MEXICO: Decentralized Infrastructure Reform and Development Program

1. MEXICO: Decentralized Infrastructure Reform and Development Program Jose Luis Irigoyen October 2003

2. Program Concept • Long range program to support infrastructure development at subnational levels, anchored to comprehensive sector strategies fully owned by respective authorities: • direct assistance in first stages limited to States (although municipalities may benefit indirectly) • …and three main infrastructure sectors (Transport, W&S, Urban Dev.&Housing) • TA to prepare other sectoral strategies /programs, and to strengthen institutional capacity of key state entities (including fiduciary and safeguard areas)

3. Program Concept • “Holistic” approach to reform & development of selected sectors through program financing: • implementation of fully articulated reform and investment programs adapted to State’s priority needs, typically over 3-4 year period • … reflected in specific sector strategy statements to be provided to BANOBRAS • strong results orientation, with Bank loan disbursements linked to meeting certain specific (performance) / output targets

4. Program Concept • Demand driven program open to all States which meet certain “entry” conditions • Conditions ensure state’s financial, fiscal & debt management policies are satisfactory/sustainable • Each State can choose the specific (sub) sector(s) in which wishes to participate • Strategies and programs proposed by State would have to meet “sector elegibility” criteria • Guidance for design of measures to promote sector efficiency, cost recovery, financial sustainability, quality/access of infrastructure services to the poor • Not a mechanical screening device

5. Program Concept • Guidelines /rules defined through “Program Operating Regulations” Manual to be agreed with BANOBRAS: • Entry conditions and sector eligibility criteria • Overall rules of operation and fund channeling arrangements (Bank- BANOBRAS – States) • Framework for handling fiduciary and safeguard responsibilities (program preparation & execution) • BANOBRAS: borrower /main executing agency • Processes for due diligence and approval by BANOBRAS and the Bank

6. Loan M$ State Y State Entity State Dept. Cofinanced programs (municipal infrastr.) Cofinanced programs (municipal infrastr.) Own programs (state infrastr.) Municipality Y1 Municipality X1 Program implementation set up World Bank GOM Guarantee Program Loan US$ BANOBRAS Loan M$ State X State Entity State Dept. Own programs (state infrastr.)

7. Some operational challenges & their effect in product design • Simultaneous pursuit of performance & output targets to exploit synergies between implementation of reforms and achievement of physical outputs • Performance-based disbursement provides strong incentive for states to carry out remaining reforms beyond those established through eligibility criteria • Output-based investment operation allows to stay with reforms & development program until actual results are achieved in the form of agreed outputs • “Hybrid” loan combining performance-based & output-based disbursement rejected

8. Some operational challenges & their effect in product design • Emphasis on customizing sector programs and targets to situation/needs of individual states to maximize strategic impact • detailed sector performance/output targets (and disbursement parameters) available only at time sector program is agreed upon with BANOBRAS • … but this makes more difficult delegation of responsibilities under open “wholesale” approach • Series of programmatic loans each one dealing with a state (at least in early stage) • Loans involving various sectors within parameters of longer term framework described in first loan

9. Loan 2 US$ Loan M$ State Y State Entity State Dept. Cofinanced programs (municipal infrastr.) Cofinanced programs (municipal infrastr.) Own programs (state infrastr.) Municipality Y1 Municipality X1 Program implementation set up Program Project World Bank GOM Guarantee Loan US$ BANOBRAS Loan M$ State X State Entity State Dept. Own programs (state infrastr.)

10. Some operational challenges & their effect in product design • Output-based disbursements to maximize efficiency of entity in reaching output target • Use of benchmarked unit cost indicators to determine ceiling on disbursement for production of a given output by state (or municipality) • Evidence of “eligible” actual expenditure through ex-post demonstration that total expenditure under eligible sectoral program equal or exceed amount of disbursements which state has earned via meeting output objectives • Report-based disbursements (evidence in the form of audited statements of accounts)

11. Some operational challenges & their effect in product design • Application of SWAP beyond pre-specified pools to entire sector investment program, regardless of source of financing • use of state-level public expenditure reviews, state program level financial management, procurement, environmental and social assessments, as needed to determine compliance with agreed frameworks • action plans agreed with State to strengthen relevant practices, if policies are substantially in line but further improvement desirable • Yet many unresolved issues around fiduciary and safeguard frameworks

12. Sub-programs for which partial WB financing will be used Eg., Guanajuato road sector program and WB financing Gap to be covered after adjusting program

13. Possible approaches to organization risk management • Framework applies to entire Sector Program or to Bank financed subprograms ? Framework State 1 State 2 Sector Program & Policies Sector Program & Policies Country legislation improved practices Bank financed subprograms Bank financed subprograms Fully consistent W/Bank policies

14. Possible approaches to organization risk management • What provisions for risk aversion ? • Zero tolerance for Bank financed programs vs comparability (not exactly matching) • Distinction between substantive & non-substantive gaps/departures from WB policies, and their implications for pooling under SWAPs • SWAPs call for increased delegation to country procedures and frameworks • activities/transactions become a large multiple of Bank financing, a problem for prior reviews • ring-fencing not a solution in long run (especially for infrastructure sectors)

15. Eg., tentative framework for safeguards based on global risk • Sectoral Risk is a function of: • Technical complexity of program • Potential for triggering safeguards • Potential departures from SG in local policies • Institutional Risk: • Ability of institutions to screen projects, design risk mitigation measures, enforce procedures • Assessment of sectoral & environmental agencies

16. Eg., tentative framework for safeguards based on global risk • Global risk as function of sectoral and institutional risk

17. Eg., tentative framework for safeguards based on global risk • Level of delegation based on Global Risk • Global Risk 1: DL1 - Bank accepts State procedures • Global Risk 2: DL2 - Bank accepts State procedures contingent on strengthening program • Global Risk 3: DL3 - Bank reviews ex-ante all Sectoral Risk 3 projects • Sectors can have different levels of delegation • Level of delegation reassessed at MTR once capacity demonstrated

18. Some issues regarding the role of BANOBRAS • Financial intermediation & administration of program resources: • On-lends to state(s) assuming full credit risk (can charge differential risk spreads to take account of variations in creditworthiness) • … but spreads non-competitive under current market conditions • Scope of due diligence • review/approval/supervision of sector strategy & financing proposals in line with agreed Operational Manual, in consultation with Bank • specific performance /implementation targets incorporated into loan agreement with states