvements, including, among many others: 1) improved HR practices such as hiring through competitive “concursos” placements, 2) carrying out a nearly one-year consultation focused on the institutional and technical strengthening o f the internal control and audit function and 3) Modernization o f four primary financial and administrative systems: HR, procurement, fixed assets and a web-based planning and management system.

134. Other desirable improvements in P F M areas will require longer-term solutions: changing the budget execution culture, particularly in decentralized sector units, and strengthening the cadre o f P F M professionals.

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Procurement Framework

135. The Brazi l Country Procurement Assessment Report (CPAR) dated January 2004 concluded that the procurement function in the country has an overall satisfactory framework that i s solid and perceived to serve the objectives o f economy, efficiency and transparency in public procurement. The Government has been improving transparency and supervision o f i t s procurement by making use o f e-procurement systems. Brazi l has two auditing institutions at the federal level that oversee public procurement. The Federal Secretariat o f Internal Control (SFC) under the Controller General’s Office o f the Republic (CGU) i s responsible for internal control and audit. External audit i s the responsibility o f the Court o f Accounts o f the Nation (TCU), whose institutional structures and functions are wel l defined. The States, including R io de Janeiro, have a structure similar to that o f the Federal Government with regard to roles and responsibilities for procurement supervision. Furthermore, the State’s General Attorney Office (PGE) and the Secretariat o f Planning provide advice to contracting entities; draft amendments to the legislative and regulatory framework and implement regulations; monitor public procurement; provide procurement information; manage statistical databases; report on procurement to other parts o f government and provide implementation tools and documents to support training and capacity development o f implementing staff.

D. DISBURSEMENT AND AUDITING

136. Once the Bank formally notiJies the Borrower that the loan is available for withdrawal, the Borrower may submit a withdrawal application so that the proceeds o f the loan would be deposited by the Bank into a local currency (Brazilian Real) account o f the State Treasury for the Borrower’s use. The exchange transaction would be done by the Central Bank o f Brazil.

137. The Bank will disburse the single loan tranche into an account o f the Central Bank denominated in USD, which forms part o f the country’s official foreign exchange reserves. The Central Bank will immediately credit the disbursed amounts to the State’s Single Treasury Account, thus becoming available to finance budgeted expenditures. The National Treasury will then provide the Bank a written confirmation o f the transaction.

E. ENVIRONMENTAL ASPECTS

138. The specific actions supported by the DPL are not l ikely to have any significant effects on the environment, forests, or natural resources. A review was carried out to assess whether functioning o f the UPAs pose environmental or social concerns. Regarding the environmental aspects, handling o f waste management was found to be in compliance with the requirements o f current national norms and regulations. Specifically, (a) a l l phases o f health care waste management (Le., collection, internal disposal, treatment, transportation and final disposal) fol low acceptable norms and regulations; (b) norms related to work-related environmental hazards and occupational safety are also being followed; and (c) adequate training is provided to staff working in the UPAs to be able to fo l low these national norms and regulations. In order to minimize future risks, SESDEC has been implementing a Plan (Plano de Gerenciamento de Residuos de Serviqos de Sa6de - PGRSS) to standardize al l procedures related to health care waste management. Regarding the social aspects, the

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review revealed that no expropriation o f land was necessary and n o resettlement was involved during the construction o f the UPAS.

139. An analysis o f the environmental implications o f the policies supported by the DPL to improve the business environment in the State reveals they are also not l ikely to have an environmental impact. The streamlining o f the State registration process for businesses is not going to impact the processes required by the environmental licensing agency. Moreover, f i r m s that tend to benefit the most from these types o f reforms are micro- and small enterprises, either new f i r m s or previously informal ones. Given the scope o f these companies’ activities, and the fact that these reforms are not expected to increase the economic activity o f large companies (such as in the mining sector), the potential environmental impact o f increased business activities i s deemed to be low.

F. R I S K S AND R I S K MITIGATION

140. The proposed operation in considered to be o f moderate risk.

Economic, Political and Institutional Risks

141. Economic risks. Moderate to Substantial. O n the economic front, the main risk derives from the ongoing global and financial crisis and i t s effect on the State’s fiscal position. However, the commitment and capacity o f GORJ’s financial and economic team indicates that fiscal repercussions o f the global crisis will be managed prudently so as not to offset the gains made in the last three years. In case the crisis turns to be more prolonged or more severe than expected GORJ may have to readjust expenditures to reflect the corresponding decrease in revenues.

142. Political and Institutional risks. Moderate. Political situation in the State o f Rio de Janeiro remains very complex and some aspects o f reforms remain controversial. In particular, public employee unions may oppose greater scrutiny o f their members’ performance. Moreover, with the exception o f top public officials in key positions, the technical capacity o f the State administration i s weak.

143. However, these r isks have been effectively mitigated by the rapid pace o f reform implementation and their irreversible nature. The same factors are likely to ensure continuity o f reforms in the pol icy areas supported by the DPL after the November 2010 State political elections. The Bank will continue to support the reform agenda by providing technological assistance in the policy areas supported by the DPL through the R io de Janeiro State Renovating and Strengthening Public Management Technical Assistance Project.

R i s k s related to specific sectors

144. Business Environment. The implementation o f the Cadastro Fcicil requires the development and testing o f new software. While the project so far is on track, delays in the implementation o f the new system are possible, SEFAZ has created a new division to manage projects such as the Cadastro Fdcil and this particular project has been appointed i ts own manager and a close monitoring o f the development and implementation i s being done.

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145. The implementation o f the Rio Poupa Tempo units is well underway. The first unit was opened in July 2009, and the second one was opened in November 2009. The relative success o f this initiative will depend to a large extent on the ability o f these centers to assemble in one place as many agencies providing services to businesses as possible. Another objective i s to significantly improve the quality o f services provided in these units. Maintaining a high level o f quality in service delivery will be a challenge, and JUCERJA, as part o f the mandate to oversee the project, has planned annual performance reviews for these centers. The Bank has requested that these reviews include specific evaluations o f the performance o f the services related to businesses operations. These reviews should also ensure that the targeted population i s being served by these centers.

146. Education. As part o f the efforts to improve education services in State schools, a new school management system (ConexGo Educaqdo) has been developed and implemented with the purpose to improve system efficiency and increase accountability among teachers and students. However, implementation and operation o f such a complex scheme require training o f school teams and a convincing process to get their commitment. In order to overcome these challenges, SEEDUC has already put in place a permanent training team to work with State schools' staff.

147. O n the challenge o f reducing age-grade distortion, the reform being implemented trough FundaqGo Roberto Marinho's Acceleration Program (Projeto Autonomia), depends primarily o n the motivation o f school principals and o n the capacity o f SEEDUC to manage Program logistics. There may be some resistance from principals to implement the Program in their schools. In order to mitigate this risk, SEEDUC is running a public relations campaign at the school level to explain the potential benefits o f the program to the principals, teachers and parents in order to build motivation.

148. Health. In order to improve quality o f urgent and emergency health care in the State o f Rio de Janeiro, a new model was implemented through the set up o f 22 UPAS. However, the U P A system will not work properly if hospitals do not provide sound information to regulate referral and counter-referral systems for urgent and emergency care. To mitigate this risk, SESDEC created a State agency that i s in charge o f defining, implementing and supervising the regulation mechanisms o f these health services.

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ANNEX 1: LETTER OF DEVELOPMENT POLICY

GOVERN0 DO ESTADO DO RIO DE JANEIRO

Rio de Janeiro, November 19,2009

Mr. ROBERT 8. ZOELLICK President The World Bank

' Washington, DC

This letter presents the Fiscal Sustainability, Human Development and Competitiveness Program of the State of Ria de Janeiro. This program is aimed at reinforcing the recent progress in the provision of public services, most notably in the areas of education and health, and the quality of the business dmate, backed-up by a continuous improvement of the State finances. The global economic cn'sis and its expected impact on revenues increased the uncertainty of being able to afford sustaining these policies in the immediate future. Hen- the State of Rio de Janeiro believes that it is necessary to request financial assistance from the Wwld Bank, in the form of a Development Policy Loen - DPL, to guarantee the continuation of these structural refonns.

State of Rio de Jeneim: recent developments, challenges and outlook

The State of Rio de Janeiro has the third largest population and the second highest GDP in Brazil. The urbanization rate of the state is around 98 percent and its population 1s highly in the metropolitan region of the municipality of Rb de Janeiro (75 percent). In 2007. the State's Gross Domestic Product (GW) was US222 billion (12 percent of national GDP). The State's most important economic sectors are oil, machinery and pharmaceutical mdustnes, and services. The most dynamic of these sectors is the petroleum industry, which has also benefited industries such as shipbuilding and petrochemicals.

Rio de Janeiro has the second highest per capita household income in the nation (the State average is 20.4 percent higher than the national one). The proportion of poor people in its population is 22 percent while the country's proportion is 29 percent The proportion of people in extreme poverty in the state is 6 percent in the State versus 11 percent in the country. In the last decade almost one million new job positions have been created in the State. Its adult popubtion holds the highest level of school education in the country and the highest adult literacy rate (outside the federal district). Rio is also characterized by better access to basic public infra-structures (electric power, water supply, sanitation, and garbage collection) than the national averages.

However, various social and economic challenges remain. Income inequality is high even in comparison with similar states, which contributes to poverty rate in the State dedining less and more slowly than in the rest of the country over the last decade.

The size of the informal economy is also a challenge, comprising of around 44 percent of the existing employment opportunities in the State. Within the capital city, the population of favelas (urban slums) has increased at a rate three times higher than the growth rate of the city's population. The State is also characterized by the fourth-highest homicide rate in the country. These rates are even higher in the Rio de Janeiro metropolitan region.

The excellent adult outcomes in education are not replicated for children, which perform far from the top in the nation. Ria fell from sixth place in 2005 to ninth place in 2007 in the Basic Education Development Index - DEB, the main indicator of education performance for Brazil. Education outcomes in Rio de Janeiro State are the lowest in the Southeast Region.

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GOVERN0 DO ESTADO DO RIO DE JANEIRO

Fewer than half of students enrolled in State secondary schools graduate (44.5 percent), compared with 60 percent for the other Southeast states and 50 percent for Brazil as a whole. Likewise, the percentage of age-grade distortion for primary education (45.3 percent in 2006) is among the worst in the country, and for secondary school age-grade distortion reached nearly 64 percent in 2008.

In the health sector Rio de Janeiro also needs to improve its performance. Although some progress has been made by reducing infant mortality and other basic health conditions, health outcomes in Rto de Janeiro still trail well behind other states in Brazil3 SouMeast Region. The insufficiency of quality hospital care and urgent and emergency care facilities in Rio de Janeiro State is partly responsible for the inadequate outcomes. Mothers face poor prenatal care prevention and lack of quality delivery services at hospitals. Adults lack adequate preventative care, and face poorly-equipped hospitals to provide emergency care in the case of heart attacks.

There are two main problems faces by the State administration in the health services area since it took office in 2007. First, poor coverage and quality throughout its health system, compounded by the fact that national health strategies implemented by Brazil's Unified Health System only covered 27 percent of the State's population (11 percent in the Rio Municipality) in 2007, compared with a national coverage of 58 percent Also important is the fact that state's health system was not sbuctured into health networks, and basic health units were not able to refer patients to higher-level care or to follow up with them when the patients were counter-refwed from these upper levels. Second, there remain critical management-related issues in the health system due mostly to the lack of coordination between its key players and units, incipient culture of using of management tools and, inadequate incentives for personnel that result in absenteeism and low productivity, uneven distribution of human resources across areas and functional structures, and poor managerial skills and lack of trained hospital managers.

The fiscal situation of the State of Rio de Janeiro experienced a turning point in 2008, when positive pnmary and fiscal balances dramatically improved. From 2003 to 2006 the fiscal balances were characterized by fiscal deficits and low positive primary balance. From 2008 to 2008, primary balances improved substantially so that total fiscal balances moved from deficit to a surplus of more than R$2 billion. Tax revenues - on average 56 percent of total revenues - increased 25 percent from 2003 to 2008 led by increases in the collection of the ICMS, which represents over 85 percent of tax revenues in the State. Revenues from the oil and gas sector - which represent on average $3 percent of total revenues - increased 80 percent from 2003 and 2008 led by price effects. Both the positive economic environment and a significant increase in tax collection efforts explain these increases.

On the expenditure side, fiscal adjustment efforts consisted in both limiting the growth of current expendrtures (mostly wages and purchase of goods and services) and improving the quality of the budget execution process. Growth of the major expenditure aggregates was modest in comparison to growth in revenue (for example, current expenditures, which represent 95 percent of total spending, increased 22 percent). Smce its inception, the current administration introduced a series of measures related to budgetary and financial programming. cash management, and internal control that helped to improve the spending process. These efforts helped to keep expenditure growth rates well below revenue growth rates, hence the positive fiscal situation of 2008.

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GOVERN0 DO ESTADO DO RIO DE JANElRO

The net consolidated debt to revenue ratio has failen during the last six years, from 202 percent in 2003 to 160 percent in 2008. As a result, R i de Janeiro is in compliance with the Fiscal Responsibility Law that requires the ratio of net consolidated debt to net current revenue to be below the ceiling of 200 percent, as well as the Fiscal Adjustment Program with the National Treasury. Since most of the State debt stock refers to the 1999 agreement with the Federal Government, debt service is linked to the evolution of the Net Current revenues. As these have grow so has debt service.

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Policies to be suppotted by the DPL

The medium-term strategy of the Government of the State of Rio is focused on fostering permanent and sustainable economic development and the improvement of social Welfare. In order to achieve these goals, the State seeks assistance from the World Bank in four key policy areas: (i) fiscal consolidation; (ii) business environment; (iii) quality and efficiency of basic education; and (iv) coverage and efficiency of health services. This support would allow the State to continue the successful implementation of its policies in these areas, given the expected impact of the global economic crisis on the State revenues during 2010.

fiscal consolideton

In the fiscal area, Government's strategic actions are built on three pillars:

enforcing fiscal austerity and respect of budgetary limits to create fiscal space for the State's priority investments and provision of services; increasing revenue collections as well as rationalizing expenditures related to goods and services to reach a batanced budget; and

0 developing the institutional framework, processes and procedures to effectively and efficiently conduct fiscal management on a day-today basis.

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Additionally, the State has chosen to reinform transparency and credibility as the main drives of its fiscal consolidation efforts. The outcome of such actions are evident by the strict compliance with the targets set in the 20082010 Fiscal Adjustment Program (PAF) signed with the National Treasury Semtariat - STN.

business envitvnmenl

With a view to diversify the economic base of the State, which relies heavily in a few sectors, the Government seeks to improve Rio's competitiveness and to promote the attraction of new investments. A key factor among others to reach this objective is to improve business environment. This includes the easing of bureaucratic processes and a greater integmtion of organizations that deal with businesses at different levels of government (national, state and municipal). It is also expected to contnbute to reduce informality, for it is well known that it in part sterns from complicated and excessive bureaucracy.

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GOVERN0 DO ESTADO DO RIO DE JANEIRO

The State's main actions are:

fadlitaton of firms registration (via Cadasfro FW/ initiative), which will modiiy the current business registration procedure with the Finance Secretariat; implementation of integrated service centers (the Rio foupa Tempo that will provide services such as company registration, licensing and permits, among other sBrvices, in one location); implementation of the digital book keeping of tax information (fscmm@o fiscal Digiial - SPED), which will require companies to generate in digital format documents related to payment of taxes and sales and purchases, among other activities; progressive adoption of electronic tax invoices (Nola fiscal EMr6nica), which will improve the performance of the tax collection system and is being supported under the first policy area of this oparation; re-engineering and Implementation of processes related to key interactions between SEFAZ and businesses; transfer to electronic form and daital certification of processes and documents at the Commerce Board (Junta Comercial); and implementation of REGIN, which will centralize the many other documents and requirements needed b register and operate a business in Bfazil.

besic educetion

The State education strategy rests upon four pillan:

improving primary and secondary school completion rates by focusing on the large number of students in the system who are more than two years behind grade level. The Fundago Roberto Marinho (FRM), which has pioneered in televised education in Brazil, has developed a highly regarded accelerated curriculum, which enabtes overage primary students to complete 8th and 9th grades in a single school year and secondary students to complete the 3 year high school curriculum in 1.5 years; modernizing system management and the efficiency of resource use, mainly through the intrcxfuction of the innovative Conexao fducacao, which is equipping all schools with wireless internet, laptops for all teachers and smart cards for all teachers and students. In addition to promoting access to digital teaching and learning resources, ConexBo Educa@o will allow for real-time monitoring of student and teacher attendance and students' lunch and transport consumption. building new, full-day secondary schools and upgrading physical conditions in all schools, which is a top priority of the Educatron Secretariat, but the State is well aware that it can only be achieved gradually over the next several years: and boosting learning outcomes - to address the most important challenge facing the education sector in Rio de Janeiro - is requiring improving the quality of school leadership by professionalizing the process through which school directors are appointed and held accountable for results, introducing annual, SchooClevel targets for improving student learning outcomes and student flows, based on annual state learning assessment results, and reforming the system of in-service teacher.

4

55

w

GOVERN0 DO ESTADO DO RIO DE JANEIRO

health services {especially in disadvantage amas and for poor people)

As already mentioned, the two major challenges faced by the State Government in this area are the lack of coverage and quality of urgency and emergency care and the low efficiency and poor management culture in health services. In order to address these challenges the Secretariat of Health has been adopting the following actions since early 2007:

implement 24-hour rapid service units (Unidades de Pronto Atendimento - UPAS) in low-income areas to provide treatment options that are less expensive than hospital care but with more capacity to attend complex medical cases than family health clinics; increase coordination within the urgent and emergency care network through referral and counter-referral mechanisms; implement a system of performance-based state financial transfers to municipalities to financially assist municipalities and improve their efficiency and quality of health care services; implement health- protocols (Le. mechanisms that define the diagnosis, management, and treatment procedures for specific disease or medical conditions) starting with the more costly and prevalent diseases; and

0 advise the judicial courts on their decisions directing the State to carry on health- related expenditures so as to increase the proportion of such expenditures denving from technically-assisted judicial court orders.

Request for financial assistance

The Government of the State of Rio de Janeiro believes that the set of policies described above, some of which are specifically supported by the Fiscal Sustainability, Human Development and Competitiveness Program, constitutes a coherent and sustainable effort to support economic and social development in the State. The Government of the State of Rio de Janeim is deeply committed to t s development program and to the specific policies supported by the DPL. With this letter the Government would like to request financial assistance from the World Bank in the form of a single tranche Development Poky Loan - DPL, aimed at supporting the measures already taken in connection with the mentioned program as well as those necessary to consolidate them.

Yours sincerely,

5

56

U 5

m m m v) a, a, - -

.

- 0 ."

0 I

0 .

ANNEX 3: MACRO ECONOMIC OUTLOOK AND DEBT SUSTAINABILITY IN THE STATE OF RIO DE JANEIRO

Fiscal Analysis: State of Rio de Janeiro: 2003 - 2008

Evolution o f Fiscal Balances, 2003 - 2008

The fiscal situation o f the State o f Rio de Janeiro experienced a turning point in 2006, when positive primary and fiscal balances dramatically improved. From 2003 to 2006 the fiscal balances were characterized by fiscal deficits and low positive primary balance. From 2006 to 2008, primary balances improved substantially so that total fiscal balances moved from deficit to a surplus o f more than R$2 billion. See Figure A3.1.

Figure A3.1. Total, Primary and Overall Balance from 2003 to 2008

4,000

E 3,000

c- cn

c,

m

E

E

- 2 2,000

e - 1,000

.- CI

.- I ez 0 *

0

2003 2004 2005 2006 2007 2008

...*... Total Balance - C Primary Balance Overall Balance I

Source: SEFAZ

Evolution o f Fiscal Revenues, 2003-2008

The State’s revenues benefited from a favorable economic environment in Brazil and worldwide, a boom in commodity prices which increased royalties from the o i l sector, as well as significant improvements in tax collection efforts. Between 2003 and 2008, tax revenues increased by 25 percent thanks largely to increases in the collection o f the ICMS34; oi l and gas sector revenues grew by 80 percent; and federal transfers doubled (See Table A3.1).

34 Impost0 estadual sobre circulaqrib de mercadorias eprestaqiio de serviqos, or State tax on circulation o f goods and services

62

Table A3.1. Evolution o f Revenue between 2003 and 2008 R$ million in real terms

2003.00 Values %

2004.00 2005.00 2006.00 2007.00 2008.00 Values % Values % Values % Values % Values %

31,450 18,388 2,227 3,729 7,106

Transfers revenues accounted for about 9% o f total revenues between 2003 and 2008 (see Table A3.2). As such the State o f Rio i s less dependent from Federal transfer than most Brazilian States. Federal transfers represent 68% o f overall transfers received by the State o f Rio during the same period. Transfers expenditures represented about 20.5% o f total current expenditures between 2003 and 2008. Two thirds o f the transfers went to Municipalities and one third to the Fund for Maintenance and Development o f Basic Education (FUNDEB). State net transfers o f Rio de Janeiro are negative since transfers to Municipalities and FUNDEB are larger than transfers from the Federal government and FUNDEB. Given i t s overall fiscal situation, the level o f State net transfers is sustainable. (See section on Evolution o f Fiscal Balances. 2003 - 2008)

1.00 33,071 1-00 33,872 1.00 37,010 1.00 38,359 1.00 42,746 1.00 0.58 19,823 0.60 19,423 0.57 20,755 0.56 21,375 0.56 22,921 0.54 0.07 2,786 0.08 3,267 0.10 3,521 0.10 3,446 0.09 4,440 0.10 0.12 3,729 0.11 4,587 0.14 5,653 0.15 4,629 0.12 6,728 0.16 0.23 6,732 0.20 6,594 0.19 7,080 0.19 8,909 0.23 8,658 0.20

Table A3.2. Evolution of Transfers between 2003 and 2008 Units: Thousand R$

2003 2004 2005 2006 2007 2006

Transfers Revenues 2,226,764 2,766,240 3,267,049 3,521,207 3,445,647 4,439,963 (As a share of total revenue) 7% 8% 10% 10% 9% 10%

Current Transfers

FPE Other Federal Transfers

federal Transfers

2,213,271 2,757,180 3,149,805 3,354,937 3,345,312 4,187,090 2,694,940 1,432,304 1,961,665 2,390,014 2,598,190 2,254,135

1,033,916 977,822 1,074,268 1,170,155 1,169,042 1,317,725 398,388 983,843 1,315,746 1,428,036 1,085,093 1,377,214

Transfers Revenue from FUNDEB 780,568 795,177 759,418 754,926 1,090,470 i,4a9,887

Private Transfers Capital Transfers

399 338 373 1,820 707 2,263 13,493 29,059 117,244 166,270 100,335 252,873

Transfers Expenses 6,020,432 6,531,346 6,523,117 6,926,345 7,355,697 8.31 I ,301 (As a share of current expenditure) 19% 21% 20% 20% 21% 22%

Transfers to Municipality Transfers to FUNDEB

4,288,034 4,658,684 4,664,217 4,967,745 5,071,681 5,535,271 2,776,030 1,732,398 1,872,662 1,858,900 1,958,600 2,284,016

Net Transfers -3,793,668 -3,745,107 -3,256,069 -3,405,139 -3,910,050 -3,871,338

Source: SEFAZ

Evolution o f Expenditures, 2003-2008

Fiscal adjustment efforts f rom 2003 to 2008 consisted to a large extent in limiting the growth o f current expenditures, including salaries as well as goods and services (custeio). Between 2003 and 2008, current expenditures (which on average represented 95 percent o f total expenditures) increased by 22 percent. In contrast, capital expenditures which constituted 5 percent o f total expenditures increased by 60 percent, with investment growing by 87 percent over the same period. Current expenditures were composed mainly o f social and wage expenditures (26 percent), goods and services (26 percent), and transfers to municipalities (20 percent). Between 2003 and 2008 social and wage expenditures increased the most (30

63

percent) followed by transfers to municipalities (27 percent) and operating cost (20 percent). However, these growth rates were modest compared to revenue growth, and this explains the comfortable fiscal situation o f 2008.

Table A3.3. Evolution of Current and Capital Expenditures from 2003 to 2008

Expenses

I Total Expenses Wages and Salary Pensions Custeio Interest Payments Transfers Capital Expenditure

32,121

1 9,436 5,884 1,361 2,403 6,020

1,011

2004.00

100 I I 100 33,711

8,382 5,195 9,122 2,219 6,523

1,609 5% I 2,611 Source: SEFAZ

= 100 YO

23% 17% 27% 6% 19%

7% -

36,906

10,238 6,198 9,023 2,513 1,356

1,519

R$ million in real terms 2008.00

100 I I 100

Evolution o f net consolidated debt, 2003-2008

Following a lax fiscal stance in the 1980s and 1990s, the State o f R io de Janeiro benefited from three bailout operations from the Federal Government between 1989 and 2003 (see Box 1). In accordance with the conditions o f the last bailout and following the enactment o f the Fiscal Responsibility L a w in 2000, the State o f Rio de Janeiro was obliged to tighten its fiscal stance.

Despite very strict observance o f the debt renegotiation contract, the stock o f the GORJ’s refinanced debt has continued growing during the present decade. The stock o f this debt amounted to almost R$50 bi l l ion in the f i rs t quarter o f 2009, or 94 percent o f the total debt o f Rio de Janeiro. Several factors have mntributed to shape the debt dynamics o f the Rio State Government: the automatic rollover o f part o f the interest due on the debt with the National Treasury Secretariat (above the 13 percent cap), wholesale price shocks (the debt stock i s corrected by wholesale prices that are very closely linked to exchange rate variations) and revenue performance (as debt service payments are linked to revenue). The relatively small non-federal debt or extra-limite debt has benefited from the appreciation o f the real. (See Table A3.4)

64

Table A3.4. Rio de Janeiro State Government- Consolidated Debt, 41-2009 R$ mil l ion

Consolidated debt (I) 52,990 Intra-limit debt (93.8 %) 49,707

National Treasury (STN)

National Treasury (STN) BNDES I N S S IADB IBRD Other

Extra-limit debt (6.2 %) 49,707

3,283 117 976 108 923 3 99 760

Deductions (11) 7,502 Financial Assets 7,502 Net Consolidated Debt (1-10 45,489 Memo Items Net Current Revenue 31,924 Net Consolidated Debt / N e t Current Revenue 142% I Fiscal Responsibility Law Ceiling: 200%

Source: SEFAZ

At the same time, thanks to the State’s good revenue performance and consistent fiscal adjustment, the net consolidated debt to revenue ratio has fallen during the last six years, from 202 percent in 2003 to 160 percent in 2008. As a result, R io de Janeiro i s in compliance with the Fiscal Responsibility L a w that requires the ratio o f net consolidated debt to net current revenue to be below the ceiling o f 200 percent. See Figure A3.2.

Figure A3.2: Evolution of Net Consolidated Debt, 2003-2008

60,000 i 50,000

v) 40,000

E 30,000

20,000

10,000

E 0 .- f *

2003 2004 2005 2006 2007 2008

250%

200%

150%

100%

50%

0%

-Net Consolidated Debt Net Current Revenue -Net Consolidated debt / Net Current Revenue (%

Source: SEFAZ

Debt service has been growing modestly, mainly f rom interest payments. As per the Fiscal Responsibility Framework, debt service is capped at 1 1.5 percent o f net current revenues. Hence, as these have grown so has debt service. However, the ratio o f debt service to net current revenues has decreased from 12 percent in 2003 to 8 percent in 2008. See Figure A3.3.

65

Figure A3.3. Evolution of Amortization and Interest Payments on the Debt

W INTEREST PAYMENTS W DEBT AMORTIZATION

4,000,000

Personnel Expenditures (5 60% NCR)

Executive (5 54% NCR)

Legislative (5 6% NCR)

Judiciary 5 6% NCR)

Public Ministry (5 4% NCR)

Net Consolidated Debt (5 200% NCR) Debt Service (5 11,5% NCR)

3,500,000

3,000,000

2,500,000

2,000,000

1,500,000

1,000,000

500,000

47 2% 38 9% 40 2% 36.1% 34 7% 31 7%

39 3% 31 3% 31 0% 27 5% 26.2% 23 9%

2 1% 2 0% 2 4% 2 2% 2.3% 2 1%

4.8% 4 6% 5 6% 5 1% 4 9% 4.4%

1 0% 1 0 % 1 3% 1.3% 1 4 % 1.2%

202 2% 204 3% 190 1% 172.5% 173 5% 160.4%

12 3% 12 0% 11 7% 8 3% 12 0% 7 9%

2003 2004 2005 2006 2007 2008

Source: SEFAZ

Evolution o f Fiscal Responsibility Indicators from 2003 to 2008

Since 2003, the State has improved in al l indicators monitored by the Federal Treasury under the Fiscal Responsibility Law. Thus, by 2008 al l indicators were wel l below their prudential limits, indicating a comfortable situation on the fiscal and debt sides. See Table A3.5 and Figure A3.4.

66

Figure A3.4. Evolution of Fiscal Responsibility Law Indicators

aJ 200% a C aJ 5

250%

........................ ............ .......................... ............

I - --- .II, - - w o o - - - - - - - - - - - - - 2004 2005 2006 2007 2008 2003

- - Personnel Expenditures .+.-.+* Net Consolidated Debt e- Debt Service

Source. SEFAZ

Impact of the Financial Crisis

The F l ~ m i n e n s e ~ ~ Economy

The economy o f the State o f Rio de Janeiro i s recuperating from the impact o f the global financial crisis, which hit the industrial sector hard but did not affect the booming extractive industry. In June 2009, the State’s Production Index increased 0.5 percent month on month. This was the second consecutive increase, indicating that the effects o f the crisis are bottoming out. However, this Index s t i l l remained 7.4 percent below and industrial production 10 percent below the level o f June 2008. This i s in contrast with the dynamism o f production in the extractive industry, which increased 11.4 percent in May 2009 compared to the previous year, and 3.9 percent compared to the previous month. Similarly, in June 2009 capacity utilization surpassed the level o f 80.4 percent reached a year earlier. Looking forward, confidence indexes based on enterprise surveys performed in the State also suggest a strong recovery starting in the second quarter o f 2009 - Indice de ConJianza do Empresdrio Industrial Fluminense. See Figure A3.5 below.

35 Fluminense i s an inhabitant o f the State o f Rio de Janeiro.

67

Figure A3.5. Confidence Index and Expectations o f Industrials in the State o f Rio de Janeiro

-I( ICE1 RJ * ' '~~~& ' c Current Conditions - E Expectations 70 -.l

40 35 1 30 I I I I I 1

Source: Federaqao das Indzistrias do Estado do Rio de Janeiro (FIRJAN)

The external sector o f the State o f Rio de Janeiro registered a positive balance in June 2009 despite a sharp drop in exports relative to imports. The trade balance stood at US$28.7 mi l l ion with exports at US$918.4 mi l l ion and imports at US$889.6 mil l ion. Compared to June 2008, exports have dropped 54.7 percent and imports 37.1 percent, resulting in a reduction o f the trade surplus o f 95.1 percent. The drop in exports for the first semester o f 2009 was due to a price decrease o f 49.7 percent despite a quantity increase o f 25.6 percent. Currently, the U.S. remains the State's main export partner. The sharp drop in exports also highlights the need for the State to diversify i t s export destinations.

Fiscal impact o f the global financial crisis

From September 2008 to April 2009, the fiscal revenues o f the State o f Rio de Janeiro showed resilience to the global crisis. This i s a consequence o f the structure o f the economy. Indeed, the economy relies heavily o n o i l and gas production which, because o f the cost structure, can only adjust volumes to demand fluctuation with a substantial lag. Hence, despite the crisis, State tax revenues increased 16.6 percent in the f i rs t trimester o f 2009 compared to the previous year. Revenues from the sales tax (ICMS) remained very strong, and increased 10.4 percent in the f i rs t quarter o f 2009 compared to 2008. Revenues from taxes on vehicle ownership (IPVA) also increased during that period (by 24 percent), benefiting from countercyclical measures targeted to the vehicle sector at the federal level. As such, state revenues were only minimally affected by the 20.6 percent reduction in industrial production observed during the same period. Moreover, while Transfers from the Federal Government (FPE) fel l 6 percent compared to the previous year, this had a l imited impact on overall State revenues, which are only modestly dependent on these transfers.

Starting in May 2009, however, the State's fiscal balances have started deteriorating mainly as a result o f decreased revenue collection and relatively rigid current expenditures and a large increase in capital expenditures. In particular, revenues in the third bimester f e l l 6.2 percent below projected levels, driven by a drop in patrimonial taxes which include oi l and gas receipts, and a stagnation o f the sales tax receipts (ICMS). Capital revenues were also below bimestrial targets. On the expenditures side, personnel expenditures increased 1 1.5 percent in May-June 2009 compared to the previous year, and capital expenditures increased 69.4

68

percent. Overall, whi le total revenue growth was st i l l positive at 3.5 percent, total expenditures increased by 10.2 percent; as a result primary balances were 25.6 percent lower in May-June 2009 than in the same period o f the previous year.

The reduction in fiscal revenues from the o i l and gas sector i s o f particular concern for two reasons. First, revenues from oi l royalties have been responsible for a large fraction o f the observed increases in fiscal balances (Figure A3.6), which highlights the risks associated with the volatility o f those revenues and increases the importance o f avoiding their use for the financing o f current expenditures. Second, revenues from royalties directly affect the funding o f the social security fund for the State’s public servants (Rio Prev idh ia) . However, the relatively high transfers made to the State’s Pension Fund during the period o f high o i l prices - turned into assets o f the Fund - are expected to reduce the need for large transfers during 2009.

Figure A3.6. The evolution of Fiscal Balances with and without Royalties 6,000,000

4,000,000 -Gross Operating Balance (With Royalties)

- -0 - Gross Operating Balance (Without Roya It ies)

-Primary Balance (With

_ _ _ m Primary Balance (Without

00 2,000,000

0

0 0 N

0 v k er

rc

‘0 Royalties)

Royalties) a

Overall Balance (With Royalties)

Royalties)

= -2,000,000 a 0 c I- -4,000,000

-6,000,000 *-----Overall Balance (Without

-8,000,000

1003 ZOO‘ ZOO’ $06 TOO’ TO@

Source: SEFAZ

Looking forward, even under the most pessimistic scenario, and without assuming any revenues from the l ikely exploitation o f the newly discovered “Pre-Sal” reserves, projected revenues from o i l royalties are expected to offer a comfortable situation to the State o f R io during the coming decade. To a large extent, this i s due to the fact that production i s expected to benefit, starting in 201 0, from the exploitation o f the “Tupi” field, which is part o f the “Pre- Sal” layer, and i s the largest f ield discovered in the Americas since Mexico’s Cantarell (1 976). The new revenues from “Tupi” are likely to compensate for any foreseeable decline in revenues derived from further reduction in oi l prices.

69

Fiscal and Debt Proiections for 2009-2019

The projected fiscal accounts o f the State of Rio de Janeiro suggest a sustainable trend in the medium term.36 The trajectory o f revenues in the medium term i s largely driven by sales tax and capital revenues, as well as revenues from o i l royalties. O n the expenditures side, the main determinants are personnel expenditures and purchases o f goods and services. The resulting fiscal balances, i.e. the primary fiscal baiance, the overall balance and the gross operating balance, are al l expected to record surpluses for the projected period, thus creating fiscal space for increased State Investments.

The main risks to a deterioration o f fiscal balances in the medium term are related to fluctuations in both macro and micro variables. On one hand, fiscal balances are sensitive mainly to the exchange rate, GDP growth, and inflation. Revenues are also sensitive to the volatility o f o i l and gas receipts, which in turn depend on the quantity o f o i l produced and the price o f oil. O n the other hand, expenditures are sensitive to accumulated judicial claims (precatdrios) that the State o f Rio de Janeiro must pay to a wide range o f creditors. There i s uncertainty on the exact date o f such payments and this uncertainty is modeled using scenarios prepared by SEFAZ.

The objective o f the analysis is to establish whether any given shock that i s considered may negatively affect revenues or increase expenditures and thus squeeze the fiscal space for investments. The baseline projection o f the fiscal and debt aggregates under the baseline scenario indicates a comfortable situation, with positive primary fiscal balances. In particular, revenue growth i s higher than expenditure growth after 2014, resulting in an increasing fiscal balance. On the debt side, the overall increase for 2008-2019 is about 2.5 percent, well below the limits set by the Federal Government. In comparison, between 2003 and 2008, the State debt increased by 32 percent at current prices, driven mainly by the intra-Zimite debt (See Figure 4). Based on data on the schedule o f amortizations and interest payments for 2009- 2019, the stock o f debt corrected by the IGP inflation is expected to increase by 16 percent until 2015, and decrease afterwards as the amortization schedule increases. See Figure A3.7.

__ Figure A3.7: Evolution o f Net Consolic

Net Consolidated debt, 2003 - 2019 70 000 000

60 000 000 Prqect

I 30000000

8 20000000

10 000 000

2003 2005 2007 2009 2011 2013 2015 2017 2019

Source.

ted Debt and Debt Service, 2003-2019

Amortization and interest payments schedule for 2009-2019

4,000,000 3,500,000 3,000,000 2,500,000 ; 2,000,000

=- 1,500,000 f 1,000,000

500,000

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

- Total interest Paymentr Total Debt Amortization

;EFAZ

36 We use the Government Finance Statistics (GFS) fiscal classification and the assumption for fiscal projections presented in Annex 6.

70

Fiscal Responsibility Law Indicators Pro-iections

The fiscal and debt sustainability analysis shows a sustainable path for the main fiscal responsibility law indicators for 2009-2019. Hence, personnel expenditures as a ratio o f net current revenue (NCR), the net consolidated debt per NCR and the debt service as a share o f NCR will remain below the limits set by the Federal Government (See Figure A3.8). Personnel expenditures per NCR, which are assumed to grow in l ine with the nominal GDP growth rate and the population growth rate, are slightly increasing, but remaining below the limits o f 60 percent o f NCR. The net consolidated debt to NCR indicator i s expected to decrease by 89 percent from 2009-2019 driven by the projected surpluses in the overall fiscal balance, Le., including the net interest payments. Given the amortizations and the interest payments profiles, the debt service per NCR i s following a sustainable path with no major debt principal repayments expected for the next 10 years.

Figure A3.8: Fiscal Responsability Law Indicators, 2003-2019 I

W E W

er c

S U 0) z

a

L

t! w

L

U

x

250%

200%

150%

100%

50%

0%

2003 200420052006200720082009201020112012201320142015 2016201720182019

- - Personnel Expenditures .*-*.-. Net Consolidated Debt -Debt Service

Source. SEFAZ . ._ _ _ . . _ _.. . . -

Risk Analysis

The risk analysis assesses the impact o f uncertainty surrounding fundamental macroeconomic variables such as the exchange rate, the GDP, oi l revenues, and inflation on the fiscal and debt projection^.^^ The analysis consists o f adding stochastic shocks to the fundamental economic variables and assessing the impact o f these shocks on projected fiscal and debt aggregates. We also assess the impact o f simultaneous random shocks on the fiscal and debt aggregate by performing Monte-Carlo simulations which draw shocks from specific probability distributions.

The risk analysis finds that the fiscal situation o f Rio State i s sustainable and the impact o f the current World Bank operation i s positive and sustainable. Since the portion o f foreign- denominated debt i s small, the impact o f the exchange rate on the debt dynamics i s not significant. The impact o f the different scenarios for royalties revenues does not change the

The assumptions made for the fiscal projections and to assess the impact o f risks related to macroeconomic

71

37

variables and “Pre-sal” o i l production are found in the final section o f this Annex.

positive sustainability result. The payments related to judicial claims do not affect sustainability either. Figure A3.9 below shows that the State Government is likely to remain below FRL requirements, even when subject to a combination o f stochastic shocks.

Figure A3.9: Risk Analysis

, . . . . . . . . . , . . . . . . . . . , i i i i i i i . .

2010 2012 2014 2016 2018

Time

Probability - 0.1 - 0.5 - 0.9 - 0.25 J ( - ( ( 0.75

180%

160%

140%

120%

100%

80% 2008 2010 2012 2014 2016 2018

Time

Pro ba bi I i ty - 0.1 - 0.5 - 0.9 - 0.25 . 0.75

56%

54 %

52%

50%

47%

45% i

...* ......................... .i . . . .

!008 2010 2012 2014 2016 2018

Time

Probability - 0.1 - 0.5 - 0.9 - 0.25 _ " x 0.75

2008 2010 2012 2014 2016 2018

Time

Probability - 0.1 - 0.5 - 0.9 - 0.25 I 0.75

Impact o f the Loan on Fiscal Aggregates

Overall impact o f the proposed operation on Rio de Janeiro State fiscal position i s manageable and does not violate the limits o f Fiscal Responsibility Law. The loan will affect the fiscal aggregates by increasing net current revenues and fiscal balances in 2010. N e t debt is also affected through an increase in the stock o f debt denominated in foreign currency and through a change in the cash flow profile. Interest repayments will increase by 2% in the near term. N e t current revenue, level o f investment, primary balances, gross operating balance and fiscal responsibility law indicators will change as indicated in Table A3.6.

72

Table A3.6: Wlhout Bank Operalion With Bank Operation Variation

Unl: R$ Thousand

I, Total Revenue Taw Revenue Sccial Contributions Other Current Revenue Ofwhich: Interest revenue

R o y a l t i Royaities (ss of Total revenue)

Current Transfers Caplal Transfers

Net Current revenue

~ _____

2 w 9 2010 2011 2012 2013 2009 2010 2011 2012 2013 2010 2011 2012 2013

42,999,365 46,586,876 48,176,256 50,496,806 52,752,731 23940,082 26,111,022 28,367,722 30,747,843 33233,225

914,594 977,664 1,042,092 1,108,640 1,176,045

12,480,453 13,450,948 13,145,585 13,318024 12,151,905

1,330,455 1,414,232 184,049 719,586 651289 4,292,225 4,717,901 4,700,219 4,527,777 3,623,193

42,999,365 47,640,876 48,176,256 50,496,806 52,752,731 23940,082 26,111,022 28,361,122 30,741,843 33,233,225

914,594 971,664 1,042,092 1,108,640 1,176,046

12,480,453 13,450,948 13,145,585 13,318,024 12,751,905

1,330,455 1,414,232 184,049 719,586 651,289 4,292,225 4,717,901 4,700,219 4,527,177 3,623,193

lP? 1096 16% P?? 7% 4,417,573 4,675,912 4,935,192 5,198879 5,460,902 1,246,664 1,311,330 685,665 123,420 124,654

looh 10% 1096 5% 7% 4,411,513 4,675,912 4,935,192 5,198,879 5460,902 1,246,664 2425330 685,665 123,420 124,654 11% 0% 0% 0%

II.Tota1 Expenditures Employee Compensation

Ws and Selvices

Interest Payments

Transfers

Pensions

Precatobs

111. Gross OperaSng Balance (141) W. lnvesbnent in Non. FiMncial Assets

V. Primary Balance (Primary Balance/ NCR) VI. Net Lending I BorroHing (Overall Balance)

32,658,661 35,641,448 36,623,904 38,327,211 39969,789 32,658,661 36,695,448 36,623,904 38,327,211 39,969,789 3% 0% WC 0%

40,041,142 42,250,134 44,448,317 46,565,345 4,759,737

11311,425 12,091,451 12,888,289 13,711,335 14,544,984

10,785389 11,416,118 12049,142 12,692,928 13,332,651

2,369,647 2,383,000 2,402,018 2,399,431 2,384,324

8,768,805 9,281,604 9,796,269 10,319,684 10839,796

6,539,348 6,781,329 7,013,895 7,129,420 1,332,087

266,528 290,621 298,703 312,548 325895

2,958,224 4,336,743 3,721,940 3,931,461 3,992,994

1,892,818 3,470,036 2,672,868 2,635,859 2,301203

2,106,598 1,775,473 2,673,041 2,975,446 3,411,826 6% 5% 7% 8% 9%

1,065,405 666,704 1,055,072 1,295,601 1,684,792

40,041,142 42279,441 44,506,660 46,623,765 48,817,942

11,311,425 12,091,451 12,888,289 13,711,335 14,544,984

10,185,389 11,416,118 12049,142 12,692,928 13332,651

2,369,647 2,412,308 2,460,362 2,457,851 2,442,529

8,768,805 9,281,604 9,796,269 10,319,684 10,839,796

6,539,348 6,187,329 1,013,895 7,129,420 7,332,081

266,528 290,621 298,703 312,548 325,895

2,958,224 5,361,435 3,669,596 3,873,040 3,934,789

1,178,207 4,216,149 2,379,513 2,351,050 2,068,838

2,319,209 2,083,362 2,966,396 3,260,255 3,651,191

1,280,017 1,145,286 1,290,083 1,521,990 1,865,951

1% 2% 2% 2%

24% 4 % -1% .1%

22% -11% 1 1 % .lo%

17% 11% 10% 7%

32% 22% 17% 11%

Impact o f the Operation on Specific Government Finance Categories

Net Current Revenues (NCR). The IBRD loan disbursement will be counted as an extraordinary capital transfer to the State Government and therefore will increase the net current revenues in 20 10.

Investment. The proposed operation will increase the fiscal space, therefore allowing more room for investment in 2010 allowing the investment as a share o f N C R to increase from 9 percent to more than 11 percent.38

38 The minimum level o f investment i s guaranteed by the allocation o f 5% of the oil revenues to the Fundo Estadual de Conservaqrio Ambiental (FECAM), a state's environment conservation fund. The fiscal space left for further investment i s defined on one hand by the surplus o f the gross operating balance net o f the total amortization and on the other hand on the capital transfers negotiated every year with the Federal Government to finance definite investment projects. . In the following analyses, no assumptions have been made on prospective projects with Unigo. As such, al l investment expenditure wil l only be within the fiscal space left by the gross operating balance.

73

Primary balances. The operation will increase the primary balance. The increase in the capital transfers will be absorbed by an increase in the level o f investment; such increase will be less than proportional.

Gross operating balance. The operation will increase the gross operating balance in 2010 allowing for more fiscal space for investment.

Debt service and debt dynamics. The Bank operation will increase the debt service profile, but remaining s t i l l below the FRL requirements. As expected, the loan disbursement will increase the stock o f debt, but the operation will not affect the debt sustainability o f the State o f Rio de Janeiro, which will also remain within FRL requirements.

Time

WB loan - Wthout W0 loan - With W0 loan

2008 2010 2012 2014 2016 2018

Time

WB loan - Without WB loan - With WB loan

2008 2010 2012 2014 2016 2018

P

's E E 1 B

0 z

e n 'E

....I ! i .I .... .j ....... I .....I ..... !

2008 2010 2012 2014 2016 2018

Time

- With WB loan

Tim.

WB loan - Without WB loan WB loan - Without WB loan - With WB loan

2010 2012 2014 2016 2018

Time

WE loan - Without WB loan - With WB loan

Impact on FRL Indicators3'

Personnel Expenditure as a share of NCR. The proposed operation will not affect personnel expenditures per se since the State Government cannot use external credit operation proceeds to finance their personnel expenditures. However, since the loan will increase the net current revenue, the personnel expenditures expressed as a share o f NCR will improve at loan disbursement in 2010.

I t i s important to assess the impact o f the operation on the State's FRL indicators as per the State Debt

74

39

renegotiation agreement. These indicators reveal the fiscal health o f the State.

Net Consolidated Debt and Debt services as a share of NCR. The Bank loan will increase the debt service profile and the debt stock; however debt service and debt stock will remain below the FRL requirements.

2008 2010 2012 2014 2016 2018

Time

- With WB loan WB loan - Without WE loan

2008 2010 2012 2014 2016 2018

Time WE loan - Without WB loan - With WB loan

Assumptions for Risk Analysis

Under the baseline scenario, the fiscal accounts o f the State o f Rio de Janeiro will evolve as follow: revenues and expenditures will broadly grow in l ine with IPCA inflation and a growth variable estimated by SEFAZ corresponding to a composite variable o f growth factors. Under the baseline scenario, this growth variable i s estimated to 1% and under the pessimist scenario this variable is assumed to grow at 0%. The fundamental macroeconomic variables that are affecting fiscal projections are detailed in Table A3.7.

75

Table A3.7: Assumptions for Fiscal Projections

Variables Assumptions Base year figures- 2008 REVENUES Tax Revenues ICMS Motor Vehicle Tax (IPVA) Others tax revenues Social Contributions Transfers Current Transfers

Federal transfers (incl. FPE) Other current transfers FUNDEB and other Capital

Grants Capital Transfers

Other Current Revenues Non financial assets and Admin. Fees Interest revenue Royalties Sales and miscellaneous Deduction to Revenue Net Current Revenue

Increase with real GDP growth and IPCA inflation Increase with growth variable estimated by SEFAZ and IPCA inflation Increase with growth variable estimated by SEFAZ and IPCA inflation. Increase with personnel growth and IPCA inflation.

Increase with growth variable estimated by SEFAZ and IPCA inflation Increase with growth variable estimated by SEFAZ and IPCA inflation Increase with growth variable estimated by SEFAZ and IPCA inflation

Increase with population growth and IPCA inflation

Increase with growth variable estimated by SEFAZ and IPCA inflation

Revenues from CFT Bonds. Data provided by SEFAZ Increase with projection on Royalties growth Increase with growth variable estimated by SEFAZ and IPCA inflation Transfers to municipalities and social contribution revenues Current Revenue deducted by transfers to municipalities and social contribution revenues

Net Real Revenue EXPENDITURES Wages Goods and Services Transfers to municipalities Interest payments Social Benefits (Pensions) Investment

Amortizations Precatdrios IBRD Loan

Estimates provided by SEFAZ

Increase with personnel growth and IPCA inflation. Increase with growth variable estimated by SEFAZ and IPCA inflation. Increase with growth variable estimated by SEFAZ and IPCA inflation. Obtained from Debt Department o f SEFAZ 5 years Moving average 5% o f FECAM and fiscal space left by the gross operating balance after payments o f debt. Obtained from Debt Department o f SEFAZ Estimates provided by SEFAZ expressed as a share o f Net Current Revenues US$485 million disbursed in one tranche.

Regarding the macroeconomic variables, the pro'ections for the exchange rate are based on the forecast o f the Economic Intelligence Uni$', while those for the national population growth rate a stemming from the estimates o f IBGE, the Brazilian Institute o f Geography and Statistics. Estimates for the personnel growth rate are provided by SEFAZ.

In order to produce alternative series for the macroeconomic variables, we fol low the IMF standards and use a hal f standard deviation stemming from the historical data4'. Hence, since a lower real GDP growth rate can be a risk for the state government, we assume for the alternative real GDP growth, a rate corresponding to the baseline real GDP growth rate minus a hal f o f the appropriate standard deviation. In the same way, higher inflations are assumed for the alternative scenario by adding 0.5 standard deviation to the baseline projection. Finally, we assume an increase o f 20% in the depreciation rate as an alternative scenario,

Estimates as o f August, 26 2009. The historical data are on an annual basis, from 1998 to 2008.

40

41

76

which is also a common alternative used by the IMF. The assumptions for the baseline and the alternative scenarios are summarized in Table A3.8.

GPI inflation

alternative baseline (higher)

3.0% 6.6% 4.5% 8.1% 4.5% 8.1% 4.5% 8.1% 4.5% 8.1% 4.5% 8.1% 4.5% 8.1% 4.5% 8.1% 4.5% 8.1% 4.5% 8.1% 4.5% 8.1%

Personnel growth

alternative baseline (hiaher)

Table A3.8: Assumptions for Macroeconomic Variables (Baseline and Alternative Scenarios)

IPCA inflation

alternative baseline (higher)

4.5% 6.0% 4.8% 6.3% 4.5% 6.0% 4.3% 5.8% 4.0% 5.5% 4.0% 5.5% 4.0% 5.5% 4.0% 5.5% 4.0% 5.5% 4.0% 5.5% 4.0% 5.5%

Judiciary Debt -precat6rlos - (% of NCR)

baseline (hiaher) alternative

Year

2009 201 0 201 I 2012 2013 2014 201 s 201 6 2017 2018 2019

Year

2009 2010 201 1 201 2 2013 2014 201 5 201 6 2017 2018 2019

2.0% 3.0% 2.0% 3.0% 2.0% 3.0% 2.0% 3.0% 2.0% 3.0% 2.0% 3.0% 2.0% 3.0% 2.0% 3.0% 2.0% 3.0% 2.0% 3.0% 2.0% 3.0%

Real GDP growth rate

0.8% 2.0% 0.8% 2.0% 0.8% 2.0% 0.8% 2.0% 0.8% 2.0% 0.8% 2.0% 0.8% 2.0% 0.8% 2.0% 0.8% 2.0% 0.8% 2.0% o m o 2.0%

alternative baseline (lower) -0.07% -1.1% 4.25% 3.2% 4.13% 3.1% 4.08% 3.0% 4.08% 3.0% 4.08% 3.0% 4.08% 3.0% 4.08% 3.0% 4.08% 3.0% 4.08% 3.0% 4.08% 3.0%

Population growth rate

baseline 1.1% 1.1% 1 .O% 1 .O% 1 .O% 0.9% 0.9% 0.9% 0.9% 0.8% 0.8%

I

Growth variable estlrnated by SEFAZ

ERJ

alternative baseline (lower)

1 Yo 0% 1 Yo 0% 1 Yo 0% 1 Yo 0 Yo 1 Yo 0 Yo 1 Yo 0% 1 Yo 0 Yo 1 Yo 0 Yo 1 Yo 0 Yo 1 Yo 0% 1 Yo 0%

Exchange rate (R$IUS$)

alternative baseline (higher)

1.83 1.83 2.13 2.18 2.1 1 2.16 2.10 2.16 2.10 2.15 2.10 2.15 2.13 2.19 2.15 2.22 2.17 2.24 2.18 2.26 2.20 2.27

Revenues from royalties are calculated as a share a o f the revenues o f o i l and gas as shown in the following formula:

Royalties = a(Poil x Veil + P,,, x V,,,)

The share, called diquotu, i s an anticipated percentage o f the contracts on the f ield concession and the historical average is around 2%. In order to make the projections, estimates were used, which were provided by SEFAZ on commodity prices and production o f o i l and o f gas.

Four cases were considered. First the baseline case considers the production o f “Tupi” o i l f ield without any further extraction o f the “Pre-sal” layer. Then three cases are used as alternative scenarios o f future production o f the “Pre-sal layer”: scenario 1 depicts an optimistic view on the o i l revenues coming from the “Pre-sal” o i l field, scenario 2 presents a moderate projection o f o i l revenue and finally scenario 3 present lower revenues.

The following table shows the estimates for the prices and productions o f the o i l and gas as wel l as the resulting royalties using the historical average o f 2% for the aliquotu.

77

Table A3.9: Baseline scenario for revenue from royalties

634 671 676 637 50 1 840 84 1 777 71 3 662 620

Year

2009 201 0 201 1 201 2 2013 2014 2015 2016 2017 201 8 2019

634 671 676 637 50 1 774 775 71 1 647 596 554

Production of Oil (Million of

Barrel) baseline

634 67 1 676 637 501 528 529 465 40 1 35 1 309

4,292 4,718 4,700 4,528 3,623 4,902 4,893 4,542 4,206 3,945 3,727

Production of Gas (MMBtu")

baseline 16,565 11,377 8,359 7,607 5,751 5,393 4,865 4,258 3,740 3,334 2,993

4,292 4.71 8 4,700 4,528 3,623 4,704 4,689 4,332 3,990 3,724 3,500

Price of Oil (Wbarrel)

baseline 54.68 65.00 66.30 67.63 68.98 70.36 71.77 73.20 74.66 76.16 77.68

Price of Gas (US$/MMBtu")

baseline 4.00 6.00 8.00 8.50 9.00 9.50 10.00 10.10 10.20 10.30 10.40

I/ MMBtu stands for one million British Thermal Unit (BTU), the traditional unit of energy. 21 Using the baseline scenario for the exchange rate.

Table A3.10: Alternative scenarios for the oil production

Production of Oil (Million of Barrel) I Year

2 0 0 9 2 0 1 0 2 0 1 1 2 0 1 2 201 3 2 0 1 4 201 5 2 0 1 6 2 0 1 7 2 0 1 8 201 9

Alternative 1

671 676 637 501 906 907 843 779 728 686

11 Using the baseline scenaric

Royalties (Million of R$)

baseline 4,292 4,718 4,700 4,528 3,623 3,770 3,728 3,343 2,975 2,683 2,433

Alternative 3 4,292 4,718 4,700 4,528 3,623 4,506 4,485 4,122 3,775 3,503 3,274

78

ANNEX 4: BRAZIL AT A GLANCE 1V8/09

POVERTY and SOCIAL La t in Upper-

Amer ica mlddle- Braz l l 8 Carlb. I ncome

9 0 0 8 Po pulat io n, mid-year (millio ns) 8 2 0 GNIpercapda(Atlasmethod, US$) 7,300 GNI (Atlas method, US$ billions) 14013

Average annual growth, 2002-08

Population (%) 12 Labor force (%) 2 2

Poverty (%of population below national po verty line) 22 86

Llfe expectancy at birth (@am) 73 Infant mortailty (per 1000hve bitfhs) 20 Child malnutrdion (%of children under5) 2 Access to an improvedwatersource (%ofpopulation) 91 Literacy (%ofpopulation age 159 86 Gross primary enro llment (%of school-age population) UO

Male 134 Female P 5

M o s t recent es t lmate ( la tes t year avallable, 2002-08)

Urban po pulat io n (%of total population)

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

' 1988 1998

GDP (US$ billions) 3304 8438 Gross capital formation/GDP 2 2 7 T O Exports of goods and services/GDP D 9 6 9 Gross domestic savingslGDP 2 7 9 150 Gross national savings/GDP

Interest payments/GDP 19 17 Total debt/GDP 3 0 7 2 6 6 Total debt service/exports 2 5 9 7 5 8 Present value of debtlGDP Present valueof debt/exports

Current account balance1GDP 13 - 4 0

1988-98 1998-08 2007 ' (average annualgmwth) GDP 2 3 3 3 5 7 GDP per capda 0 7 2 0 4 6 Exports of goods and services 5 4 9 1 6 7

561 824 5,801 7,D7 3,252 5,854

13 0 7 2.3 14

78 75 73 71 22 21 4

91 95 91 94

118 111 PO 10 116 D 9

2 0 0 7 ' 2008

13333 15752 177 8 9 u 7 143 8 3 8 1 n5 6 9

0 1 - 18 11 10

n 3 162 272 228 8 6 156

u 1 9 Di l

2008 2008.12

5.1 3 3 4.1 2.5

-0.8 14.2

Developmentdiamond'

Life expectancy

GNI Gross per primary capita nrollment

&

Access to improved water source

- Bradl - Upper-mlddle-income gnup

Economlcratbs'

Trade

Domestic Capital savings formation

Indebtedness

- Brazil - Upper-mlddle-income gmlp

STRUCTURE o f the ECONOMY

@of GDP) ' 1988 1998

Agriculture D.1 5.5 Industry 43.6 25.7

Manufacturing 310 15.7 Services 46.2 68.8

Household final consumption expenditure 59.5 64.3 General gov't final consumption expenditure P.6 20.8 Imports of goods and services 5.7 8.9

(average annual growth) Agriculture Industry

Services Manufacturing

1988-98 1998-08

2.5 4.4 15 2.8

2.6 3.0 3.3 4.0

Household final consumption expenditure 3.9 3.0 General gov't final consumption expenditure 0.7 2.9 Gross capital formation 2.6 2.8 Imports of goods and services 14.6 5.5

2 0 0 7 ' 2008

6.0 6.7 28.1 28.0 n .4 16.0

66.0 65.3

60.8 60.7 8 . 9 20.2 P.1 14.2

2007 ' 2008

5.9 5.8 4.8 4.3 4.7 3.2 6.0 5.3

8.8 6.9 4.7 5.6 13.5 U .8

20.8 18.5

Growth o f capltsl and GDP (%)

20 I

10

0

04 05 08 07 OB -1 0

-GCF *GDP

Growth of expotts and lmpotts (%) 1 30 20 10 0

-1 0 -20 04 05 06 07 08

- Expolfr .-C lmpolts

Note: 2008 data are preliminary estimates. 'Thediamonds showfourkey indicators inthecountry(in bo1d)comparedhith its income-groupaverage. Idataaremissing,thediamondwill

be incomplete.

79

PRICES and GOVERNMENT FINANCE

Damsrk,wices

Consumer prices Implicit GDP deflator

&pm.mBrmamp p::::'€dm hYk+c cwm-ya-ws) Current revenue Current budget balance Overall surplusldeficit

TRADE

p'&+yl

pwm&i-oxq Total exports [fob]

Coffee Soybeans Manufactures

Total imports [cif] Food Fuel and energy Capital goods

Export price index ,Gm:!@) Import price index ,GW:!@) Terms of trade &WW!@)

BALANCE of PAYMENTS

pwmt&-KLq Exports of goods and services Imports of goods and services Resource balance

Net income Net current transfers

Current account balance

Financing items [net] Changes in net reserves

Mi%%-#-- Reserves including gold I/M$m&kws? Conversion rate fECh&&$)

1988

980.2 651.1

10.8 -2.0 4.0

1988

32,809 2.091 3,175

18.389 14,605

376 4,104 4,195

88 44

199

1988

35,650 17,500 18.150

-13.776 -20

4,180

-2,931 -1.249

9,140 9.53E-8

EXTERNAL DEBT and RESOURCE F L O W 1988

101.295 IBRD 1.824 IDA

Total debt service 9,448 IBRD 429 IDA 0

/IWm&i-ox:) Total debt outstanding and disbursed

Composition of net resource flows Official grants 46 Official creditors -340 Private creditors 3,194 Foreign direct investment (net inflows] 2,804 Portfolio equity [net inflows) 189

World Bank program Commitments 0 Disbursements 0 Principal repayments 268 Net flows -268 Interest payments 161 Net transfers -429

1998

1.7 4.2

0.0 0.0

-0.8

1998

50,736 3,253 2,178

29,387 57.714

2.514 4.100

16,102

99 104 95

1998

59,037 75,722 -16,685

-18.188 1,458

-33,416

25,446 7,970

44,556 1.2

1998

224,632 171

48.465 77

0

103 3,632

15,728 31,913 -1,768

0 0

61 -61 15

.77

2007

4.5 3.7

23.9 2.3

-2.3

2007

160,649

6,709 83,943

12 0,6 2 2 2.082

20.085 25,125

114 94 121

10,558

2007

184,603 157,795 26,808

-29.291 4,029

1.551

85,933 -87,484

180,334 1.9

2008

7.1 5.9

24.8 3.0 -1.6

2008

197,942 16,539 10,952 92,683 173,107

2,812 31.463 35.929

128 100 127

2008

228,393 220,247

8,146

4,224 -40,562

-28,192

31.161 -2,969

206,806 1.8

2007 ' 2008

231.032 255,614 6,704 8,150

53,941 55,420 480 481

0 0

155 -754 2,076

19.105 27,188 34,585 45.058 26.217 -7.565

0 0 374 1,606 115 146

258 1,459 364 335 -106 1,125

Development Economics 11f19109

80

MAP SECTION

This map was produced by theMap Design Unit of The World Bank.The boundaries, colors,denominationsand any other information shown onthis map do not imply, on the part ofThe World Bank Group, any judgmenton the legal status of any territory,orany endorsement or acceptance ofsuch boundaries.

B R A Z I L

STATE OF RIO DE JANEIRO

Rio Para buna

Lagoa deAraruama

Natividade

Itaperuna

Miracema

S o Fid lis

Campos

S o Jo oda Barra

Juiz de Fora

Leopold na

Muria

IBRD 27970

JUNE 1996

Nova Friburgo

Petr polis

VoltaRedondaBarra Mansa

Resende

Bras lia

Area of map

B R A Z I L

Atlantic Ocean

COLOMBIA

PERU

BOLIVIA

CHILE

ARGENTINA

PARAGUAY

GUYANA

S U R I N A M E

VENEZUELA FRENCHGUIANA

Atlantic Ocean

Paci

fic

Oce

an

Rio Para ba do Sul

RioPombaRio

Novo

Rio Pa

raba

do Su

l

Rio Pa

ratin

ga

do Sul

Rio Para

ba

Rio

Grand

e

Rio Itabapoana

Rio Muria

Ba a deSepetiba

Ba a da Ilha Grande

R. Pira

Rio Preto

Ba a deGuanabara

LagoaFeia

Rio Guandu

Santa Cec liaPumping Station

Rio

Piab

anha

Barrado Pira

0 25 50 75

KILOMETERS

PARAŒBA DO SUL RIVER BASIN BOUNDARY

RIVERS

SELECTED CITIES AND TOWNS

STATE CAPITAL

MUNICIPAL BOUNDARIES

STATE BOUNDARIES

INTERNATIONAL BOUNDARIES (INSET)

Rio de Janeiro

M I N A S G E R A I S

E S P ΠR I T O

S A N T O

S O P A U L O

23°00’

45°00’ 44°30’ 44°00’ 43°30’ 43°00’ 42°30’ 42°00’ 41°30’

23°00’

22°30’

41°00’ 40°30’

22°00’

21°30’

21°00’

20°30’

40°30’41°00’41°30’42°00’42°30’43°00’43°30’44°00’44°30’45°00’

22°30’

22°00’

21°30’

21°00’

20°30’

A T L A N T I C O C E A N

FunilReservoir

Valen a

Paracambi

Itagua

Angra dos Reis

Parati

Duquede Caxias

NovaIgua u

Nitor i

Mag

Teres polis

Para bado Sul

ItaboraRio Bonito

Cachoeirasde Macacu

Carmo

Maric

Silva Jardim

S o Pedroda Aldeia

Cabo Frio

Maca

Bom Jardim

Cordeiro

Cantaglo

Concei ode Macabu

GuanduWater Treatment

Plant

Tres Rios

Santo Antoniode P dua