Document of The World Bank

FOR OFFICIAL USE ONLY

Report No. 35479-PK

INTERNATIONAL DEVELOPMENT ASSOCIATION

PROGRAM DOCUMENT

FOR

A PROPOSED CREDIT IN THE AMOUNT OF SDR 62.7 M I L

(US$90 MILLION EQUIVALENT)

TO

THE ISLAMIC REPUBLIC OF PAKISTAN

FOR A

FIRST NORTH WEST FRONTIER PROVINCE DEVELOPMENT POLICY CREDIT

April 4,2006

Poverty Reduction and Economic Management South Asia Region

or

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 be otherwise disclosed without Bank Authorization. r

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PAKISTAN - GOVERNMENT FISCAL YEAR July 1 - June 30

AAA ADP A W B CAS COA CWIQ D A C DFID DPC EMIS FBS GDP GoNWFP HD HRM IDA M D G M O E M O H MTBF MVT NAM NFC NWFP PAC PFAA PGDP PHC PID PIDA PIFRA PIHS PPSC PRP PRSP PSD PSLSMS SAC SDA SIDB TB-DOTS

CURRENCY EQUIVALENTS (Exchange Rate Effective as o f Aprl4,2006)

US$1 = 60.25 PKRs

ABBREVIATIONS AND ACRONYMS

Analytical and Advisory Activities Annual Development Program Area Water Board Country Assistance Strategy Chart o f Accounts Core Welfare Indicators Questionnaire Departmental Accounts Committee Department for International Development Development Policy Credit Education Management Information System Federal Bureau o f Statistics Gross Domestic Product Government o f North West Frontier Province Human Development Human Resource Management International Development Association Millennium Development Goals Ministry o f Education Ministry o f Health Medium-Term Budget Framework Motor Vehicle Tax New Accounting Model National Finance Commission North West Frontier Province Public Accounts Committee Provincial Financial Accountability Assessment Provincial Gross Domestic Product Provincial Irrigation Department Primary Health Care Provincial Irrigation and Drainage Authority Project to Improve Financial Reporting and Accountability Pakistan Integrated Household Survey Provincial Public Service Commission Provincial Reform Program Poverty Reduction Strategy Paper Private Sector Development Pakistan Social and Liv ing Standards Measurement Survey Structural Adjustment Credit Sarhad Development Authority Small Industries Development Board Tuberculosis - Dai ly Observation Therapy Sessions

Vice President: P r a h l Patel, SARVP Country Director: John W. Wall, SACPK

Sector Director: Sadiq Ahmed, SASPR Sector Manager: I jaz Nabi, SASPR

Task Team Leaders: Paul Wade and Hanid Mukhtar. SASPR

PAKISTAN FIRST NORTH WEST FRONTIER PROVINCE

DEVELOPMENT POLICY CREDIT

TABLE OF CONTENTS

I . INTRODUCTION ..................................................................................................................... 1 I1 . COUNTRY AND PROVINCIAL CONTEXT ...................................................................... 2

A . Recent Developments in Pakistan 2 B .

..................................................................................................... Recent Developments in NWFP ....................................................................................................... 4

I11 . NWFP GOVERNMENT’S POVERTY REDUCTION AND DEVELOPMENT STRATEGY ................................................................................................................................... 7

The NWFP Government’s Reform Program - Phase I (2001 - 2006) ............................................... 7 A . B . The Government’s Reform Program - Phase I1 (2006 - 2010) ........................................................ 16

I V . BANK SUPPORT TO THE GOVERNMENT’S PROGRAM ......................................... 26 A . Overview ......................................................................................................................................... 26 B . Bank Support .................................................................................................................................. 26 c . D . E . F .

Analytic and Advisory Services ...................................................................................................... 27 Lessons from Previous Policy Based Lending Operations (SACS) ................................................. 27 The Proposed Development Policy Credit ...................................................................................... 28 Benefits o f the Operation ................................................................................................................ 35

Poverty and Social Impacts ............................................................................................................. 36 Implementation, Monitoring and Evaluation .................................................................................. 37 Fiduciary Aspects ............................................................................................................................ 38 Credit Administration, Disbursements, and Fiduciary Assurance .................................................. 39 Coordination wi th Other Donors ..................................................................................................... 39 Environmental Aspects ................................................................................................................... 40 R i s k s and Risk Mitigation ............................................................................................................... 41

V . OPERATION IMPLEMENTATION .................................................................................. 36 A . B . C . D . E . F . G .

LIST OF TABLES

Table 1: Pakistan . Recent Macroeconomic Trends ........................................................................................ 3 Table 2: NWFP Selected Economic Indicators, 2004105 - 2007/08 ............................................................. 17 Table 3: Estimated Revenue Transfers to NWFP under Original and Amended 1997 NFC Awards ........... 21 Table 4: NWFP Medium-Term Budget Framework (percent ofprovincial GDP) ” ..................................... 22 Table 5: Selected Monitoring Indicators for NWFP DPC ............................................................................. 38

LIST OF ANNEXES

ANNEX 1 : Letter o f Development Policy and Government Reform Program ANNEX 2: Policy Matrix ANNEX 3: Poverty and Employment in NWFP ANNEX 4: Human Development in NWFP: Challenges, Progress and Future Prospects ANNEX 5: Public Finance Management ANNEX 6: Modernization in the Civi l Service and Administration o f Multi-tiered Government ANNEX 7: Accelerating Economic Growth ANNEX 8: NWFP - Fiscal, Economic and Social Indicators ANNEX 9: Pakistan - Fiscal, Economic and Social Indicators ANNEX 10: Status o f Bank Group Operations ANNEX 1 1 : Relations with the IMF

Map: IBRD 34635

.. 11

The NWFP DPC 1 was prepared by an I D A team consisting of:

Martyn Ambury Shahnaz Arshad Harsha Aturupane Ismaila Ceesay Agnes Cou f fnha l Tekola Dejene Inaam H a q Isfandyar Zaman Khan Tahseen Sayed Khan Benjamin Loevinsohn Ambreen Iqbal M a l i k Shaheen M a l i k Eric Dav id Manes Ranj ana Mukherjee Hanid Mukhtar Naveed Hassan Naqvi Arlene Reyes Uzma Sadaf Irum Touqeer Paul Wade

Shahnaz Wazir Ali Parvez Hasan David Rosenblatt

Consultant (SASPR) Senior Urban Specialist (SASEI) Senior Economist (S ASHD) Senior Financial Management Specialist (SARFM) Senior Health Economist (SASHD) Lead Operations Officer (SASAR) Senior Health Specialist (SASHD) Private Sector Development Specialist (SASFP) Lead Education Specialist (SASHD) Lead Public Health Specialist (SASHD) ET Consultant (SASAR) Research Analyst (SASPR) Senior Private Sector Development Specialist (SASFP) Senior Public Sector Specialist (SASPR) Senior Economist (SASPR) Education Economist (SASHD) Program Assistant (SASPR) Procurement Specialist ( S A R P S ) Team Assistant (SASPR) Senior Economist, Task Team Leader (SASPR)

Peer Reviewers Consultant Consultant Lead Economist and Sector Leader (LCSPR)

... 111

CREDIT AND PROGRAM SUMMARY

PAKISTAN FIRST NWFP DEVELOPMENT POLICY CREDIT

Recipient:

Implementing Agency:

Amount:

Terms:

On Lending Terms:

Objective and Description:

Benefits:

Risks:

Disbursement:

Project ID Number:

Government o f Pakistan

Government of the Nor th West Frontier Province (GoNWFP)

SDR 62.7 mi l l ion (US$90 mi l l ion equivalent)

Standard IDA terms; 35-year maturity with 10-year grace period

IDA terms

T h e proposed NWFP DPC 1 i s a transition operation that will complete the series o f three IDA credits that assisted the government’s fiscal reform agenda, and will also commence a new series o f IDA support for the government’s medium-term reform program with a strong emphasis o n human development and inclusive growth. The reform program launched by DPC 1 will support the fo l lowing pillars o f the government program: (i) human development (for progress in education and health); (ii) fiscal reform; (iii) governance reform (focused on financial management, procurement, c iv i l service and administrative devolution); and (iv) continued support for private sector development to create sustainable employment opportunities.

The DPC program will support and help finance the reform program o f NWFP. Beneficial outcomes are expected to include (i) improved education and health status for broader parts o f the population in the province, that will help increasing the poor’s participation in economic growth; (ii) reduced incidence o f poverty as a result o f broad based, inclusive growth; (iii) restoration o f the province’s financial health: a sustainable fiscal position with more resources for poverty reduction expenditures; and (iv) strengthened governance, accountability and transparency in government operations. In addition, NWFP’s reforms could strengthen reform competition and encourage learning across provinces in Pakistan.

Risks include: (i) polit ical r isks; (ii) risks o f limitations o n reform implementation capacity; (iii) fiscal risks; and (iv) external shocks. Important r isk mitigating factors are: cumulative progress in key areas that will strengthen the constituencies for reform, making reversal difficult, and the Bank sustaining and deepening i t s pol icy dialogue and disbursing against a set o f prior actions. Fiscal r i sks have been addressed with measures to increase fiscal space: increasing own revenue collection, interest savings stemming fi-om prudent debt management, buildup o f assets in pensions fund to meet future liabilities, and containing the c i v i l service wage bill.

The full amount o f US$90 mi l l ion equivalent will b e disbursed in a single tranche upon effectiveness.

PO90689

1v

PROGRAM DOCUMENT FOR A PROPOSED FIRST NWFP DEVELOPMENT POLICY CREDIT

TO THE ISLAMIC REPUBLIC OF PAKISTAN

I. INTRODUCTION

1. After a decade o f severe macro-economic problems, anemic growth and stagnation in poverty reduction and social indicators, in 1999 Pakistan embarked on a new course with comprehensive economic and governance reforms aimed at restoring macroeconomic stability, raising growth grates and reducing poverty. The federal reform programs have been supplemented by reforms in several provinces. Since the bulk o f public expenditure o n service delivery i s incurred at the provincial level, the provincial reforms are key not only to improving country-wide social outcomes but also moving to a higher growth trajectory.

2. The government o f the North West Frontier Province (NWFP) launched i t s broad based reform program in 2001 focused on strengthening the provincial budget, realizing the potential o f the private sector to spur rapid economic growth and promoting human development. The Bank, guided by the Country Assistance Strategy (CAS) has supported the reform program with two Structural Adjustment Credits (NWFP SAC 1 and 2, presented to the Board, respectively, in July 2002 and June 2004), analytical work (the NWFP Economic Report “Accelerating Growth and Improving Public Service Delivery: The Way Forward”, 2005), prepared jo int ly with the Government o f the NWFP (GoNWFP), and technical assistance (workshops/training). This reform program has achieved positive outcomes. The government has taken charge o f the broad- based reform program and reform has gathered momentum. Reform efforts are being supported by several donors, and the f i rst Development Forum for NWFP i s planned for M a y 2006.

3. Going forward, a consensus has emerged in the Bank‘s dialogue with the NWFP government that t o tackle poverty effectively, economic growth has to be inclusive and must create better j o b opportunities. The provincial development strategy thus i s sharpening the focus o n structural changes that substantially improve social indicators and the quality o f the work force. This has required setting out a vision for human development and social protection and aligning reform and budget priorities to realize the vision. A strategy document summarizing the Government’s program “Provincial Development Program, 2005/06 - 2007/08” i s expected to be approved by Cabinet in April 2006.

4. Consistent with this objective, the proposed operation supports the transition o f the government’s development strategy from broad-based structural reform to one that i s focused o n human development, social protection and inclusive growth. T h i s transition operation i s the f i rs t in a series o f three proposed Development Policy Credits to support the Government o f NWFP’s strategy for human development and inclusive growth. It will include selected reforms o n the economic and governance fronts that will ensure the human development program’s sustainability and transparency, and accelerate the pace o f j o b creation in NWFP.

5. The President’s memorandum in support o f the operation assesses progress o n the broad- based reform program and sets out the more focused human development agenda going forward. The government’s commitment to the broad reform agenda remains undiminished and the Bank will continue to support i t v ia analytical work, technical assistance and possibly a separate pol icy based lending operation.

6. The program document for SAC 2 identified key areas where satisfactory progress could lay the basis for a follow-on operation, i.e., the third SAC. The government has implemented reforms in l ine with the program content outlined for the third credit and thus has met al l prior actions for the proposed transition operation DPC 1.

7. This program document presents the country and province context and recent developments in Pakistan and the NWFP (Section 11). The government’s poverty reduction and development strategy and reform program are presented in Section 111. Section lV presents the Bank’s support to the NWFP, describes the proposed operation and lists pr ior actions for DPC 1 and triggers for DPC 2. Section V describes implementation o f the operation and risks.

11. COUNTRY AND PROVINCIAL CONTEXT

A. Recent Developments in Pakistan

A.l Political Developments

8. Notwithstanding the fal l out f rom the Afghan war and the war on terrorism, Pakistan i s benefiting from a period o f relative stability that has contributed to deepening o f reform at the federal level and, following the second local government election in 2005 (the f i rs t was held in 2001), has l ed to the institutionalization o f the new local government system. The decentralization initiative has started the process o f transferring responsibility and resources for public service delivery to local governments. Elections in 2002 restored the National and Provincial Assemblies and the reform program has been carried forward under the elected government. General elections are due in 2007, and the prospects are good for maintenance o f the government’s pro-reform orientation. There have been increased tensions in Balochistan and along the border with Afghanistan. On the other hand, Pakistan’s relations with the international community have continued to improve over the past two years, in particular with India, which has contributed to the country’s stability.

A.2 Economic Developments

9. Economic growth has remained strong and broad based. The domestic fiscal situation remains sustainable, despite earthquake-related expenditure pressures. The economy i s projected to grow by 6.3 percent in FY06 in spite o f the impact o f the October 2005. Growth in recent years has been broad-based with a l l key sectors o f the economy making a significant contribution. Prospects for rapid growth to be sustained over the next 3 years are good, provided that polit ical and macroeconomic stability are maintained, that the momentum o f structural reforms and investments to reduce the cost o f doing business i s sustained, and that domestic savings and public and private investment continue to increase. The FY06 Budget projected an increase in the fiscal deficit f r om 3.3 percent o f GDP in FY05 to 3.8 percent o f GDP in FY06, reflecting an increase in salaries o f government employees and a significant increase in the development budget. Additional expenditure related to earthquake assistance i s projected to increase the fiscal deficit to 4.4 percent o f GDP. Nonetheless, the fiscal deficit remains consistent with a stable macroeconomic framework and the Fiscal Responsibility and Debt Limitat ion Law, and i s projected to remain so in the coming years.

10. Inflationary pressures remain and the trade and current account deficits have widened significantly. Inflationary pressures have persisted over the past 18 months and inflation i s projected to be between 8-8.5% in FY06. Imports have been growing rapidly, and the

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trade deficit has risen sharply - t o US$4.4 bi l l ion in FY05 and projected to increase further to $7 billion in FY06. The main reason for this has been strong import demand, fueled partly by healthy growth but also by relatively loose monetary policy pursued by the authorities during the last three years; real appreciation of the rupee o f about 6 percent over the past year has also contributed. The Government and the central bank plan to take additional steps on the monetary, exchange rate and fiscal fronts to reduce demand pressures and curb the current account deficit.

11. The IMF-supported Poverty Reduction Growth Facil ity (PRGF) was concluded in December 2004, and the Government o f Pakistan did not request a successor IMF program. IMF Post-program Monitoring was deemed unnecessary by the IMF’s Board. Pakistan i s now o n a standard Art ic le IV surveillance schedule. An IMF Article IV Consultation mission took place in August 2005, and the Staff Report was discussion on November 2, 2005 (see Annex 11 for the IMF’s November 2005 Public Information note). Debt sustainability analysis has been carried out by the IMF and by the Wor ld Bank, and indicates that the government’s debt reduction path (which i s prescribed in the Fiscal Responsibility and Debt Limitat ion Law) i s consistent with a sustainable debt outlook.

Table 1: Pakistan - Recent

Real GDP at factor costs Consumer prices (period average)

Gross national savings Total Investment

o/w Government Budget balance (excluding grants)

Net o f Earthquake Impact Total government debt

Source: GOP, IMF and Staff estimates.

lacroeconomic Trends 2001/02 2002103 2003104 2004/05 2005106

PreLActual Projection (Annual percentage changes)

3.1 4.8 6.4 8.4 6.3 2.5 3.1 4.6 9.3 8.7

(In percent of GDP) 19.0 22.0 19.3 15.6 15.6 16.8 16.9 17.3 16.8 19.0 2.9 2.1 2.9 3.5 3 .I -5.5 -3.8 -2.3 -3.3 -4.4

-3.6 80.2 74.3 67.9 61.1 56.5

Note: FBS investment figures for 2004105 are likely to underestimate investment levels.

12. Provinces’ and especially NWFP’s, fiscal position i s strengthened by the January 19, 2006 Amendment to the N F C Award. Provincial public finances are expected to strengthen following the recent decision to increase o f provinces in federal divisible taxes. The amended NFC Award not only provides a greater share (45 percent vs 42.5 percent in the original Award) in divisible revenue, the share will increase by 1 percentage point each year to reach 50 percent by 2010/11. In addition NWFP and Balochistan, in particular, benefit fkom a substantial increase in subventions. NWFP tends to gain the most as i t s share o f total NFC transfers to provinces i s expected to increase fkom 14 percent t o 15 percent.

A.3 Developments in Education and Health Sector Policies

13. A number o f pol icy and other initiatives have been launched by the Federal Ministry o f Education (MOE) which will have an impact on provinces’ education programs. In the education sector these initiatives range f rom a review o f the 1998 National Education Policy to establishing a National Curriculum Council t o review (and possibly reform) the present curricula. The MOE has also commissioned a National Education Census which could potentially be used by the NWFP E M I S as a baseline to integrate private sector data. Similarly, the Federal Ministry o f Health (MOH) has initiated new programmatic initiatives in a number of major federal programs. With regard to NWFP, the provincial government has taken some important steps under i t s

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B.3 The 2005 Earthquake

17. NWFP along with Azad Jammu and Kashmir were hit by a powerful earthquake on October 8, 2005 that devastated about a quarter o f the geographical area o f NWFP, affecting about 3% million people or one-sixth o f the province’s population. More than 22,500 people died from the earthquake and twice this number was injured, many o f them permanently disabled. A very large number o f casualties were school children. Nearly 4000 schools, mainly public, collapsed or were damaged and thousands o f school children died as they were attending school when the quake hit. Whi le most schools were restarted in temporary shelters, the reconstruction o f these schools i s part o f the agenda being pursued by the Government o f NWFP and the Federal Government as part o f the wider reconstruction effort in the earthquake effected areas. The earthquake also caused extensive damage to other public infrastructure and to private property. The loss in employment and output in the affected districts o f the province i s estimated to be as high as 25 percent and the overall impact on provincial GDP (PGDP) in 2005/06 about 3.6 percent.

18. The replacement cost o f the damage caused by the earthquake in NWFP alone i s estimated to be about Rs 90 bi l l ion (US$1.5 billion) or 12 % - 13 percent o f PGDP. A part o f this reconstruction cost wil l fa l l on the private sector and households. Yet a major portion o f this has to be borne by the Government. In addition, the cost o f rehabilitation and providing rel ief t o the people o f the affected areas adds to the public expenditure. Given the frailty o f provincial finances and the weak capacity o f the provincial (and districts’) administration, the burden o f the damage caused by the earthquake i s too large for the provincial government to bear. Realizing this, the federal government has decided to assume the responsibility o f funding most o f the reconstruction expenditure. Nonetheless, the impact o f the overhead cost o f relief, rehabilitation and reconstruction efforts on the provincial budget would be significant. With the loss in provincial revenue estimated to Rs 0.5 b i l l ion and provincial expenditure increasing by about Rs 3.5 b i l l ion the provincial deficit i s projected to increase by 0.5 percent o f PGDP in FY06.

B.4 Development Challenges and Opportunities for NWFP

19. Millennium Development Goals (MDGs). Although NWFP has made progress towards the MDGs much remains to be done to achieve several MDG targets. Based o n 2001/02 data, NWFP i s on track to meet the infant mortality target and also - if the preliminary 2004/05 PSLSMS headline results are verified - the target for the proportion o f immunized children aged 12-23 months and for access to safe water. However, i t i s not on track to meet other important MDGs such as poverty reduction, school enrollment, and ratio o f female-to-male literacy. I t i s expected that as new data become available these indicators will show improvements as a result o f recent years’ reform efforts. However, i t i s clear that if Pakistan i s t o meet i ts MDGs, special attention to provinces l ike the NWFP i s essential; hence the shift in the focus o f the provincial development strategy to human development and inclusive growth (For additional information on the status o f reaching the MDGs and other HD indicators, see Annex 4).

20. Challenges. The overarching challenge for the province i s t o promote rapid and inclusive economic growth. This involves the challenge o f promoting human development and the challenge to reduce rural vulnerability whi le tapping the potential o f the private sector t o sustain high economic growth and employment generation.

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(i) The challenge to accelerate human development

21. Education and health indicators for NWFP, mainly f rom the Pakistan Integrated Household Survey (PMS) 2001/02 and preliminary results f rom the PSLSMS 2004/05, show that the overall education and health status in the province i s below the country average. In the case o f education the difference i s driven entirely by the indicators for females, which are worse in the NWFP than in the country as a whole. The GoNWFP recognizes three main challenges in improving education sector performance in the province - increasing equitable access, improving education quality and strengthening governance and service delivery. Also health outcomes in the NWFP are generally lower than the national average. The health sector continues to face significant challenges in terms o f quality o f health services and performance o f the sector. These include: l o w levels o f health expenditure, underperformance o f the Primary Health Care (PHC) system, uneven and poor quality of hospital services, weak public sector management, motivation and measurement o f results, and unregulated and l o w quality o f services in the private sector. For more details o n health and education, see Annex 4.

(ii) The challenge to reduce rural vulnerability

22. In NWFP 4 out o f every 5 people derive their livelihoods f rom the rural areas, and the widespread vulnerability-in particular among farmers in rainfed areas-has been highlighted with recurring droughts affecting large part o f the population. Accelerating agricultural growth and rural employment creation i s hence a central development challenge. However, agricultural growth i s l imi ted by a number o f constraints in factor inputs - land, water and credit - and in supporting institutions and regulations, choice o f outputs and production technology. Reducing rural vulnerability would depend critically on addressing these constraints.

(iii) The challenge to strengthen the private sector to promote rapid economic growth

23. Poverty reduction requires more rapid pro-poor, broad based inclusive growth with substantial employment generation. Sustained rapid growth will require strengthening the weak investment climate in the province and giving greater room to the private sector in decisions that affect the provincial economy.

24. Economic potential. The province has substantial economic potential. Historically, the provincial economy has been dependent o n relatively l o w value-added agnculture as the largest production sector, services, and public employment (especially in the armed forces). The manufacturing sector i s quite l imi ted but has potential for growth through use o f local inputs. There i s substantial mineral wealth in the province such as precious and semi-precious stones, marble, and granite that can be exploited with improvements in infrastructure, a better pol icy environment, and opportunities for training on advanced techniques. There i s also considerable potential to further develop NWFP’s r i ch hydel resources, in particular by encouragmg small hydel generation plants and developing off-grid localized energy distribution f rom these plants to local industry. The province can attract manufacturing industry, e.g., agro-processing using local r a w materials, by offering them localized and inexpensive sources o f energy above long-run marginal cost. Similarly, availability o f better infrastructure related to tourism and a better image of the province can help develop in the long run the potential that exists for tourism. There i s also considerable potential for economic growth in urban centers.

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111. NWFP GOVERNMENT’S POVERTY REDUCTION AND DEVELOPMENT STRATEGY

25. NWFP was the f i rs t province to embark on a comprehensive reform program in 2001. Faced with slow growth, rising poverty, and poor human development outcomes, the provincial government developed a reform program to address the root causes o f these poor outcomes: inadequate service delivery, poor governance, and an investment climate that translated in to a high cost of doing business in the province. The provincial government la id out i t s development objectives and the strategy to achieve them in the Provincial Reform Program (PRP) 2001-20042. The PRP also formed the core o f the provincial PRSP developed as part o f the full national PRSP in 2003. In l ine with the national PRSP and the specific challenges o f NWFP, the overarching development objectives o f the provincial government’s reform program are poverty reduction, accelerating broad-based inclusive growth and improving human development.

26. As discussed in the previous section o f this Program Document, the f i rs t phase o f the NFWP Government’s reform program has achieved important outcomes. The Bank supported the government’s efforts v ia policy-based lending (NWFP SAC 1 and 2), analytical work (the NWFP Economic Report “Accelerating Growth and Improving Public Service Delivery: The Way Forward”), and technical assistance. The reform momentum has been maintained, and the program i s being supported by several donors. A Development Forum i s planned for M a y 2006.

27. The 2005 NWFP Economic Report highlighted the need to accelerate progress in human development, while continuing to improve the province’s prospects for more rapid, inclusive growth. A consensus has emerged in the Bank’s dialogue with the NWFP Government that t o tackle poverty effectively, economic growth has to be inclusive and must create better j o b opportunities. The provincial development strategy thus i s sharpening the focus o n structural changes that substantially improve education and health indicators and the quality o f the w o r k force. T h i s has required setting out a vision for human development and social protection and aligning reform and budget priorities to realize this vision. A strategy document summarizing the Government’s program, “Provincial Development Program, 2005/06 - 2007/08”, i s expected to be approved by Cabinet in April 2006.

A.

28. a.

b.

C.

d.

The NWFP Government’s Reform Program - Phase I (2001 - 2006)

The government’s reform program 2001 - 06 has consisted o f the fo l lowing pillars: Accelerating economic growth by establishing an effective and transparent enabling environment for private sector development both in the urban and rural economy; Fiscal reforms to ensure fiscal sustainability, adopt and fol low a medium-term budget fkamework, enhance effectiveness and accountability o f expenditures, and strengthen resource mobilization; Reforms to accelerate human development and improve service delivery in basic social services. A key element o f the strategy i s improving the education and health status of girls and women, and reducing the province’s high ferti l i ty rate; and Governance reforms in public financial management, procurement, c i v i l service and administration o f multi-tiered government (province/district/tehsil).

The Provincial Reform Program formed the basis for the Bank’s first and second Structural Adjustment Credits to the province (2002 and 2004).

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29. Both the provincial and federal governments have shown strong ownership o f the provincial reform program. At the provincial level, the government has shown strong commitment through steady reform implementation, even through changes o f government. The federal government has fully supported the reform program, namely through the transfer o f additional fiscal space to the province, and has seen i t as a useful instrument for implementing the PRSP at the provincial level, thus contributing towards reaching the national MDGs.

A.l Reforms to Accelerate Economic Growth

A.1.a Private Sector Development

30. development:

The provincial government has been pursuing a three-pronged strategy for private sector

(i) Institutionalizing public-private dialogue to promote demand-responsiveness of public sector agencies and policy-making bodies;

(ii) Creating an enabling and competitive environment; and (iii) Expanding the role o f the private sector.

(i) Institutionalizing public-private dialogue

3 1. In the past the provincial government has tended to make important po l icy and regulatory decisions affecting the business environment without consultations with the private sector. The private sector had very l imited means o f raising their concerns with government officials; in particular, there was n o mechanism for public-private sector policy dialogue. In the recent past the government has started to develop the private sector’s role and the public sector’s capacity in pol icy malung, problem solving and investment facilitation. It has created venues for public- private dialogue by including private sector representatives in a number o f key pol icy making, problem solving, and managing bodies. These include an Investment Facilitation Council headed by the Chief Minister and an Investment Facilitation Committee headed by the Chief Secretary supported by a restructured Sarhad Development Authority (SDA) (into an ”NWFP Industrial Facilitation Authority”). The objective o f such institutionalized interaction with the private sector i s to recognize i t s importance as a key stakeholder in the administration o f the province. This i s expected to elevate private sector development and economic growth as k e y elements in the provincial priorities.

(ii) Creating an enabling and competitive environment

32. Investors have been facing high transaction costs for new investments and high regulatory costs and administrative barriers. This reflects lengthy and costly regulatory and approval processes that have involved many government agencies. Weaknesses in governance structures and s h l l s deficiencies in the local labor market have also reduced the attraction o f investing in the province. The government has initiated steps to reduce administrative barriers and improve the functioning o f markets for skilled labor.

33. Administrative barriers. The government has streamlined and reduced the number o f annual industrial inspections f rom 23 to 13, and has introduced exemption based labor inspection for companies with proven track record o f compliance with labor laws. However, there i s s t i l l considerable scope for lowering administrative barriers and the resultant high transaction costs facing new investors through more streamlined and cost-effective implementation o f regulations.

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34. Access to skilled personnel. The technical and vocational training provided by the public sector has suffered from poor quality, l o w effectiveness and limited relevance to potential employers. Th is reflects, among other things, inadequate management systems, inappropriate incentive structures and n o link to employers and the sk i l ls needs o f industries in the province. On the supply side, a good start has been made with the recent inclusion o f private sector majority (and chairperson) o n governing boards o f government-run training institutes, including the advisory board for technical education and manpower at the provincial level and Central Management Committees for technical training institutes at the district level. An Advanced Technical Training Center has been established with the chair person coming f rom the private sector but further capacity strengthening i s needed.

(iii) Expanding the role of the private sector

35. The provincial government has traditionally been having ownership interests in a number of economic activities in the province. I t has in the recent past started a process o f repositioning the state’s role away f rom roles that are in direct competition with the private sector to provision of effective regulation. It has divested public sector production units established by S D A in industrial estates, and has announced (May 2005) i t s decision to set up Industrial Estate management committees consisting o f and led by private sector representatives. I t has also leased out or completed bidding process for lease o f a l l remaining small hydel projects to the private sector; leased out a large number o f government mineral exploration and industrial development units; dissolved four autonomous bodies; and retrenched staff o f autonomous bodies. Notwithstanding some progress in divestment, the government i s s t i l l involved in many activities that have long been privatized in other developing countries, spanning financial services, industrial estates, transport, construction, and tourism.

A.1.b Agriculture

36. Growth in agriculture plays a central part in the NWFP’s growth and poverty reduction strategy, in light o f i ts large share o f the provincial economy and employment, i t s economic potential and the fact that the majority o f the poor l ive o f f apcul ture. The sector has in recent years been facing key challenges that have needed to be addressed in order to realize the potential of the agricultural sector within a framework o f sustainable natural resource use. There has been progress in some o f the areas below but this i s expected to accelerate n o w that the government has announced i t s Agricultural Sector Strategy. The key issues include:

37. Public expenditures: The sector has been receiving the lowest per capita allocations, even though it has a higher proportion o f poor people depending o n agriculture for their livelihoods. I t therefore needs to re-align public expenditures within the sector in l ine with priorities identified in the Agriculture Strategy. There has been init ial progress in this area over the last year.

38. Making government research and extension services more effective: There are weak linkages between agricultural research, extension and farmers to ensure that research and extension priorities correspond with farmers’ needs and market trends. B o t h agricultural extension and research fail to deliver relevant up-to-date services and science based knowledge outcomes, respectively. Institutional arrangements have resulted in ambiguity in terms o f overall responsibility for research between the research institutes and the universities. Furthermore, incentive structures are not aligned between the institutions which leads to suboptimal outcomes.

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39. Facilitating and strengthening private sector participation and improving the regulatory environment: Small farmers (the overwhelming majority o f farmers in the province) have weak capacity and suffer f rom limited market information and poor access to modem and high- productivity technologies. Farmedproducer organizations, marketing groups (of producers, processors and traders) and multi-stakeholder District Agncultural Coordination Forums can help farmers overcome these problems. Whi le there has been a lacuna o f such organizations and forums in the province, the government has in recent years enabled the formation o f farmer groups such as commodity associations for horticulture and livestock, cooperatives and service associations. A total of 75 Farm Services Centers have also been established (on average 3 in each district). They need to gradually be made self-financed and self-managed and their coverage expanded. In agriculture and livestock, the provincial government departments need to be restructured and made more responsive to private sector needs. Certain features o f a number o f laws and regulations currently undermine economic incentives for producers and need revisions.

40. Improving market infrastructure and information systems: Market infrastructure i s weak especially in the areas o f cold chains, collection points and storage. This results in considerable post-harvest losses o f highly perishable products. Market information (on price, quality, and new varietieshtandards that meet consumer preferences) and analysis i s not provided. T h i s can be improved through partnership with farmer organizations and the private sector, using media and extension services. Provision of such information could facilitate diversification o f export markets beyond the present narrow range o f products and small number o f destinations

41. Improving water management: Since the late 1990s with the start of the National Drainage Program the provincial government has identified weaknesses in the institutional structures in the irrigation sector that have an important bearing on water management. It has therefore gradually pursued reforms towards decentralization o f the Provincial Irrigation Department (PID). W h i l e much remains, some progress has been made towards having, (i) an autonomous Provincial Irrigation and Drainage Authority (PIDA) that control, o w n and have responsibility for constructing, operating and maintaining part o f the intra-provincial irrigation and drainage infrastructure; (ii) a financially self-accounting quasi-autonomous Area Water Board (AWB) that control, own or lease the parts o f irrigation and drainage infrastructure, and (iii) autonomous farmer organizations (FOs) established at the distributary or minor level owned and controlled by farmers. Government has established and has trained 24 autonomous farmer organizations for water management. 19 o f them have signed Irrigation and Drainage Management Transfer Agreement with the local Area Water Board. Six farmer organizations have n o w taken over the management o f four distributaries and been authorized to assess, collect and retain 40 percent o f the abiana (water charges) collected.

A.2 Fiscal Reforms

42. The objective o f fiscal reforms to date has been to restore fiscal sustainability and increase the fiscal space for improving public services such as infrastructure, l a w and order, and social services. In order to improve delivery o f social services, increased expenditures have also needed to be complemented with corresponding measures in fiscal decentralization, so as to give service providers (local governments) additional resources to deliver.

43. The need to restore fiscal sustainability and increase fiscal space had become urgent by the start o f the Provincial Reform Program in 2001. In the preceding decade the provincial finances had become increasingly unsustainable. High debt service costs and fixed establishment costs had forced successive cuts in development spending and led to an acute infrastructure deficit, including o f schools, health care facilities and roads. K e y elements in the fiscal strategy

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have been reducing the heavy debt service burden through early retirement of high cost debt (to the federal government) financed by parts o f the proceeds from IDA financing, and improving the composition o f spending with a shift towards social spending and investment. The latter has included rationalization o f the project portfolio in the Annual Development Program (ADP), so as to accelerate the completion o f projects in the portfolio. These elements have been supplemented with cost control in the c iv i l service by containing growth in the number o f staff positions (the federal government determines wages and pay scales o f federal c iv i l servants. There i s a very strong polit ical compulsion for the provincial governments to follow these pay scales) and efforts to mobil ize a higher share o f revenues locally. The whole set o f fiscal measures needed to be put in a medium-term budget context t o ensure that fiscal sustainability would be achieved over the medium term; hence the government adopted a Medium-Term Budget Framework (MTBF) in 2002 which forms the basis for the annual budgets.

44. This strategy has been successfully implemented during four years o f reforms. The government has increased fiscal space through early retirement o f some o f i t s more expensive debt, which has halved the debt service burden from 1.8 percent o f provincial GDP (PGDP) in FYOl to 0.9 percent in FY05. The composition o f spending has also improved which, together with the increased fiscal space on high priority social spending, has enabled an increase in such spending f rom 2.6 percent o f PGDP in FY02 to 3.3 percent in F Y 0 4 - FY05 while overall spending levels fe l l slightly in percent o f PGDP. The share o f social sector expenditures reached 39 percent of total expenditures in FY05 - 10 percentage points higher than in FY02 -with heavy emphasis on education and health sector development expenditure. The level o f locally-financed development spending increased more than 3 folds between FYOl and FY05 to Rs 11.6 bil l ion. Rationalization o f the ADP portfolio in FY04 and greater emphasis o n allocating more funds to the on-going investment schemes in FY05 more than halved the “throw-forward ratio” o f the ADP portfolio. This indicates sharply improved effectiveness o f investment spending. Despite the increase in government salaries, the wage bill was contained through only selective recruitments. This along with reduction in interest payments helped in reducing non-development expenditure from 7.9 percent o f PGDP in FYOl to 6.1 percent in FY05. The fiscal deficit was contained to less than 1 percent o f PGDP (on average) which i s at a sustainable level.

45. Fiscal decentralization has also been strengthened, albeit less than desired and less than in other provinces, to give greater role to the local governments in delivery o f public services. NWFP was one o f the f i rs t provinces to use a needs-based formula (based o n population and indicators o f social development and backwardness) for budgetary transfers to the districts starting in FY02. All non-salary recurrent expenditures and district development spending were devolved to the districts in FY03. The PFC Awards o f FY04, FY05 and F Y 0 6 have continued to strengthen fiscal devolution with a range o f measures. The most important ones are: matching incentive grants to Districts for additional revenue mobilization; allowing districts to retain user charges in health and education with matching grants for collecting revenues over the targeted amounts; matching grants for O&M in the road sector; and enhanced non-salary allocation o f Districts by 10 percent in FY04 and by 25 percent in FY053. Nevertheless, continued reforms in fiscal decentralization are necessary in the near and medium term; starting with devolving the salary budgets to the districts.

46. Substantial progress has been made in recent years towards a sustainable fiscal position while meeting the higher demands for service delivery and public investments. Good progress has very recently been made with the President’s amendment to the 1997 NFC Award in the interim period until the next, revised NFC Award. It wil l take effect in FY07. Nevertheless,

The FY06 PFC Award projects increases o f 25% pa. in O&M allocation for the next 3 years.

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more needs to be done by the provincial government in raising own revenues, and by the federal government in devisinglfacilitating mechanisms and supporting measures to reduce provinces’ fiscal dependence on the federal government.

A.3 Reforms to Accelerate Human Development

A.3.a Education

47. In the f i rs t phase o f reforms in the education sector, the focus has been on improving access to education. The NWFP introduced a range o f pol icy initiatives to expand school enrolment and attendance, especially among girls, and to reduce regional disparities. The key demand side policies introduced to raise school attendance were providing tuit ion free publ ic primary and secondary education, and free textbooks, f irst for girls and then for al l children f rom grades 1-10 in al l government primary schools.

48. Demand for schooling (and quality o f schooling) had also been negatively affected by the high incidence o f teacher absenteeism. The government addressed this by implementing a system of monitoring and reducing teacher absenteeism where Executive District Officers (Education) could take disciplinary action based on timely reports. However, continued progress o n monitoring i s needed. T h i s could include closer involvement in teacher monitoring by stakeholders in the local community (parents o f school children) which can lead to lower teacher absenteeism. To that effect, the government introduced measures to empower PTAs, including the establishment and training o f PTAs for a l l primary schools and some authority t o monitor teacher attendance. (Success o f the latter has however been limited).

49. In addition, the NWFP implemented a phased program to reduce supply side constraints to education expansion, especially for children in rural areas, by: (a) increasing essential school facilities such as classrooms, sanitation, water, and boundary walls for security which required a substantial increase in development spending o n schools; and (b) increasing the number o f school teachers with special efforts to recruit more female teachers to address concerns by parents o f female students; and (c) giving PTAs authority to spend finds on Instruction Materials and Repairs (IMR).

50. The combination o f demand and supply side initiatives enabled the NWFP to make promising progress in increasing enrolment, especially among girls, in recent years. Total enrolment in primary and secondary education rose f rom 2.9 m i l l i on students in 2002/03 to 3.2 mi l l ion students in 2004/05. During this period girls’ enrolment increased f rom 0.8 m i l l i on to over 1.0 mi l l ion students. The rise in total enrolment was most marked in the primary cycle, where enrolment increased f rom 2.1 mi l l ion to 2.3 m i l l i on during this period, with girls accounting for more than ha l f the increase in enrolment. In terms o f enrollment ratios, preliminary results f rom the Pakistan Social and Living Standards Measurement Survey (PSLSMS), conducted in 2004/05, suggest that the overall gross primary enrollment ratio rose from 77 percent in 2001/02 to 80 percent in 2004/054, and from 56 to 65 percent for girls.

A.3.b Health

51. During the last four years, health sector reforms have mainly focused on improving access to health services - a key challenge facing the sector - but also o n addressing causes o f poor access such as inadequate financing, especially for development spending, and poor

The PSLSMS data are prel iminary and only indicative since only headline results have been released by the FBS. The micro data need to be released and assessed by the Bank to veri fy the headline results.

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management and inefficiency in service delivery. Reforms to improve access have in particular focused o n access to key preventive services including Tuberculosis (TB) Da i l y Observation Therapy Sessions (DOTS) and Mother-Child Health/ Family Planning. NWFP has made good progress in al l o f these areas except management reforms where progress has been slow.

52. Access to key preventive services - Programmatic Reforms to strengthen Communicable Disease Control and Maternal Health Programs. NWFP has done wel l in the implementation o f programmatic reforms including expansion o f TB DOTS services, expanding access to family planning and primary health services through the Lady Health Worker (LHW) program and implementing steps to enhance access to H I V / A I D S services for vulnerable population sub- groups. Steady implementation since the start o f reforms (2001/02) has expanded the TB DOTS program f rom 10 to a l l 24 districts in NWFP. Just in the last two years this has increased population coverage from 60 percent to 100 percent. T o improve access to Mother-Child Health/ Fami ly Planning services, the number o f LHWs has increased by close to 50 percent since 2001/02, increasing coverage in the last two years f rom 50 percent to about 60 percent. The Government has also taken steps to enhance access to H IV /A IDS services for vulnerable populations and five contracts with NGOs have been signed for provision o f services in different areas o f the province targeting sex workers and intravenous drug users. These reforms appear to have led to significant improvements in health indicators. Preliminary results f rom the 2004/05 PSLSMS survey indicate that the immunization rate for children 12-23 months has increased from 57 percent in 2001/02 to 76 percent in 2004/05, and the antenatal coverage o f pregnant women by health professionals f rom 34 percent to 39 percent. Nevertheless, considerable challenges remain: Under the TB DOTS program case detection rate i s s t i l l l o w at 58 percent. The program needs to strengthen district supervision, introduce DOTS strategy in teaching hospitals and expand the program in the private/NGO sector. Needed improvements in maternal health services require greater efforts to increase contraceptive use and access to slulled birth attendants . 5 3. Management and Organizational Reforms. Management and organizational reforms undertaken to facilitate public access to health services include strengthening o f management structure; rationalization and standardization o f district health services; autonomy to tertiary hospitals; and promoting public private partnerships. A Health Sector Reform unit has been strengthened to provide leadership and cover a l l aspects o f reforms and to monitor the reform process. In order to strengthen the management structure, separate male and female cadres o f doctors have been merged, a new career structure o f paramedics has been approved and a management cadre has been notified. Implementation o f the latter i s awaiting resolution, which i s being sought, o f procedural bottlenecks and legal issues involv ing seniority o f staff.

54. Rationalization and standardization o f District Headquarters Hospitals has been initiated in 17 districts hospitals with a focus o n ensuring capability in a prioritized range o f medical specialties i s making steady progressing.. The Government has ensured adequate financing. However, i t i s too early to assess i t s impact o n quality and utilization o f services. All tertiary hospitals have been given financial and administrative autonomy with the a im to improve quality o f services. A third party assessment o f the autonomy has been commissioned to learn lessons and plan i t s expansion to the district headquarters.

55. Increased allocations for the health sector. During the last four years the health sector allocations have been adequate and have increased in l ine with the MTBF. The health expenditures have risen at an annual growth rate o f 13 percent, mainly due to increased development expenditures with a rising share in total development spending. Challenges ahead reflect existing capacity constraints and procedural bottlenecks that limit the use o f additional allocated resources and thereby undermine their potential benefit. In addition lack o f an

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institutional mechanism to track health expenditures at the district level limits evidence-based decision making. The Health Department needs to further prioritize expenditures, focusing on services which are cost effective and have larger impact on health outcomes.

A.4 Governance Reforms

56. The GoNWFP recognizes that problems o f weak governance have been at the heart o f the province’s poverty and development challenges and has made improving governance and public sector performance a central element in the PRP since i t s inception. T o address these challenges, the government launched a wide range o f reforms in (i) public financial management; (ii) procurement; (iii) civ i l service reform; and (iv) carrying the devolution process forward; the latter with the goal o f improving the administration o f multi-tiered government (province/district/tehsil) and making local governments more accountable for improved service delivery.

A.4.a Public Financial Management

57. The province’s reforms in public financial management a im at (i) improving the reliabil i ty and accuracy o f financial data, (ii) institutional reform to strengthen internal audits, and (iii) improving accountability and legislative oversight. These reforms are in accordance with a comprehensive financial management reform action plan prepared and agreed between the Bank and the GoNWFP as part o f the Provincial Financial Accountability Assessment (PFAA, 2003). In the first phase o f reforms to date the main emphasis o f public financial management reforms in the province has been o n establishing an integrated, automated accounting system that connects a l l provincial level and district accounting offices to provide real time information. Whi le work has also been ongoing in institutional reform and improving accountability and legislative oversight, the emphasis will shift increasingly to these areas in future operations.

58. Improving the reliability and accuracy of financial data. The thrust o f the province’s financial management reforms relies on the implementation at the province and district level o f an automated accounting system (under the Bank-supported Pakistan-wide project for strengthening accounting and financial reporting (PIFRA)). As part o f PIFRA execution, the province has computerized i t s accounting system and as a f i rs t in the country, prepared and executed in FY05 i t s provincial government budget o n the basis o f the new Chart o f Accounts (COA), using the principles o f the N e w Accounting Mode l (NAh4) consistent with international best practice. In FY06 this was expanded to a l l 24 district governments o f NWFP. T h i s will improve the reliabil i ty and timeliness of consolidated provincial accounts. The province has also progressed ahead o f schedule in computerizing the district government accounting system and has established full connectivity between the provincial government and many District Accounting Offices. Reflecting this progress, the achieved reconciliation levels and timeliness in financial reporting far exceed the targeted milestone levels in the medium-term reform plan. Fo r the first 4 months o f FY06, actual reconciliation levels achieved for expenditures, receipts, suspense and intergovernmental accounts, o n average, were 96 percent, 97 percent, 95 percent, and 100 percent respectively. Timeliness o f reporting has n o w improved from a lag o f 8 weeks to 6 weeks.

59. Institutional reforms. Institutionalizing the internal audit function has been a major challenge in all governments in Pakistan. GoNWFP has initiated the process ahead o f other provinces by notifying the establishment o f internal audit function in 19 provincial departments but considerable work remains for future operations to ensure that implementation has any significant effect.

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60. Improving Accountability and Legislative Oversight. T h e Public Accounts Committees (PAC) and Departmental Accounts Committees (DAC) have reduced the number o f unsettled audit observations for provincial and district government accounts but a substantial backlog still remains. This reflects to some extent the many years o f backlog that the government inherited at the start o f reforms in 2001/02 but also inadequate frequency o f DAC meetings to clear unsettled audit observations.

61. Overall, N W F P has achieved substantial progress in public financial management reforms - unparalleled among Palustan’s provinces - towards achieving reliable, comprehensive, accurate, and timely information pertaining to provincial and district governments’ financial transactions. Reforms ahead will continue as outlined in the PFAA action plan.

A.4.b Procurement

62. N W F P has since the start of the Provincial Reform Program been the country’s leading province with regard to procurement reforms although recently implementation has been falling short. The provincial government has implemented reforms in phases. Marlung the end o f the f i rs t phase, GoNWFP passed the Procurement Ordinance in 2002 as the f i rs t government (federal and provincial) in the country. Continuing with i ts lead on procurement reforms, in 2003 it passed a new Procurement L a w for goods, works and services, again a first in the country, and the main achievement in phase 2. However, while being a major improvement the L a w does not fully meet international best practice. GoNWFP also adopted standard bidding documents for goods, works and services based on the model o f the Pakistan Engineering Council and notif ied by the Department o f Planning.

63. The vision o f procurement reform seems to have blurred after the adoption o f the 2003 Procurement L a w and subsequent implementation has not been satisfactory. Most implementing agencies have no t fully adopted it in their operations with the result that most procurement i s s t i l l being done using the o ld set o f directives, notifications and manuals. The reason for inaction in implementation seems to be lack o f awareness and ownership o f the law, slack enforcement and l imi ted capacity to implement the law. Hence, notwithstanding progress made further work i s needed to bring the Procurement L a w up to international standard, make it effective and ensure i t s implementation. T h i s will be the central part o f procurement reforms in future operations.

A.4.c Civil service and administration of multi-tiered government

64. By the t ime the PRP started in 2001/02, decades o f neglect had taken i t s t o l l o n governance in the province, as in the rest o f the country. The result was excessive staff, poor compensation at higher levels, declining quality o f c i v i l servants, over-centralization o f decision- making, complaints o f widespread corruption and malfeasance, poor management systems, frequent transfers o f staff, including o f high-level staff with resultant l i tt le time and experience in the post, and cumbersome and costly procedures. T o address these challenges and with the overarching objective o f improving service delivery the government has been pursuing reforms in the areas o f personnel management and devolution. These reforms a im at increasing levels o f efficiency, effectiveness and ethical standards in the c i v i l service, malung c i v i l servants more accountable to users through administrative decentralization, and raising their levels o f competence and integrity.

65. The government i s implementing i t s strategy in phases. Since 2001/02 to date it has focused on containing the size o f the c i v i l service, increasing posts and/or hiring mainly in high priority areas (education, health and police); maintaining merit and transparency in new

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recruitment, postings and transfers; and developing a computerized Human Resource Management (HRM) database that will enable marked improvement in personnel planning and management. I t has also taken init ial steps towards administrative decentralization.

66. Progress to date i s as follows: The government has la id the groundwork for improved professionalism and accountability in state institutions, and has successfully contained growth in staffing levels, limiting growth in sanctioned posts to 1-2 percent per annum after rationalization and restructuring in 200 1. I t has streamlined recruitment processes whilst maintaining their merit- based integnty and has established an independent Provincial Public Service Commission for recruitment for mid- and upper level staff.5 The average length o f tenure o f Department Secretaries has increased markedly over the last three years (from 7 to 17 months) but i s s t i l l too short to assure optimum levels o f j o b performance and greater accountability in these key policy and management roles. The government has changed i t s human resources management systems to remove inconsistencies with devolution, and has developed and put in place a computerized c iv i l service Human Resource (HR) database. The computerized HR database will allow the government to monitor compliance with human resources management policies and the size o f the c iv i l service establishment. This will help eliminate "ghost" workers f rom payrolls and yield a more accurate estimate o f the government pension liabilities. Less positive i s the new contract employment legislation (approved in 2005) that has not fully addressed the issues o f performance and wage cost f lexibil i ty or o f reducing levels o f unfunded pension liability.

67. NWFP also has moved towards a more decentralized administration with greater administrative autonomy at the district level albeit less so than in other provinces with better polit ical alignment between provincial and district governments. Still, the province has issued amendments to the Local Government Ordinance with the goal o f establishing new district services with district and tehsil cadres in 2006 and seeks Bank technical assistance in this area.

B. The Government's Reform Program - Phase II (2006 - 2010)

68. The N W F P government's reform program has n o w evolved f rom the broad-based program summarized above to one that, going forward, focuses on inclusive growth and human development. The government recognizes that sustained inclusive growth in the province will require not only a favorable investment climate but, as importantly, a healthy and educated labor force. Investing in human capital, particularly in children, i s therefore critical t o meeting this objective. Accomplishing the twin objectives o f human development and inclusive growth will also require continued fiscal and expenditure reforms, as wel l as governance reforms.

69. The government i s deepening i t s human development reform agenda to accelerate progress on education and health. It plans to enhance health and education programs significantly, so as to enable greater access to quality health services i s vitally important for improving l i fe expectancy and productivity. In addition, the government i s developing a social protection strategy that would include targeted measures to help the poor cope with chronic poverty and vulnerability. Social protection programs will help ensure equity, and promote access by the poor to essential services.

In NWFP, the Provincial Public Service Commission has authority to recruit staff in grades 17 to 21 and in grades 11 to 16 in non-devolved departments. The autonomy and areas o f authority o f the PPSC were eroded to some extent w i th the authority for selecting candidates for grades BPS 11-16 in devolved departments transferred to new district recruitment committees where senior district officers continue to spend a disproportionate amount o f their time dealing with irregular requests to appoint, promote and transfer staff.

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70. Whi le the core o f the PRP going forward i s the program for improvement in human capital, the government will support i t with continued fiscal and governance reforms to ensure that HD continues to get the importance it deserves from a fiscal and governance perspective. Improvement in HD indicators as envisaged in the PRP is expected to improve the quality o f the work force. An improved supply o f workers wi l l be met by increased demand for workers v ia continued focus on the growth agenda. The Government o f the NWFP is fully committed to the growth agenda as seen in the thrust o f the new provincial development strategy (2006 - 08) that will be presented at the provincial donor forum in M a y 2006. A critical sub-set o f that reform program i s to further strengthen the private sector for sustainable growth and i s supported by the proposed DPC.

7 1. Reforms leading to improved service delivery would improve human development outcomes. GoNWFP aims at raising the primary school net enrollment rate f rom 41 percent in FY02 to 55 percent in FYO8, and the secondary school net enrollment rate f rom 12 percent in FY02 to 20 percent in FY08. It targets raising the immunization rate (full immunization) for children between 12 and 23 months f rom 60.5 percent in FY02 to 80 percent by FY08 and 85 percent by FY10. I t also aims at raising the contraceptive prevalence rate f rom 22.5 percent in FYOl to 35 percent by FY08 and 38 percent by FY10. Reform-led improvements in the investment climate would induce an increase in private investment f rom 11.7 percent o f provincial GDP in FY04 to about 15 percent o f provincial GDP by FY08 and subsequent years. This would contribute to raising total investment in the province f rom about 15 % percent o f provincial GDP in FY04 to about 19 1/4 percent over the medium term. With improvement in HD indicators, particularly improved secondary, technical and vocational education, NWFP will have a better skilled work force in the medium term. Along with fiscal and governance reform, the government i s implementing a strategy to invigorate the private sector t o generate employment opportunities. The annual rate of growth in provincial real GDP i s expected to increase from 5.6 percent in FY05 (and from the average over the last decade o f 4 % percent) to 7.2 percent in FY08 and 7.5 percent in FY 10. Consistent with this path o f inclusive growth, 600,000 additional jobs (net) would be created by FY08, bringing the unemployment rate down from 13 percent in FY04 to 11 percent in FY08 and further to 9 % percent in FY10. In the outer years, high growth and labor s h l l formation will reinforce each other.

Table 2: NWFP Selected Economic Indicators, 2004105 - 2007108 2004105 2005106 2006107 2007108

Real GDP, % change 6.3 3.0 6.9 7.2 Unemployment rate (%) 12.8 16.1 12.4 11.2 Real GDP per capita, % change 4. I 0.9 4.8 5.1 Investment, % o f PGDP 16.6 I 7.1 18.7 19.2 Fiscal balance, YO o f PGDP -0.5 -1.4 -0.7 -0.4

72. strategy to date and prioritizes interventions as follows:

Government’s reform strategy going forward strengthens the reform pil lars o f the

Pillar One: Accelerating Human Development and Improving Service Delivery

73. Whi le there have been improvements in human development outcomes yielded by the implementation o f the reform program, the GoNWFP i s also cognizant that significant challenges remain requiring a deepening of the HD reform agenda within the overall fiscal and fiduciary framework. Specifically, the objective o f the HD reform program i s t o improve the access and quality o f service delivery while significantly reducing gender and regional disparities. Going

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forward, the reform program focuses on the following three key themes: (i) further improving access, coverage and utilization o f social services including social protection services (covering both public and private services); (ii) improving quality o f service delivery; and (iii) enhancing stewardship functions o f the government including financing, monitoring & evaluation and promoting public-private partnerships.

74. I n education, while the focus on access in primary education remains, the reforms are being expanded to cover elementary and secondary education. In access, a differentiated pol icy i s being introduced to address regional and gender disparities. T o make education more meaningful, critical reforms are being introduced to improve the quality of education, supported by the development o f a strong monitoring and evaluation fiamework. I n health, preventive health care remains a priority. Moreover, there i s now an intensive focus on improving utilization and quality o f primary and secondary health care through innovative partnerships with the private and NGO sector. In addition, the health reforms seek to enhance stewardship functions o f the government for enhancing monitoring and evaluation, strengthening partnership with private sector, including NGOs, and financing o f the sector as a whole. The specific sectoral reforms are presented below. Financing for HD sectors will be enhanced within the medium-term development framework, and the level and composition o f health, education and social protection budgets will be aligned with sectoral priorities. See also Annex 4 for more detail o n human development.

a. Education Sector

75. The education sector reforms will be broadened and deepened in several ways. First, as primary enrolment and completion rates rise, the demand for places in middle schools, secondary schools and colleges will increase over time; in response, the NWFP government plans to expand the middle, secondary and college education sector to increase participation beyond primary education. In the near term the government will mainly expand middle school education by increasing school facilities at that level, according to expansion targets set by districts and agreed between the provincial government and district governments. Over the medium term it will expand secondary and college education, again in the context o f targets established by districts and agreed between the provincial and district governments. T o improve access, it will strengthen public-private partnerships through the Education Foundations. Over the next two years it will restructure the Elementary Education Foundation to enable it to implement innovative programs to support the private sector.

76. Second, demand side interventions will be introduced with a focus on regional and gender equity. In the near term the government will commence a program o f stipends for girls to attend middle and secondary schools in poor districts where female middle and secondary enrolment i s particularly low. This demand side initiative will complement the supply side measures to expand middle and secondary education for girls. Further, the initiative will be poverty focused, as the districts where female enrolment i s lowest are also the regions where poverty rates are the highest. The emphasis o n poverty focused demand side initiatives will be strengthened in coming years, and the GoNWFP will introduce a program o f incentives for teachers to work in remote, rural schools.

77. Third, the quality o f education, at a l l levels, will be a key focus o f the education program. Policies to improve education quality will emphasize measures to raise the competencies and performance o f teachers, and the cognitive achievement levels o f students. In the near term the GoNWFP will establish an institutional framework for teacher development. T h i s will cover the service conditions for teachers, such as entry criteria in to the profession and career progression, pre-service teacher education, and professional development through both on-site and off-site

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teacher training and support. In coming years i t will institute a program o f special support for schools with low learning outcomes. This wil l include regular monitoring o f learning levels, and the implementation o f special measures to assist the weakest schools, including providing extra financial resources, directed additional management attention, special incentives for good teachers to locate in such schools, and appointing good head teachers to these schools, as needed.

78. Fourth, the NWFP education program will place strong emphasis on objective monitoring and evaluation. In the near t m the government will establish a specialized technical unit in the Department o f Education to undertake monitoring activities. This unit will be staffed with the right s h l l mix to manage ongoing monitoring, establish linkages with the E M I S data, and develop linkages with district governments and to use the data analysis for policy development. In coming years the government wi l l introduce a system o f external Third Party Validation (TPV). The TPVs will be a useful external accountability instrument, assessing the quality o f the internal monitoring systems by confirming the results with ongoing departmental monitoring. Annual TPVs would be conducted through independent and external agencies to assess various reform inputs including stipends, textbooks, provision o f facilities, availability o f teachers, and functioning of PTAs.

b. H e a l t h Sector

79. In health the reforms wil l be broadened by: (i) testing innovative approaches to strengthen the management and organization o f primary and secondary health services; (ii) building partnerships with the non-state sector; (iii) increasing managerial autonomy; and (iv) enhancing accountability in the public sector through significantly strengthening monitoring and evaluation.

80. The f i rs t key reform i s to improve the utilization and quality o f Primary Heal th Care (PHC) services by testing of managerial and organizational innovations using a controlled, before and after, evaluation targeting the worst performing districts in the province. The three approaches that will be tested in the near term include: (a) contracting out management o f responsibility for delivering a package o f PHC services to NGOs, in keeping with the President’s PHC Initiative; (b) providing increased administrative and financial autonomy (and requisite powers) t o district managers so they can effectively manage the District; and (c) providing, along with administrative and financial autonomy, performance based incentives to district managers and key staff. This i s the f i rs t time that any provincial government wil l implementing focused reforms which could have far reaching impact o n health sector management and quality o f service delivery.

8 1. The second area o f reform i s to improve quality, equity, and uti l ization o f secondary care by introducing hospital r e f o m and develop models o f autonomy. This would explicit ly address issues o f human resource management, governance, and financing for district hospital governance, management, and autonomy. In the medium term, i t i s expected that improved models o f autonomy will be implemented in district hospitals. NWFP i s taking the leading in introducing hospital reforms at the secondary level. T h i s reform measure will b e supported through DPC 2.

82. Third, a series of reforms measures are envisaged to be implemented to strengthen the Department’s stewardship over the sector. A key measure over the medium term w i l l focus on significantly strengthening monitoring and evaluation through the establishment o f an independent monitoring and evaluation cell in the Department o f Health. The unit will undertake performance assessment, coordinate inter district dialogue, and enhance accountability by

19

disseminating disaggregated district performance indicators to the public through the media and the Department o f Health’s website.

83. The government will also strengthen partnerships with the private and NGO sector. T o that effect i t will restructure the NWFP Health Foundation by re-orienting i t s role, functions, and scope o f work. Measures would be taken to enhance i t s autonomy. In addition, the recently- established Health Regulatory Authority (HRA) would develop a clear strategy in order to improve the quality o f care provided in the private sector.

C. Social Protection

84. The provincial government has recently added social protection as the fifth pi l lar t o i t s reform program as reflected in i t s PRSP. However, while the provincial PRSP highlights the importance o f social protection in combating poverty, fostering human development and achieving the Mi l lennium Development Goals, l i tt le has been done to implement planned actions. The province relies on federal spending and key programs are federally mandated and financed. The province spends very l itt le f rom i t s own resources. As elsewhere in Pakistan, public-private partnership i s an important pil lar o f assisting the vulnerable, and a number o f NGOs provide a variety o f services to the vulnerable groups. Although significant, both formal and informal safety nets interventions are far f rom sufficient to alleviate poverty, and deep and widespread poverty remains one o f the main features o f NWFP’s social and economic reality.

85. The government i s committed to developing a comprehensive social protection reform strategy that would strengthen targeted programs to address chronic poverty and vulnerability through financially sustainable programs, coordinated at the federal level, that facilitate participation o f the poor and vulnerable in basic social services. The Government o f NWFP i s currently taking stock o f social protection programs and their outcomes. The stock-takmg wil l form a base for social protection reform strategy and an action plan for i t s implementation, which will be developed in tandem with ongoing work o n a national social protection strategy and decided based o n the results o f the stock-taking and related consultations. L ike ly areas o f init ial engagement would focus on social protection administration and implementation improvements, including (i) organization and coordination at the provincial and districts levels; (ii) human resource capacity building; (iii) introduction o f MIS and provision o f other up to date equipment; and (iv) physical infrastructure. Subsequently, existing programs would be audited and tightened up in order to increase their effectiveness and efficiency. N e w programs, including scaling up o f demand side incentives (and perhaps expanding these to participation in health programs, e.g., nutrition), workfare and community-based service delivery for vulnerable groups o f the population will be gradually introduced, in close coordination with national pol icy developments.

Pillar Two: Fiscal and Expenditure Reforms

86. The medium-term fiscal reform strategy is being closely integrated with the government S strategy for human development and inclusive growth. In order to improve delivery o f social services, increased expenditures, combined with sector-specific measures in education, health, and water and sanitation, are being complemented with corresponding measures in fiscal decentralization, so as to give service providers (local governments) additional resources to deliver. Additional critical public investment will be needed to crowd-in private investment in order to provide employment to the better educated work force.

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87. The high-investment/high-growth strategy envisaged in the medium-term reform program wi l l have important development rewards but it w i l l also require additional fiscal resources for its implementation. The recent, temporary amendment in the 1997 NFC (National Finance Commission) Award (amended by the President in January 2006) that devotes a higher share o f the divisible p o o l to the provinces i s a step in the right direction but needs to be made permanent through a new NFC Award.

Original NFC Award Amended NFC Award 5-Year Additional

2006/07 2007108 2008109 2009/10 2010111 Total 2006107 2007108 2008109 2009110 2010111 Total Transfer Divisible Pool (Net of 2.5% General Sales Tax Transfers 35.0 39.6 44.8 50.6 57.3 227.2 34.6 40.3 47.1 55.0 64.2 241.2 14.0 Revenue from 2.5 GST 4.5 5.2 5.9 6.8 7.8 30.1 5.0 5.7 6.6 7.5 8.6 33.4 3.3 On Population bmis 2.6 3.0 3.4 3.9 4.5 17.4 3.5 4.0 4.6 5.2 6.0 23.2 5.8 On OZT Collections basis 1.9 2.2 2.5 2.9 3.3 12.7 1.5 1.7 2.0 2.3 2.6 10.2 -2.5

Grants and Subventions 4.3 4.9 5.5 6.3 7.1 28.0 9.7 11.0 12.5 14.1 16.0 63.3 35.2 Total Resource 43.8 49.6 5 . 2 63.7 72.2 2.35.4 49.3 57.0 66.1 76.6 88.8 337.8 52.5 R o v i n c e s 14.0% 13.9% 13.9% 13.9% 13.9% 13.9Yq 15.0% 15.0% 14.9% 14.9% 14.9% 14.9% 24.6%,

88. The NWFP’s finances will get a strong boost f rom the amended N F C Award (see Table 3 for comparison o f the estimated revenue transfers to the province under the terms o f the original and the amended 1997 N F C Awards).6 Under the new arrangement, NWFP will get an increase of about Rs 5.6 b i l l ion (12.7 percent) in FY07 compared to the terms of the original 1997 NFC Award. Overall, the province i s l ikely to get an additional Rs 52 b i l l ion during the next 5 year if the amended Award stays in place.

89. The NWFP government plans to strengthen own finances and i s committed to a full implementation of the fiscal reform program that started in 2001. Increasing own resource mobilization will be a major challenge given the existing federal - provincial assignment o f tax instruments that leaves NWFP with a non-buoyant and narrow tax base.’ There i s some potential to generate higher own revenues over the medium term f rom revenue sources such as the Motor Vehicle Tax (MVT), Stamp Duty, Professional Tax, Urban Immovable Property Tax, Agricultural Income Tax and taxing services. However, the growth strategy also requires increased resource transfers f rom the federal government and external development assistance.

90. To strengthen own revenue mobilization, the government will address corruption in tax administration, make it more effective, strengthen collection of broad based taxes and user charges. Besides improving tax administration through improved incentives, training and computerization o f tax records,’ the provincial government plans to focus more intensely o n relatively broad-based provincial taxes. Collection o f MVT, which i s far below potential, i s being streamlined through a more automated collection o f the tax. T o improve the structure and revenue potential o f the property tax, the provincial government i s in the process o f f inalizing a survey o f properties. K e y measures for rationalizing and improving the y ie ld o f user charges include: improving the water rate formula with the a im o f making it self financing and a review o f higher education fees and user charges for health services, with adequate safety nets for the poor. Because o f these measures, the provincially collected revenue i s projected to increase at an

The recent amendment i s l ikely to be continued until such time that the N F C announces a new Award. Federal laws also exempt 7 out o f 24 districts in the province from paying taxes to the provincial government. Other tax administration measures include: a clearly defined and streamlined role o f the Board o f Revenue (BoR) and

the Excise and Taxation (E&T) Department; modernizing the mode o f application o f laws and administration o f agricultural and land-based taxes; and improving coordination between the B o R and E&T Departments. The GoNWFP has initiated a new study to improve revenue administration in the key revenue collecting Departments.

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average rate o f 16 percent p.a. f rom FY05 to FY10. With federal transfers expected to increase by 15 percent p.a. overall provincial revenue i s projected to increase by 15 percent p.a.

WO1-03

4verage

91. The government will also continue to create fiscal space by following i t s strategic debt management pol icy to save interest payments through better debt management (in particular by retiring loans fkom the Federal Government at high (16-17 percent p.a.) interest rates).

FY04 FYO5 FY06 FY06 FY07 FYO8 FY09 FYI0

Actuals Actuals W B format Proj. Proj. Proj. Proj. Proj. Prelim. Budget

Table 4: NWFP Medium-T

9.3 6.0 0.9 0.4 0.4 0.6 1.7 1.6

9.6 6.4 3.7 0.5 1.2 0.5 0.1 0.6 3.1

-0.2 -0.2 0.3

0.2 -0.1 -0.2 0.2 0.4 0.2 0.2

-0.1

7.5 67.3 32.7

41.1 31.7

8.2

1 .o

~

rota1 Revenues and Grants Federal Tax Assignments (NFC) Provincially collected revenues

Tax Revenues Non-tax Revenues

Net Hydel Profits from WAPDA Federal and Foreign grants

oiw Federal grants

rota1 Expenditures

Wages Pensions Non-Wage Operations & Maintenance Interest Payments Subsidies 21 Transfer payments to local governments

Current Expenditures

Development Expenditures

Fiscal Balance (including earthquake effects) Fiscal Balance (excluding earthquake effects) Drimary Fiscal Balance (incl. earthquake effects,

Financing (Net) Domestic Debt Federal Debt (CDL) State Bank Overdrafts Foreign Debt, Net (incl. SAC)

Foreign Project Assistance Budget support

Change in cash balances and Other Financing

Wemorandum Items

Real GDP growth rates % Zurrent spending in % o f total spending Development spending in % of total spending

Social sector share of total spending (%) o/w Education

Health

9.1 5.1 0.8 0.3 0.5 1.5 1.5 1.3

9.5 7.9 3.7 0.7 1.3 1.7 0.3 0.2 1.7

-0.4 -0.4 1.2

0.8 0.2

-0.7 -0.4 0.4 0.0 0.6 1.2

2.7 82.6 11.4

34.0 26.9

7.7 4.7 0.8 0.3 0.4 1.2 1.0 0.9

8.9 6.9 3.8 0.5 0.9 1.1 0.1 0.4 2.0

-1.1 -1.1 0.0

1.1 -0.2 -0.6 0.0 1.1 0.1 1.0 0.9

5.6 77.3 22.7

39.4 30.6

8.2 5.2 0.8 0.3 0.4 1 .o 1 .o 1.0

8.7 6.4 3.6 0.5 0.7 1.0 0.2 0.4 2.2

-0.5 -0.5 0.5

0.5 0.2

-0.6 0.0 0.1 0.1 0.0 0.9

6.3 74.1 25.9

38.6 30.3

7.5 6.5 7.8

2.71 1.41 2.01

9.0 5.3 0.7 0.3 0.4 0.9 1.9 1.8

10.2 7.7 4.4 0.6 I .4 0.9 0.1 0.4 2.4

-1.2 -1.2 -0.3

1.2 -0.6 0.0 0.0 0.8 0.2 0.8 0.9

6.6 75.9 24.1

34.1 25.9

6.8

8.1 5.3 0.8 0.4 0.4 0.9 1 .o 0.9

9.5 6.7 3.9 0.6 0.9 0.9 0.1 0.6 2.7

-1.4 -0.8 -0.5

1.4 0.4

-0.7 0.0 1.3 0.0 1.3 0.3

3.0 71.1 28.9

39.4 30.6

7.7

8.7 5.3 0.8 0.4 0.4 0.8 1.7 1.6

9.4 6.6 3.6 0.5 0.9 0.8 0.1 0.4 2.9

-0.7 -0.6 0. I

0.7 -0.1 -0.2 0.0 1.1 0.1 0.8 0.0

6.9 69.6 30.4

39.7 30.7

7.9

8.9 5.5 0.8 0.4 0.4 0.7 1.7 1.6

9 3 6.3 3.7 0.5 1 .o 0.6 0.1 0.4 2.9

-0.4 -0.3 0.2

0.4 -0.1 -0.2 0.0 1.5 0.2 1.1

-0.8

7.2 68.3 31.7

40.1 30.9

8.0

9.1 5.7 0.8 0.4 0.4 0.6 1.7 1.6

9.4 6.4 3.7 0.5 1.1 0.6 0.1 0.4 3.0

-0.3 -0.3 0.2

0.3 -0.1 -0.2 0.0 0.7 0.2 0.2 0.0

7.5 67.9 32.1

40.5 31.3

8.1

1 .o 1.4 1.3 1.3 1.1 Debt servicing (in % of PGDP) 3/ Public Debt (in % of PGDP) Source: GoNWFP Fiscal tables and Bank s ta f f projections

2/ Wheat subsidy. 3/ Interest and normal repayment o f principal.

92. Accelerating growth and facilitating access to service delivery wi l l require not only increasing the overall level of public expenditures, but also improving the composition and effectiveness of these expenditures, with relatively more emphasis on investment and operations and maintenance, less on consumption, and better management of investment projects. In i t s medium-term budget framework (FY06 - FYlO) the government plans to reduce overall current

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expenditure in terms o f provincial GDP (from 6.7 percent in FY06 to 6.4 percent in FY10)9 whi le significantly enhancing spending on high-priority sectors, l ike education and health. A large increase (of 24 percent p.a.) i s projected in Operations and Maintenance (O&M) expenditure to maintain the value o f public capital stock. Sustained retirement o f expensive federal debt will continue to lower interest payments. Regarding public investment, the government plans to increase development spending by 20 percent p.a. and raise i t s level f rom 2 percent o f PGDP in FY04 - FY05 to 3.1 percent o f PGDP over the medium term. I t will invest more in priority areas that include roads, irrigation networks, education, health and water supply and sanitation while containing the “throw-forward” o f the Annual Development Program at i ts current level in real terms. Reforms will also aim at raising the effectiveness of public investment spending through specific measures to improve the selection o f projects, avoid post-approval escalation o f costs and improve monitoring and supervision o f projects (in addition to procurement reforms described below).

93. The fiscal framework also envisages measures to fully meet future liabilities and making the budget process more effective and transparent. I t will continue to build up the Pension Fund, the General Provident Fund and the Frontier Highway Authority Funds. Drawing o n the newly established Human Resource database for the c i v i l service it will explore pension reform options by projecting pension liabilities under different reform options and scenarios. With regard to the budgetary process the government will continue to improve budget preparation through phased roll-out o f Performance Budgeting to other districts. In order to improve budget execution, it plans to launch a system in the coming fiscal year that will enable timely reporting o f the consolidated fiscal deficit (province and districts) and other key fiscal aggregates o n a quarterly basis. I t wil l attain accurate and timely information on the fiscal accounts o f district governments and TMAs o n a monthly basis, and disseminate it to provincial departments and to the public.

94. By continuing fiscal decentralization reforms the Government wi l l enable local governments to function more effectively and hence improve the delivery of social services.” As a key step towards further fiscal decentralization the government has initiated the process o f devolving the payment o f district s ta f f salaries through (district) Account N, and it i s possible that this can take effect f rom July 2006. This would provide proper incentives to districts for efficiency gains in staffing. In addition, it also intends to increase the share o f district development budgets executed through (district) Account N. I t has also made headway in formulating a transparent formuldsystem o f incentive grants to Districts for good performance in service delivery, and i s considering instituting conditional grants. In this mechanism development funds could be transferred to the district governments (through Account N) as part o f performance agreements between the provincial and district governments. Also, over the medium t e r m the Provincial Finance Commission should be made permanent to institutionalize fiscal decentralization and review o n an ongoing basis fiscal performance o f the districts.

95. The combined effect o f the provincial government’s fiscal policies and reforms over the medium term are summarized in i ts MTBF (see Table 4 and Annex 8, Table 4). T h e broad outcomes include: (i) the provincially collected revenue will remain at 0.7 percent o f PGDP in 2006107 but would increase to 0.8 percent o f PGDP in 2007108, and in h t u r e years would increase at the same rate as nominal PGDP; (ii) the provincial government’s current expenditure wi l l increase to 6.7 percent o f PGDP, mainly due to earthquake-related expenditures, but would decline to 6.3 percent within the next two years, and then would remain at that level; (iii)

The increase in recurrent expenditure in 2005/06 (to 6.7% o f GDP) i s because o f the one-time expenditure (or Rs 3.3 billion) to be incurred by the province to restore the services in earthquake affected areas. lo This also requires progress in administrative and functional devolution (see pil lar IV).

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provincial development expenditure wi l l continue to increase as percent o f PGDP; (iv) the 2005/06 fiscal deficit will increase to 1.4 percent o f GDP due to the impact o f earthquake (on provincial income and public finances), reduction in federal grants and increase in provincial development expenditure. The fiscal deficit would drop sharply in 2006/07 and would continue to decline as a percent o f PGDP in future years; (v) the stock o f public debt will decline as a percent o f PGDP; and (vi) interest payments will on average decline by 0.1 percent o f PGDP each year.

Pillar Three: Governance Reforms

96. Weak governance has been at the heart o f the province’s development challenges and going forward the focus on human development will require continued improvements in (i) public financial management, (ii) procurement; (iii) civ i l service reform; and (iv) carrying the devolution process forward; the latter with the goal o f improving the administration o f multi-tiered government (province/district/tehsil) and making local governments more accountable for improved service delivery. The main components o f governance reforms are discussed in Annex D. Briefly, the thrust o f governance r e f o m s i s as follows:

a. Public financial management

97. The government wil l continue to implement i t s medium-term strategy for public financial management reforms as outlined in the P F A A action plan. These reforms a im at improving the reliability and accuracy of financial data, institutionalizing the internal audit function and improving accountability and legislative oversight. See Annex 5 for more information o n public financial management reforms.

b. Procurement reforms

98. Whi le the province has made substantial progress in procurement reforms, including promulgating a new Procurement Law, further work i s needed to actually make the L a w effective and ensure i t s implementation. The government i s refining phase 3 and onwards o f i t s Procurement Reform Act ion Plan to bring procurement practices to international standard over the medium term. It will implement phase 3 o f the action p lan in the near term. Among other things, this will include specifying the needed amendments in the procurement l a w and the Standard Bidding Documents, and putting in place a system for posting and updating market prices for use in cost estimates in bidding contracts.

C. Modernization of the civil service and administration of multi-tiered government

99. Over the near and medium term the government will continue i t s current policies o f c i v i l service cost control through judicious and l imi ted increases in the size of the c iv i l service with the vast majority being hired in high priority areas (health and education). I t will continue to increase the average time in post o f senior staff and make the monitoring results publicly known. The PPSC will continue to regulate and monitor selection, appointment, promotion and transfer o f a l l staff in BPS 15-21 at local government and provincial levels and for professionals and technical specialists in grades BPS 1 1-1 5 at the provincial level. Contract employment policies can be used judiciously to provide more attractive terms and conditions o f employment to fill posts in less attractive areas that often lack competent c iv i l service staffi in particular women teachers and qualified health workers. In addition, in the near term a priority for the government i s to design and establish district services, including district and tehsil cadres.

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100. The HRM database will continue to be fully operational and be integrated with PIFRA. I t will be in regular use, with reliable and timely data provided for HRM planning and monitoring of establishment levels, appointments, promotions and transfers at provincial, district and tehsil levels. It can also be used, for instance, t o monitor at provincial and district levels the success o f policies to recruit and retain female teachers at girls’ schools and health workers at basic health units in disadvantaged districts.

101. Over the medium t e r m the organizational review processes will be rol led out to a l l sectors after the in i t ia l reviews in health and education. The reviews will cover the functions o f a l l provincial, district and tehsi l units with a focus on service delivery outcomes. The reviews will form the basis for an action plan for staffing, organizational structure, business process and capacity building and for producing results-oriented j ob descriptions for al l posts. The action plan will be implemented over the medium term, supported by necessary amendments to laws, rules and regulations. (See also Annex 6 for further detail on c i v i l service and administrative reform.)

Pillar Four: Accelerating Economic Growth

102. With the overarching goal o f reducing poverty in the province the NWFP government’s medium-term strategy also sets out to increase employment opportunities through accelerated, inclusive growth. The government, supported by the Bank’s analytical work and the ground work in ,recent years, has developed an overall strategy for economic growth that will be presented at the forthcoming NWFP development forum (May 2006). The growth strategy i s supported by complementary reforms to ensure sustained human development and improved quality o f the work force. The main elements o f the NWFP government’s forward-looking growth strategy are presented in Annex 7.

103. In brief, the strategy for inclusive growth aims to deepen the earlier reform to strengthen the private sector, enhance the role o f the urban centers in generating growth and modernize agriculture. The component for agriculture i s drawn f rom government’s recently announced Agricultural Policy (2005) that seeks to encourage the movement towards high value products (horticulture, livestock and others) for both domestic and international markets and thereby exploit the province’s considerable growth potential in these products. Though expansion o f the livestock sector will need to remain within the carrying capacity o f the rangelands in order to maximize the earning potential o f the sector and assure long term sustainability.

104. The next phase o f the growth strategy aims to (i) strengthen the private sector by promoting demand-responsiveness o f public sector agencies; (ii) improve the functioning of industrial estates; and (iii) strengthen the legal framework for modernizing agnculture and enhance the capacity o f small farmers and livestock holders. This will include: ensuring that the new one-window investor facilitation center coordinated by the private sector and the corresponding line agencies i s operational (i.e., that it has been staffed and has started serving potential investors); transferring management o f industrial estates to the private sector; revising the Agricultural Produce Act; and establishing Milk Producers Associations. T h i s phase of the growth strategy will be completed in 2006.

105. The government will implement a subsequent phase o f i t s growth acceleration strategy by 2007. This will include merging S D A and Small Industries Development Board (SIDB), transferring management control o f Bank o f Khyber to the private sector, setting up the Mines Magistrate to strengthen enforcement o f mining property rights and address labor concerns, developing an enabling framework for private provision o f power and o f municipal services, and

25

restructuring the technical and vocational training system consistent with principles of being private sector led and responsive to labor market demands.

106. The medium-term growth strategy will also promote development o f urban centers. This will involve better functioning o f urban land markets and better planning for urban development including better provision o f public services and infkastructure. The most important requirement to make the land markets function optimally i s a system that abolishes the current t it le ambiguities and determines title conclusively. Urban development will b e improved by strengthening the capacity o f city governments to develop credible plans for improving ci ty infrastructure, bringing Building Byelaws and Regulations at par with international standards and integrating these with cities’ integrated strategic plans and promoting public-private partnerships in municipal service delivery.

IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM

A. Overview

107. The Bank’s current assistance strategy in NWFP i s guided by the Pakistan CAS and reaffirmed by the CAS Progress Report, discussed by the Board in June 2002 and April 2004, respectively. The assistance strategy i s fully consistent with the national PRSP which sets out a program to strengthen macroeconomic stability and government effectiveness at a l l levels, improve the business environment (both at the federal and provincial level) for growth, and improve equity through pro-poor and pro-gender equity policies and programs, also at both the federal and provincial level.

108. Recognizing that the provinces and local governments in Palustan bear most o f the responsibility for delivering public services including education and health, but have very l imi ted “fiscal space” to provide these services, the CAS and the CAS progress report lay out three strategic principles for which provinces will get assistance through development pol icy lending: (i) client “pull” and selectivity; (ii) adoption o f a programmatic approach; and (iii) reliance on partnerships. Highlighting these principles the CAS emphasizes assisting those provinces which have embarked upon a comprehensive fiscal and economic reform program, have built credible track records o n implementation and have sought the Bank’s assistance. All three strategic principles are applicable to the proposed operation. NWFP has a comprehensive medium-term reform program that includes fiscal, governance and economic reform components. Consistent with the CAS objectives the overarching goal o f the NWFP provincial re form program i s to reduce poverty by promoting growth and accelerating human development, and the reform program i s fully aligned with achieving PRSP objectives at the provincial and local level. The government has high ownership o f and strong commitment to continued reforms. The Senior Minister i s the key champion o f reform and there i s a core group o f capable re form leaders within the administration. Together with donors such as DFID, the Bank has a strong partnership with NWFP.

B. Bank Support

109. The Bank‘s wider program o f support t o NWFP covers both lending and non-lending activities. The Bank initiated in 2002 a program o f three single-tranche Structural Adjustment Credits over the period FY03-05 to provide performance-based budget support to enable the province to restore financial equilibrium while undertaking i t s Provincial Reform Program. The second o f these credits for NWFP was approved in June 2004 for the amount o f US$90 mill ion. The following are ongoing Bank projects in NWFP: (i) the NWFP On Farm Water Management

26

Project (US$28 mi l l ion IDA), which i s helping to reduce water losses and implement farmer managed irrigations system; and (ii) N W F P Community Infrastructure Project I1 (US$42 mi l l ion IDA), which supports community driven small infrastructure schemes. In November 2005 these projects were restructured with financial reallocations in response to unusual natural disasters in 2005 (floods and earthquake). The NWFP On Farm Water Management Project also received additional financing o f US$10 mill ion. The province also receives support f rom the Bank through several nationwide or multi-province operations: these include (iii) Palustan Poverty Alleviation Fund 11, (iv) H I V / A I D S Prevention Project, (v) Second Project to Improve Financial Reporting and Accountability (PIFRA II), (vi) Protected Areas Management Project (GEF), (vii) National Highways Rehabilitation project; and (viii) Pakistan Earthquake Emergency Recovery Credit. The proposed DPC 1 i s complementary to the Bank’s PRSC credits.

C. Analytic and Advisory Services

110. Knowledge partnership i s a key element o f the Bank’s assistance to the NWFP. Since SAC 2 the analytical base has been strengthened further with the NWFP Economic Report and related Bank E S W with a bearing on provincial policies. These include the nationwide rural factor markets study (ZOOS), the national Growth and Competitiveness Study (2006), the Country Gender Assessment (2006) and the nationwide Administrative Barriers study (2005). Previous studies that have had considerable influence o n formulation o f the medium-term pol icy framework include the Provincial Financial and Accountability Assessment (PFAA, 2004), the Country Procurement Assessment Review (CPAR), the Devolution Study (2004) and the Palustan Public Expenditure Review (PER, 2003).

11 1. The Bank has in recent years been assisting the Government o f NWFP in developing a core set o f phase I1 analytical activities with the objective o f expanding the reform agenda through knowledge partnerships with the Bank and with a network o f academic and donor supported initiatives. The NWFP Economic Report that lays out a medium- and long-term development strategy for the province was prepared through such a knowledge partnership. I t s jo in t preparation has enhanced ownership o f the strategy presented in the report, and the Government i s using the report as a basis for i ts new Provincial Development Program for FY06 - FY08, and for the design o f this and follow-on operations. It will also’use the Economic Report as the analytical basis for the f i rst NWFP Development Forum scheduled for M a y 2006.

112. The Bank foresees possible technical assistance in cooperation with donors in the following areas: in public expenditure management and budgeting where DFID i s l ikely to continue i t s technical assistance in performance budgeting and improved human resource management with particular focus on education and health, and in .the area o f administrative devolution with assistance to district governments to build human resource management capacity as they establish separate district services; and in teacher and school management training (NORAD and GTZ).

D. Lessons from Previous Policy Based Lending Operations (SACS)

1 13. remain val id for the DPC program. These include:

Many of the lessons in the Implementation Completion Reports for NWFP SAC 1 and 2

(i) A strong dialogue between the Bank and the provincial government at the technical as wel l as the cabinet level i s a key to success for a reform program. The increasingly strong policy dialogue, including through analytical work jo in t ly with the Government, has also strengthened government ownership o f the reform program further.

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The D P C needs to show sensitivity to local political conditions. Sequencing and prioritization o f reforms, pace o f progress and achievement o f outcomes can be significantly affected by changing polit ical and social realities.

The interface o f federal and provincial policies must be given more attention in subnational Bank operations in Palustan since issues o f provincial share in total revenue collections and industrial and trade policy implications are crucial for regional development.

Factor in higher revenue transfers f rom changes in NFC Awards into the fiscal program only when an agreement on the N F C materializes. This lesson also emphasizes the need for provincial governments to explore al l revenue raising measures provided for in the Constitution o f Pakistan.

For programs that fund facility improvements, a maintenance program must be in place. A large part o f SAC 2 funds were spent o n educational and health facilities. Maintenance i s critical t o preserving the gains and the districts are currently weak in this regard.

Timely and reliable M&E depends o n regular updating o f performance indicators. Several indicators identified to monitor SAC 2 were long-term in nature, in particular poverty data. Real wage data can be used as monitoring indicators for poverty trends.

(vii) Capacity building efforts need to track changes in levels o f responsibility as a result o f decentralization. With greater responsibilities in the districts comes the need for additional capacity. For example, the large investments in school rehabilitation need to be matched with resources to facility inspections to monitor school condition as we l l as teacher attendance. Another example i s the capacity in the Provincial Public Service Commission, which has taken o n greater recruitment responsibilities, especially in 2004, but has not increased i t s staff commensurately.

E. The Proposed Development Policy Credit

114. As stated earlier, the proposed DPC 1 i s a transition operation that assesses progress o f the broad-based reform program o f the Government o f NWFP pursued in 2002-06 (prior actions for this operation) and then going forward, lays out the framework (triggers fo r the next proposed operation) for development pol icy lending that i s focused o n human development and inclusive growth.

Prior actions for the proposed DPC 1

115. The broad reform program supported by two SACS and the agreed pr ior actions of the proposed DPC 1 focused on the following: (a) Accelerating economic growth by establishing an effective and transparent enabling environment for private sector development both in the urban and rural economy; (b) Fiscal reforms to ensure fiscal sustainability and create fiscal space, adopt and fol low a medium-term budget framework, enhance effectiveness and accountability o f expenditures, and strengthen resource mobilization; (c) Reforms to accelerate human development and improve service delivery in key sectors (especially basic social services), focusing on access to and quality o f services; and (d) Governance reforms in public financial management, procurement, c iv i l service and administration o f multi-tiered government (province/distict/tehsil).

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a. Accelerating economic growth

1 16. Whi le the success o f the growth-related reform program wil l depend on a comprehensive range o f measures included in the government’s overall strategy for inclusive growth discussed in the previous section, the following have been deemed particularly important, and are being supported by D P C 1, to enable the private sector to realize its full growth potential: (i) institu- tionalizing public-private dialogue to ensure that government decisions affecting private business are consistent with the private sector’s investment and growth objectives, (ii) improving private sector’s access to skilled manpower and (iii) allowing the private sector to expand into sectors previous dominated by state owned enterprises.

117. Furthermore, agnculture i s central to economic growth in NWFP. The government recognizes this and has made agriculture a key plank in i t s growth strategy. The main elements supported by D P C 1 for strengthening agnculture are: (i) aligning public expenditure allocations in the sector with Agricultural Policy priorities, (ii) ensuring that agricultural research in the province i s tuned to the needs o f farmers as they move to higher value added crops and (iii) strengthening extension services through Farm Services Centers to assist farmers in adapting modem technologies in their cultivation practices.

11 8. government, and their current status, are as follows:

The specific pr ior actions in the growth pil lar for DPC 1, previously agreed with the

0 Establish Investment Facilitation Council headed by the Chief Minister and Investment Facilitation Committee headed by the Chief Secretary. Status: Done. “Investment Facilitation Council”, Notif ication No. AEA (IND) 10-342, November 11, 2005 and “Investment Facilitation Committee”, Notif ication AEA (IND) 10-342, Nov. 12,2005.

0 I n order to adopt a demand driven approach to the operation of technical and vocational training institutes to meet the skills needs of the private sector: include representatives of the private sector in the management committees of such institutions and appoint private sector representatives as chairpersons. Status: Done. Notif ication No. DTE&MT/PTB/227-Vol-111/1768, 11” M a y 2005.

0 Restructure Sarhad Development Authority (SDA) to include an investment facilitation center; make SDA the secretariat for the Investment Facilitation Council and the Investment Facilitation Committee; and create management committees for industrial estates consisting of; and led by, private sector representatives. Status: Done. “Restructuring o f S D A & SIDB”, Notif ication No. SDA/D (P71)/IFA-96/3492, 1 8th November, 2005. “Industrial Estate Management Committee”, Notif ication No . SDA/PS-CH: 866, 18” M a y 2005.

0 Reduce government shareholding of Bank of Khyber to 65 percent. Status: Done. The government increased total capital through a new emission to the public in February 2006 that reduced i t s share to 65 percent.

0 Re-align public expenditures with the priorities set out in the Agriculture Policy. Status: Done. Fiscal budget FY05/06 shows increasing share o f expenditures in the identified priority areas.

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0 Initiate steps to establish an autonomous agrialtural research system consistent with the priorities set out in the Agriculture Policy; establish 75 Farm Services Centers; and establish Multi-stakeholder District Agricultural Coordination Forums in all (24) districts. Status: Done. A total o f 75 Farm Services Centers have been established and are in operation. The NWFP Agricultural Research System (Handing over) (Repeal) A c t , 2005 (NWFP Ac t No. XV o f 2005) removed ambiguity and duplication by transferring research responsibilities to the Department o f Agnculture and Livestock under which an autonomous research body will be established. Fol lowing notification of the GoNWFP, 24 District Agricultural Coordination Forums have been established and are operational.

b. Fiscal reforms

119. The government’s fiscal reforms are comprehensive. The critical fiscal objectives are: (i) ensuring a sustainable fiscal position; (iii) continuing to improve effectiveness o f public investment spending; (iii) containing public consumption to maintain proper expenditure composition and balance between public investment and consumption; and (iv) raising own revenue mobil ization to create fiscal space.

120. SAC 2 preparation, and their current status, are as follows:

The specific pr ior actions in the fiscal area in DPC 1, agreed with the government during

e The FY05 Budget outcome, including overall deficit, to be in line with the medium-term budget framework (MTBF). Maintain FY05 throw-fonuard ratio of development projects at or reduce it below the FY04 level of 3.0 years, and contain the establishment budget to the FY04 level in terms of percent of provincial GDP (3.6 percent). Status: This pr ior action has been met. June (Final) fiscal accounts show that:

o The fiscal deficit was Rs 3 b i l l ion (0.5 percent o f PGDP), significantly less than the MTBF target o f Rs 4.1 billion.

o The throw-forward ratio o f development projects was reduced to 2.7 years, below the target o f 3.0 years.

o The overall establishment cost was also contained at the target o f Rs 21 b i l l ion (3.6 percent o f PGDP) set in the MTBF.

Implement the following tax administration and tax policy measures in the FY05 budget in light of policy-based studies: (i) introduce a system of bonus payments to excise and taxation staf linked to revenue collection per$ormance; and (ii) open Tax Facilitation Centers with support from private sector for collection of selected taxes. Status: Done. Cash bonus incentives to tax collectors for good performance were established with Finance Department releasing Rs 1.5 m i l l i on to the Excise and Taxation Department. Tax facilitation centers have started operating in urban centers for collection o f Mo to r Vehicle Tax and other revenue items.

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c. Accelerating human development through improved service delivery

c.1 Education

121. In the f i rs t phase o f reforms l imi ted access to education services was deemed the most binding constraint for education in the province. K e y demand side constraints were the cost o f education that effectively reduced demand for education by the poor and in particular for girls, and the high incidence o f teacher absenteeism that reflects poor monitoring o f teacher attendance. Enhanced involvement by PTAs in monitoring and running operations in the schools could

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effectively limit teacher absenteeism. The specific prior actions in the education sector for DPC 1, agreed with the government during SAC 2 preparation, and their current status, are as follows:

e Distribute free textbooks to all primary school students, and all g i r l middle and high school students, in government schools. Status: Done. Source: NWFP Textbook Board, District Governments.

e Ensure that functional PTAs with authority to monitor teacher attendance and utilize instructional material and repair (IMM) funds wil l continue to exist in al l primary schools; train and make PTAs fu lb functional with similar authority in twenty percent (20 percent) of middle and high schools; and ensure that districts release I M M funds to al l existing PTAs. Status: Done. Funds released by March 2006. Notif ication gives PTAs said authority. Training has been provided with donor assistance.

c.2 Health

122. L imi ted access to key preventive services, such as TB (tuberculosis) daily observation therapy sessions (DOTS), family planning and primary health services (through the Lady Health Worker program) and H IV /A IDS services, has been critical constraints o n the health status o f the population in the province. The specific pr ior action in the health sector for DPC 1, agreed with the government during SAC 2 preparation, and i t s current status, is:

e Extend the coverage of the TB DOTSprogram from 17 to al l (24) districts; deploy 2,500 new Lady Health Workers to district hospitals to reach target of 13,000; and enter into at least three contracts with NGOshrivate sector organizations for the provision of HIV/AIDS preventive sewices for vulnerable populations. Status: Targets for TB D O T S coverage and Lady Health Workers have been met. Three contracts with N G O s have been signed for provision o f H IV /A IDS preventive services.

d. Governance reforms

d.1 Public financial management

123. Improving the reliability, accuracy and timeliness o f financial data has been the most important challenge in public financial management. The o ld chart o f accounts was lacking breakdown in a number o f categories that were needed for proper reporting and cost attribution. The agreed prior action for DPC 1 and its current status i s as follows:

Publish the provincial budget in a format based on the New Chart of Accounts. Status. Done. Source: Published budget documents. Both the FY05 and FY06 budgets have been published based o n the N e w Chart o f Accounts (as the f irst province in the country).

d.2 Procurement

124. The key challenge regarding procurement i s ensuring that the new Procurement L a w i s aligned with international best practice and that i t i s applied across al l government agencies. The agreed pr ior action for DPC 1 and i t s current status i s as follows:

e Prepare a road map satisfactory to the World Bank, for the revision of the Procurement Law to better align it with international best practice, specifying the resources, point person and timeframe needed for such revision. Status: Done. The provincial government has presented the road map for procurement reforms in a funding request (February 21, 2006), and a subsequent letter issued by the provincial government declares that it will

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take a l l necessary steps to implement the road map, including providing own financing if other funding i s not available.

d.3 Civil service and administrative devolution reforms

125. The effectiveness and integnty o f the c iv i l service has been undermined by poor human resource planning and management systems. This has led to prevalence o f ghost workers and ghost retirees and has made accurate estimation o f the province’s pension liabilities impossible. A key obstacle to improving service delivery through devolution to district governments has been inconsistencies between various pieces o f legislation and regulation. The agreed pr ior actions for DPC 1 and their current status are as follows:

Develop, computerize and put into operation a Human Resource Management database for the provision of reliable and timely data for personnel management and planning. Status: Done. The core HR database was established in November 2005. 97 percent o f personnel records (out o f 284,000) have been completed and loaded to the system. Since November 2005, the database has been in use for the in i t ia l preparation o f the salary budget for FY07.

Remove inconsistencies in the designation of the appointing authority for different levels of officers and staff of the departments devolved to the districts. Status: Done. Local Government, Elections and Rural Development Department Notif ication 7, October 2005, amended the NWFP District Government Rules o f Business to f i r ther delegate the power o f appointing authority for officers and staff in BPS-1 to BPS-10 to the Executive District Officer. This removed the previous inconsistency between various regulations regarding the appointing authority.

Triggers for the follow-on operation, DPC 2:

126. IDA will continue in DPC 2 to support the Governments’ twin strategy o f human development and accelerated economic growth. Accomplishing these objectives will require continued fiscal and expenditure reforms, as wel l as governance reforms. Therefore, DPC 2 will have two additional pillars to the HD and economic growth pillars: fiscal and expenditure reforms; and governance reforms. The proposed follow-on operation, DPC 2, will be triggered by specific actions that the government has committed to put in place to shift the focus o f the development strategy f rom broad-based reforms to more focused human development and inclusive growth. The priorities and central pillars o f the new strategy are as follows:

Pillar One: Accelerating Human Development and Improving Service Delivery

a. Education Sector

127. Whi le a wide range o f measures are necessary for substantial progress and are included in the government’s comprehensive education sector reform program, the fo l lowing have been deemed particularly important and will be supported by DPC 2: (i) expand demand side interventions with a focus o n regional and gender equity, (ii) improve education quality through professional development o f teachers to raise their competencies, (iii) align objectives for service delivery and outcomes through contracts between the provincial and district governments; (iv) enhance cost effectiveness in spending on facilities and enhance monitoring by involving PTAs more closely; and (iv) improve objective monitoring and evaluation to ensure accountability and

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proper performance incentives in service delivery. The specific tnggers in the education sector for DPC 2, agreed with the government, are as follows:

Access trigger. Stipends for girls enrolled in grades 6-10 introduced in 7 districts where girls middle and secondary enrolment rates are less than 12percent. Quality trigger. Institutional framework for teacher development notifed. Governance trigger. Partnership agreements signed between provincial and at least SO percent of the district governments, including monitoring targets and indicators for the education sector. Service delivery trigger. The revised guidelines for increased budgetary authority for PTAs to use both recurrent and development budgets issued and capacity building activities outlined. Monitoring and evaluation trigger. Education sector reform unit in the Department of Education strengthened with monitoring and planning functions and fully staffed.

b. Health Sector

128. The government strategy for improving health outcomes i s comprehensive and several initiatives are being taken, the most critical actions at this stage are deemed as follows: (i) improving the utilization and quality o f PHC services by testing o f managerial and organizational innovations. This will include contracting out management to NGOs in agreement with the affected district governments. (ii) As a f i rst step in testing the innovations the provincial government needs to establish baseline assessments o f quality in thePHC facilities o f selected districts to be contracted out. The specific health triggers for DPC 2 are as follows:

Partnership agreements signed with District Governments for implementation of management innovations (contracting with NGOs).

Baseline assessments of quality of care in PHC facilities of selected districts contracted out.

Pillar Two: Fiscal and Expenditure Reforms

129. moving towards fiscal decentralization, the trigger for DPC 2 is:

Consistent with maintaining a sustainable fiscal position and sustaining the process o f

The FY07Jiscal budget to be in line with the MTBF and devolution principles. This includes that the announced budget shows key FY07 budgetary indicators to be in line with the MTBF agreed with the Bank and transfers o f district governments’ salary budgets to district Account I V in l ine with the provisions o f the PFC Award. K e y budgetary indicators will be the overall deficit (adjusted for operational shortfall), the revenue deficit and the level and detailed composition of education and health sector budgets.

Pillar Three: Governance Reforms

a. Public financial management

130. After the creation o f districts as new polit ical units it has been virtually impossible for the provincial government to compile consolidated, reconciled and accurate financial reports for the province as a whole in a timely manner. The key reason i s the absence o f an integrated computerized accounting system with a uni form set o f accounts for a l l district accounts offices. The agreed trigger for DPC 2 is :

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Achieve operational IT connectivity and productivity for 20 District Finance and District Accounts Ofice sites using uniform chart of accounts under the new accounting modeel.

b. Procurement

13 1. The key procurement goal to be reached over the medium term i s ensuring that the new Procurement L a w and Standard Bidding Documents are aligned with international best practice and are applied across al l government agencies.

132. trigger for DPC 2:

Continued progress towards meeting this goal i s the expected outcome of the following

SpeciJj, amendments in the procurement law and the Standard Bidding Documents, as agreed with the Bank, and put in place a system for using market based cost estimates in bidding contracts.

Pillar Four: Accelerating Economic Growth

133. The growth trigger for DPC 2 focuses sharply on talung forward government’s program for strengthening private sector’s role in generating employment opportunities for the NWFP work force. As discussed in section 111, government has a developed a broad based strategy for strengthening the private sector. The most critical area within the purview o f the provincial government to induce more private investment i s to lower the transaction costs faced by investors. Investors have been facing high transaction costs for new investments and high regulatory costs and administrative barriers. This reflects lengthy and costly regulatory and approval processes that have involved many government agencies. Streamlining these processes to lower transactions costs i s a critical action in this regard. T o that effect, the fo l lowing agreed for DPC 2.

Ensure that the new one-window investment facilitation center coordinated by the private sector and the corresponding line agencies is operational.

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Box 1. Triggers for DPC 2

Accelerating Human Development and Improving Social Service Delivery Education

Access trigger. Stipends for girls enrolled in grades 6-10 introduced in 7 districts where girls middle and secondary enrolment rates are less than 12%. Quality trigger. Institutional framework for teacher development notified. Governance trigger. Partnership agreements signed between provincial and at least 50% o f the district governments, including monitoring targets and indicators for the education sector. Service delivery trigger. The revised guidelines for increased budgetary authority for PTAs to use both recurrent and development budgets issued and capacity building activities outlined. Monitoring and evaluation trigger. Education sector reform unit in the Department of Education strengthened with monitoring and planning functions and fully staffed.

Health Partnership agreements signed with District Governments for implementation of management innovations (contracting with NGOs). Baseline assessments of quality of care in PHC facilities o f selected districts contracted out.

Fiscal and Expenditure Reforms The announced FY07 fiscal budget to be in line with MTBF and devolution principles.

Public Financial Management and Governance Reforms Achieve operational IT connectivity and productivity for 20 District Finance and District Accounts Office sites using uniform chart of accounts. Specify amendments in the procurement law and the Standard Bidding Documents, as agreed with the Bank, and put in place a system for using market based cost estimates in bidding contracts.

Accelerating Economic Growth and Promoting Private Sector Development Ensure that the new one-window investor facilitation center coordinated by the private sector and the corresponding line agencies i s operational.

1/ Details on monitoring of these triggers and their link with outcomes are provided in Annex 2 (policy Matrix) I F. Benefits of the Operation

134. Support for reform. Establishing a programmatic series o f Development Policy Credits to continue Bank support for NWFP’s reform program i s an appropriate response to the progress made by GoNWFP across the reform spectrum. These reforms have consolidated gains achieved under SAC 1 and SAC 2 but the reform process needs to be sustained over the medium te rm to substantially improve outcomes. The DPC can help further strengthen the ongoing reform process in the province. The government has a determined strategy to reduce poverty, improve provision of social and other public services, improve social indicators and public sector governance, and provide better employment prospects through broad-based inclusive growth. Progress in these areas would be very valuable in pulling the province towards moderate social leanings. If the government can remain engaged with the Bank and be provided the resources needed for service delivery and development - important issues for the local electorate - that would help reduce the risk o f policy reversal. Reform progress in the province could also induce more reform competition and learning across provinces in Palustan.

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135. Impact on poverty and human development. GoNWFP’s reform program supported by DPCs will help the province in achieving better socioeconomic outcomes and reduce poverty: the reforms are expected to accelerate human development by improving access to social services, aiming at reducing gender and regional disparities, and by improving quality o f services. The reforms are also expected to facilitate and sustain broad-based inclusive growth with rapid increase in per capita real incomes.

136. Debt restructuring. The proceeds f rom the D P C credit are currently transferred by the Government o f Paktstan to the province on IDA terms and with the federal government carrying the exchange rate risk. Thus, the DPC provides the GoNWFP with relatively less expensive and long-term funds which it can substitute for more expensive types o f debt. The DPC proceeds thus benefit NWFP by improving i t s debt profile, lowering i t s interest burden, and thereby creating more fiscal space for priority spending.

V. OPERATION IMPLEMENTATION

A. Poverty and Social Impacts

137. The key objectives o f the proposed operation are to reduce the incidence o f poverty and improve health and education outcomes. GoNWFP’s reform program i s designed to achieve these goals. The reforms supported by the DPC 1 are expected to have a substantial, beneficial impact on poverty reduction and social outcomes in the province:

(i) The credit would directly go for measures aimed at poverty reduction. This includes continuing recent years’ rapid expansion in real spending o n social services and boosting the delivery systems. This will provide greater access and better quality education, especially for girls, aiming at narrowing rapidly the gender gap, and higher coverage o f immunization and health programs that contribute to reduced ch i ld and maternal mortality rates as wel l as improved equity in access to better quality health services.

(ii) Acceleration o f economic growth l ed by the private sector remains fundamental t o poverty reduction through employment growth and higher incomes. The reform strategy aims at revitalizing the private sector and increasing trade, broad-based inclusive growth and the private sector’s role in service delivery. Streamlining business regulations and improving infrastructure will improve the investment climate for private sector development, benefiting in particular medium and small enterprises where the bulk o f employment growth i s expected to come. Agriculture sector reforms are expected to contribute to raising household incomes in rura l areas where poverty i s most widespread and thereby directly reduce poverty.

(iii) The fiscal restructuring frees up more resources for poverty reduction expenditures. The medium-term framework i s sustainable and ensures adequate resources for social spending in a well-balanced expenditure pattern. The fiscal reforms do not require retrenchment o f staff in the provincial administration nor in public enterprises.

(iv) Governance reforms o f institutions, policies and processes will improve accountability and effectiveness of public expenditures, transparency and rule o f law. Improving governance in these areas will positively affect the poor and disempowered.

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B. Implementation, Monitoring and Evaluation

138. The Finance Department i s responsible for overall implementation o f D P C 1. T h e DPC Reforms Unit in the Finance Department coordinates actions among the concerned departments and agencies. Continuing the practice from SAC 2 implementation the Senior Minister chairs quarterly inter-ministerial meetings reviewing progress in reforms implementation and ensuring coordination under the DPC. The Finance Secretary chairs monthly meetings with Secretaries f rom the key implementing departments.

139. The Bank team’s supervision plan will monitor actions and review implementation progress o f the proposed DPC. The Policy Matr ix (Annex 2) o f the proposed operation provides a results framework that describes expected medium-term outcomes, as wel l as indicators to measure progress during the annual operations. During the supervision phase o f this first DPC, these benchmarks will be regularly evaluated and interim steps taken by the GoNWFP wil l be monitored. As the operation evolves, circumstances might change which could require flexibil i ty in decision-making for achieving the intended development goals. Whi le maintaining a clear focus o n the desired impact outcomes o f the program, the Bank team also recognizes the importance o f linking ongoing monitoring to decision-mahng o n appropriate adjustments to reflect these realities.

140. Monitoring will draw o n data and findings from a range o f sources to monitor progress o n social indicators, public service delivery and fiscal implementation. Poverty and human development outcomes will be tracked by the triannual P M S surveys which mainly help to track outcomes l ike ne t enrolment and drop out rates. The new round o f PIHS (which i s n o w called the PSLSMS), fielded in 2004-05, has just been released to the Bank which will serve to benchmark these indicators. Real wages will be tracked on an annual basis (based on daily nominal wage data) and used as interim monitoring indicators for poverty trends. Service delivery can be tracked by the Core Welfare Indicators Questionnaire (CWIQ) component in the Pakistan Social and Living Standards Measurement Survey (PSLSMS) with intermediate indicators assessing access, satisfaction and use o f key services measured at the district level. The CWIQ will complement the PSLSMS and i s intended to be fielded annually. Since the CWIQ is a f i r s t t ime experiment in Pakistan i t s quality and sustainability in an annual fashion i s yet t o be explored with the Federal Bureau o f Statistics, where the dialogue i s s t i l l ongoing. The f i rst round data o n CWIQ have also just been made available to the Bank. Information o n education and health service delivery wi l l also be provided through annual Third Party Validation surveys. It will be essential t o design content o f the third party validation to ensure the direct link with prescribed indicators. In addition annual monitoring reports prepared by the Health and Education Reforms Units, monthly reports o n teacher absenteeism provided by Education District Officers and other data f rom the government’s administrative databases such as the Education Management Information System and Health Management Information System will be used. Progress in fiscal implementation will be tracked using quarterly fiscal reports and annual budgets.

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Provincial GDP growth rate Poverty Head Count (caloric) Provincial Tax Revenue Growth Pro-poor PRSP expenditures (share) Development expenditures (share) Reconciled fiscal data using the N e w Accounting M o d e l Gross primary enrollment rate Gross primary enrollment rate female Primary school dropout rates Girls schools with essential facilities

Full immunization, % o f children 54% e 76%’

100 % 12-23 months

% o f population with access t o TB Control (DOTS) Antenatal coverage o f pregnant women by health 34% 39%

20%

professionals , Contraceptive Prevalence Rate 22% 22.5%’

Table 5: Selected Monitoring Indicators for NWFP DPC I Indicator Prior to 2001 Most Recent Planned by

and start of Observation end of DPC 3 SAC 1 (End FY08)

6.9%a 46.3%b 2 1.4%‘ 57.6%d 25.9%

97% o f receipts and 96% o f expenditures

77% e

56% e

24% e

85%

4% 44

15% 56.9% 26% 0%

70% e

54% e

24% e

50%

7-7.5%

18.3% 62.0 31.7 100%

83% 70% 16% 100%

80%

....

100 50%

35%

C. Fiduciary Aspects

141. Financial Accountability Environment. NWFP i s ahead o f other provinces and the federal government with regard to reforms in public financial management. The Provincial Financial Accountability Assessment provides an in-depth analysis o f the strengths and weaknesses o f the financial control environment in the Provincial Government. I ts assessment i s that the system in place does provide reasonable safeguards for reliance on government financial accountability systems to ensure that funds are used for the purposes intended. T h i s assessment i s planned to be updated during FY 2006, using the PEFA PFM Measurement Framework, in order to provide baseline performance indicators and their trajectory o f change over time. The notable progress also being made in the province in implementing PIFRA reforms i s demonstrative of the province’s firm commitment towards the enhancement of public sector financial accountability.

142. An IMF Safeguards Assessment o f the SBP was conducted in 2001. It highlighted significant vulnerabilities at the SBP particularly as relating to i t s financial statements and disclosure policies which fe l l short o f acceptable Central Bank standards. However, since a program o f reform had since been agreed with the IMF and was being implemented, the r isks associated with foreign exchange management and control have been mitigated. The State Bank o f Pakistan has transitioned to producing financial statements which accord with international

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accounting standards and formats. An independent review o f the SBP’s internal audit function, as recommended by the Safeguards Assessment, has since been completed and the recommendations implemented. The SBP has also established a formal process o f reconciling data reported to the Fund as wel l as implemented guidelines to prohibit operations that pledge or encumber reserves, or place restrictions on, or otherwise impair the availability of, foreign exchange reserves outside an authorized framework. Equally, the SBP’s Act has been accordingly amended to strengthen and guarantee i t s independence and autonomy in the management o f reserves as required under the Safeguards Assessment. The financial management risk associated with the Program i s therefore rated ‘low’.

D. Credit Administration, Disbursements, and Fiduciary Assurance

143. Funds flow arrangements for the Credit are as follows: The Government o f Palustan shall identify a Foreign Exchange Deposit Account with the State Bank o f Pakistan (SBP) into which the proceeds o f the Credit will be disbursed o n a single tranche basis upon Credit effectiveness. The Rupees equivalent o f the funds in the Account will, within two working days, be transferred into the Consolidated Fund o f the Government o f NWFP (Account No. 1 - Non- Food) held with the SBP.

144. Disbursements f rom the Consolidated Account No.1 (Non-food) by the Government o f NWFP shall not be tied to any specific purchases and n o special procurement requirement shall be needed. The proceeds of the Credit shall, however, not be applied to finance expenditures in the negative l i s t as defined in the Schedule o f the Financing Agreement. If any port ion o f the Credit i s used to finance ineligible expenditures as so defined in the Schedule o f the Financing Agreement, IDA shall require the Government to promptly, upon notice f rom IDA, refund an amount equal to the amount of the said payment to IDA. Amounts refknded to IDA upon such request shall be cancelled f rom the Credit.

145. Accounting and Assurance Requirements for the Credit. The SBP, o n behalf o f the Government, shall maintain an appropriate accounting system in accordance with generally acceptable accounting principles. For this Credit, n o additional assurance requirements in the fo rm o f a formal audit i s required, in the light of the fiduciary environment as established with the management o f foreign exchange reserves by the SBP. However, within 45 days o f disbursement o f the Credit by IDA, the Finance Secretary o f the Province shall provide a certificate to IDA confirming the receipt of the Rupees equivalent o f the Credit into the Consolidated Fund Account o f the Government o f NWFP, the date o f the receipt and the exchange rate applied to translate the Credit currency into Rupees.

E. Coordination with Other Donors

146. Achieving the reform objectives will be supported by IDA’S close collaboration with donors, in particular DFID, during the preparation and implementation of this series o f DPCs. DFID has been collaborating with the Bank in providing AAA and technical assistance and in program-related areas such as providing funding towards the NWFP Economic Report and technical assistance in performance budgeting. I t i s expected that technical assistance from DFID will continue. The Bank also foresees possible technical assistance f rom other donors in the area o f administrative devolution with assistance to district governments to build Human Resource management capacity. NORAD and GTZ provide assistance to build capacity and facilitate reform implementation in the education sector; GTZ also to the health sector. The EU i s considering providing budget support t o GoNWFP aligned with the DPCs. The GoNWFP plans

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t o host i ts first development forum in 2006 and gather additional assistance from development partners for i ts medium-term reform program as la id out in the series o f DPCs.

F. Environmental Aspects

147. The Bank’s Draf t Country Environmental Assessment (CEA) provides a broad overview of Palustan’s environmental policies and institutions. The CEA concludes that the legislative framework for environmental management i s largely in place and the country has made progress in establishing regulatory institutions for environmental management. However, implementation o f policies remains uneven with the binding constraints being insufficient resources and inadequate compliance incentives. Recognizing these problems the Medium Term Development Framework 2005-2010 (MTDF), which was adopted in mid-2005, recommends a significant increase in the budget allocated for environmental management to support implementation o f the legislative framework.

148. With i t s immense altitudinal variation NWFP i s r i ch in natural resources, biodiversity and cultural heritage. The Provinces natural assets have played a crucial role in providing the platform for economic development. The rangelands which cover the bulk o f the landmass, sustain a growing livestock industry, while the Province’s forests play an important role in protecting watersheds, preventing the siltation o f dams and reducing the incidence o f landslides and soil erosion. However, the resource base i s under stress owing to population pressures, the influx o f refugees and poverty.

149. There i s a high level o f environmental awareness in the Province and the government has responded to these pressures by introducing the Sarhad Provincial Conservation Strategy (SPCS) which aims to promote conservation and sustainable development. Unmatched elsewhere in Palustan three districts in NWFP have integrated the SPCS into their development agenda. Environmental management within the province i s guided by the Pakistan Environmental Protection Ac t 1997, which requires EPA approval for the execution o f large public and private projects. NWFP EPA has three zonal offices in the province and has established an Environment Impact Assessment (EN) training center in Peshawar. The National Environment Policy provides the framework for addressing resource management issues relating to water, air quality and forests.

150. The proposed NWFP Development Policy Credit (DPC), as the f i rs t in a series o f 3 annual credits, prescribes a series o f policies and reforms to support three overarching objectives: ( i) economic growth and macroeconomic stability; (i i) improvements in human capital; and (iii) growth enabling fiscal and governance reforms. The s ta f f s rapid assessment o f the environmental impact o f the pol icy reforms proposed in the DPC pr ior actions and triggers is:

Pillar I: Accelerating economic growth through (i) increased private sector investment and productivity and (ii) improvements in agricultural productivity.

151. Private sector activity i s to be stimulated by lowering administrative barriers and the transactions costs o f investment. The administrative reforms are not l ikely to have any direct environmental impact. Given the structure o f the Province’s industry it i s anticipated that the bulk o f industrial development wil l entail broad based growth of light industries, with a modest environmental footprint and l o w pollution intensity.

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152. Agnculture i s the backbone o f the NWFP economy and plays a crucial ro le in shaping development outcomes. The DPC envisages reforms that improve agricultural infrastructure to reduce post-harvest losses; a shift to higher value products and improvements in agncultural research and extension. The DPC also recognizes the need to protect the growth potential o f the natural resource base. Accordingly, i t promotes research and extension for the protection o f common property natural resources, and calls for growth o f livestock to be limited to the carrying capacity o f common property pastures.

Pillar 2: Fiscal and expenditure reforms through (i) improvements in sustainability and expenditure composition and (ii) strengthening the revenue base.

153. Pil lar 2 promotes fiscal discipline and stability which can be expected to raise government revenues for priority spending programs. The fiscal reforms do not recommend a reduction in resources allocated to environmental agencies.

Pillar 3: improving access and quality of education and (ii) improving health service delivery.

Accelerating human development and improving social service delivery by (i)

154. Pil lar 3 will have n o direct and identifiable environmental impact. Though there may be tenuous long run gains. Improvements in human capital should reduce poverty and lower the current over-dependence o n “depletable” natural resources (e.g., biomass for fuelwood).

Pillar 4: Governance reforms.

155. Pil lar 4 seeks to improve the accountability and efficiency o f the public sector. To the extent that these reforms encompass the environmental agencies there will be improvements in environmental compliance.

156. The overall conclusion o f this assessment i s that the DPC will have n o negative environmental effect and may have beneficial consequences by improving the sustainability o f common property management and promoting public sector efficiency.

G. Risks and Risk Mitigation

157. Risks associated with the government’s medium-term reform program include: (i) polit ical risks; (ii) risks stemming fi-om l imited government capacity to implement reforms; (iii) fiscal risks; and (iv) external shocks. These r isks remain relevant but some have diminished in the last few years.

(i) Political risks. The main opposition to reforms in NWFP i s l ikely to come fi-om government employees. Reforms will challenge privileges and lack o f accountability for certain employee groups (e.g., teachers and health personnel, revenue collectors, provincial senior c i v i l servants etc). These groups are not regarded as a strong polit ical force that can delay reforms that the provincial government i s determined to implement.

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158. The elected government has a very high degree o f ownership o f the reform program. I t s commitment to these reforms stems from the need to make a real change in the provincial economy and improve delivery o f social and economic services in order to stay in office. Overall i t i s the s taf fs assessment that the reform package i s politically viable.

159. In addition, there i s the potential risk o f spillover o f the regional security situation, i.e., the continuing conflict in Afghanistan and the border area that could result in a serious deterioration of l aw and order and suspension o f reforms. The assessment i s that this risk i s small. The conflict in the border areas i s contained and the religious coalition governing NWFP i s firmly in control and engaged with donors on reforms.

(ii) Risks of limitations on reform implementation capacity exist. Experience so far shows that weak implementation capacity has at times delayed but importantly, not derailed, reform implementation. Whi le implementation capacity i s weak, the Bank i s taking this into account by appropriately pacing and consolidating reforms in one operation. The need for capacity strengthening i s also being addressed with technical assistance f rom donors. The government i s planning to use the occasion o f the First NWFP Development Forum this coming spring to seek additional technical assistance and capacity building by donors in a wide range o f areas.

(iii) Fiscal risks. In light o f the recent interim amendment to the NFC award that will provide additional fiscal space to the province the prospective fiscal r i s k over the medium term has to some extent shifted f rom being a r i s k to overall fiscal sustainability more towards a risk o f not maintaining the appropriate spending composition for achieving the goals o f human development, facilitating growth and poverty reduction. Less judicious use o f public resources could lead to higher spending o n lower priority areas - both in the composition o f the c i v i l service through rapid recruitment across the board as wel l as the spending composition o n goods and services and choice o f development projects. Whi le this could sow the seed in the near term, i t would most l ike ly only threaten overall fiscal sustainability in the outer years (after 4-5 years) if also own provincial revenue collection or the unpredictable flows o f hydel profits f rom WAPDA fal l short o f MTBF targets. At that time the fiscal adjustment would more l ike ly b e a squeeze on spending - ADP spending and O&M, in particular - than a ballooning deficit since the financing o f the latter would be limited. Continued commitment to the MTBF and i t s path for high-priority expenditures and overall deficits will be required to mitigate this risk. Fiscal risks have been addressed with a comprehensive set o f measures to increase fiscal space, including increasing own revenue collection, interest savings stemming f rom prudent debt management, buildup o f assets in pensions fund to meet future liabilities, and containing the c iv i l service wage bill.

(iv) External shocks. Another major risk i s possible external shocks, either in the national economy (impacting o n resource transfers f rom the center and o n own revenues), droughts that affect the majority o f the population whose livelihood i s l inked to agriculture, or the possibility o f tensions along the borders disrupting normal commerce and possibly affecting the polit ical environment as described above. T o a l imi ted extent increased emphasis on improved irrigation networks and water use arrangements could mitigate the effect o f droughts but overall these are real r i sks with limited potential for risk mitigation. These r isks must b e recognized and weighed in the context o f potential benefits. The impact o n the provincial fiscal budget o f lower than projected growth - national and provincial -wou ld mainly be felt on the revenue side. The larger effect would be through lower transfers f rom the center. Temporary shocks to revenue could be offset by increased lending f rom the federal government subject to a sustainable fiscal path. Permanent shocks would need a corresponding expenditure adjustment.

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Anne,y I Page I of 15

ANNEX 1 LETTER OF DEVELOPMENT POLICY

AND GOVERNMENT REFORM PROGRAM

R~f:OMPRES-vVB( WFP-I DA)X1406/0 7 Dated: April 4,2006

Dear Mr- Wotfowitz.

1 am enclosing a letter of the Government of North West

Frontier Pro\rinca (NWFP), addressed to the Ministry of Finance, Government of Pakistan, dated 2gt" March, 2006, delineating a broad and comprehensive refarm agenda, through which the Government of N W P proposes to strengthen and cansatidate its economic program. The Government of N W has sought assistance frm the International Development Association of SDR 62.7 rnilljon (US$ 90 rnifllan equlvatent)

The Government of Pakistan supports this continued initiative and recommends the proposal for consideration of the International Development Association.

Wdh regards, n Sincerely,

Mt. Paul Wotfowitz, President, The Warld Bank, Washington D.C. 20433, U S A .

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GOVERNMENT OF NWFP FINANCE DEPARTMENT

SAC Reforms Monitoring Uni t

Dated Peshawar March 29,2006 NO. FD/SAC-IIYDFID-SU~~O~~/~OO~-O~NO~-II

To Dr. Salman Shah, Advisor to Prime Minister, on Finance and Planning, Government o f Pakistan.

Subject: GOVERNMENT OF ZWP-LETTER OF DEVELOPMENT POLICY

1. The North West Frontier Province i s faced with huge challenges because o f i t s geographical location, repercussions o f situation on i ts western border, low investment in human capital and a weak private sector, factors that all contribute to malung it one o f Pakistan’s poorest provinces. Poverty in NWFP i s widespread, especially in rural areas. Estimated Provincial GDP per capita in 2002/03 was only 60 percent o f the average for the country. NWFP has a weaker resource base than other provinces. The Provincial economy i s mostly based on relatively low value-added agriculture, services, public employment and low slulled workers’ remittances from inside and outside the country.

2. I t i s the present elected government’s tacit resolve ever since coming into power and commencement o f this program to improve the standard o f l iving o f citizens o f the province. Despite encouraging progress on the broad reform program, analysis shows that without deepening and broadening human development reforms, several key MDGs will not be met by 2015. The recently completed NWFP Economic Report highlights the critical role o f human development in reducing poverty in the province. Sustained improvement in human development indicators i s also critical for upgrading the s k i l l s o f the labor force required for more rapid economic growth in the future. For these reasons, the principal focus o f the reform program in 2006-2008 will be on human development (HD) while undertaking other reforms to facilitate more rapid, inclusive growth.

3. Wh i le the core o f DPCs going forward i s the program for HD improvement, i t will need to be supported by continued fiscal and governance reforms to ensure that HD continues to get the importance it deserves from a fiscal and governance perspective.

4. Improvement in HD indicators as envisaged in the DPC program i s expected to improve the quality o f the work force. An improved supply o f workers will be met by increased demand for workers via continued focus on the growth agenda. A vision document hghlighting government’s program, “Provincial Development Program, 2005-08” wil l be approved by the Provincial Cabinet in April 2006. The government o f the NWFP i s fully committed to the growth agenda as seen in the thrust o f the new provincial development strategy (2006-08) that will be presented at the provincial donor forum in May 2006.

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5. program:

The DPC will support the following pillars o f the Government o f NWFP’s reform

1. re form to accelerate human development and improve service delivery in social sectors, to improve education and health status particularly of girls and women, and reduction in high fertility rate;

ii. fiscal reforms in order to ensure fiscal sustainability and fol low a medium-term budget framework, enhance effectiveness accountability o f expenditures, and strengthen resource mobilization;

... 111. governance reforms in public financial management, procurement, c iv i l service and

administration o f multi-tier government (province/district/tehsil); and

iv. accelerating economic growth by providing an effective and transparent environment for private sector development both in the urban and rural economy.

6. NWFP and Azad Jammu & Kashmir were badly affected by a devastating earthquake o n October 8, 2005. I t created havoc in many districts and affected 3.5 mi l l ion people o f the province. Over 22,000 died and more than 40,000 were injured as a result o f this earthquake. Around 4,000 schools, mostly government schools, collapsed and thousands o f children present in the schools died. Though most o f the schools have restarted functioning by malung temporary arrangements, the reconstruction o f the schools i s a top priority for the government o f NWFP and the federal government as part o f rehabilitation strategy in the earthquake affected areas. Public infrastructure and private property crumbled down as a result o f earthquake.

7. Rs. 90 bi l l ion (US$ 1.5 billion) are required for reconstructiodrehabilitation in the earthquake affected areas. The cost o f relief, rehabilitation and reconstruction will add to public expenditure and will have significant effects o n the provincial budget.

The Provincial Reform Program

Education Reforms

8. Our government i s increasing the emphasis o n education sector reforms. W e seek to improve access and quality o f education and are strongly committed to achieving universal enrolment and completion o f primary education, and to eliminating gender and regional disparities in education attainment. Our education pol icy framework also has the important objective o f increasing participation in quality middle and secondary education, particularly among girls. The policy framework i s designed to increase equitable access to primary and secondary education, based o n a combination o f demand and supply side policies.

9. W e have started with elementary education but also intend to expand it to secondary education. Our government has introduced a range o f pol icy initiatives to expand school enrolment and attendance and to address regional and gender disparities. The key demand side policies to raise school attendance are providing tuit ion free education and free textbooks. W e have distributed free textbooks to al l primary school students, and to a l l girl middle and high school students, in government schools. In addition, we are implementing a phased program to reduce the supply side constraints, especially for children in rural areas, by increasing essential school facilities such as classrooms, sanitation, water, and boundary walls for security; increasing the number o f primary school teachers; and seeking to promote private-public partnerships in

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education to enhance access. The combination o f demand and supply side initiatives have enabled the NWFP to make promising progress in increasing enrolment, especially among girls, in recent years. Total enrolment in primary and secondary education has r isen from 2.9 mi l l ion students in 2002/03 to 3.2 mi l l ion students in 2004/05. During this period, girls enrolment has increased from 0.8 mi l l ion t o over 1.0 mi l l ion students. The rise in total enrolment has been most marked in the primary cycle, where enrolment has increased f rom 2.1 mi l l ion to 2.3 mi l l ion during this period, with girls accounting for more than hal f the increase in enrolment.

10. T o make education more meaningful, critical reforms are being introduced to improve the quality o f education, supported by the development o f a strong monitoring and evaluation framework. In the coming years our government wi l l expand middle school education by increasing school facilities at the middle school level, according to expansion targets set by districts and agreed between the provincial government and district governments.

11. The NWFP plans to introduce further pol icy initiatives to increase equitable access to quality education, such as upgrading schools, and launching a phased expansion to middle and secondary schools. The government also plans to introduce a policy o f providing incentives for female teachers posted in remote and rural areas. The package o f incentives that will be tried out could include a financial allowance and malung transport arrangements for teachers to attend schools where access i s a critical constraint.

12. Second, demand side interventions will be introduced with a focus o n regional and gender equity. Our government wil l commence a program o f stipends for girls in grades 6-10 f rom FY07 in seven districts to attend middle and secondary schools in poor districts where female middle and secondary enrolment i s particularly low. Further, the initiative will be poverty focused, as the districts where female enrolment i s lowest are also the regions where poverty rates are highest. The emphasis on poverty focused demand side initiatives will be strengthened in the subsequent years by introducing a program of incentives for teachers to work in remote, rural schools.

13. Third, the NWFP education program will place strong emphasis o n objective monitoring and evaluation. In the near future we will establish a specialized technical unit in the Department of Education to undertake monitoring activities. This unit will be staffed with the right slul l mix to manage ongoing monitoring, establish linkages with the EMIS data, and develop linkages with district governments and to use the data analysis for pol icy development. W e wil l use Third Party Validations (TPVs) for independent monitoring and a useful external accountability instrument, assessing the quality o f the internal monitoring systems by confirming the results with ongoing departmental monitoring.

14. Free education i s n o w provided in government schools up to class 10. In FY03, Rs 230 m i l l i on were expended o n provision o f free textbooks to a l l primary students in government schools. In FY04, Rs 300 mi l l ion were spent o n free textbooks for al l primary students, and girls up to the lo* class in government schools. In FY06, Rs 100 m i l l i on are being provided for supply o f free textbooks to 300,000 students f rom katchi grade to 10* grade. The program will gradually be expanded to provide free textbooks to al l students in government schools.

15. The quality o f education has among other factors suffered from frequent absenteeism by teachers. A major reason for teacher absenteeism has been the l o w teacher interest in teaching in schools that are away f rom their homes, at current salaries. The Government has decided to amend the rules for primary teachers’ recruitment to address this difficulty. Under the n e w rules primary school teachers (PST) are recruited o n merit, 75 percent o f whom are recruited at the

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union council level and the remaining 25 percent at the distnct level. Moreover, a schedule o f preference in descending order o f qualification for recruitments has been made, to ensure teacher appointments and availability (particularly o f females in remote areas). This means that for urban area based recruitment, the standards o f pre-service training and qualification will be the most stringent, and will be increasingly less for recruitment from increasingly underdeveloped areas. In an effort to improve quality, entry qualification o f the teachers was enhanced f rom matric to F M S C during the last 3 years. Hence, for instance, the qualification rules for female teachers from backward areas have been relaxed considerably to encourage educated females to take up teaching as a profession.

16. Programs for teacher training and to improve the quality o f textbooks are underway. At present, one teacher f rom every primary school i s being trained annually around the new textbooks being developed, through funding and technical support f rom bilateral donors. The province also participated in the National Student Assessment in Language and M a t h through the Provincial Education Assessment Center (PEACE) established at Abbottabad.

17. There has been a continuing shortage o f middle and secondary level teachers, partly due to recruitment problems and partly due to existing ru les whereby teachers in this cadre were being promoted as a routine to high schools without having the competence to teach at that level. T o address this, the Provincial Cabinet has approved rules for district based recruitment o f secondary and middle school teachers and the rules are in the process o f administrative approval. The Government also intends to introduce new legislation in the Provincial Assembly so that for promotion purposes, educational service can be treated differently f rom other services.

18. The government will further strengthen the teachers’ training program to improve the quality o f service. Twenty elementary colleges for teacher training have been restored to offer both pre-service and in-service training for male and female teachers separately. At present training i s imparted in teaching methodology and textbooks, but the government i s considering extending the training to character building o f the teachers as well. Over 4,000 teachers have been imparted training in the use o f internet for educational purposes. Another 4,000 teachers at the high school level were trained. In addition, 27,000 head teachers and head masters will be trained in school management and computer usage. At present, about 100 high and higher secondary schools have computer laboratories set up under public-private partnerships, and another 169 are being set up in al l districts under a 50/50 shared project with the Federal Government. About 122 computer laboratories are already functional and have newly recruited staff.

19. Education in the province has suffered in the past f rom poor management. The government i s addressing this problem in two ways. The district education managerial staff has been given needs based training in planning and management. The government also intends to provide managerial training o n a continuing basis at the Provincial Institute for Teachers’ Education. Detailed j o b descriptions, users’ manuals, and compendiums o f rules and policies have been prepared and distributed to the district governments. The government intends to select suitable staff f?om the present staff as we l l as fresh recruits, and provide training. B o t h the teaching and management cadres will be supported by strategic professional development plans and training. A strategy for professional development o f the two cadres will be developed and notif ied in the current year, and implemented in the next fiscal year.

20. Parent-Teacher Associations (PTAs) are formed in most schools. Wh i le ensuring that PTAs remain fully functional (i.e., with authority t o monitor teacher attendance and uti l ize funds for instruction materials and repairs (IM&R) received f rom government) in a l l primary schools, we have also established and made PTAs fully functional in twenty percent (20 percent) o f

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middle and high schools. The PTAs have been trained in the past and continue to be trained by using donor funding. We will in the near future issue revised guidelines for increased budgetary authority for PTAs to use both current and development budgets, and outline capacity building activities.

21. Our government has taken steps to commence the long-term development o f the college sector. A Frontier Education Foundation was established in the early 1990’s to stimulate private sector investment in college education. A Regulatory Authority was instituted in 2001 to accredit private colleges and ensure minimum quality standards in the private sector. The Department o f College Education has been supporting the expansion o f public colleges, especially for girls, to future policies and actions.

22. In order to ensure proper monitoring and evaluation an education sector reform unit in the Schools & Literacy Department will be established. Partnership agreements wil l be signed between provincial and at least 50 percent o f the district governments, including monitoring targets and indicators for the education sector.

Health

23. Our objective in the health sector remains to significantly improve health indicators in the province over the medium term. Over the last year we have refined our health sector strategy further. W e a im at improving the management structure, reorganizing the healthcare system and having a multi-level referral system, focusing on preventive and primary health care, removing obvious gaps in facilities, increasing budgetary allocations as wel l as user charges, and increasing reliance on the private sector with adequate regulation. Towards this end, we have already taken a number o f steps and several more are planned. Reforms to improve access have in particular focused o n access to key preventive services including TB DOTS and Mother-Child H e a l t m a m i l y Planning.

24. The health sector reforms have implemented a number o f programs such as expanding TB DOTS, increasing neonatal tetanus coverage, and improving access to fami ly planning and primary health care services by increasing substantially the number o f Lady Health Workers to district hospitals. The TB D O T S program has expanded fkom 10 to a l l 24 districts in NWFP, as targeted. By September 2005, the population coverage had increased f rom 20 to 100 percent. The immunization rate o f children under two has increased f rom 57 percent to 73 percent. Hepatitis B vaccination has been introduced across the province with a reported coverage o f 73 percent; neonatal tetanus campaigns have been completed in al l high r i s k districts increasing coverage o f pregnant women f rom 39 percent to 45 percent. The pol io campaign i s o n track with 42 percent reduction in the number o f new cases in the last three years and only 3 established cases o f po l io have been reported by September 2005. The EPI program was approved which has made functional 15 new centers in FY03 and will fill gaps in manpower, cold chain, enhancing managerial support t o the districts, and expanding social mobil ization activities and opening new EPI centers.

25. In addition to a planned broadening of health sector reforms outlined below we will continue our reform efforts in a number of areas: The government intends to continue i t s emphasis o n family planning. The most recent estimate o f the Contraceptive Prevalence Rate (CPR) in the province i s 33 percent. The previous target in our Provincial Reform Program was to increase the CPR from 30 percent in FY03 to 40 percent by FY 10 and to 48 percent by FY 15. A s fertility rates remain high in the NWFP and unmet contraceptive need i s 35 percent the government will reinforce i t s efforts to raise the CPR to meet a revised target o f 40 percent by

Annex 1 Page 7 of 15

F Y 0 6 and 50 percent by FY15. T o improve district management and implementation, the government will appoint a focal person at the ED0 level to coordinate family planning supplies in Population Welfare with the Reproductive Health Project.

26. The Roll Back Malaria Program will continue to expand and improve service delivery by ensuring prompt treatment within 24 hours, increasing preventive measures, promotion o f treated bed nets and selective indoor residual spraying. A Provincial Laboratory i s proposed in the Peshawar EDO’s office for the next phase o f the program. Malaria officers were made redundant during downsizing in 2001 but a revival plan has been submitted for this cadre.

27. In implementing steps to enhance access to H IV /A IDS services for vulnerable sub groups o f the population. Three contracts with NGOs have been signed for provision o f services in different areas o f the province targeting sex workers and intravenous drug users. The MV/AIDS Program will expand coverage and continue working with the NWFP A I D S consortium. Month ly and quarterly surveillance reports are to be collected and submitted regularly. Registration o f b lood banks, safe blood banking and scrutiny o f b lood banks i s to be strengthened. Mapping for high-risk groups i s t o be continued, and treatment for patients at the centre established in the Hayatabad Medical Complex i s to be consolidated and improved. Technical evaluation o f B C C services will be undertaken. The draft monitoring and supervision plan prepared for a l l activities undertaken at the provincial and district level has to be approved and implemented. Technical capacity building o f pathologists and blood bank offices as wel l as quality assurance standards for safe blood transfusions wil l continue.

28. Public-Private Partnership: Workmg with NGOs and the private sector i s to be further enhanced especially for TB Control, HIV/AIDS, R o l l Back Malaria, immunization coverage, Family Planning and RH during FY05-08. PP Partnership wil l be monitored and evaluated; Standard Operating Procedures have been prepared by the Health Foundation and approved by the Chief Minister, N W F P for public private partnership. The government wil l assure economic access to health care for the poor.

29. The government intends to organize workshops for community mobilization, creating awareness and sk i l l s development o f district community committees and other stakeholders to increase the community’s role in accountability and better service delivery. In other programs, the government i s committed to provide access to safe water, sanitation, universal pr imary female education and gender equity to enhance progress o f health outcomes over the medium and long term.

30. Capacity building: The government recognizes that the overall health management capacity i s l imited in the province to make decentralization effective in improving service delivery. To address this limitation, the government has planned to develop s k i l l s and communication at the appropriate level. Workshops and short training sessions to ensure strong commitment at a l l levels o f government will be conducted to make and maintain effective changes in the health system. The government will also make a training need assessment for the relevant staff. Training for planning and budgeting will be undertaken for EDOs in 8 districts. In addition, induction o f CME/CPD and in-service training i s planned at the district level.

3 1. The government i s committed to Standardization of DHQ hospitals. Standardization implementation in the f i rs t 8 districts i s t o be initiated and a Planning Commission-I (PC 1) will be processed in FY05-06. 25 percent o f the total construction work for Standardization in 8 districts has been completed till 30th June 2005. The remaining work wil l be completed by FY06.

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Indicators for monitoring and evaluation have been developed and baseline data collected from all the DHQ hospitals o f NWFP will be analyzed.

32. The Department o f Health was restructured in l ine with the Devolution initiative with a substantive shift o f staff and resources, and significant delegation o f administrative and financial powers to the districts. Good progress was made to build capacity o f District Managers with training in planning and budget formulation. A management cadre i s in the process o f being created, and the separate male/female cadres o f doctors were merged. A Health Sector Research and Reform unit was established to strengthen capacity for planning and monitoring the reform process. Four tertiary hospitals have been given financial and administrative autonomy with the aim o f achieving financial self-sufficiency in three years, and a study has been initiated to protect access o f the poor through safety nets. T o ease the critical shortage o f nurses and improve quality o f care at the district and sub-district hospitals, posts were created as part o f the rationalization program and 3 18 trained nurses have already been recruited. Rationalization and standardization o f District Headquarters Hospitals have been initiated in 22 districts. The institutional reforms to improve district health care are underway so that district health facilities can treat more non- serious or non-urgent cases. This has resulted in seven district hospitals being upgraded to A level with capability in 24 medical specialities. Facility specific contracts have been introduced to reduce absenteeism.

33. Our government has developed and approved a long-term p lan for health sector reform. W e will broaden reforms in this next phase o f health sector reforms. W e will: i) test innovative approaches to strengthen the management and organization o f primary and secondary health services; ii) build partnerships with the non-state sector; iii) increase managerial autonomy; and iv) enhance accountability in the public sector through significantly strengthening monitoring and evaluation.

34. Our strategy for improving health outcomes i s comprehensive and several initiatives are being taken. The most critical actions at this stage are deemed as: i) improving the utilization and quality o f Primary Health Care (PHC) services by testing o f managerial and organizational innovations. This will include contracting out management to NGOs in agreement with the affected district governments. ii) As a f i rst step in testing the innovations our government wil l establish baseline assessments o f quality o f care in the PHC facilities o f selected districts. In the near future we will s i g n partnership agreements with District Governments for implementation o f management innovations (contracting with NGOs). Baseline assessments o f quality o f care in PHC facilities o f selected districts will be contracted out.

Fiscal Reforms

35. The central strategy for fiscal reforms till n o w has been to restore fiscal sustainability and to create fiscal space for high pr ior i ty spending areas l ike infrastructure and l a w & order. These steps coupled with measures in fiscal decentralization are aimed to provide additional resources to local governments for better performance.

36. The main thrust o f the fiscal strategy i s to reduce heavy debt burden by premature retirement o f expensive debts and by improving the composition and effectiveness o f spending. This strategy has been successfully implemented during these reforms. The debt service burden declined from 2.2 percent o f PGDP in F Y 0 2 to 1.3 percent in FY05. Public debt ratio declined to 12 percent o f PGDP in FY05, and i s l ikely to decline to 9 percent over the medium term. Premature retirement o f expensive debt helped in creating fiscal space for spending in social sector. The share o f social sector spending was 39 percent in FY05, 10 percentage points higher

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than in FY02 with full focus on education and health sector development expenditure. A three fold increase was noticed in the development expenditure f rom FYOl to FY05 while rationalization of the development portfolio in recent years has increased the effectiveness o f development spending, and as a result, the Throw Forward ratio o f the Annual Development Program was reduced to 2.8 years, below the target o f 3 years.

37. The federal government recently made an amendment in the National Finance Commission Award o f 1997 as a result o f which the provinces will get higher share f rom the Federal Div is ib le Pool. NWFP will get an increase o f Rs. 5.6 b i l l ion in FY07 while i t i s l ikely to get Rs.52 billion in the next 5 years compared to the trajectory without the recent change in the award.

38. The Government o f NWFP has tried to mobilize additional revenues to meet its major objectives o f improving public services. Additional revenues have been mobilized through further tax reforms, accelerating and rationalizing user chargers, and improving tax administration. Tax reform measures included restructuring and reducing the number o f provincial taxes; imposing an income-based Agricultural Income Tax (AIT) to complement the province’s land-based tax; and harmonization o f AIT and Motor Vehicle Tax rates with other provinces. User charges have been raised for tertiary-level social services and irrigation water. Collection o f provincial own revenues will be 0.7 percent o f the PGDP in FY07 but would increase to 0.8 percent o f PGDP in F Y 0 8

39. W e have ensured a sustainable fiscal outcome for FY05 in line with the medium-term budget framework (MTBF). The fiscal deficit was 3 b i l l ion (0.5 percent o f PGDP) against the MTBF target o f Rs 4.1 billion. Overall establishment cost o f R s 21 b i l l ion (3.5 percent o f PGDP) also remained within the limit set in the MTBF. In order to mobilize more own provincial revenue cash rewards to the tune o f Rs 1.5 mi l l ion were paid to the employees o f Excise & Taxation Department for good revenue collection performance while Tax Facilitation Centers for Motor Vehicle Tax and other revenue items have started operating in Peshawar, Mardan and Abbottabad. Our government will continue to ensure fiscal sustainability in coming budgets. Budgetary indicators for FY07 will also be in line with the MTBF and devolution principles.

40. The Government of NWFP has also instituted several reforms in the preparation, processing, and execution o f the budget, such as posting fiscal data o n the web economic classification o f expenditures in budget documents; piloted preparation o f program and performance budgeting; initiated computerization o f updated land records on a pi lot basis; online linking o f the Provincial and District Budgets; and establishing a professionally staffed Budget Analysis Unit, which i s n o w fully functional and playing an important role in tracking and reporting o n the consolidated fiscal deficit and key fiscal indicators on a quarterly basis.

41, Substantial progress has been achieved in the area o f fiscal decentralization. NWFP was the f i rst province to use a needs-based formula (based o n population and indicators o f social development and backwardness) for budgetary transfers to the districts starting FY02. All non- salary recurrent expenditures and district development spending were devolved to the districts during FY03 and FY04. The PFC Awards o f FY04 strengthened fiscal devolution by providing matching incentive grants to Districts for additional revenue mobilization and enhancing non- salary allocation o f Districts by 10 percent; directly transferred Octroi grants to Tehsils (instead o f the Districts) to ensure timely transfer o f funds; and piloted devolving the Urban Immovable Property Tax (UIPT) in two districts. Another key step in this direction i s that f rom this coming fiscal year, FY07, the salary budget o f district staff will be disbursed through district Account-IV. W e will also pi lot conditional grants to increase development budget for districts in l ine with

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assessed service delivery needs, and pi lot a performance contract based system for staff in at least two districts.

Governance Reforms

42. Our government recognizes that weak governance has been a main obstacle to reducing poverty in the province and engender social development. The government has therefore launched a wide range o f reforms in (i) civ i l service and administrative devolution; (ii) public financial management; and (iii) public procurement. ; (iii) the latter with the goal o f and making local governments more accountable for improved service delivery.

(i) Civi l service reform and administrative devolution

43. By the time PRP started in 2001/02, decades o f neglect had taken its to l l on governance in the province, as in the rest o f the country. The result was excessive staff, poor compensation at higher levels, declining quality o f c i v i l servants, over-centralization o f decision-malung, complaints o f widespread corruption and malfeasance, poor management systems, frequent transfers o f staff, including o f high-level staff with resultant l i tt le time and experience in the post, and cumbersome and costly procedures. T o address these challenges reforms have been initiated in the area o f personnel management and devolution.

44. The provincial government wants to improve the efficiency, effectiveness and ethical standards o f the c iv i l service in order to raise levels o f public service delivery. Our reforms also a im at making c iv i l servants more accountable to users through administrative decentralization and raise their levels o f competence and integrity

45. Our vision o n maintaining meri t in public sector employment i s visible in practice. In i t ia l steps have been taken to lessen recruitment delays, increase tenure, and respond to actuarial liabilities. Complaints o f excessive and out-of-turn postings and transfers within the bureaucracy have been addressed. W e have reduced the level o f ‘churning’ amongst the Secretary cadre and have successfully contained growth in staffing levels.

46. The province init ially took the lead in implementing administrative and operational aspects o f devolution o f power including hl ly devolving 12 Provincial Departments to the districts, and placing 200,000 out o f 280,000 provincial employees in districts. Other measures have also been taken to institute administrative devolution.

47. As many as 24 Departments o f the Provincial Government were identif ied either for staff reduction, amalgamation or closure. A s a result o f their re-organization the number o f Departments was reduced from 46 to 23, and a surplus pool o f 6000 staff members created, most o f whom have n o w been absorbed in new vacancies in the Districts. The pool has n o w been reduced to just over 1500 employees. At least 90 percent o f new sanctioned posts have been in Health, Education or Police and in Basic Pay Scale 5 or above. The remaining sanctioned posts are increasing by n o more than 3 percent (new sanctioned posts increased at the ratio o f 1.7 percent in budget for FY2005/06) per annum. This pol icy will be continued in the coming years.

48. The rules governing the management o f c i v i l servants have been revised and simplified. The Annual Confidential Report Fo rm (staff performance assessment) has also been simplif ied to make reporting easier, and the procedure prescribed to make these timely and definite. An amendment in the administrative rules was made to strengthen the Public Service Commission and make it autonomous.

Annex I Page I1 of 15

49. The government has changed its human resources management systems to respond to the requirements o f the Local Government Ordinance (LGO) and devolution and has put into operation a computerized HR database that will allow i t to monitor compliance with human resources management polices and with the size o f the c iv i l service establishment. The core HR Database was established in November 2005 and has since then been in use for the init ial preparation for the salary budget for FY07. 97 percent o f the personnel records (out o f 284,000) have been completed and loaded to the system. The records o f 77,000 out o f 99,000 c iv i l pensioners are ready for periodic updating.

50. The Finance Department has already initiated a performance based budgeting process covering 201 service delivery units in health, education and agriculture within Peshawar and Kohat districts. Tight budgetary targets will however make this challenging. If our c iv i l service is to be more effective, the levels o f efficiency must also rise; i t wil l n o longer be a question o f maintaining within affordable limits the current staff doing their work in the same way. Policy, management and service delivery jobs will have to be redesigned and staff wil l have to learn new ways o f workmg in more effective organizational structures. These new ways o f working and organizational structures will include responding to the needs o f devolution and in particular to the requirements of the LGO to create district services. Our government must also delegate the appropriate levels o f fiscal authority t o local governments so that the managers are empowered to do their new jobs.

5 1. Inconsistencies with regard to the devolution o f appointing authority has been addressed. Specifically, the inconsistency between the NWFP C iv i l Servant Ac t o f 1973 and other regulations has been removed to make them consistent with the District Service Rules. NWFP district ru les o f business have been notif ied while District Coordination Officers have been declared as the appointing authority for the staff in Basic Pay Scale 11-15 and the Executive District Officers have been declared as the appointing authority for the staff in Basic Pay Scale 1- 10.

(ii)-Public Financial Management

52. Our province has since 2001 been implementing reforms in Public Financial Management. I t has satisfactorily implemented the key elements according to the medium term action plan: i) improving the reliabil i ty and accuracy o f financial data, ii) institutional reforms to strengthen internal audits, and iii) improving accountability and legislative supremacy. The main emphasis o f public financial management reforms in the province has been on establishing an integrated, automated accounting system that connects al l provincial level and district accounting offices to provide real time information. Whi le work has also been ongoing in institutional reforms and improving accountability and legislative watch, the emphasis will shift increasingly to these areas in future operations.

53. Reliability of financial reporting has improved markedly. The reconciliation levels o f fiscal accounts achieved by the NWFP continue to exceed those reported for a l l other provinces. A s on June 30, 2005, reconciliation levels for expenditures, revenues, suspense accounts and intergovernmental accounts had reached 97 percent, 95 percent, 100 percent and 100 percent, respectively. This achievement would be further enhanced with the operation o f a uni form chart o f accounts that started this year, FY06, for the entire province. Fiscal and financial data distortion and unreliability, hitherto a common feature within the province, would n o w be reversed and province-wide data aggregation according to functions, major and minor heads will more reliably be generated with timeliness.

Annex I Page 12 of I 5

54. Our province remains fully committed to embracing financial management reforms as reflected in the performance under our medium-term program o f actions and has made very substantial progress - unparalleled in Pakistan - towards achieving reliable, comprehensive, accurate, and timely information pertaining to provincial and district governments’ financial transactions. The provincial government has supported the 24 district governments in the key area o f converting the district governments’ budget for F Y 0 6 f rom the legacy chart o f classification to the New Accounting Model (NAM)-based new chart o f accounts. The budget computerization unit o f the Department of Finance, supported by PIFR4, has enabled this successful conversion and the implementation rollout o f the provincial government’s adopted new chart o f accounts to the 24 districts in the province. The province o f Punjab i s the only other province that has also, in FY06, achieved this transition to a uniform chart o f accounts for the provincial and district governments but has a lower number o f integrated F M I S productive sites. W e a im at achieving operational IT connectivity and productivity for 20 District Finance and District Accounts office sights using uni form chart o f accounts under the N e w Accounting Model.

(iii) Procurement reform

55. NWFP has since the start o f the Provincial Reform Program been the country’s leading province with regard to procurement reforms. Government o f N W F P passed Procurement Ordinance in 2002 as the f irst government (federal and provincial) in the country. Continuing with i t s lead o n procurement reforms, in 2003 our government passed a new Procurement L a w for goods, works and services, again a f irst in the country.

56. W e have prepared a road map to revise the procurement l aw and relevant regulations in order to bring them to international standard and ensure their implementation over the next two years. This includes amendments in the procurement l aw and the standard bidding document as wel l as their implementation, and putting in place a system for posting and updating market prices as a basis for cost estimates in bidding contracts. The provincial government has requested the Wor ld Bank to provide an IDF grant in order to revamp the procurement reforms.

Private Sector Development and Growth Oriented Reforms

57. Our government intends to reduce poverty through accelerated broad based economic growth l ed by the private sector. Hence improving the investment climate for private investment i s pivotal in the provincial government’s growth strategy. The provincial government recognizes that federal policies in this area will have a strong bearing o n the success o f provincial efforts. The provincial government has developed strategies to improve the investment climate, enhance productivity in agriculture and water use efficiency, reduce the role o f the public sector in commercial and industrial activities, and promote public-private partnerships.

58. Government o f NWFP continues to realize the significance o f private sector led growth. Early outcomes f rom the March 2005 investor conference demonstrate good resonance with the private sector regarding the measures taken. These efforts undertaken under the championship o f the Department o f Industries were widely recognized, and there i s a need to spread them across other departments; in particular those that have a direct bearing on sectors where NWFP has a comparative advantage. As part o f the NWFP Economic Report a number o f sector studies were carried out. Based on specific recommendations in these studies our government will operationalize the broad strategy into action plans to be implemented immediately and over the medium term. We also intend to seek technical assistance f rom the Bank group and other donors to strengthen the capacity o f relevant agencies to implement reform measures.

Annex I Page 13 of 15

59. Our strategy for Private Sector Development i s based on the following initiatives:

1.

ii. iii.

Institutionalizing public-private dialogue to promote demand-responsiveness o f public sector agencies and policy-making bodies; Creating an enabling and competitive environment; and Expanding the role o f the private sector.

60. Furthermore, our government introduced a new Industrial Pol icy in 2005. Key features o f the new policy are: (a) exempting industrial units in the industrial estates o f NWFP from the imposition o f property tax for a period o f 5 years. (b) Similarly, a l l new un i ts that will be set up in the NWFP will also be exempted f rom payment o f property tax for a period o f 5 years. (c) The provincial government has decided to do away with the unnecessary labor inspections. Any industrial unit which ensures compliance of labor laws (by filling a Performa to be provided by the Directorate o f Labor) wi l l be exempted from labor inspections for a period o f three years. Further exemptions can also be obtained in the same manner. The units will, however, provide their production data and other details t o the Directorate o f Industries and Labor every year. (d) In order to reduce the number o f taxes that industry has to pay, the provincial government has decided to exempt the industrial units in NWFP from the payment o f Education Cess, which i s recovered by the Workers’ Children Education Board.

61. With regard to institutionalizing public-private dialogue our government has established an Industrial Facilitation Council t o be headed by the Chief Minister, having members f rom both the public and the private sectors. I t wil l work as the apex body for facilitating investment in NWFP and will take high-level decisions to address the problems faced by the industrialists in NWFP. The Industrial Facilitation Committee headed by Chief Secretary NWFP will meet more frequently to settle the problems o f the industrial sector in the province.

62. In order to ensure growth it i s imperative that the province creates the enabling environment to position itself to take advantage o f i t s natural endowments and Hyde l power i s an obvious candidate. W e have leased out 7 o f 9 hydel plants to the private sector and will lease out the remaining two which are currently undergoing refkbishing. Leasing out these plants should be seen as just one step o f an overall effort t o involve the private sector more deeply in this sector.

63. T o adopt a demand driven approach for technical and vocational training institutes whereby labor skills needs o f the private sector are met, our government i s planning private sector representation on the boards o f such institutions with the boards being headed by a chairman f rom the private sector. The government has restructured Sarhad Development Author i ty to act as secretariat and investment facilitator for both bodies. Aiming at fostering an enabling environment for transfer o f management o f industrial estates to the private sector, our government has set up Management Committees for Industrial Estates that include, and are headed by, private sector representatives.

64. Privatization initiatives are also progressing in order to expand the ro le o f the private sector. A Provincial Privatization Board has been constituted with the Secretary Industries in the chair. I t utilizes the services o f private sector professionals such as Chartered Accountants and Lawyers on need basis. The privatization notif ication authorizes the privatization board to dispose o f loss malung government owned entities. Our government has started reducing i ts share holding in the Bank of Khyber, the f i rs t phase o f which has been successfully done after the recent P O

Annex I Pnge 14 of 15

for 41 mi l l ion shares. This has reduced the government’s share holding to 65 percent. We plan to o f f load a further 14 percent to institutional investors by September 2006 which wil l reduce the government’s shareholding to 5 1 percent.

65. specific reforms.

In addition to policy reforms cutting across sectors we have also undertaken sector

Mining

66. In accordance with the National Mineral Policy 1995, the Government o f NWFP established the Directorate General Mines and Minerals (DGMM) in August 2001 by integrating three existing mineral related departments, Mineral Wing o f D I C M D , Mineral Wing o f S D A and Inspectorate o f Mines. The a im i s to provide a one window facil i ty to attract as well as facilitate national and overseas investment in the mineral sector o f the province. Currently there are more than 1200 mining concessions for different minerals in the private sector, earning about Rs.140 mi l l ion per year for the government. Investment friendly regulatory and fiscal regimes are being introduced by modify ing mining concession rules to facilitate and promote investment in the mineral sector of NWFP.

67. In April 2005 the Government o f NWFP through Gazette notification announced the Nor th West Frontier Province Mining Concession Rules. These rules cover and address wide range o f issues pertaining to various types o f licenses and issuance o f licenses for both large scale and small scale mining purposes. The notification has l a id down comprehensive l i s t o f rules and regulations encompassing reconnaissance license, exploration license, mineral deposit retention license or mining lease, and financial matters including royalties.

Agriculture

68. Agricultural growth i s probably the most effective mechanism for poverty reduction, and a main propeller o f growth in NWFP. In view o f the importance for future growth, Government o f NWFP has constituted a committee under the Minister for Agriculture, Livestock, and Cooperatives Department with the Chief Secretary NWFP, Secretary Agriculture, and private sector stakeholders as members. The vision o f the government i s to achieve food security with exportable surpluses to generate employment and income opportunities in the province.

69. province. The goals o f the pol icy will be achieved by pursuing a number o f objectives:

The a im of Agriculture Policy i s to uplift the economy and reduce poverty in the

0 Poverty reduction 0

0

0

0 Strengthening public-private partnership 0

0 Conservation o f water resources

Food security and self sufficiency Integration and improvement o f service delivery system Capitalizing o n the comparative advantages

Farming community participation in decision making

Annex I Page 15 of I S

* Tax re l ie f measures 0 Gender mainstreaming

70. The agriculture sector has been receiving the lowest per capita allocations wen though i t has a higher proportion o f poor people depending on agriculture for their livelihoods. The provincial government has realigned public expenditure towards priorities identified in the agriculture policy. The budget for FY06 shows increase in share o f expenditures in the identified priority areas.

71. Our government has initiated steps to establish an autonomous agricultural em consistent with the priorities set out in our Agriculture Policy announced

have demerged the university and research institutes with a view to removing ambiguity and duplications that hindered progress in the area for many years. We w i l l strengthen the linkages between agriculture research & extension and the farmers to align research and extension priorities with farmer needs and market trends. We will also help develop further varities o f certain high value horticulture tailored to specific backward areas and districts and promote private milk processing plants. Our government will continue to build the capacity o f small farmers through the development o f f m e r organizations. We will in the near future help th ate sector establish milk producers associations, and horticultural co-group o f pr s, processors and traders at the provincial level. 75 farm services centers have been established and are fully operational. Apart from this, 24 district agricultural coordination forums have been established and are operational.

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72. Our government i s l l l y committed to the reforms program outlined above. We are determined to implement this program. We believe that the program is strong and focused. I t i s built around an integrated monitoring framework. I t presents a new, ambitious, and holistic vision o f our medium term economic development based on a strategic prioritization o f key actions agreed upon after extensive consultations and intensive lesson learning. It within the overall PRSP framework for Pakistan. We submit this program to seek support for it by International Devel Association, starting with a US$90 million credit as the f i rst in a series o f three pment Policy Credits to support our Medium-Term Reform Program for FY06 - F

With warm regards,

Yours Sincerely,

Go ernrnen f pG2?*py

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Annex 3 Page 1 of 9

ANNEX 3 POVERTY AND EMPLOYMENT IN NWFP

Poverty trends in NWFP

1. NWFP i s Pakistan's poorest province, both in terms o f the aggregate level o f economic activity generated within the province vis-&vis i t s population and the household income and consumption levels. Poverty in the province has remained high and has increased since the late 1990s. Poverty estimates show that more than 44 percent o f NWFP's population l ived below the poverty l ine in 1998199, which by 2001/02 had increased to 46 percent (see Figure l)." Poverty in rural areas o f the province exceeded that in the urban areas by considerable margin. In 2001/02, about 48 percent o f the population in rural areas belonged to households below the poverty line, compared with 35 percent in urban areas. Moreover, this gap between the rural and urban poverty has been widening. T h e share o f the poor population in rural areas increased by seven percentage points between 1990/91 and 2001/02, while in urban areas it shrank by two percentage points during the same period.

Figure 1: Poverty trends in NWFP and Pakistan (World Bank poverty lines) Percent o f popu la t ion consuming b e l o w the pover ty l i ne _ _

NWFP

2o 10 L 90-91 93-94 98-99 2001-02

Pakistan I"-

90-91 93-94 98-99 2001-02

.. Urban -Rural -Overall

Source: HIESiPIHS for relevant years

2. Notwithstanding the level o f poverty, a significant number o f the NWFP's population has remained vulnerable to even small changes in income. In 2001/02, about 57 percent o f the province's population was concentrated close to the poverty l ine (i.e. having consumption in the range o f plus or minus 25 percent o f the poverty line). This implies that a relatively small reduction in income can push a significant number o f people below the poverty line.

I' T h e estimate o f poverty reported in this annex are World Bank staff estimates derived by using different Household Income and Expenditure Surveys (HIESs) for most o f the 199Os, and Pakistan Integrated Household Survey (PIHS) for 1998/99 and 2001/02. These poverty estimates are based on the poverty lines that are held constant in real terms f rom the early 1990s to 2001/02 to assure proper inter-temporal comparisons. The Basic Needs poverty lines used in the annex are Rs 680 and Rs 767 per adult equivalent per month for rural and urban areas, respectively. These are somewhat different from the poverty l ine adopted by the government o f Pakistan (Rs 674 per month per equivalent adult male in 1998/99 Rs.) i s arrived at by estimating an expenditure level that i s required to attain a minimum threshold o f calorie consumption (2350 calories per equivalent adult per day). However, a few methodological issues surrounding the measurement o f poverty using this line remain to be settled, and there is no consensus yet on the provincial poverty estimates (the government's recently published PRSP contains no province level estimates o f poverty incidence).5

Annex 3 Page 2 of 9

education level o f household heads and

poverty Households attended school incidence whose constituted (see head 62 Figure had percent never 3). o f

the population o f NWFP, but comprise 71 percent o f the lowest consumption quintile; whereas households with head having an education o f matric level or above constituted 16 percent o f the population, but only 11 percent o f the lowest quintile.

3. Extreme poverty accounted for a relatively small share o f the poor in the NWFP, as only 13 percent o f NWFP’s population in 2001102 has consumption below 75 percent o f the poverty l ine 2001102.

~~~~

- 40

s 20

0

= g - - 2 3 z 2 m , ,~ b J 2 F a i a 8:

g o 2 0 % & c.c 1 h ii f j z g 0 All NWFP Bottomquintiie (per capita consn.)

ProJiIing the poor

4. Examining other characteristics (than consumptiodincome) o f the poor helps not only to better understand the multi-dimensional nature o f poverty, but also identify the characteristics that keep the poor in the cycle o f l o w earning potential and l o w capability.

5. Land ownership: Estimates show that in rural NWFP, l ike other rural areas in Palustan, ownership o f agncultural land i s closely associated with poverty. Households owning n o land constituted almost 70 percent o f the rural poor population in 2001/02, whereas households with more than 1 hectare constituted less than 10 percent o f the rural poor population (Figure 2).

6. Land distribution in NWFP appears to have marginally deteriorated between 1998199 and 2001/02. The proportion o f rural landless and marginal landowners has increased, while the

Figure 2: Distribution of rural population in NWFP by land ownership I

no !and in O<ha<=l l<ha<=2 2<hac=4 4cha hhold

0 All rural MNFP Bottom quintiie (per capita consn.)

Source: PIHS (2001/02)

proportion o f landowners with more than 1 hectare o f land had increased by about 4 percentage points.

Annex 3 Page 3 of 9

2 3 4 5

Total

quality public schooling and to increase access to it to improve education attainment among poor children.

72.1 6.4 31.9 2.7 77.1 8.3 42.5 4.9 84.0 23.0 53.9 14.4 96.1 43.5 69.9 33.4 73.1 13.6 38.3 11.8

critical health services and poor health outcomes. Table 2 shows two key indicators o f maternal health for NWFP using PIHS 2001/02 data, whi le keeping

such health indicators. I t shows that women in richer households had much better access to pre-natal consultation and assistance from skilled attendants than those in poorer households. Also, women in urban areas had much better access to maternal

in mind the l imitation of P M S survey for producing

Pre-natal Births assisted by consultation skilled attendant’

NWFP 22 17 ~ - ~ a l 20 15 u%an 36 29

Selectedper capita expenditure quintiles is‘ 15 15 3rd 19 16 5 h 43 31

the top quintile; and 20 percent in rural compared to 36 percent in urban areas.

1

areas Figure 4: Immunization coverage in NWFP

Drinking water: Drainage: No Toiler: Open source drain Outside home

51.2 68.1 33.5

10. Similarly, immunization coverage (as measured from PMS) was l imi ted among the poor in NWFP except for Polio (see Figure 4). Polio immunization coverage exceeded 90 percent in al l groups, r i ch and poor, rural and urban, and boys and girls. Other vaccinations had l o w coverage, especially for the poor. Full coverage was below 50 percent for the poor.

11. Access to water and sanitation: Access to safe drinking water and sanitation are important determinants o f health, and strongly associated with consumption poverty. Table 3 shows that in 2001/02, 51 percent o f households in the poorest 20 percent o f population relied o n potentially unsafe open sources for drinking water, 68 percent had n o access to drains and 34 percent did not have toilet facilities inside

Source: s t a f f calculations using PIHS 2001/02. Terciles contain an equal number of individuals and are specific to NWFP.

their homes. These proportions declined progressively for richer groups o f population.

Annex 3 Page 4 of 9

9 L D - / I

15. Labor force participation and /? h unemployment: The labor force - I \ / ' , & participation rates have been declining in / \ ; "\ / NWFP. As a result, these rates in 2001/02 were substantially lower than in the rest o f 5 t-------- Pakistan. Even with l o w participation rates, NWFP's unemployment rate was the highest among major four provinces in Palustan;

2

5 dJ

0 -

12. Access to electricity, gas, and telephone: Table 4: Connectivity to electricity, gas Access to electricity, piped gas and telephones enables and phone in NWFP ( percent of households to gain access to information and o ulal opportunities related to education, health and employment. Table 4 shows that the poor tended to have less access to electricity, piped gas and telephones although the access to piped gas was s t i l l l imited irrespective o f economic status o f households in NWFP. The access had expanded slightly between 1998/99 and 2001/02; the rich-poor gap in access to electricity Total

shrank but that o f piped gas and telephone widened.

The Employment Challenge in NWFP

13. This section attempts to identify the issues 5 regarding employment in NWFP. No doubt economic Total

1998'99

4 5

2001/02

on) Electricity Piped Gas Telephone

66 3 3 4 4 9 76 0 2 9 4.4 72.4 3.6 11 6 81.8 3 0 19.7 89.4 4 5 36 1 74.5 1.4

74.0 1.8 2.2 73.7 2.1 4.3 79.1 4.3 9.9 85.4 5.8 19.9 94.8 9.9 32.9

growth a major factor o f poverty alleviation. To make economic growth more pro-poor, the conditions in the labor market are critical. Growth i s l ike ly to reduce poverty significantly if it expands employment opportunities and increases wages in the sector where most o f the poor are working.

Annex 3 Page 5 of 9

earnings in NWFP for male workers were lower than in al l other provinces o f Pakistan (see Table 6).'* Research show that earnings in the N"WFP are lower for most o f professions, suggesting productivity in the NWFP in a given profession was below the national average. I t i s l ikely that the poor educational attainment o f the workforce in the NWFP contributed to low

M a l e Female Total 41051 21758 37408 punjab

Sin&, 55609 47234 55115 NWFP 40849 31351 40325 Balochistan 42172 40834 42134 Total 45039 25064 42316

-

, Source:LFSp 2001'02.

17. Employment in the public sector: Figure 6: Public and private earnings (average, Government constituted by far the largest share o f formal sector employment. Government employed 40 percent o f women and 19 percent o f men in the formal sector; in rural areas, an even larger share o f formal employment was public. The high reliance o n public

in Rs per year)

employment in female and rural employment could be a reflection o f the public sector's dominant role in service delivery in education and health. It could also be a reflection o f the lack o f development o f other, formal Source: LFsy 2o01'02. employment opportunities, especially for females and in rural areas.

18. In NWFP, l ike elsewhere in Palustan, earnings in the public sector were wel l above those in the private sector, even after controlling for educational attainment o f employees (Figure 6). Earnings in the public sector o f NWFP did not rise very steeply with the level o f education except for workers with a degree o f higher education. The wage premium to public sector employment was even larger than shown by these numbers since non-wage benefits such as pension and j o b security tended to be substantially better in the public sector as compared to the private.

Remittances

19. Given the relative l o w level o f domestic economic activity in the province and the corresponding lack o f j o b opportunities, international and internal migration has been a viable option for people in NWFP province. Many people f rom NWFP migrate to other parts o f Pakistan (especially Karachi) or overseas to find jobs. Remittances f rom the migrants, therefore, constitute a significant portion o f overall household income and an important source o f household consumption and investment.

l2 No information i s available f rom LFS o n the earnings o f the self-employed.

Annex 3 Page 6 of 9

1 2 3 4 5 Total

Quintlle (for NWFP)

20. According to P M S 2001/02, almost 30 percent and 8 percent of households in NWFP received remittances from within the country and overseas, respectively. Both f igures are more than double those in the rest o f Pakistan (see Table 7).

1 2 Qufhtile (NWP) 5 Total

Source: PIHS 2001/02.

2 1. The size o f remittances was substantial. Average annual transfers (for those that receive them) were Rs 30,000 for domestic and Rs 71,000 for international remittances. T h i s implies each household in NWFP received Rs 15,000 in 2001/02 on average, corresponding to 18 percent o f annual household consumption.

Table 7: Remittances in NWFP and Pakistan (In Rupees and YO) NWFP All Pakistan

Av. domestic remittance (all HHs) 9,039 3,989 Av. int'l remittance (all HHs) 6,015 2,998 Av. domestic remittance conditional on receiving 30,410 29,135 Av. int' l remittance conditional on receiving 71,215 72,859 % receiving domestic remittances 29.7 13.7 % receiving remittances from abroad 8.4 4.1 Av. domestic remittance (all HHs) as % o f HH expenditures 11.2 4.6

7.4 3.4 37.7 33.3 88.2 83.3

Av. int'l remittance (all HHs) as % o f HH expenditures Av. domestic remittance conditional on receiving as % o f HH expenditures Av. int'l remittance conditional on receiving as % o f HH expenditures Source: PIHS 2001/02

22. Remittances were more important among rural households than among urban households (see Figure 7 and Figure 8), indicating perhaps the even further lack o f j o b opportunities in rural areas, but also indicates the rural tradition for migrating out o f the province. Households in the upper quintiles were normally more l ike ly to receive remittances, and o n average receive larger amounts, than poorer households. This. does not necessarily mean that remittances made households better-off since counterfactual wage levels o f migrants were u n h o w n . However, i t i s wor th emphasizing that remittances made the income distribution more, not less, unequal.

Figure 7: Share receiving remittances (NWFP 2001/02, b y region and quintile)

Figure 8: Average amount received in remittances

25000 qn% a ^^ . ̂̂

L .," ," 8 45% g 20000 e 40% ln a

f 15000 B 35% 30%

20% g 25%

2 10% n 5000

0% 0

.- E 15% 5

5% 2

Source: PIHS 2001/02. Notes: NWFP 2001/02, by region and quintile. Average i s for a l l households, including both receivers and non-receivers.

23. Educational investment and migration: Remittances seem to have some positive impacts o n school enrollment rates for children. School enrollment rates for children fi-om households in NWFP that received remittances were larger than for those households that did no t receive them (by some 5 percentage-points). This positive difference in schooling investments,

Annex 3 Page 7 of 9

expanded marginally (by 0.8 percent) between 2001/02 and 2003104. Nonetheless, this expansion was the highest among a l l four provinces (Table 8). The expansion o f the labor force mainly reflects increased female labor force participation that rose by

which was larger in rural than in urban areas, i s found also when comparison i s made quintile-for- quintile and thus does not merely reflect an income effect. This suggests remittances contributed to higher human capital among recipients, possibly encouraged by the relatively stable nature o f remittance income or by the closer contact with out-of-province labor markets in which returns to schooling may wel l be higher than in N W F P itself.

Change

points) % of Labor Force 2001102 2003104 (percentage

MaleNWFP 65.2 65.7 0.5 Female NWFP 7.2 10.2 3.0 NWFP overall 36.4 37.2 0.8 Pakistan 43.3 43.7 0.4

Post 2001/02 developments

24. The NWFP economy seems to have accelerated since 2001/02, which i s l ikely to lead to some important structural changes in the provincial economy and will impact the level o f poverty in the province. However, since n o additional survey data are available since the 2001/02 PIHS to analyze household income and consumption, i t i s not possible to update the entire analysis provided above, especially linkage between poverty and other socio-economic indicators. T h i s section therefore will update some employment related information using the latest available LFS, 2003104.

Labor force participation

Unemployment

26. The female unemployment rate declined significantly, by 12 percent (or 3.9 percentage points), while the overall unemployment rate in NWFP province declined marginally (Table 9). With the expanded labor force, the total number o f emdoved individuals in

Table 9: Unemployment rate by sex and year I

Change

points) 2001102 2003104 (percentage Unemployment

rate (YO) Male, NWFP 11 10 -0.9 Female, NWFP 33 29 -3.9 NWFP overall 13 13 -0.4 Pakistan 8 8 -0.6 I .

NWFp increased; especially so for Source: LFS 2001/02 and 2003104

females.

27. Despite some signs o f declining unemployment rates, the gender difference in unemployment rate i s s t i l l large-females are 3 times more l ike ly to be unemployed than males. Also, the overall unemployment rate in N W F P i s 60 percent higher than that o f overall Pakistan.

Annex 3 Page 8 of9

however, the adult literacy rate o f females improved more than 25 percent between 2001/02 and 2003/04, which was much faster than that o f males, only around 5 percent (Table 10). The overall adult literacy

Change

P o ) points) 2001/02 2003/04 (percentage Adult literacy rate

Male 58.4 61.8 3.4 19.9 25.2 5.3

NWFP 39.3 43.0 3.7 Pakistan 50.0 51.6 1.6

labor force participation, unemployment, and literacy rate in comparison to the rest of Pakistan. I t also confirms that gender gaps, despite of narrowing somewhat between

30. m i l e labor force and employment had expanded in NWFP between 2001/02 and 2003/04, real annual earnings also grew, but more slowly than the rest o f Pakistan (Table 12). However, this does not necessarily mean a l l Pakistan 42,317 46,172

Table 12: Real annual wage earnings (only forwa eem lo ees

2001102 2003104 % increase

employees benefited the same. Source: LFS 01/02 and 03/04

Unemployment % o f Labor Force rate (%) Literacy Rate ("h)

2003104 N W F P Pakistan N W F P Pakistan N W F P Pakistan Male 65.7 70.6 10.0 6.6 61.8 63.7 Female 10.2 15.9 29.0 12.8 25.2 39.2 Total 43.7 43.7 13.0 7.7 43.0 51.6

o f yearly wage earnings declined 8 percent during the same period.

changes in yearly earnings i s much larger for 32. Figure 10 indicates the variation o f

females than for males. The bottom 10 percentile o f male employees earned 7 percent less in 2003/04 than in 2001/02, while the top 10 percentile o f male employees earned around 10 percent more in 2003/04 than in 2001/02.

'' The literacy rates analyzed are those f r o m LFSs and should no t b e compared with those obtained f r o m PIHs as the two surveys use different sampling frames.

10.0

5.0

0.0

-5.0

-10.0

Wage quintiles

Annex 3 Page 9 of 9

Male 40

30

20

10

0

-10

-20

-30

-40

Female 40

30

20

10

0

-10

.20

-30

-40

Conclusions

34. NWFP province has been struggling with persistent poverty incidence, stagnant growth opportunities, high unemployment rates, and large gender gaps in various socio-economic outcomes. The studies above revealed that the poor face limited access to health, education, and infrastructure services and also limited employment opportunities. There are also large gender gaps in access to health, education, and other services and employment opportunities.

'

35. Recent data suggests some signs o f improvement in growth prospects, employment, and gender gaps since 2001102. World Bank estimates (2005) indicate that the provincial real GDP growth rate rose to 6.3 percent by 2004/05. According to Labor Force Survey 2003/04, labor force participation and employment have been expanding, while gender gaps in adult literacy, labor force participation and unemployment rates have shrunk substantially. Also, the comparison between previous PIHS data and the preliminary PSLM data suggests significant improvements in education, health and other infrastructure services, although comparability between the PIHS and PSLM i s yet to be examined.

36. There are, however, some worrying signs too. Recent expansion o f employment involves a significant increase in low wage income earners, which might limit the impact o f expanded employment on poverty reduction. The PSLM 2004105 will provide a more complete understanding o f recent development in poverty and other socio-economic indictors in the NWFP.

Annex 4 Page I of 6

ANNEX 4 HUMAN DEVELOPMENT IN THE NWFP: CHALLENGES, PROGRESS AND

FUTURE PROSPECTS

Introduction

1. The Government of the NWFP recognizes the importance o f human development and i s strongly committed to improving education, health and social protection outcomes in the province. Historically, human development indicators in the NWFP have generally been below the national average for Palustan. For instance, in 2001/02 (when the last survey with verified data was undertaken), the overall literacy rate was 38 percent compared to the national average o f 45 percent; and the pre-natal consultation rate for women was 22 percent relative to the Pakistan average o f 35 percent. T h e human development component o f the N W F P Government’s overall reform program initiated in 2001 and supported through IDA credits included specific reforms to bring about quantitative and quality improvements in education and health. The reforms took advantage o f two key developments: the devolution reforms initiated by the Federal government to help increase accountability in the system; and the increased fiscal space created through macro-economic reforms, which allowed the government to significantly increase the financing available for the social sectors.

2. The human development reforms aimed to increase access and to improve the quality o f services delivered, and were init ially focused on basic education and primary health care services. K e y reforms included enhanced education and health sector financing, in both allocations and expenditures. The increased resources went towards essential improvements in infrastructure, especially improving school infrastructure and upgrading secondary health care facilities, and increasing the supply of service providers, particularly recruitment o f teachers and nurses. Resources were also allocated to improving the quality of services; for instance providing budgets for school recurrent expenditures and preventive health care. Efforts were made to improve quality through better accountability in the system; for example by increasing community involvement in the schools management. Targeted programs were launched to increase participation in social services through for example, the introduction o f incentives l ike free textbooks. These actions focused, as a priority, on reducing gender disparities in the human development sectors. Organizational restructuring at both provincial and district levels were also initiated in l ine with the national devolution program.

Progress during the past five years and future challenges

3. Between 1998-2002 there was progress in education and health outcomes, with primary school enrolment rates improving more than the national average, particularly in rural areas, and immunization rates in the province exceeding the average for Palustan. Wh i le the 2004/05 PSLSMS results are only indicative at this stage, they suggest continued improvement in these areas after the 2001/02 P M S survey. For example, the NWFP showed a consistent increase in net enrolment rates f rom 41 percent in 2001/02 to 47 percent in 2004/05, while net enrolment rates in the rest o f Palustan except Punjab have either stagnated or decreased. Outcomes towards the health MDGs are also better compared to Palustan as a whole, with the province registering a lower infant mortality rate and higher immunization rate o f children aged 12-23 months.

4. However, the l o w init ial conditions o f human development levels in Pakistan mean that considerable challenges remain. According to the P M S 2001/02 and the latest P S L M 2004/05, literacy rates in NWFP (38 percent and 45 percent respectively) are persistently and significantly below the Pakistan average (45 percent and 53 percent respectively). This difference in the

Annex 4 Page 2 of6

Province

overall literacy rate can be traced to lagging female literacy in both urban and rural NWFP. At 26 percent, female literacy in NWFP is wel l behind the country average for female literacy at 40 percent. In addition there i s a wide regional variation in net primary enrolment rates across the districts in NWFP, ranging from 16 percent (10 percent for girls) in rural district o f Kohistan, to 81 percent (80 percent for girls) in the urban district o f A b b ~ t a b a d ' ~ . In health, too, challenges remain: including the l o w use o f contraceptive methods, 22 percent o f currently married women aged 15-49; and the very l o w post-natal consultation rate for women, just 4 percent within 6 weeks after delivery.

1998/99 P IHS 2001/02 P IHS 2004/05 P S L M (prelim.) M a l e I Female I Both M a l e I Female I Both Male 1 Female 1 Both

Literacy Rate (population 10 years and older) Pakistan 59 31 45 NWFP 56 20 37 Punj ab 57 34 46 Sindh 65 35 51 Balochistan 54 16 36

Pakistan 80 61 71 NWFP 84 54 70

Sindh 75 54 64 Balochistan 79 46 64

Pakistan 47 37 42 NWFP 41 30 39

Sindh 47 35 41 Balochistan 44 28 36

Pakistan 21 13 17 NWFP 21 6 13 Punjab 20 14 17 Sindh 25 18 22 Balochistan 17 4 11

GER at Primary Level (Age 5-9)

Punjab 82 68 75

NER at Primary Level (Age 5-9)

Punj ab 47 40 44

NER at Matric Level (Age 14-15)

58 32 57 20 57 36 60 31 53 15

83 61 97 56 84 69 76 51 77 44

46 38 48 33 47 43 46 34 39 24

20 14 21 10 22 16 18 14 9 4

45 38 47 46 36

72 77 76 63 62

42 41 45 40 32

17 15 19 16 7

65 64 65 68 52

94 93

100 84 83

56 53 60 53 44

21 23 20 23 12

40 53 26 45 44 55 41 56 19 37

77 86 65 80 89 95 65 75 49 67

48 52 40 47 55 58 42 48 29 37

16 19 11 17 18 19 18 2c 6 s

I Sources: PIHS 1998/99 and 2001/02, Preliminary FBS data for 2004/05 from PSLM survey (based on CWIQ methodology)

5. The NWFP government i s fully aware that higher human development outcomes are critically important for future economic growth, social development and poverty reduction. To achieve the required progress on human development education, health and social protection programs need to be significantly expanded and strengthened. Improvements in education and s k i l l s are a necessary foundation for sustained development. Enabling greater access to quality health services i s v i ta l ly important for improving l i f e expectancy and productivity. In addition,

l4 See Figure A.2 for details. W h i l e this paper focuses primarily on policies for the province in general, the wide variation in enrolment and literacy rates across the 24 districts o f NWFP requires that government strategy to improve indicators need to be focused on the districts that lag behind. In addition to tackling generic problems l ike poor retention rates that pervade he province, the incentive structure and interventions need to be tailored to relieve the varied district-specific binding constraints on development in the most underdeveloped districts.

Annex 4 Page 3 of 6

targeted measures are required to help the poor cope with chronic poverty and vulnerability. Effective social protection programs are needed to help address equity, and promote access by the poor to essential services. Given the importance o f these sectors, the government i s deepening its human development reform agenda to accelerate progress on education, health and social protection.

Recent policy developments: National programs in Human Development

6. The Federal Government o f Pakistan has launched a series o f national pol icy measures in education, health and social protection to improve human development levels in the country. The measures, described below, have the potential t o complement and benefit the HD pol icy program o f the NWFP.

7. Education. Recent initiatives and policies launched by the Federal Ministry o f Education (MOE) will have an impact o n the NWFP education reform program. The Federal MOE i s undertaking a review o f the 1998 National Education Policy aimed at refining and strengthening the current policy framework and establishing consistency between the Federal and Provincial education sector development programs. The National Curriculum Council, comprising members f rom the public and private sector, including academics and researchers, i s currently reviewing the technical content, norms and goals o f the school curriculum. The improved curriculum that i s expected to result f rom this review should enable the NWFP education authorities to strength the quality o f education within the province. The MOE has commissioned a National Education Census through the Federal Bureau o f Statistics to gather information on a l l schools - public, private, and madrassahs. T h i s Census could be used by the NWFP as a baseline to integrate data o n the private education sector into the Education Management Information System (EMIS). The MOE is also undertaking a review o f the National E M I S to align it with the E M I S in the provinces. In addition, the MOE is strengthening school census data to assess progress o n key indicators for the MDG and Education for All initiatives, such as the analysis o f primary completion rates. The MOE has also commenced a National Assessment o f Education Systems W A S ) to measure learning outcomes. The N E A S wil l be a key tool to measure education quality in the provinces and the country as a whole, over time. The Punjab i s implementing an education sector reform program that IDA i s supporting through a series o f education sector development policy credits. In addition, Sindh has commenced the preparation o f an education sector development program. Lessons f rom these provincial programs will cross-fertilize each other.

8. Health. The Federal Ministry o f Health (MOH) has initiated new programmatic initiatives, including expanding TB DOTS through public-private partnerships, a program to train community midwives, and hepatitis prevention and control programs. In addition, work i s also in progress to strengthen the Lady Health Worker program by introducing programmatic and management reforms, and a new MCH strategy i s being developed to address maternal health challenges. All o f the above initiatives are l ike ly to help a l l provinces in Palustan, including the NWFP, to make progress o n key outcomes and are l ikely to be implemented with federal financing through provincial and district systems. The new initiatives are l ike ly to increase work load o n the provincial and district systems and would necessitate capacity building o f provincial and district systems for effective program implementation. The Ministry o f Heal th in collaboration with J ICA has developed a modif ied Health Management Information System (HMIS) to strengthen regular monitoring and reporting o f health services. This i s an important area and the leadership o f the federal government would facilitate the development and implementation o f the H M I S at the provincial and district level.

Annex 4 Pclge 4 of 6

9. The President’s Initiative on Primary Health Care: The continuing underperformance o f the primary health care (PHC) system has been an area o f key concern in the health sector. The President’s Init iative on PHC i s based on promising results of contracting out management o f PHC in Punjab to an NGO the Punjab Rural Support Program. I t outlines an ambitious reform plan to contract out management o f PHC system in phased manner to rural support programs across Palustan. NWFP’s reform program to be supported by DPCs includes the management reforms to implement the proposed President’s initiative in the province.

Future HD reforms by the NWFP under the DPC series

10. The NWFP government has been encouraged by the progress shown by i t s reforms in health and education. However, the NWFP i s also aware that significant challenges remain, requiring the reform agenda to be broadened and deepened. There i s high level polit ical recognition o f the challenges and a commitment to tackle these issues through the formulation of a wider and deeper human development reform program, which builds o n the efforts o f the previous SACS and the ongoing reform efforts in other provinces. The GoNWFP i s also aware that the proposed human development reform agenda needs to fit within the overall fiscal and fiduciary framework o f the province. The central objectives o f the human development reform program are to improve the access and quality o f services while significantly reducing gender and regional disparities. Going forward, the reform program focuses on the fol lowing three key themes: (i) improving access, coverage and utilization o f social services including social protection services (covering both public and private services); (ii) improving quality o f service delivery; and (iii) enhancing stewardship functions o f the government including financing, monitoring & evaluation and promoting public-private partnerships.

Education Sector

11. The education sector reforms will be broadened and deepened in several ways. First, as primary enrolment and completion rates rise, the demand for places in middle schools, secondary schools and colleges will increase over time. The NWFP government plans to expand the middle, secondary and college education sector t o increase participation beyond primary education. The proposed DPC 2 will mainly support the expansion o f middle school education by assisting the government to increase school facilities at the middle school level, according to expansion targets set by districts and agreed between the provincial government and district governments. The proposed DPC 3 will provide support for the expansion o f secondary and college education, again in the context o f targets established by districts and agreed between the provincial and district governments. T o improve access, public-private partnerships will be strengthened through the Education Foundations. By DPC 3 the Elementary Education Foundation will be restructured to enable it to implement innovative programs to support the private sector.

12. Second, demand side interventions will be introduced with a focus on regional and gender equity. The proposed DPC 2 will assist the NWFP to commence a program o f stipends for girls to attend middle and secondary schools in poor districts where female middle and secondary enrolment i s particularly low. This demand side initiative will complement the supply side measures to expand middle and secondary education. Further, the initiative will be poverty focused, as the districts where female enrolment i s lowest are also the regions where poverty rates are highest. The emphasis o n poverty focused demand side initiatives will b e strengthened in the proposed DPC 3, which will assist the NWFP to introduce a program o f incentives for teachers to work in remote, rural schools.

Annex 4 Page 5 of 6

13. Third, the quality o f education, at levels, wi l l be a key focus o f the education program. Policies to improve education quality will emphasize measures to raise the competencies and performance o f teachers, and the cognitive achievement levels o f students. The proposed DPC 2 will support the NWFP to establish an institutional framework for teacher development. This will cover the service conditions for teachers, such as entry criteria into the profession and career progression, pre-service teacher education, and professional development through both on-site and off-site teacher training and support. The proposed DPC 3 wil l assist the government to institute a program o f special support for schools with l o w learning outcomes. This will include regular monitoring of learning levels, and the implementation o f special measures to assist the weakest schools, including providing extra financial resources, directed additional management attention, special incentives for good teachers to locate in such schools, and appointing good head teachers to these schools, as needed.

14. Fourth, the NWFP education program wil l place strong emphasis o n objective monitoring and evaluation. The proposed D P C 2 will support the establishment o f a specialized technical unit in the Department o f Education to undertake monitoring activities. This unit will be staffed with the right s l u l l mix to manage ongoing monitoring, establish linkages with the EMIS data, and develop linkages with district governments and to use the data analysis for po l icy development. The proposed DPC 3 would assist the government to introduce a system o f external third party validation. The TPVs will be a useful external accountability instrument, assessing the quality o f the internal monitoring systems by confirming the results with ongoing departmental monitoring. Annual TPVs would be conducted through independent and external agencies to assess various reform inputs including stipends, textbooks, provision o f facilities, availability o f teachers, and functioning o f PTAs.

Health Sector

15. In health the reforms will be broadened by: (i) testing innovative approaches to strengthen the management and organization o f primary and secondary health services; (ii) building partnerships with the non-state sector; (iii) increasing managerial autonomy; and (iv) accountability in the public sector through significantly strengthening monitoring and evaluation.

16. The f i rst key reform i s to improve the uti l ization and quality o f PHC services. This wil l entail testing o f managerial and organizational innovations using a controlled, before and after, evaluation targeting the worst performing districts in the province. The three approaches that will be tested include: (a) contracting out management o f responsibility for delivering a package of Primary Health Care services to NGOs, in keeping with the President’s PHC Initiative; (b) providing increased administrative and financial autonomy (and requisite powers) to district managers so they can effectively manage the District; and (c) providing, along with administrative and financial autonomy, performance based incentives to district managers and key staff. T h i s i s the f irst time that any provincial government will be implementing focused reforms which could have far reaching impact o n health sector management and quality o f service delivery. This reform measure will be supported through DPC 2.

17. Second area of reform i s t o improve quality, equity, and uti l ization o f secondary care by introducing hospital reform and develop models o f autonomy. T h i s would explicit ly address issues o f human resource management, governance, and financing for district hospital governance, management, and autonomy. In the medium term, i t i s expected that improved models o f autonomy will be implemented in district hospitals. NWFP i s taking the lead in introducing hospital reforms at the secondary level. T h i s reform measure will be supported through DPC 2.

Annex 4 Page 6 of 6

18. Third, a series o f reform measures i s envisaged to be implemented to strengthen the Department’s stewardship over the sector. A key measure to be supported under DPC 3 will focus o n significantly strengthening monitoring and evaluation through the establishment o f an independent monitoring and evaluation cell in the Department o f Health. The unit will undertake performance assessment, coordinate inter district dialogue, and enhance accountability by disseminating disaggregated district performance indicators to the public through the media and the Department o f Health’s website

19. The DPC will support reforms to strengthen partnerships with the private and NGO sector by restructuring the NWFP Health Foundation. The Health Foundation’s role, functions, and scope o f work will be reoriented and measures taken to enhance i t s autonomy. In addition, the recently-established Health Regulatory Authority (HRA) will develop a clear strategy in order to improve the quality o f care provided in the private sector.

Social Protection

20. Whi le the provincial PRSP highlights the importance o f social protection (SP) in combating poverty, fostering human development and achieving the Mi l lennium Development Goals, l i tt le has been done to implement planned actions. The province relies o n federal spending and key programs are federally mandated and financed. The province spends very l i t t le f rom i t s own resources. As elsewhere in Pakistan, public-private partnership i s an important pi l lar o f assisting the vulnerable, and a number o f NGOs provide a variety o f services to the vulnerable groups. Although significant, both formal and informal safety nets interventions are far f rom sufficient to alleviate poverty, and deep and widespread poverty remains one o f the main features o f NWFP’s social and economic reality.

21. The Government i s committed to developing a comprehensive SP strategy that would strengthen targeted programs to address chronic poverty and vulnerability through financially sustainable programs, coordinated at the federal level, and thereby facilitates participation o f the poor and vulnerable into basic social services. As part o f DPC 2, the Government o f NWFP i s currently tahng stock o f social protection programs and their outcomes. The stock taking would fo rm a basis for a social protection reform strategy and an action plan for i t s implementation, which would be developed in tandem with ongoing work on a national social protection strategy and decided, based o n the results o f the stock taking and related consultations. L i ke l y areas o f in i t ia l engagement would focus o n improving social protection administration and implementation, including (i) organization and coordination at the provincial and districts levels; (ii) human resource capacity building; (iii) introduction o f M I S and provision o f up to date equipment, and (iv) physical infrastructure. Subsequently, existing programs would b e audited and tightened up in order to increase their effectiveness and efficiency. N e w programs, including scaling up o f demand side incentives (and perhaps expanding these to participation in health programs, e.g., nutrition), workfare and community-based service delivery for vulnerable groups o f the population will be gradually introduced, in close coordination with national pol icy developments.

Annex 5 Page I of3

ANNEX 5 PUBLIC FINANCIAL MANAGEMENT

Summary and background

1. Compared with other provinces, financial management in NWFP for a long time always been significantly better than in the other provinces and the federal government. The Provincial Financial Accountability Assessment (2004) provides an in-depth analysis of the strengths and weaknesses o f the financial control environment in the provincial government. I t s assessment i s that the system in place does provide reasonable safeguards for reliance on government’s financial accountability systems to ensure that funds are used for the purposes intended. This assessment i s planned to be updated during FY 2006, using the PEFA PFM Performance Measurement Framework, in order to provide more qualitative baseline performance indicators and their trajectory o f change over time. The tremendous progress also being made in the province in implementing PIFRA reforms i s demonstrative o f the province’s firm commitment towards the enhancement o f public sector financial accountability.

Progress on financial management reforms

2. The NWFP government’s commitment to reform the financial management system in the province continued, and indeed strengthened, under the program o f structural and economic reforms initiated in 200 1/02. This i s adequately reflected in the province’s financial management performance under the SAC 2 program, which shows unparalleled progress among provinces towards achieving reliable, comprehensive, accurate, and timely information pertaining to provincial and district governments’ financial transactions. A s part o f PIFRA execution, the province has computerized i t s accounting system and as a f i rst in the country, prepared and executed in FY05 i ts provincial government budget on the basis o f the new Chart o f Accounts (COA), using the principles o f the N e w Accounting Model (NAM) consistent with international best practice. Budget execution and accounting are also being camed out o n the same coding structure. Since SAC 2, the provincial government has also supported a l l 24 district governments in the key area o f converting the district governments’ budgets for f rom the legacy chart o f classification to the new Chart o f Accounts based o n the N e w Accounting Model. Full conversion for a l l districts was achieved with the FY 2005/06 budget as the f i rst province in the country. The budget computerization unit o f the Department o f Finance, supported by PIFRA, has enabled this successful conversion and the implementation roll-out o f the provincial government’s adopted new chart o f accounts to a l l districts as the f i rs t province in the country The Province o f Punjab i s the only other province that has also, in FY 2005/06, achieved this transition to a uni form chart o f accounts for the provincial and district governments but with a lower number o f integrated F M I S productive sites.

3. As o f June 30, 2005, the level o f accounts reconciliation in NWFP (at 97 percent, 95 percent, 100 percent and 100 percent respectively for expenditures, receipts, suspense accounts and intergovernmental accounts) exceeded those in other provinces. On October 31,2005, actual reconciliation levels reported were 96 percent, 97 percent, 95 percent and 100 percent respectively. With the province and district governments adopting the uni form chart o f accounts under NAM in FY06, this achievement would be further enhanced, towards the end o f the fiscal year. In addition, as this wil l facilitate consolidation o f fiscal and financial data (by major and minor heads o f revenue and expenditures), the reliabil i ty and timeliness o f these data are expected to improve substantially. For sustained progress o n improved accounting in NWFP, continued financial and technical support f rom P IFRA would be important. PIFRA I1 has adequate resources to support the finance departments to carry out some of these PIFRA related activities

Annex 5 Page 2 of 3

specific to the provinces and the NWFP finance department i s encouraged to uti l ize some o f the funds available to finance eligible activities under the project. What i s encouraging i s that all DDOs of the devolved as wel l as the provincial departments have been provided basic training on the new chart of accounts and refresher training programs are being programmed to be held before the budget for the next fiscal year (FY 2006107) i s f inally prepared.

4. In terms o f achieving the SAC 2 medium-term outcomes, the NWFP has scored beyond expectations in al l areas except: (a) in the area o f progressive clearance o f backlogs o f audit reports and accounts by the Public Accounts Committee (PAC); (b) the systematic and coherent implementation of functional internal audit functions in government departments; and (c) improving the frequency and regularity in conducting Departmental Accounts Committee (DAC) meetings to settle departmental audit observations (draft and advance paragraphs) with a v iew to reducing the residual number o f f inal advance audit paragraphs submitted to the parliamentary public accounts committee for review.

Implementation of P IFRA in the province 5 . Eighteen accounting and budgeting sites in NWFP have now become productive in the use o f PIFRA S A P systems in processing o f financial transactions. T h i s leaves a total o f 16 sites (excluding the 24 District Finance Offices). The plan remains that the remaining budgeting and accounting sites under the responsibility o f the provincial government shall achieve full connectivity in FY 2006107 (September 30,2006).

Departmental Accounts Committees (DACs) 6. The number o f unsettled audit observations for the fiscal years 2001/02 and 2002103 has been declining due to periodic DAC meetings. There s t i l l remains a backlog o f unsettled audit paragraphs up to 2002103 since the regularity and fiequency o f D A C meetings were never adequate to clear backlogs o n departmentallagency accounts. D A C meetings should be institutionalized and held at least twice a month.

Backlog of Review of Audit Reports and Accounts by PAC 7. The Public Accounts Committee (PAC) o f the NWFP has been established and has completed deliberations on the reports and accounts for fiscal year 1997198. I t s f inal report on that year has been presented to, and approved by, the Provincial Assembly. As at date, the reports and accounts o f the fo l lowing 12 fiscal years remain unreviewed by the PAC: 1985186- 1988189, 1990191, 1992193-1993194, 1996197, 1998199 -2001/02. In addition, the 2002103 fiscal year report and accounts (with 377 paragraphs) have yet t o be delivered to the PAC f rom the Provincial Governor. At the rate at which PAC deliberations are taking, the PAC will not b e able to clear the backlogs even over the next 10 years unless specific actions are taken by the concerned departments’ D A C s to further eliminate, through thorough review, a l l those paragraphs which are frivolous, and hence avail to the P A C only those paragraphs o f significant accountability issues. Some action has been initiated in this direction by the PAC’s formal request t o departments to carry out the exercise o f pr ior review for the accounts and report o f FY 2001/02. Out of a total o f over 1400 PAC paragraphs for FY 2001/02, the pr ior review o f the DAC has enabled the reduction o f these paragraphs to 463. These remaining paragraphs have been scheduled for completion o f PAC reviews in 25 PAC working days. Overall, there are 5 126 audit paragraphs yet to be reviewed by the P A C over the 12 year period. The PAC Secretariat has opined that the P A C members and their secretariat staff require exposure to modem practices o f legislative oversight in order to enhance their effectiveness. Capacity building has been sighted as a way to mitigate the knowledge gap in financial management. The Bank and other donors have been requested to support the Committee in this direction and there are s igns that this

Annex 5 Page 3 of 3

support would be forthcoming after conducting a follow-up PFAA using the PEFA Public Financial Management Performance Measurement framework indicators for the province.

Challenges ahead

8. Going forward, the province’s most critical challenges relate to: (a) achieving province- wide operational IT connectivity through the PIFRA system, connecting a l l province and district finance and accounts office sites; (b) the provincial government’s ability t o strengthen the PAC and i t s Secretariat to build up the capacity to clear the 12 years’ backlog o f unreviewed audit reports and accounts; and (c) adoption o f the use o f the new Internal Audit Manual, produced under PIFRA and being piloted at the federal level, by al l the internal audit officials nominated for each o f the 19 notified departments at the provincial government. In another vein, i t i s critical that the audited finance and appropriation accounts o f the province and the districts are submitted timely to the Provincial Assembly and the District Council. The office o f the Auditor General o f Pakistan needs to address this. I t i s also critical that PIFRA provide more proactive support t o a most reforming province to benefit f i o m the needed functionalities and report generation supported under the SAP/R3 system. The pre-requisite to addressing these challenges i s the desired improvement in accuracy and timeliness o f provincial financial data, which, in turn, requires that key government offices involved in financial management should be connected to the new IT based system at the earliest.

9. The progress achieved towards providing comprehensive and reliable financial and fiscal data has, apart f rom the commitment and drive o f the provincial government in embracing reforms, been a product o f the pace o f implementation o f the PIFRA project in the province. In the absence o f a complete roll-out o f the PIFRA systems in the entire province (provincial and district governments), the required level o f comprehensiveness, reliability, and timeliness o f data cannot be achieved. For this reason, PIFRA connectivity, province-wide, i s a most urgent need that could foster and promote accountability in the province. The government i s therefore committed to achieving operational IT connectivity and productivity o f a l l 20 Distr ict Finance and District Accounts Office sites using uni form chart o f accounts under the new accounting model by June 30,2006 (supported under DPC 2).

10. Not ing that the provincial and a l l district governments o f the NWFP would, during FY 2006/07 be fully connected to the PIFRA system and with a v iew to providing increased assurance that financial and fiscal data are reliable, accurate, comprehensive and timely, i t i s o f vital importance that the province provides the output data in an acceptable format and allows the data to be fully accessible to users on a timely basis. The government i s committed to making budget execution statements available for a l l provincial and district governments o f NWFP according to function, major, and minor heads, and posting them to the website o f the Department o f Finance and the Accountant General within three weeks o f the end o f each calendar month by January 2007 (supported under DPC 3).

11. In achieving this, the provincial and district governments would be improving on their c i v i l accounts information that i s produced, largely unreconciled at that stage, by the 15th o f the month following the month to which the accounts relate. I t would also assure the transparent provision o f reliable, uniform, and comprehensively validated financial and fiscal information for better decision malung.

Annex 6 Page 1 of 2

ANNEX 6

TIERED GOVERNMENT MODERNIZATION IN THE CIVIL SERVICE AND ADMINISTRATION OF MULTI-

1. The Government i s committed to service delivery improvement by increasing levels o f efficiency, effectiveness and ethical standards in the c iv i l service, malung c iv i l servants more accountable to users through administrative decentralization, and raising their levels o f competence and integrity. Government realizes that although service delivery improvements are to be driven from the sectors, in particular f rom education and health, human resource (HR) policies at the provincial, district and tehsil levels must support and not inhibit service delivery improvements. This wil l require decentralized and merit-based HR policies for the provincial and local governments to have effective HR pol icy monitoring and evaluation systems in place, including for establishment control.

2. The government will continue implementing i t s strategy for c i v i l service and administrative reform in coming years. I t sets out to improve the quality o f provincial c iv i l service outputs through a program o f restructuring focused o n pol icy and regulatory functions at the provincial level and effectively devolving service delivery functions to local government at the district and tehsil levels. Over the near and medium term the government wil l continue i t s current policies o f c iv i l service cost control through judicious and l imi ted increases in the size o f the c i v i l service with the vast majority being hired in high priority areas (health and education). I t will continue to increase the average time in post o f senior staff and make the monitoring results publ ic ly known. The PPSC will continue to regulate and monitor selection, appointment, promotion and transfer o f a l l staff in BPS 15-21 at local government and provincial levels and for professionals and technical specialists in grades BPS 11-15 at the provincial level. Contract employment policies can be used judiciously to provide more attractive terms and conditions o f employment to f i l l posts in less attractive areas that often lack competent c i v i l service staff; in particular women teachers and qualified health workers.

3. In addition, in the near term a priority for the government i s to design and establish district services, including district and tehsil cadres. These cadres will include a new education management cadre, which government has recently approved. The government will need to reallocate posts and HR management functions to districts and tehsils, and promulgate new laws, rules and regulations to enable the effective operation o f local government services. It also needs to decide where the responsibility lies for merit-based selection, appointment, promotion and transfer o f senior officers, professional and technical staffs transferred to local government. One option it i s considering is that the PPSC becomes legally and institutionally enabled to carry out monitoring and reporting o n processes and outcomes for appointment, promotion and transfer o f senior staff in the districts and tehsils in relation to adherence with merit-based principles.

4. Further restructuring will be required within local government (and in provincial departments) to increase the efficiency and effectiveness o f service delivery. In the near term government will develop a methodology and carry out an organizational review o f one service delivery function and prepare a ‘blueprint’ for further reviews in the longer term. An early priority wil l be to carry out a functional review o f the health sector focused o n service delivery. Partnership agreements for delivery o f education services will be developed between the province and the districts. These will establish role clarity in education service delivery to underscore service delivery improvements.

Annex 6 Page 2 of2

5. Government has already initiated a performance based budgeting process covering 20 1 service delivery units in health, education and agnculture within Peshawar and Kohat districts. Annual results agreements, as part o f new j o b descriptions, now need to be put in place for unit heads, DOs, DDO and EDOs for those districts and departments where performance based budgeting has been piloted. This will ensure role clarity and accountability in the management and delivery o f the targeted services.

6. The Human Resource Management (HRM) database will continue to be fully operational and be integrated with PIFRA. The latter will constitute a powerful tool for financial and human resource management in the province. The HRM database will be in regular use, with reliable and timely data provided for HRM planning and monitoring o f establishment levels, appointments, promotions and transfers at provincial, district and tehsil levels. I t can also be used, for instance, to monitor at provincial and district levels the success o f policies to recruit and retain female teachers at girls’ schools and health workers at basic health units in disadvantaged districts. Government will now need to expand the user base o f the system, including additional networked terminals for key units at the district and tehsil level, in order to underscore compliance with planned new requirements to update payroll and budget data f rom the HRM database only.

7. The Government will make an actuarial assessment o f pension liabilities based o n the HRM database and on that basis develop new pension policies within total compensation costs that are fiscally sustainable and compatible with maintaining planned levels o f PRSP spending. Ghost employees and ghost pensioners wi l l be identified and removed f rom the payrolls.

8. Over the medium term the organizational review processes will be rol led out t o a l l sectors after the in i t ia l reviews in health and education. The reviews will cover the functions o f a l l provincial, district and tehsil units with a focus o n service delivery outcomes. They will form the basis for an action plan for staffing, organizational structure, business process and capacity building and for producing results-oriented j o b descriptions for a l l posts. The action plan will be implemented over the medium term, supported by necessary amendments to laws, rules and regulations. The roll-out o f the annual results agreements process will be completed in l ine with performance based budgeting. The Government could need technical assistance to carry out the actuarial review o f pension liabilities and options; t o make more effective and ensure the roll-out of i t s p i lot performance based budgeting system; and to migrate i t s HR database over to the PIFRA supported accounting and enterprise system.

Annex 7 Page I of 4

ANNEX 7 ACCELERATING ECONOMIC GROWTH

1. With a per capita income which i s only about two-thirds o f that o f Pakistan, the NWFP i s one o f the poorest provinces in Pakistan. The province also has a population growth rate that i s higher than in the rest o f the country.

2. The province contributes only about 10 percent to Pakistan’s economy. It has a narrow economic structure but substantial economic potential. Historically, the provincial economy has been mostly dependent on relatively l o w value-added agriculture as the largest production sector, services, and public employment (especially in the armed forces). The manufacturing sector i s quite l imited but has potential for growth through use o f local inputs. There i s substantial mineral wealth in the province such as precious and semi-precious stones, marble, and granite that can be exploited with improvements in infrastructure, a better policy environment, and opportunities for training on advanced techniques. There i s also considerable potential t o h r t h e r develop NWFP’s r i ch hydel resources, in particular by encouraging small hydel generation plants and developing off-grid localized energy distribution f rom these plants to local industry, e.g., agro-processing using local raw materials. Similarly, availability o f better infrastructure related to tourism and a better image o f the province can help develop in the long run the potential that exists for tourism. There i s also considerable potential for economic growth in urban centers.

3. Persistent poverty reduction requires more rapid pro-poor, broad-based growth with substantial employment generation. Sustaining rapid growth will require strengthening the weak investment climate in the province considerably; better infrastructure for no t only industry and services, but also agriculture; and over the medium and long term, raising the education and sk i l ls level considerably of the largely illiterate and unskilled workforce. However, there i s also a need for well-targeted poverty alleviation programs for vulnerable groups.

4. The provincial government’s vision i s to achieve sustained poverty reduction not only through accelerating broad-based economic growth but also with the private sector as the engine of this growth. In order to achieve i t s objectives for poverty reduction and employment growth the government’s medium-term strategy aims at raising the annual rate o f growth in provincial real GDP from the average over the last decade o f 4 ‘/z percent to 7.2 percent in FY08 and 7.5 percent in FY10. T h i s requires increased private investment and therefore improving the investment climate, including for agriculture, and strengthening the government’s role as investment facilitator. The province’s strategy to improve the investment climate i s aligned with that o f the federal government. Whi le federal policies remain o f paramount importance for the investment climate for a l l provinces in Pakistan, provincial governments have considerable impact on the investment climate through discretionary implementation o f federal policies and through their own provincial regulatory framework.

a. Private Sector Development

5. In coming years the provincial government will continue to implement i ts three-pronged strategy for private sector development where the main thrust remains institutionalizing public- private dialogue to promote demand-responsiveness o f public sector agencies and policy-making bodies, creating an enabling and competitive environment for private sector development, and expanding the role o f the private sector.

6. Institutionalizing public-private dialogue to promote demand-responsiveness of public sector agencies and policy-making bodies: The GoNWFP has recently created venues for public- private dialogue by including private sector representatives in a number o f key pol icy making,

Annex 7 Page 2 of 4

problem solving, and managing bodies. It i s important that these initiatives be complemented with mechanisms to ensure active implementation. Over time, this structure for public-private dialogue will facilitate removing policy- and regulatory-induced barriers to investment and more detailed actions will be identified by the partners in this dialogue.

7. Creating an enabling and competitive environment: The government wil l continue its efforts to strengthen governance, reduce administrative barriers, and improve the functioning o f markets for skil led labor in the province while also aiming at improving the management o f urban areas and enhancing enforcement o f property rights, particularly for activities in autonomous areas. In that regard it will charge the Sarhad Development Authority with facilitating new private investments and coordinating a one-window investor facilitation center t o be established in the near term (part o f trigger for DPC 2). With regard to improving access to skilled personnel, the reform strategy over the medium term would need to expand the pool o f trainable workers through the reforms in basic education; improve the quality and market-orientation o f provincial colleges and increase their supply o f well-qualified students; set up mechanisms to assist f i r m s in developing firm-specific ski l ls ; and restructure the Technical Education and Vocational Training System (the latter by DPC 3) consistent with principles o f close private sector involvement and a demand-driven approach for training. With regard to mining - a sector with considerable growth potential - weak enforcement o f property and leasing rights as wel l as other constraints have restricted i t s growth. Given the large number o f court cases and hence long lags the government i s considering the establishment o f a special Mines Magistrate in the medium term responsible for a l l cases related to mining.

8. Expanding the role of the private sector: Notwithstanding some progress in divestment, the government i s s t i l l involved in many activities that have long been privatized in other developing countries, spanning financial services, industrial estates, transport, construction, and tourism. Continuing reforms related to industrial estates, the government intends to have transferred management o f industrial estates to the private sector by DPC 2. Medium-term reforms include merging S D A and the SIDB and transferring management control o f Bank o f Khyber to the private sector (by DPC 3). The provincial government wil l also develop the private sector's role and i ts own capacity in executing public-private partnerships (for instance in infrastructure and energy investments). This will also require formalizing the supporting framework to execute well-designed, competitive partnership transactions. The government has requested Wor ld Bank assistance for capacity building in this area. It wil l also develop an enabling framework for provision o f municipal services.

9. A new but s t i l l important element in the province's development strategy i s the use of urban centers to stimulate the growth process since much o f the economic growth and employment generation will need to come in urban areas. Urban centers in the province have the potential t o be a driver o f growth but tapping this economic potential requires that the urban investment climate i s improved. This would involve better functioning o f urban land markets and better planning for urban development including better provision o f public services and infrastructure. The most important requirement to make the land markets fimction optimally i s a system that abolishes the current t it le ambiguities and determines tit le conclusively. Based o n this long-term goal, a series of steps are required to consolidate tit le determining responsibility with one department with n o overlapping jurisdictions and parallel records o f ~wnersh ip , ' ~ and introduce compulsory registration of property transactions. The supply or utilization o f urban land

There i s a need to (a) update existing records o f departments involved in administering urban land; (b) ensure that future transactions take place through registered documents; (c) computerize the Registrar's Department to enable an electronic property register and (d) lower stamp duties to encourage registration, leading to compulsory registration o f all property transactions.

Annex 7 Page 3 of4

can be improved by addressing biases in laws and differential policy treatment between different market segments, owners and tenants; by raising land non-utilization fees; and by disposing provincially owned land in prime commercial locations.

10. Urban development has not been guided by a clear government strategy. There i s n o integrated strategic planning for urban development projects, and investments are not aligned to a strategic plan. No particular ministry or departmental agency has a clear mandate for Local Economic Development, and multiple agencies undertake developmental activities in the cities with n o coordination between the agencies. Starting with Peshawar, the economic center in the province, the government would f irst need to settle on a strategy for how to unleash i t s economic potential. I t intends to establish an apex bodyhteering committee that would formulate the vision, develop the overall strategy and policy framework, and coordinate investment planning across agencies. The apex bodylsteering committee would be headed by the Chief Minister, include al l stakeholder groups as members, and be supported by a capable and effective unit in the provincial government as secretariat.

11. The government also intends to fundamentally restructure the City Development and Municipal Department of Peshawar and provide it with a clear mandate for local economic development, developing integrated strategic and action plans. I t will bring Building Byelaws and Regulations at par with international standards and base them o n the city’s integrated strategic plan; and ensure that al l development funds to be invested in the ci ty district are based on the strategic plan. I t wi l l need to strengthen the technical capacity o f the different agencies to p lan and manage development projects. It will also develop an enabling environment for private sector participation in municipal service delivery through Public-Private Partnerships.

b. Agriculture

12. Growth in agriculture will continue to p lay a central part in the NWFP’s growth and poverty reduction strategy, in light of i t s large share o f the provincial economy and employment, i t s economic potential and the fact that the majority o f the poor l ive o f f agriculture. The government has recently developed an a p c u l t u r a l sector strategy that i t presented in i ts Agricultural Policy 2005 document. The A p c u l t u r a l Policy addresses the critical challenges and constraints facing the sector and incorporates a number o f the key recommendations f rom the jo in t Government/Bank NWFP Economic Report. It formulates the set o f reforms over the medium term o f which parts will be covered by the DPCs.

13. The main objective in the new agricultural strategy i s to encourage the movement towards high value products (horticulture, livestock and others) for both domestic and international markets and thereby exploit the province’s considerable growth potential in these products.16 Under this strategic priority, the government will carry out pol icy and institutional reforms, as wel l as investment programs, in the fol lowing areas:

14. Making research and extension more efective to stimulate new sources of growth in high-value products. The government will strengthen the linkages between agricultural research, extension and the farmers to align research and extension priorities with farmers’ needs and market trends, and help introduce new varieties o f sheep and goats suitable for d i f fer ing regions. It will also develop further varieties o f certain high-value horticulture tailored to specific backward areas and districts and promote private milk processing plants.

l6 Expansion o f the livestock sector w i l l need to remain within the carrying capacity o f the rangelands in order to maximize the earning potential o f the sector and assure long term sustainability

Annex 7 Page 4 of 4

15. FaciEitatingprivate sector participation by creating the right institutional and legdative framework for the agricultural sector: The government will continue to build the capacity o f small farmers by developing farmer organizations. I t will, in the near term, establish Milk Producers Associations (supported under DPC 2) and a horticultural core group o f producers, processors and traders at the provincial level. I t wi l l also review the strategy for Farm Service Center so that they can be converted into self-financing and farmer-operated organizations in coming years. Over the medium term, the government will establish horticulture and 1ivestocWmilk marketing groups at the district level; restructure the provincial departments for agnculture and livestock to make them more responsive to private sector needs and demands; and start efforts to address the institutional weaknesses in research and extension services with a thorough diagnosis o f existing institutional arrangements. I t will then restructure and strengthen the research institutes, and in the medium term put in place a participatory extension service.

16. The government will need to strengthen the legal framework to achieve the goals o f the new Agricultural Policy. N e w acts and legislations need to be prepared and issued to support the new government initiatives and existing Acts amended as appropriate. These include revising the Agricultural Produce A c t in the near term (part o f DPC 2 trigger) and the Seed Act, Pesticide Act and Livestock Ac t over the medium term. There i s also a need to initiate the process for establishing Sanitary and Phytosanitary measures and rules.

17. Improving market infrastructure and information systems to broaden and deepen input and output markets. In the near and medium term the government intends to work in partnership with farmers and the private sector to improve input and output market information through the use o f media and extension services, and explore ways to reduce the transaction costs in the marketing o f outputs, particularly for small farmers. T h i s will include developing a fruit and vegetable marketing strategy that would strengthen the public-private partnership. I t will develop key infrastructure in partnership with the private sector, such as primary collection centers and grading, sorting and packaging facilities for horticulture crops and vegetables as wel l as cold storage facilities, and provide market intelligence and information on new varietieshtandards in order to facilitate diversification o f export markets.

c. Implementation of the overall growth strategy for PSD and agriculture

18. The government wil l implement i t s growth strategy in phases over the medium term. The f i rs t phase will include the fol lowing steps: ensure that the new one-window investment facilitation center coordinated by the private sector and the corresponding l ine agencies, has been staffed and has started serving potential investors; transfer management o f industrial estates to the private sector; revise the Agricultural Produce Act; and establish Milk Producers Associations. This will be supported under DPC 2.

19. The government will implement the second phase o f i ts growth acceleration strategy by DPC 3. This will include merging S D A and SIDB, transferring management control o f Bank o f Khyber to the private sector, setting up the Mines Magistrate to strengthen enforcement o f mining property rights and address labor concerns, developing an enabling framework for private provision o f power and o f municipal services, and restructuring the technical and vocational training system consistent with principles o f being private sector l ed and responsive to labor market demands.

Annex 8 Page I of4

STRUCTURE OF THE NWFP PROVINCIAL ECONOMY fl

(%of Provincial Gross Domestic Product (PGDP) Agriculture Industry

Services

(annual real growth) Agriculture Industry

Services

Nominal PGDP, Rs Billion Nominal PGDP per capita (Rs)

Manufacturing

Manufacturing

PROVINCIAL FINANCES gl

(Yo Of PGDP) Total Revenue & Grants

Province's Own Revenue Federal Transfers ind. Grants

Total Expenditure Current Expenditure

Capital Expenditure (net)

Fiscal Balance incl. Grants Fiscal Balance Total Outstanding Debt

Interest payment & debt servicing

ANNEX 8 NWFP -FISCAL, ECONOMIC AND SOCIAL INDICATORS

Table 1: NWFP at a Glance

SOCIAL INDICATORS

Population, 2004105 (million) a! PGDPlGDP per capita, 2005 (US$) b/

Average annual growth, 1981-05 Population (%)

Most recent estimate (latest year available since 1990) c/ Poverty: % of population below poverty line dl Urban population (% of total population) e/ Infant mortality (per 1,000 live births) Access to safe water (% of households) e/ Access to toilet facilities (% of households) e/ Literate population (% of population 10 yrs &older) Proportion attending primary school (aged 4 to 9)

Male Female

ALL- NWFP a/ PAKISTAN

21 155 484 714

2.7 2.6

48 37 17 32 56 82 58 61 58 54 38 45 77 72 97 83 56 61

5

4

199Ol91 1998199 2004105 100.0 100.0 100.0 23.2 23.8 19.4 27.3 26.3 25.7 15.5 13.3 16.2 49.4 50.1 55.0

ma. 1.5 2.7 n.a. 10.0 10.9 ma. 4.1 14.1 n.a. 3.2 6.1

106 328 599 7,045 17,913 28,697

Per Capha Incorm (RI)

41wO

360W

31wO

26wO

21wO

16000

11wO

6w0

............_..____.._

1991-95 199w99 2004105

1991-95 1996-00 2002103 2003l04 2004/05 Fiscal M a n u and Public Debt 1

8.6 12.0 9.4 8.8 8.7 5.5 10.0 7.5 6.8 6.4 1.5 2.5 1.3 1.1 1.0 3.1 2.0 1.9 2.0 2.3

0.9 0.8 1.4 0.9 (2.2) (1.2) (0.5) (1.1) (0.6) 17.2 17.3 15.4 13.8 11.9

Source: a) Population figures are based on the National lnstltute of Population Studies and World Bank Staff estimates. b) NWFP GDP per capita estimates are preliminary esfimafes. c) Pakjstan Integrated Household Survey (PIHS) 2001/02, or otherwise indicated d) World Bank Staff Estimates based on PIHS 2001/02 e) Pakistan Integrated Household Survey (PIHS) 199W99 0 World Bank Staff Estimates g) Medium Term Budget Framework

Annex 8 Page 2 of 4

14.1 12.8 11.8 7.5 10.5 6.1 9.5 8.0 8.4 5.0 8.1 4.6 4.6 4.8 3.4 2.4 2.4 1.6

11.0 10.5 12.6 14.9 11.1 13.4

24.5 27.3 23.1 24.0 25.1 25.7 1.6 0.0 1.5 0.1 2.0 0.1

16.4 15.5 15.7 13.8 18.2 16.2 10.8 9.6 10.6 8.3 12.9 10.7 5.6 5.9 5.1 5.5 5.4 5.5 3.1 4.7 2.4 4.2 2.3 4.0 3.4 7.1 3.4 5.9 2.5 5.3

Table 2: NWFP Distribution of Provincial GDP bv Sector

Crops Major crops M ino r crops .

Livestock, Fishery, & Forestry

Industry Min ing and quarrying Manufacturing

Large scale Small scale

Construction Utilities

Services 50.4 49.4 52.5 53.5 52.4 55.0 Transport, storage, and communication 9.1 7.2 13.2 13.0 11.1 15.2 Wholesale and retail trade 19.3 18.9 17.8 16.2 19.1 16.2 Finance and insurance 5.4 3.7 3.0 2.3 3.7 2.4 Ownership and dwellings 2.9 2.8 3.2 2.3 2.9 1.9 Public administration and defense 6.1 8.2 6.1 9.0 6.0 9.8 Other services 7.5 8.7 9.1 10.7 9.6 9.6

Source: NWFP: World Bank Staf f Estimates at current prices.

Annex 8 Page 3 of 4

4.3 6.2

-0.2 1.9

10.9 14.0 14.1 19.0 6.1 6.2 5.2

6.1 5.8 9.7

21.8 3.5

-0.7 5.4

6.6

Table 3: Sectoral Growth Rates o f NWFP GDP at Constant 2000/01 Prices 1999100 2000101 2001/02 2002/03 2003/04 2004105

,griculture 5.4 -4.2 3.2 7.2 3.3 2.7 Crops

Ma jo r crops M i n o r crops

Livestock, Fishery, & Forestry

ndustry Minining and quarrying Manufacturing

Large scale Small scale

Construction Uti l i t ies

'e IT i c e s Transport, storage, and communication Wholesale and retail trade Finance and insurance Ownership and dwellings Public administration and defense Other services

WFP GDP at factor cost

-8.4 -5.8

-13.7 15.5

-1.5 9.1 1.9

-0.3 5.3

16.9 -14.5

2.8 -1.9 -1.5 -6.7 7.3

17.2 5.4

2.3

-15.5 4.4 -17.5 7.0 -11.2 -1.1

2.4 2.6

-6.4 2.1 8.3 2.8 1.6 6.0

-1.5 5.7 6.2 6.3

-2.8 -6.0 -23.5 -1.4

1.4 9.1 5.5 4.7 0.3 5.2

-16.5 17.4 4.5 1.8

-0.8 23.4 4.9 7.3

-1.9 6.1

3.8 4.7 1.8 8.9

4.9 49.2

6.9 7.4 6.3

16.8 -9.4

8.5 5.3 7.9

-4.4 8.2

16.7 7.9

7.4

4.3 6.1 0.0 2.8

17.0 6.3

17.2 25.1

6.3 -6.9 37.9

6.6 11.4 9.7 4.5 3.5 4.3 0.7

8.2

'akistan GDP at factor cost 3.8 1.8 3.1 4.8 6.4 8.4

Source: NWFP: World Bank Staff Estimates.

7 12 .- e .- I$ i .- l i E

Annex 9 Page I of 6

28.5 26.1 22.3 21.6 22.5 23.8 24.9 25.1 15.9 16.3 17.6 18.2 49.0 50.1 52.7 53.3

ANNEX 9 PAKISTAN - FISCAL, ECONOMIC AND SOCIAL INDICATORS

I ':

T a b l e 1: Pakistan a t a Glance

POVERTY and SOCIAL Pakistan

2005 Population, mid-year (millions) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)

Average annual growth, 1999-05

Population (%) Labor force (%)

Most recent estimate (latest year available, 1999-05) Poverty (% of population below national poverty line) Urban population (% of total population) Life expectancy at birth (years) Infant mortality (per 1,000 live births) Child malnutrition (% of children under 5) Access to an improved water source (% of population) Literacy (% of population age 15+) Gross primary enrollment (% of school-age population)

Male Female

KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1985

GDP (US$ billions) 31.1 Gross capital formationlGDP 18.3 Exports of goods and serviceslGDP 10.4 Gross domestic savings/GDP 5.9 Gross national savingdGDP 22.7

Current account balance/GDP Interest payments/GDP Total debtlGDP Total debt servicelexports Present value of debtlGDP Present value of debtlexports

-4.1 1.7

43.2 24.5

1985-95 1995-05 (average annual growth) GDP 5.2 3 7 GDP per capita 2 6 1 2 Exports of goods and sewices 9 8 6.5

155.8 690

107.3

2.4 3.0

33 34 64 74 35 90 47 68 80 57

1995

60.6 18.5 16.7 15.8 21 .o -4.0 2.0

49.9 27.6

2004

6.4 3.9

-1.5

South Asia

1,447 590 859

1.7 2.1

29 63 66 49 84 61

103 108 97

2004

96.1 17.3 16.0 18.4 23.0

2.0 0.8

37.1 22 3

2005

7.0 5.2 7.6

LOW- income

2,343 510

1,188

1.9 2.2

31 50 79 43 75 61

100 105 94

2005

110 7 16.8 15.3 12.2 18.0

-1.3 0.7

31.8 12.3

2005-09

6.5 4.6

15.5

Development diamond'

Life

1 GN I Gross per primary capita enrollment

L

Access to improved water source

-Pakistan .... __ Low-income wouD

Economic ratios.

Trade T

Indebtedness

Pakistan

STRUCTURE of the ECONOMY

(% of GDP) Agriculture Industry

Services Manufacturing

lgE5 lgg5 2005 I Growth of capital and GDP (X) I

Household final consumption expenditure 82.0 72.4 73.3 80.0 - 1 5 1

imports of goods and services 22.8 19.4 14.9 19.9 I -GCF -GDP General gov't final consumption expenditure 12.1 11.7 8.4 7.8

(average annual growth) Agriculture Industry

Services

Household final consumption expenditure

Manufacturing

1985-95

4.1 6.3 5.7 5.2

4.3

1995-05

2.7 4.4 5.9 4.3

3.5

2004

2.2 12.0 14.1 6.0

8.2

2005

7.5 10.2 12.5 7.9

16.8

1 Growth of exports and imports (x) I 50 40 30 20 10 0

-10 General gov't final consumption expenditure 3.9 2.4 2.1 2.3 - 2 0 1 Gross capital formation 4.3 0.8 -3.2 1.7 -Exports -O'lrnports Imports of goods and services 3.4 1.4 -8.6 44.1

Note: 2005 data are preliminary estimates. Group data are to 2004. The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete.

Annex 9 Page 2 of 6

Pakistan

PRICES and GOVERNMENT FINANCE

Domestic prices (% change) Consumer prices Implicit GDP deflator

Government finance (% of GDP, includes current grants) Current revenue Current budget balance Overall sumluddeficit

TRADE

(US$ millions) Total exports (fob)

cotton Rice Manufactures

Total imports (cif) Food Fuel and enemy Capital goods

Export price index (2000=100) Import price index (2000=100) Terms of trade (2000=100~

BALANCE of PAYMENTS

(US$ millions) 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

Memo: Reserves including gold (US$ miilions) Conversion rate (DEC, locaVUS$)

EXTERNAL DEBT and RESOURCE FLOWS

(US$ miilions) Total debt outstanding and disbursed

iBRD IDA

Total debt service IBRD IDA

Official grants OWcial creditors Private creditors Foreign direct investment (net inflows) PorLfolio equity (net inflows)

World Bank program Commitments Disbursements Principal repayments Net flows Interest payments Net transfers

Composition of net resource flows

1985 1995

.. 13.0 4.5 13.9

16.4 17.1 -1.3 -2.5 -7.8 -6.7

1985 1995

2,460 7,759 279 62 222 454

1,922 4,627 6,009 10,296

_. 1,627 1.398 1.722

.. 117

.. 107

.. 110

1985 1995

3,247 9,628 7,106 13,023

-3.859 -3,396

-506 -1,729 3,090 2,709

-1,275 -2,416

227 2,647 1,048 -231

1,190 3,534 15.2 30.8

1985 1995

13,465 30,229 352 3,581

1,312 3,340

1,435 3,216 58 413 19 55

257 312 443 932

-169 318 131 442

0 1.280

678 706 152 691 37 235

115 456 40 233 75 222

2004

4.6 7.8

15.1 1.1

-1.8

2004

12,395 48

634 7.568

13,607 659

3,066

115 118 98

2004

15,123 17,714 -2.591

-2,207 6,684

1.886

-809 -1,077

11,395 57.6

2004

35,687 2,601 6,020

4,285 386 141

574 -685 152 152 156

781 304 385 -81 143

-224

2005

9.3 9.8

14.3 -0.1 -3.0

2005

14,371 111 933

8,288 18,724

706 4,534

124 131 94

2005

17,725 25,557 -7,832

-2.394 8,819

-1,407

2,019 -61 2

10,722 59.1

2005

35,208 2,464 6.651

2,736 400 161

379 905

-389 1,162

465

847 984 431 554 130 424

Inflation (%) 30

00 01 02 03 04 05

GDP dellator *CPI - Export and import levels (US$ mill.)

20,wo T I 15,WO

10,wo

5.WO

0

I 99 00 01 02 03 04

ll Exports ll Imports

Current account balance to GDP (%) I 5 4 3 2 1 0 i 2 3 4

:omposition of 2005 debt (US$ mill.) I 6,651

C 1,621

D 7.367

I 4 - iBRD E - Biiateml B - IDA D . Other multilateral F - Private C- IMF G - Short-term

Development Economics 4/4/06

Annex 9 Pnge 3 of 6

Table 2: Pakistan Social Indicators

Latest s ing le year Same region l income group

South Low- 1975-80 1985-90 1999-05 Asia income

POPULATION Total population, mid-year (millions)

Urban population (“A ofpopulation) Total fertility rate (births per woman)

POVERTY (“A of population) National headcount index

Urban headcount index Rural headcount index

Growth rate (% annual average forperiod)

INCOME GNI per capita (US$) Consumer price index (1995=100) Food price index (1995=100)

INCOMElCONSUMPTlON DISTRIBUTION Gini index Lowest quintile (% of income or consumption) Highest quintile (% of income or consumption)

SOCIAL INDICATORS Public expenditure

Health (“A of GDP) Education (% of GNl) Social security and welfare (% of GDP)

Net primary school enrollment rate (% of age group)

Male Female

Access to an improved water source (% of population)

Urban Rural

Total

Total

Immunization rate (% of children ages 12-23 months)

Measles DPT

Child malnutrition (% under 5 years) Life expectancy at birth (years)

Total Male Female

Mortality Infant (per 1,000 live births) Under 5 (per 1,000) Adult (15-59)

Male (per 1,000 population) Female (per 1,000 population)

Maternal (per 100,000 live births) Births attended by skilled health staff (%)

82.7 108.0 155.8 1,447.7 2,338.1 3.0 2.6 2.4 1.7 1.8

28.1 30.6 34.5 28.3 30.7 7.0 5.8 4.5 3.0 3.6

330

2.0 0.2

1 2

53

53 53 54

105 156

283 29 1

420

2.7

83 95 78

50 54 49

59 58 60

96 138

232 230

32.6 24.2 35.9

670 590 185

33.0 8.8

42.3

1.1 1.3 3.1

0.2

59 87 68 89 50 85

90 84 95 93 87 80

61 67 67 71 35 48

64 63 63 62 65 64

74 66 98 92

22 1 249 198 199 500 534 23 36

510

1.5 3.2

78 82 76

75 89 69

66 67 44

58 57 59

79 122

317 266 538 3a

This table was produced from the CMU LDB system. 04/04/06 Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break in series between 1997 and 1998 due to change from ISCED76 to ISCED97. Immunization: refers to children ages 12-23 months who received vaccinations before one year of age.

Annex 9 Page 4 of 6

Table 3: Pakistan - K e y Economic Indicators

Actual Estimate Projected Indicator 2001 2002 2003 2004 2005 2006 2007 2008 2009

National accounts (as D/n of GDP) Gross domestic producta

Agriculture Industry Services

100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 24.4 23.6 23.6 22.3 21.6 21.0 20.5 20.0 19.4 23.1 22.9 23.0 24.9 25.1 25.8 26.8 27.7 28.3 52.5 53.4 53.4 52.7 53.3 53.2 52.8 52.3 52.3

Total Consumption 83.9 83.3 82.5 81.6 87.8 91.5 90.7 89.5 88.7 Gross domestic fixed investment 15.8 15.5 15.3 15.6 15.3 16.5 17.8 18.9 19.4

Government investment 5.7 4.2 4.0 4.8 4.4 2.7 3.4 3.6 3.8 Private investment 10.2 11.3 11.3 10.8 10.9 13.8 14.4 15.3 15.6

~xp01- t~ (GNFS)~ Imports (GNFS)

Gross domestic savings Gross national savings'

14.8 15.4 16.9 16.0 15.3 16.5 17.9 19.5 21.7 15.9 15.5 16.3 14.9 19.9 26.1 27.9 29.5 31.3

16.1 16.7 17.5 18.4 12.2 8.5 9.3 10.5 11.3 17.7 19.7 23.1 23.0 18.0 14.1 15.0 16.1 16.8

Memorandum items Gross domestic product 71,496 71,485 82,592 96,217 110,976 125,514 134,880 145,209 156,626 (US$ mil l ion at current prices) GNI per capita (US$, Atlas method) 480 490 520 600 670 740 810 870 920

Real annual growth rates (%, calculated f iom 2000 prices) Gross domestic product at market prices 1.9 3.2 5.0 6.4 7.8 6.3 6.5 6.6 6.8 Gross domestic income 0.8 3.1 2.8 6.0 7.2 4.0 6.3 6.1 6.0

Real annual per capita growth rates (%, calculated f iom 2000 prices) Gross domestic product at market prices Total consumption Private consumption

Balance of Payments (US% millions) ~ x p o r t s (GNFS)~

Merchandise FOB Imports (GNFS)~

Merchandise FOB Resource balance Net current transfers Current account balance

Net private foreign direct investment Long-term loans (net)

Official Private

Other capita1 (net, incl. errors & omissions)

Change in reservesd

Memorandum items Resource balance (% o f GDP) Real annual growth rates ( YROO prices)

Merchandise exports (FOB) Merchandise imports (CIF)

-0.6 0.8 ' 2.5 3.9 5.2 4.3 4.5 4.6 4.8 -2.8 0.4 -1.2 4.9 12.5 5.2 3.9 3.5 4.1 -2.2 -0.9 -1.9 5.6 14.0 5.0 3.8 3.4 3.7

10,284 11,056 13,686 15,123 17,725 20,755 24,094 28,381 33,935 8,934 9,140 10,889 12,395 14,371 16,764 19,846 23,857 29,116

12,535 11,646 14,047 17,714 25,557 32,713 37,570 42,768 49,054 10,202 9,432 11,333 13,607 18,724 23,967 28,255 32,735 38,223

3,299 4,500 6,775 6,684 8,819 9,623 10,182 10,508 10,904

322 368 612 752 1,162 3,080 5,019 4,081 4,780

-2,251 -590 -361 -2,591 -7,832 -11,958 -13,475 -14,386 -15,119

-1,112 1,591 4,204 1,886 -1,407 -4,918 -5,800 -6,237 -6,396

-489 -1,490 -868 -1,531 -1,885 1,983 1,788 2,504 2,013 747 781 -147 -685 905 1,185 1,235 1,458 1,620

-1,236 -2,271 -721 -846 -2,790 798 553 1,046 393 2,560 2,248 1,963 -680 1,623 619 670 770 770

-1,282 -2,717 -5,911 -427 507 -764 -1,677 -1,118 -1,167

-3.1 -0.8 -0.4 -2.7 -7.1 -9.5 -10.0 -9.9 -9.7

11.9 5.6 8.1 2.7 7.9 13.2 16.1 19.0 21.1 7.3 -5.1 8.0 9.3 23.6 18.6 17.3 16.1 16.6

Annex 9 Page 5 of 6

Table 3: Pakistan - K e y Economic Indicators (continued)

Actual Estimate Projected Indicator 2001 2002 2003 2004 2005 2006 2007 2008 2009

Public finance (as YO of GDP at market prices)e Current revenues 14.3 Current expenditures 15.5 Current account surplus (+) or deficit (-) -1.3 Capital expenditure 1.7 Foreign financing 1.9

Monetary indicators M2/GDP Growth o f M2 (%)

36.7 9.0

Price indices( Y R O O =loo) Merchandise export price index 91.9 Merchandise import price index 96.4 Merchandise terms o f trade index 95.3 Consumer price index ("A change) 4.4 GDP deflator (% change) 7.7

16.3 17.5 15.1 14.3 14.0 15.9 16.6 14.0 14.4 14.1 0.3 0.8 1.1 -0.1 -0.1 2.9 1.8 3.3 3.9 3.8 1.2 -0.5 -0.7 1.7 1.8

40.0 43.1 44.9 45.3 46.1 15.4 18.0 19.6 19.3 17.0

89.0 98.1 108.8 116.8 120.4 93.9 104.4 114.7 127.8 137.9 94.8 93.9 94.8 91.4 87.3 2.7 3.1 4.6 9.3 8.2 2.4 4.4 7.8 9.8 8.2

14.7 14.0 0.6 4.5 1.5

46.8 15.1

122.7 138.6 88.5 6.5 6.5

14.8 13.6 1.2 4.7 1.9

48.0 15.3

124.0 138.3 89.6 5.5 5.5

15.1 13.5

1.6 4.9 1.4

49.3 15.2

125.0 138.5 90.2

5.0 5.0

a. GDP at factor cost b. "GNFS" denotes "goods and nonfactor services." c. Includes net unrequited transfers exchding official capital grants. d. Includes use o f IMF resources. e. Consolidated central government. f. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.

Annex 9 Page 6 of 6

Table 4: Pakistan - K e y Exposure Indicators

Actual Estimate Projected Indicator 2001 2002 2003 2004 2005 2006 2007 2008 2009

Total debt outstanding and disbursed (TDO) (US$m)a

Net disbursements (US$m)a

Total debt service (TDS) (USSm)a

Debt and debt service indicators (%) TDOIXGS~ TDOIGDP TDSIXGS ConcessionaliTDO

IBRD exposure indicators (?Yo) IBRD DSlpublic DS Preferred creditor DS/public DS (%)' IBRD DSiXGS IBRD TDO vs$m)d Share of IBRD portfolio (?Yo) IDA TDO (US$TI)~

IFC (US$m) Loans Equity and quasi-equity e

Guarantees

MIGA

3 1,706

554

2,996

276.1 44.3 26.1 61.9

17.6 61.9 3.5

3,043 2.5

4,123

332.2 76.2 64.5

33,675

341

2,850

248.4 47.1 21.0 64.5

15.8 61.9 2.8

2,943 2.4

5,097

305.4 84.5 88.4

35,885

43

2,936

198.3 43.6 16.2 67.2

14.5 69.2 2.0

2,813

5,604 2.4

252.9 71.8 75.9

35,687

230

2,907

186.1 37.1 15.2

10.4 70.7

2.0 2,601

2.4 6,020

193.0 62.0

116.0

35,208

261

2,780

158.4 31.8 12.5

17.7 61.3

1.8 2,464

2.3 6,651

168.0 57.0

105.0

37,032

1871

2,438

144.5 29.5

9.5

19.9 60.4

1.6 2,149

2.1 7,309

136.0 46.0

135.0

38,668

1636

2,703

132.3 28.7

9.2

16.5 57.1

1.3 2,192

2.2 8,013

10,991

2324

2,900

121.3 28.2

8.6

15.1 52.7

1.2 2,571

2.5 8,674

42,777

1786

3,651

107.9 27.3

9.2

11.6 42.8

1 .o 2,835

9,583 2.7

MIGA guarantees (VSSm) 97.0 154.0 128.0 142.0 129.6 129.6

a. Includes public and publicly guaranteed debt, private nonguaranteed, use o f IMF credits and net short-

b. "XGS" denotes exports o f goods and services, including workers' remittances. c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the

Bank for International Settlements. d. Includes present value o f guarantees. e. Includes equity and quasi-equity types o f both loan and equity instruments.

term capital.

r o w - 0 - - 0 -

h

9: m

9 m

F.

4

m r n - w m w - m b w P u w w w - v l m o o o o o o o o m o o o o o o o o o o o o o o o o o m o o o o o o o o o N N N N N N N N - N N N N N N N N N

P g

I

1

P

1

Anne.x I1 Page 1 of 5

ANNEX 11 RELATIONS WITH THE IMF

Public infomMn Noke (PIN) Na. 051157 FOR IMMEDIATE RELEASE W e m k r 17,2005

International Monetary Fund TW I@' Street, NW Washington, D. C. 20431 USA

IMF Executive Board ConcIudEH; 2005 Article IV Consultation with Paklstan

Annex I I Pnge 2 of 5

- 2 -

Concerned with dauble digit inflation and high capacity u l i t i o n , the State Bank of Pakebn {SBP) has tightwed monetary policy. Since the beginning of 2005, the SBP tms Faisad the six-nonth t~%ssusy Ell rate by m r e Man 4 percentage p to 8 percent in May, but kept it brwdly u n c h a m since then; key inkerfst rates rernsin slightly negative in real tern. Despite the tightenlw. reserve money grwrRfi has not sled down because the SBP proorkfed substantial budget financ.ing during the year as the government% gross financing needs couM not be fcllly met from the market at prevailing rates.

Degpite h i r worker's remittances, the current account m v e d inb @dicit k 2OWO5. Exports, and in parUcukar textile exports Wdcwring the end uf the textile quota sysbrs. have pt3rfairmed welt in the first six months of 2005. But import g r w even M e r , reflecting higher ai! p r i m and shng demand, induding fix m M n e 9 . Gross reserves .Fell somewhat in x104&5, notwithstanding a contin& increase in non-ciebt-creating inflows and substantial mw*naf finanang. The mat effective lexeh;ange rate has appreciated mDdsSaly mer the last few monahs @!#en the stable U.S. ddlar-PaMstsnl: wpee exchange rate and th-ra substantial inAarbn differ9nUarl.

Annex I I Page 3 of 5

- 3 - Pakistan. They w lmW the PI&$&% of suppwt that have bwon made by the international clsmmunity to address urgent needs and assist with the remnshnrc;tbn, and called for substantial additional assistance, especially grants, to help the government wermrne the crists wihmf adversely affecting impfernentation of broader eeoncrmic policbs, In this regard. sweral Directm noted that they wwld support a request for Emergency Natural Disaster Assistsrnce from the Fund, if the Pakistani aulhwities w e to make such a request.

Annex I1 Page 4 of 5

- 4 -

Annex I I Page 5 of 5

1.8 4.4 2.5

lS.B 172

4,163

14.3 17.6 -4.3 -3.3 2.3

88.8

5.1

3.Q 9.0

10.4

124 14.3 -2.7 -1 .e

309.4 .I 879

1.7 58.3

-2s

3'9 2.5 36

1s.o i Li,8

4,402

16.1 19.7 -5.5 -3.6 2.0

810.2

613.4

2 0 65.4 8.1

12.7 83,l 0,1 2.2

285.8 4 m

3.7 61.3

4.1

4.8 3.1 1.9

22.0 1&9

4823

17.4

-3.8 -1 A 2.9

79.3

18-7

18.9

.o,d 18.3 4.1

13,2 13.7

5.1

238.0 10.251

6.9 58.4

-3 b

3.8

8-4 4.6 6 5

19.3 17.3

5533

$4.9 16.7 -23 -1 .B 1 .a

878

2. I

17.5 i S b 1.7

12.B 14.1 1.4 2 0

zts.2 1O.arZI

5.0 51.5

3 , P

8.4 9.3 8.7

16.6 18.8

8,548

14.0 l?.? -3.3 -3.0 0.2

81-1

2.2

17.1 lB.3 4.1

13.0 17.0 -1.B - 1 3

191.8 9,985

4.1 59.3

4.1

MAP SECTIOK

N.W.F.P.N.W.F.P.

B A L O C H I S T A NB A L O C H I S T A N

S I N D HS I N D H

P U N J A BP U N J A B

TRIBAL AREASTRIBAL AREAS

FED. CAPITAL FED. CAPITAL TERRITORY TERRITORY ISLAMABADISLAMABAD

GilgitChitral

Mardan

Peshawar

Kahat Rawalpindi

Bannu

MianwaliKhushab

Jhelum

Sargodha

GujratSialkot

Gujranwala

Bhakkar

JhanaLahore

KasurFaisalabad

Sahiwal

MultanD.G.Khan

Bahawalpur

Bahawalnagar

Rahimyar Khan

RohriSukkur

Larkana

Dokri

Nawabshah

Hyderabad

Thatta BadinKarachi

Bela

Gwadar

Panjgur

Kalat

Khuzdar

Quetta

Sibi

D.I.Khan

ISLAMABADJAMMU

and KASHMIR

B A L O C H I S T A N

S I N D H

P U N J A B

FED. CAPITAL TERRITORY ISLAMABAD

N.W.F.P.

TRIBAL AREAS

Jhel

um

R.

R.

Ravi

Sutlej

R.

Indus

R.

Nar

aC

anal

Nal

R.

Mouths ofthe Indus

Zhob R.

A R A B I A N S E A

IndusR.

Kuna

r

R.

ApproximateLine of Control

TAJ IK ISTAN

C H I N A

AFGHANISTAN

I S L A M I C R E P .

O F I R A N

I N D I A

70° 75°

35°

30°

75°

25°

70°65°60°

25°

30°

35°

60° 65°

30°

35°

75°

35°

30°

25°

75°70°65°

25°

70°65°

N.W.F.P.

BALOCHISTAN

SINDH

PUNJAB

••

•••

••

•••

•

•

••••

••

• •••• •• ••• • • • • • • ••

Approx. Line of ControlJAMMU

AND KASHMIR

Arabian Sea

TAJIKISTANCHINA

I N D I A

A F G H A N I S T A N

ISLAMIC REP . OF

IRAN

TURKMENISTAN

UZBEK.

PAKISTANPAKISTAN

TAJIK.

PAKISTAN

Islamabad

FED. CAPITALTERRITORY

ISLAMABAD

0 100 200 300 KILOMETERS

0 50 100 150 200 MILES

MA

RCH

2006

IBRD 34635

PROJECT PROVINCE

SELECTED CITIES

NATIONAL CAPITAL

MAIN ROADS

RAILROADS

RIVERS

PROVINCE BOUNDARIES

INTERNATIONAL BOUNDARIES

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information shownon this map do not imply, on the part of The World Bank Group, anyjudgment on the legal status of any territory, or any endorsement oracceptance of such boundaries.

P A K I S T A N

NORTH WEST FRONTIER PROVINCEDEVELOPMENT POLICY CREDIT 1

Pakistan-Assessment Letter for the World Bank May 22,2006

This note provides the IMF staffs assessment of Pakistan's macroeconomic developments and prospects as background for the three development policy loans being considered by the Executive Board of the World Bank on June l . The assessment is based on IMF staff discussions with the Pakistani authorities during a staff visit to Islamabad in March 2006, follow-up discussions at the April 2006 Spring Meetings in Washington, and at the sidelines of the 2006 Pakistan Development Forum held in Islamabad on May 10-1 1.

Economic developments in Pakistan since the 2005 Article IV consultation have been broadly favorable.

e

e

. " e

e

e

e

Real GDP growth in 2005/06 (July/June) is likely to end at a solid 6-6% percent, somewhat lower than anticipated, mainly owing to shortfalls in agricultural production.

Inflation is starting to decline. The 12-month change in the headline CPI fell from 8-8% percent in the second half of 2005 to 6.1 percent in April 2006. Average inflation in 2005/06 is likely to be around 8 percent, down from 9.3 percent one year earlier.

The nominal exchange rate has remained in the range of 59-60 rupees per U.S. dollar since late 2004; the real effective exchange rate appreciated by about 11 percent from '

December 2004 to February 2006.

The October 2005 earthquake left a heavy toll in terms of human lives and physical and social infrastructure, but had limited effects on inflation, output growth, and the external current account. Demands for government spending, however, have increased. Earthquake relief and reconstruction spending in 2005/06 could amount to up to 0.9 percent of GDP, while the overall budget deficit (excluding grants) will be around 4% percent of GDP-compared with an original budget target (pre-earthquake) of 3.8 percent.

The trade and current account deficits have been significantly larger than envisaged at the time of the 2005 Article IV consultation, and are projected to reach 51/2 and 4 percent of GDP, respectively, by end-June 2006. The continued rapid growth of non-oil imports (representing about 80 percent of total imports) is not being matched by the performance of exports and remittances. Net international reserves declined by close to US$1 billion during the first half of 2005/06, but are expected to more than fully recover in the second half on account of strong capital inflows, including from privatization and government bond issues. By end-June 2006, official reserves are expected to exceed US$10 billion (3% months of imports), compared to US$9.9 billion one year earlier.

Government reliance on State Bank of Pakistan (SBP) financing has complicated the conduct of monetary policy. During the second half of 2005, the bulk of the government's borrowing needs was satisfied by resorting to SBP financing, partly because the cut-off rate set at treasury bill auctions was not sufficiently attractive to

- 2 -

commercial banks, which continued to face a strong demand for credit from private firms and households. While financing pressures from the budget may ease somewhat in the last quarter of fiscal year 2005/06 (owing to the global bond issue and large privatization receipts), broad money and private sector credit growth are expected to remain high through end-June 2006.

0 The privatization program is gaining momentum. The sale of the Karachi Electric Supply Company and the sale of management control of Pakistan Telecommunication Company Limited and Pakistan Steel Mills during 2005/06 constitute significant landmarks in the privatization process that generated proceeds in excess of US$2 billion. The authorities intend to build on this momentum through the offer of Global Depository Receipts of the Oil and Gas Development Company before end-July 2006. Prospects for privatization in the energy sector, however, remain contingent on setting regional electricity tariffs at levels that give potential investors assurances of a reliable revenue base.

0 Market perceptions of Pakistan have improved. Standard & Poor’s upgraded its outlook on Pakistan’s foreign currency debt from stable to positive in December 2005, while Moody’s upgraded Pakistan’s credit rating to “B2-positive” in mid-March. Pakistan’s stock market index rose by over 60 percent in the 12 months to April 2006, more than fully recovering from the large correction of early 2005. On March 23,2006 the government raised US$800 million in a two-part 10-year (US$500 million) and 30-year (US$300 million) global bond deal at very favorable terms; this was Pakistan’s third and largest international bond offering since the 1999 debt restructuring, and the first with maturities longer than five years. The ability to place 30-year paper is an important indication of the markets’ positive outlook on Pakistan.

Key challenges and policy issues

0 The key near-term challenge is to contain the deterioration in the current account deficit and keep external vulnerabilities in check. The high rates of import growth might decelerate sharply in the coming months as the effects of transitory, non-recurrent factors that influenced the level of imports in 2005 (e.g., oil price spike, unforeseen agricultural imports) unwind. If this happens, the current account deficit could stabilize during the next one or two years at levels in the order of U$5-6 billion, broadly similar to the one currently projected for 2005/06. Under these circumstances, the expected increase in non-debt-creating capital inflows would help finance the bulk of the current account deficit and significant losses of international reserves would be avoided. However, if the decline in import growth turns out to be more gradual, or if there are negative shocks, external vulnerabilities could rise in the months ahead. A tightening of monetary policy to bring about a faster reduction of credit and domestic demand growth would help reduce this risk by helping to narrow the current account deficit and facilitating the accumulation of international reserves. This strategy will be more effective if supplemented by fiscal measures that ensure the decline in the public debt-to-GDP ratio mandated by the 2005 Fiscal

- 3 -

Responsibility Law (2% percentage points per year), and by greater exchange rate flexibility.

e The overall budget envelope for the years ahead needs to create fiscal space to accommodate the additional demands on government spending stemming from the October 2005 earthquake. Six months after the disaster, government estimates of the size, profile, and means of financing of prospective reconstruction expenditures remain highly tentative. Fiscal policy formulation in the years ahead needs to include explicitly the additional demands on government spending created by the earthquake, and reconcile those demands with the requirements of the Fiscal Responsibility Law referred to above, and, more generally, with other macroeconomic stability and poverty-reduction considerations.

e Efforts to raise the revenue to GDP ratio need to be reinvigorated. Recent reforms in the revenue area have focused on taxpayer facilitation to strengthen the investment climate. The focus in the years ahead should be on broadening the revenue base through continued tax administration reform, and tax policy measures aimed at bringing untaxed sectors into the net. Efforts to increase the provinces’ contribution to overall revenue collection should also continue. Much needed increases in social and development spending hinge critically on raising the revenue to GDP ratio by 3-5 percentage points over the medium term. Concrete steps to attain this goal should be laid out at the earliest.

Status of IMF Relations

The 2005 Article IV consultation was concluded on November 2,2005.’ A mid-term staff visit took place in March 2006. The 2006 Article IV consultation discussions are expected to be conducted in August 2006; it is anticipated that the IMF’s Executive Board will complete the 2006 Article IV consultation in,November 2006.

See http:llwww.imf.orglextemal/np/secl~d2OO5/pnO5 157.htm for the Public Information Notice.