brazil - rio grande do sul strengthening fiscal and water...

Document of The World Bank

Report No: ICR00003985

IMPLEMENTATION COMPLETION AND RESULTS REPORT(IBRD-83790)

ON A

LOAN

IN THE AMOUNT OF US$280 MILLION

TO THE

STATE OF RIO GRANDE DO SUL

FOR THE

STRENGTHENING FISCAL AND WATER RESOURCE MANAGEMENT DEVELOPMENT POLICY LOAN

January 26, 2017

Macroeconomics & Fiscal Management Global PracticeBrazil Country Management UnitLatin America and the Caribbean Region

CURRENCY EQUIVALENTS(Exchange Rate Effective December 30, 2016)

Currency Unit = Real (R$) 1.00 = US$ 0.31US$ 1.00 = 3.26

FISCAL YEARJanuary 1 – December 31

ABBREVIATIONS AND ACRONYMS

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ANA National Water Agency Agência Nacional de ÁguasCAGE Office of the Accountant and Auditor

GeneralContadoria e Auditoria Geral do Estado

CPS Country Partnership Strategy Estratégia de Parceria com o PaísCRH-RS Water Resources State Council of Rio

Grande do SulConselho Estadual de Recursos Hídricos do Rio Grande do Sul

DMO Debt Management Office Divisão de Gestão da DívidaDPL Development Policy Loan Empréstimo de Políticas de

DesenvolvimentoDRH Department of Water Resources Departamento de Recursos HídricosDRM Disaster Risk Management Gestão de Risco de DesastreEMATER/RS Technical Assistance and Rural Extension

Company of Rio Grande do SulEmpresa de Assistência Técnica e Extensão Rural do Rio Grande do Sul

FARSUL Agriculture Federation of the State of Rio Grande do Sul

Federação da Agricultura do Estado do Rio Grande do Sul

FEPAGRO State Agricultural and Livestock Research Foundation

Fundação Estadual de Pesquisa Agropecuária

FEPAM State Foundation for Environmental Protection Henrique Luiz Roessler

Fundação Estadual de Proteção Ambiental Henrique Luiz Roessler

FRL Fiscal Responsibility Law Lei de Responsabilidade FiscalFUNDOPEM State Industrial Promotion Agency Fundo Operação Empresa do Estado do

Rio Grande do SulGDP Gross Domestic Product Produto Interno BrutoGoRS Government of Rio Grande do Sul Governo do Rio Grande do SulGRS Government of the State of Rio Grande

SulGoverno do Estado do Rio Grande do Sul

IBGE Brazilian Institute of Geography and Statistics

Instituto Brasileiro de Geografia e Estatísticas

ICMS Value Added Tax Imposto sobre Circulação de Mercadoria e Serviços

ICR Implementation and Completion Results Report

Relatório de Conclusão e Resultados

IPSAS International Public Sector Accounting Standards

Padrões Contábeis Internacionais aplicados ao Setor Público

IRGA Rio Grande do Sul Rice Institute Instituto Riograndense de ArrozIRRF Income Tax Withheld at Source Imposto de Renda Retido na FonteIWRM Integrated Water Resources Management Gestão Integrada dos Recursos HídricosNCD Net Consolidated Debt Dívida Consolidada LíquidaNCR Net Current Revenues Receita Corrente LíquidaPROGESTÃO National Pact for Water Management Pacto Nacional pela Gestão das Águas

PRONAFNational Program for Strengthening Family Agriculture Programa Nacional de Fortalecimento da

Agricultura Familiar

NCR Net Current Revenues Receita Corrente LíquidaRGS State of Rio Grande Sul Estado do Rio Grande do SulSEAPI Secretariat of Agriculture, Livestock and

IrrigationSecretaria de Agricultura, Pecuária e Irrigação

SEFAZ Secretariat of Finance Secretaria da FazendaSEMA Secretariat of Environment Secretaria de Meio AmbienteSEPLAG Secretariat of Planning, Management and

Social ParticipationSecretaria de Planejamento, Gestão e Participação Social

SERASA Credit Verification Company Serviços de Assessoria S/ASWAP Sector Wide Approach Abordagem Setorial AmplaSTN National Treasury Secretariat Secretaria do Tesouro NacionalTCE State Court of Accounts Tribunal de Contas do Estado de Rio

Grande do SulWR Water Resources Recursos HídricosWRM Water Resources Management Gestão de Recursos Hídricos

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Vice President: Jorge FamiliarCountry Director: Martin Raiser

Senior Practice Director: Carlos Felipe JaramilloPractice Manager: Pablo Saavedra

Project Team Leader: Antonio Nucifora / Paula P. F. de OliveiraICR Team Leader: Fabiano Silvio Colbano

ICR Primary Author: Fabiano Silvio Colbano

BRAZILSTRENGTHENING FISCAL AND WATER RESOURCE MANAGEMENT DEVELOPMENT

POLICY LOAN

CONTENTS

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A. Basic Information...........................................................................................................5B. Key Dates........................................................................................................................5C. Ratings Summary............................................................................................................5C.1 Performance Rating by ICR..........................................................................................5C.2 Detailed Ratings of Bank and Borrower Performance (by ICR)..................................6C.3 Quality at Entry and Implementation Performance Indicators.....................................6D. Sector and Theme Codes................................................................................................6E. Bank Staff........................................................................................................................7F. Results Framework Analysis...........................................................................................8G. Ratings of Project Performance in ISRs.......................................................................10H. Restructuring.................................................................................................................101. Program Context, Development Objectives and Design...............................................111.1 Context at Appraisal....................................................................................................111.2 Original Project Development Objectives and Key Indicators....................................161.3 Revised Program Development Objectives (PDO) and Key Indicators, and Reasons171.4 Original Policy Areas Supported by the Program (as approved)................................171.5 Revised Policy Areas...................................................................................................171.6 Other significant changes............................................................................................172. Key Factors Affecting Implementation and Outcomes.................................................172.1 Program performance..................................................................................................172.2 Major Factors Affecting Implementation....................................................................182.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization.............192.4 Expected Next Phase/Follow.......................................................................................193. Assessment of Outcomes...............................................................................................193.1 Relevance of Objectives, Design and Implementation................................................193.2 Achievement of Project Development Objectives.......................................................203.3 Justification of Overall Outcome Rating.....................................................................283.4 Overarching Themes, Other Outcomes and Impacts...................................................283.5 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops............294. Assessment of Risk to Development Outcome.............................................................295. Assessment of Bank and Borrower Performance..........................................................296. Lessons Learned............................................................................................................32Annex 1. Bank Lending and Implementation Support/Supervision Processes.................33Annex 2. Detailed Description of Implementation of each Prior Action..........................34Annex 3. Beneficiary Survey Results................................................................................46Annex 4. Stakeholder Workshop Report and Results.......................................................47Annex 5. Summary of Borrower's ICR and/or Comments on Draft ICR..........................48Annex 6. Comments of Cofinanciers and Other Partners/Stakeholders............................51Annex 7. List of Supporting Documents...........................................................................52Annex 8. State Fiscal Situation..........................................................................................53Annex 9. Background on World Bank Operations with Rio Grande do Sul.....................66MAP OF RIO GRANDE DO SUL / BRAZIL..................................................................68

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Data Sheet

A. Basic Information

Country: Brazil Project Name: RS: Strengthening Fiscal and Water Resources Management DPL

Project ID: P148083 L/C/TF Number(s): IBRD-83790

ICR Date: 01/26/2017 ICR Type: Core ICR

Lending Instrument: DPL Borrower: STATE OF RIO GRANDE DO SUL

Original Total Commitment: USD 280.00M Disbursed

Amount:USD 280.00M

Revised Amount: USD 280.00M

Environmental Category: B

Implementing Agencies: State Secretariat of Finance (SEFAZ)Cofinanciers and Other External Partners: Not Applicable

B. Key Dates

Process Date Process Original Date Revised / Actual Date(s)

Concept Review: 11/05/2013 Effectiveness: 09/30/2014 09/30/2014

Appraisal: 02/20/2014 Restructuring(s):

Approval: 06/27/2014 Mid-term Review:

Closing: 12/31/2015 12/31/2015

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C. Ratings SummaryC.1 Performance Rating by ICR

Outcomes: Moderately unsatisfactory

Risk to Development Outcome: High

Bank Performance: Moderately unsatisfactory

Borrower Performance: Moderately unsatisfactory

C.2 Detailed Ratings of Bank and Borrower Performance (by ICR)

Bank Ratings Borrower Ratings

Quality at Entry: Moderately unsatisfactory Government: Moderately

unsatisfactory

Quality of Supervision: Satisfactory Implementing Agency/Agencies: Satisfactory

Overall Bank Performance:

Moderately unsatisfactory

Overall Borrower Performance:

Moderately unsatisfactory

C.3 Quality at Entry and Implementation Performance Indicators

Implementation Performance Indicators QAG Assessments (if any) Rating

Potential Problem Project at any time (Yes/No): No Quality at Entry (QEA): None

Problem Project at any time (Yes/No): No Quality of Supervision (QSA): None

DO rating before Closing/Inactive status: Moderately satisfactory

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D. Sector and Theme CodesOriginal Actual

Major Sector/Sector

Agriculture, Fishing and Forestry

Irrigation and Drainage 10 10

Public Administration

Sub-National Government 60 60

Water, Sanitation and Waste Management

Other Water Supply, Sanitation and Waste Management 30 30

Major Theme/Theme/Sub Theme

Economic Policy

Fiscal Policy 19 19

Fiscal sustainability 6 6

Tax policy 13 13

Environment and Natural Resource Management

Water Resource Management 38 38

Water Institutions, Policies and Reform 38 38

Public Sector Management

Public Administration 13 13

Transparency, Accountability and Good Governance 13 13

Public Finance Management 32 32

Debt Management 6 6

Domestic Revenue Administration 13 13

Public Expenditure Management 13 13

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E. Bank Staff

Positions At ICR At Approval

Vice President: Jorge Familiar Jorge Familiar

Country Director: Martin Raiser Deborah L. Wetzel

Practice Manager Pablo Saavedra Auguste Kouame

Project Team Leader:

Antonio Nucifora / Paula P. F. de Oliveira

Rafael Barroso / Paula P. F. de Oliveira

ICR Team Leader: Fabiano Silvio Colbano

ICR Primary Author: Fabiano Silvio Colbano

F. Results Framework Analysis

Project Development Objectives

The original Project Development Objective was to improve Government capacity to mitigate economic volatility in the State of Rio Grande do Sul by supporting measures to increase resources available to the government and to reinforce the Integrated Water Resource Management framework.

Revised Project Development Objectives (as approved by original approving authority)

Not applicable, since there were no formal revisions to the operation.

PDO Indicators

Indicator Baseline Value

Original Target Values (from

approval documents)

Formally Revised Target Values

Actual Value Achieved at

Completion or Target Years

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Indicator 1: Fiscal Management: Percentage of tax expenditure measures under Government control evaluated, according to the new procedures.

Value (quantitative or qualitative)

0 25 N/A 43

Date achieved 2012 2015 November, 2015Comments (incl. % achievement)

Achieved. Actual value exceeded target.

Indicator 2: Fiscal Management: Increase the share of tax arrears recovered within 60 days of their generation.


20.8 27 28.6


Achieved. The target had been achieved by the third supervision mission: 28.6 percent of the arrears generated two months prior had been collected.

Indicator 3: Fiscal Management: Increase the share of goods procured, expressed as a percentage of the total value of goods, using price information from the electronic fiscal invoice database.


0 25 51


Achieved. Actual value exceeded target. This Prior Action was highly successful in reducing procurement costs in the health sector.

Indicator 4: Fiscal Management: Increase in the number of managerial cost reports prepared by Government agencies.


0 14 13

Date achieved 2012 2015 September, 2016Comments (incl. % achievement)

Mostly achieved. Target was 93% achieved.

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Indicator 5: Fiscal Management: New policy instrument to manage contingent liabilities made effective.


No Yes Yes

Date achieved 2012 2015 May 2015Comments (incl. % achievement)

Achieved. System for monitoring contingent liabilities in place.

Indicator 6: Water Resource Management: Increase in the number of medium and small farmers that have adhered to the “More Water, More Income” Program.


413 landholders 3,000 landholders

3,096 landholders

Date achieved 2012 2015 December 2016Comments (incl. % achievement)

Achieved. According to SEAPI, the number of participants was achieved in 2016.

Indicator 7: Water Resource Management: River Basins Plans completed, discussed and approved by the river basin committees, with the supervision and facilitation of the DRH team.


1 12 7 (58%)

Date achieved 2012 2015 August 2016Comments (incl. % achievement)

Partially achieved. Overall achievement: 58%. The target was substantially met, and will certainly be entirely met in the near future, as the remainder 5 plans are well advanced, according to DRH.

Indicator 8: Water Resource Management: New hydro-meteorological stations installed in key river basins with information analyzed by the State is operating satisfactorily.


0 80 27 (34%)

Date achieved 2012 2015 August 2016Comments (incl. % achievement)

Partially achieved. Instead of installing all 80 stations, DRH coordinated with agencies that have hydro-meteorological data thus avoiding overlaps and improving coverage. As a result, a situation room to monitor hydro-meteorological data and river levels on a real time basis was installed and is operating satisfactorily.

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G. Ratings of Project Performance in ISRs

No. Date ISRArchived DO IP

Actual Disbursements(USD millions)

1 11/23/2014 Moderately Satisfactory Satisfactory 279.30

2 05/29/2015 Moderately Satisfactory Moderately Satisfactory 279.30

H. Restructuring

Not applicable, since there was no formal restructuring to the operation.

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1. Program Context, Development Objectives and Design1. The Rio Grande do Sul Strengthening Fiscal and Water Resource Management Development Policy Loan aimed to support the State of Rio Grande do Sul (GoRS) in Brazil to improve its capacity to mitigate economic volatility by supporting measures (i) to increase resources available to the government and (ii) to reinforce the Integrated Water Resource Management framework. This Development Policy Loan (DPL) of US$280 million was approved by the World Bank's Board of Directors on June 27, 2014, became effective on September 30, 2014, and closed on December 31, 2015.

1.1 Context at Appraisal Economy of Rio Grande do Sul2. Rio Grande do Sul is the southernmost State in Brazil. It has a population of 11.3 million people (in 2015), distributed across an area of 280 thousand Km2. The State has 5.6 percent of the country’s population and 3.3 percent of its land area. State GDP amounted to US$ 121.8 billion in 2015 (at market prices) or 6.7 percent of Brazil’s GDP. Per capita GDP was US$ 10,790. Poverty and extreme poverty incidence are below the national average, but above the southern region average. In 2012, the incidence of poverty was 4.2 percent, while the figures for the region and the country stood at 3.7 and 9.4 percent respectively.

3. The State of Rio Grande do Sul has significant regional diversity. The majority of the population and GDP is concentrated in the axis formed by the capital—Porto Alegre—and the Mountain region. The Southern part is characterized by large landholdings dedicated to irrigated rice farming. The Northwestern and Center-West regions are characterized by the existence of small landholders and family-owned farms dedicated to rain-fed crops. These last two regions have been losing population and participation in State GDP, while all three regions have a higher incidence of poverty.

4. The services sector and the agri-business complex are central to state’s economy. Services accounted for 65 percent of value added in 2013. Industry was the second largest sector with 24 percent, while agriculture was responsible for 10 percent. Despite the small share of agricultural production in the State GDP, it is estimated that the agribusiness complex accounts for 30 percent of the state’s GDP1 and 17 percent of its employment. The main crops in terms of production value are soybeans, rice and tobacco. Soybeans are by far the largest export item, with a value of US$ 806 million in 2016. Tobacco and beef were a distant second, with a value of US$ 158 million and US$ 154 million, respectively.

5. RGS’ GDP has grown, but with volatility. Over the last ten years, annual growth rates have ranged from -3.4 percent to +8.2 percent. Over much of this period, these fluctuations were closely associated with fluctuations in agricultural output (Figure 2). More recently, they have been associated with the downturn in the Brazilian economy as a whole. In 2015, the Brazilian economy contracted by 3.8 percent (Figure 1). Despite an uptick in agricultural output, the state’s economy contracted by 3.4 percent.

1 Foundation of Economics and Statistics (Fundação de Economia e Estatística - FEE), 2016. http://www.fee.rs.gov.br/indicadores/agronegocio/exportacoes/destaques-do-mes

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http://www.fee.rs.gov.br/indicadores/agronegocio/exportacoes/destaques-do-mes

Figure 1: Trends in GDP Figure 2: Agriculture GDP

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

-4%

-2%

0%

2%

4%

6%

8%

10%

BR RGS

Rea

l An

nu

al G

row

th

200720082009201020112012201320142015-40%

-20%

0%

20%

40%

60%

state GDP agriculture

Rea

l An

nu

al G

row

th

Source: IBGE and FEE

6. One of the key reasons for the volatility in agricultural output is the lack of regular water supply. Dry summers and periodic droughts seriously affect medium and small-size production and income in the Northwestern region where corn, soy and beans are the main crops. Favorable soil conditions and average yearly rainfall above 1,500 mm provide a promising perspective for irrigated agriculture. Nonetheless, most of the farms depend solely on rainfall and less than seven percent have irrigation facilities.

State Finances

7. The state derives the majority of its revenues from the ICMS (Imposto sobre Circulação de Mercadorias e Serviços), a state administered Value Added Tax (VAT). Revenues from ICMS are constrained by the high proportion of taxable activity that is exempt or taxed at very low rates. In part, this reflects federal mandates, since under federal law foreign exports (including the state’s agricultural products) are exempt from VAT. It also reflects agreements within the national council of state finance secretariats (CONFAZ—Conselho Nacional de Política Fazendária). Finally, it reflects a deliberate state policy of taxing domestic (intra-state) transactions at relatively low rates and granting beneficial tax treatment to individual firms through its economic development fund, FUNDOPEM (Fundo Operação Empresa). At the time of appraisal, ICMS revenues (along with state revenues from other sources) had nevertheless been increasing steadily, in real terms, for the previous five years. With the recent downturn in the state’s economy, ICMS revenues have declined.

8. State expenditures are dominated by personnel costs. In 2015, personnel spending consumed 72 percent of net current revenues (NCR).2 These expenditures are quite rigid. Under most circumstances, the Federal Constitution prohibits states from reducing the salaries of their employees in nominal terms. Federal law also dictates the pension benefits for most retirees. By law, RGS is required to pay not only the salaries of its active personnel but also the pensions of its retirees. Under the terms of the 1988 Constitution, these pension benefits are quite generous. The majority of current retirees are entitled to a pension equal to 100 percent of their individual

2 In this text, net current revenues are defined as total current revenues minus transfers to municipalities. It is different from the official concept defined in the Fiscal Responsibility Law, which also excludes from the current revenues the contributions to the pension system of the public servants.

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exit salaries, adjusted (upward) for any subsequent increase in the salary of the position formerly occupied. While the federal government and the state have attempted to rein in pension benefits, most of the reductions apply only to staff who were hired after each of the various reforms was introduced. As a result, they have very little impact on the state’s current spending obligations.

Table 1: Rio Grande do Sul’s Fiscal Accounts (Constant R$ millions of 2015)

2007 2008 2009 2010 2011 2012 2013 2014 2015

Current revenues (I) 30,752 34,350 34,510 38,857 38,671 39,655 42,057 43,383 41,599

of which: VAT 19,303 22,161 21,416 23,917 24,710 25,524 27,241 27,502 26,168

Current expenditure (II) 28,756 30,266 31,114 33,972 35,278 38,818 41,506 43,772 43,732

of which:

personnel 16,344 16,772 17,598 18,856 19,663 20,458 21,934 23,562 23,985

interest 434 406 295 227 162 1,829 1,773 1,701 1,665

other current 11,483 12,666 12,781 14,202 14,721 15,646 16,811 17,527 17,025

Current balance (III) = (I) – (II) 1,996 4,084 3,397 4,885 3,393 837 551 -389 -2,133

Investment (IV) 645 1,007 962 2,680 1,433 1,506 1,657 1,935 809

Operating balance (V) = (III) – (IV) 1,351 3,076 2,435 2,204 1,959 -669 -1,106 -2,324 -2,942

Amortization (VI) 2,511 4,446 2,775 3,863 3,088 1,477 1,583 1,863 2,075

Capital revenues (VII) 2,184 1,996 347 1,445 487 1,353 1,047 2,886 439

Cash flow (VIII) = (V) – (VI) + (VII) 1,024 626 6 -214 -642 -793 -1,643 -1,301 -4,578

Net current revenues 24,896 27,705 27,781 31,439 31,057 31,770 33,797 35,022 33,463

Operating balance/NCR 5% 11% 9% 7% 6% -2% -3% -7% -9%

Cash flow/NCR 4% 2% 0% -1% -2% -2% -5% -4% -14%

9. The state also has high debt levels. The stock of contractual debt was equal to twice the level of net current revenues in 2015 (NCR, defined as total revenues less constitutionally mandated transfers to municipalities). In addition, the state had a vast stock of contingent liabilities (mostly arising from lawsuits filed on behalf of civil servants). As discussed in Annex 8, the PD for this operation included a detailed analysis of the state’s fiscal position and prospects, including a ‘baseline’ and a ‘worst case’ scenario. Based on the most recent fiscal data available at the time (2012), the baseline scenario projected the state’s GDP to grow by about eleven percent over the period 2012-2015. Buoyed by growth in the state value added tax (ICMS), total current revenues were expected to increase by 15 percent over that period. Under the baseline scenario, total operating expenditures3 were projected to grow by 18 percent. Personnel costs were projected to increase 16 percent in real terms. The result, according to the baseline projection, was to be a slight worsening of the state’s fiscal situation in the short term. The operational deficit was projected to increase to 2.7 percent of NCR by 2015. The situation was expected to improve from 2016 onwards, as growth in revenues gradually outstripped growth in expenditures, resulting in an operational deficit of 0.8 percent in 2020. The ‘worst 3 Operating expenditures are defined as recurrent expenditures plus capital expenditures other than amortization.

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case’ scenario, on the other hand, tested the impact of zero growth in nominal tax revenues in 2013, 2014 and 2015. Under this scenario, the operational deficit was projected to increase to 18 percent of NCR in 2015 and 22 percent of NCR in the following year. By 2020, Rio Grande do Sul was projected to be running an operational deficit equal to 25 percent of NCR and borrowing R$ 8 billion (in prices of 2012) to cover its cash flow.

Table 2: Brazil's Selected Economic Indicators

2007 2008 2009 2010 2011 2012 2013 2014 2015

National accounts, prices and interest rate (annual percentage change, unless otherwise specified)

Real GDP growth 6.1 5.1 -0.1 7.5 3.9 1.9 3.0 0.1 -3.8

GDP, current prices (R$ billion) 2,720 3,110 3,333 3,886 4,374 4,80

6 5,316 5,687 5,904

GDP, constant prices (R$ billion) 999 1,049 1,048 1,127 1,171 1,19

4 1,230 1,231 1,183

Total investment (Percent of GDP) 19.8 21.6 18.8 21.8 21.8 21.4 22.0 21.0 19.2

Gross national savings (Percent of GDP) 19.8 19.8 17.2 18.4 18.9 18.4 18.9 16.7 15.9

CPI inflation, average prices 3.6 5.7 4.9 5.0 6.6 5.4 6.2 6.3 9.0

CPI inflation, end of period prices 4.5 5.9 4.3 5.9 6.5 5.8 5.9 6.4 10.7

Money, credit and interest rate (percent of GDP, unless otherwise specified)

High powered money /1 5.4 4.7 5.0 5.3 4.9 4.9 4.7 4.6 4.3

Broad money (M2) /2 28.7 34.5 35.0 35.1 37.0 36.7 36.8 37.8 38.7

Total credit 34.7 39.7 42.6 44.1 46.5 49.3 51.0 53.1 54.5

Credit to the private sector - - - - - 46.8 48.2 49.4 50.1

Selic rate, accumulated (Annual percentage) 11.85 12.48 9.92 9.78 11.62 8.48 8.21 10.91 13.29

Selic rate, end of period (Annual percentage) 11.25 13.75 8.75 10.75 11.00 7.25 10.00 11.25 14.25

External sector (US$ billion, unless otherwise specified)

Current account (Percent of GDP) 0.0 -1.8 -1.6 -3.4 -2.9 -3.0 -3.0 -4.3 -3.3

Current account 0.4 -30.6 -26.3 -75.8 -77.0 -74.2 -74.8 -104.2 -58.9

Foreign direct investments 44.6 50.7 31.5 88.5 101.2 86.6 69.2 96.9 75.1

Gross official reserves 180.3 206.8 239.1 288.6 352.0 378.

6 375.8 374.1 368.7

Gross external debt 261.7 289.6 333.6 452.8 516.0 570.

8 621.4 712.7 665.1

Exchange rate, end of period (R$/US$) 1.8 2.3 1.7 1.7 1.9 2.0 2.3 2.7 3.9

Exchange rate, average (R$/US$) 1.9 1.8 2.0 1.8 1.7 2.0 2.2 2.4 3.3

General government finances (percent of GDP)

Revenue 34.9 35.9 33.9 36.1 35.1 34.8 34.6 33.1 31.7

Expenditure 37.6 37.4 37.1 38.8 37.6 37.3 37.5 39.1 42.0

Overall balance -2.7 -1.5 -3.2 -2.7 -2.5 -2.5 -3.0 -6.0 -10.3

Primary balance 3.2 3.8 1.9 2.3 2.9 1.9 1.7 -0.6 -1.9

Net debt 44.1 37.1 40.4 38.0 34.5 32.3 30.6 33.1 36.2

Gross debt 63.7 61.9 64.9 63.0 61.2 62.3 60.4 63.3 73.7

Sources: International Monetary Fund (World Economic Outlook Database, October 2016) and Brazilian Central Bank.

Notes:

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/1 Base money is comprised of paper money held by the public and banks reserves./2 M2 is comprised of paper money held by the public and demand, investment, time and saving deposits.

10. The economic situation turned out much worse than projected under the baseline scenario. The past few years have seen a pronounced slowdown in the Brazilian economy, culminating in an unprecedented decline of 3.8 percent in 2015. This has been reflected in the state’s economy as well. While the state’s GDP grew by 8.2 percent in 2013, it declined by 0.4 percent in 2014, and 3.4 percent in 2015. This had a dramatic effect on state revenues, which increased by only five percent over the entire 2012-2015 period. State expenditures, on the other hand, continued to increase at close to the projected rate. Personnel costs increased by 17 percent in real terms; other current expenditures increased by nine percent. As a result, the operating deficit in 2015 was considerably larger than projected under the baseline scenario (8.8 percent as opposed to 2.7 percent). Amortization expenditures were also considerably higher than anticipated, resulting in a cash flow deficit equal to 14 percent of NCR. The fiscal and liquidity situation has now deteriorated to the extent that the state has difficulty in paying its bills, including wage payments.

Rationale for Bank Involvement11. This operation (the Strengthening Fiscal and Water Resources Management DPL) had its origins, in part, in the fiscal distress of the state government. Given the state’s fiscal position, the Federal Government (specifically, the National Treasury Secretariat - STN) saw the Bank as a source of short/medium term financial assistance to enable the state to weather its difficulties as well as a source of technical advice to enable the state to undertake some initial fiscal reforms and reforms for the long term. As described in Annex 9, the Bank already had considerable experience in trying to help the state to reform its finances. Based on this experience, the Bank was seen as a logical partner in addressing the crisis.

12. The World Bank management nevertheless recognized that there were considerable risks to the operation. Management was aware of the state’s fiscal difficulties. This is evidenced by the thorough fiscal analysis that was undertaken during the course of project preparation. It also knew that the state government’s ability to improve its own fiscal situation was limited by federal legislation—particularly legislation governing tax rates and personnel expenditures (including pensions).

13. Management was also aware that the particular timing of the operation presented risks. The identification mission began its work in October 2013, exactly twelve months before the upcoming gubernatorial elections. The Federal Fiscal Responsibility Law prohibits states from borrowing in the final four months preceding an election. As a result, the authorities requested a swift process.

14. Bank management decided to take this informed risk. This decision was based in part on a (justifiable) expectation that the state’s economy would continue to grow, at least modestly. It was also affected by management’s desire to preserve the Bank’s relationship with the state and the federal government. The Bank had been supporting reforms in Rio Grande do Sul over a number of years. Bank management did not expect that the actions supported by the operation would significantly improve the state’s fiscal situation, but that they would be a ‘down payment’ on a longer and deeper process of reforms.

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15. The water resources component was added, in part, to reflect the importance of agriculture to the state’s economy and the potential benefits of irrigation. It also provided an opportunity to build on ongoing work by the state in this area. At the time the state (via the Federal Government) approached the Bank for a loan, it was already preparing a similar loan with the Inter-American Development Bank (IADB). That loan included a water resources and irrigation component. Bank management decided to build upon that effort by identifying rigorous prior actions in those areas.

16. The DPL was fully aligned with the Country Partnership Strategy 2012-2015. The CPS argues “restraining growth in current expenditures and enhancing public sector efficiency will be key for increasing domestic public savings” (which is in turn were needed to finance key infrastructure investments). It continues that “Sub-national governments have made important contributions to the improvement of Brazil’s fiscal position. Going forward, further support will be provided to help the Government of Brazil consolidate, disseminate and deepen this first generation of fiscal and public sector management reforms. The Bank will use investment and development policy loans to support institutional changes and policy reforms.” Rio Grande do Sul is cited as a likely candidate for such loans.

1.2 Original Project Development Objectives and Key Indicators17. The program’s stated an overall program development objective (PDO) plus those implied by the two pillars. The overall PDO was to “improve the state government’s capacity to mitigate economic volatility by supporting measures to increase resources available to the government and to reinforce the Integrated Water Resource Management framework”. It basically implied two parts: the strengthening fiscal management and the strengthening of irrigation and water resources management.

18. The main results indicators are described below:

Percentage of tax expenditure measures under Government control evaluated. Baseline (2012): zero, Target (2015) = 25 percent.

Increase in the share of tax arrears recovered within 60 days of their generation. Baseline (2012): 20.8 percent, Target (2015) = 27 percent.

Increase in the share of goods procured, expressed as a percentage of the total value of goods, using price information from the electronic fiscal invoice database. Baseline (2012): zero, Target (2015) = 25 percent.

Increase in the number of managerial cost reports prepared by Government agencies. Baseline (2012): zero, Target (2015) = 14

New policy instrument to manage contingent liabilities made effective. Baseline (2012): No, Target (2015) = Yes

Increase in the number of medium and small farmers that have adhered to the “More Water, More Income” Program. Baseline (2012): 413, Target (2015) = 3,000

Increase in the number of river basin plans prepared, approved by the respective river basin committees, including updated information on water availability and users per basin. Baseline (2012): 1, Target (2015) = 12.

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New hydro-meteorological stations installed in key river basins with information analyzed by the State. Baseline (2012): zero, Target (2015) = 80.

1.3 Revised Program Development Objectives (PDO) and Key Indicators, and Reasons 19. Not applicable, since there were no formal revisions to the operation.

1.4 Original Policy Areas Supported by the Program (as approved)20. Fiscal Strengthening and Water Resources Management. The Strengthening Fiscal and Water Resource Management Development Policy Loan was a single tranche DPL, in the amount of US$280 million. It consisted of two pillars: one focused on measures to improve the state’s fiscal position (the fiscal pillar) and the other to improve water resource management (the water management pillar). As described on Section 2.1, the fiscal pillar consisted of five prior actions (PAs), while the water management pillar consisted of three.

21. The fiscal pillar was intended to help the state reduce expenditures, increase revenues and manage debt, in order to address its looming fiscal difficulties. Two of the prior actions focused on revenues: the first aimed at reducing tax expenditures, while the second at improving tax collection rates. Two other PAs focused on reducing expenditures, by lowering procurement costs and identifying opportunities for efficiency gains in individual units of administration. The fifth prior action aimed at improving the management of contingent liabilities.

22. The irrigation and water resources management pillar was intended to strengthen the state’s key agricultural sector. Agriculture in Rio Grande do Sul is vulnerable to periodic droughts. Although hydrological and geographical conditions in the state are suited to irrigation, its potential has remained largely untapped due to a lack of investment, weak water resource management, and ineffective systems for granting water use rights. The three prior actions under this pillar were intended to address these problems. The first expands a state program of financial assistance to small farmers for the installation of dams and irrigation works. The second strengthens the capacity of the Department of Water Resources to manage water resources on the basis of individual water basins and adjudicate and issue water rights. The third was intended to improve the data on which water resources are managed by supporting the installation of hydro-meteorological stations.

1.5 Revised Policy Areas23. Not applicable, since there were no formal revisions to the operation.

1.6 Other significant changes24. Not applicable since there was changes to the operation.

2. Key Factors Affecting Implementation and Outcomes

2.1 Program performance

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25. While the program was mostly implemented, in hindsight it seems clear that the overall PDO was too ambitious and the connection with the result indicators was less tight than desired. The state achieved four out of five result targets under the program’s fiscal pillar, and one was mostly achieved. Nonetheless, the state of Rio Grande do Sul hardly improved its ability to handle economic volatility, as the impact of the deep recession on the state’s public finances during 2015-16 amply demonstrates. The link between the indicators for the fiscal component and the PDO was thus modest. Only one out of three result targets under the water pillar was achieved, while the other two were partially achieved, but the measures also had a weak link to the overall PDO.

Prior Actions StatusPA1: The Government of Rio Grande do Sul has improved its assessment procedures for new tax expenditures. Completed

PA2: The Government of Rio Grande do Sul has established procedures to guide the recovery of tax arrears, reducing processing time and prioritizing cases with high values and high probability of recovery; and criteria to measure results of tax arrears recovery actions.

Completed

PA3: The GoRS has mandated the use of price information from the electronic fiscal invoice database as a reference price to inform its procurement processes of goods. Completed

PA4: The GoRS has mandated all of its agencies that have implemented the Cost Policy and System for more than one year to prepare, as part of their annual report, a managerial cost report.

Completed

PA5: The GoRS has created a policy to identify and estimate the fiscal risks created by contingent liabilities, and prevent and mitigate their fiscal impact. Completed

PA6: The GoRS has reinforced its commitment to sustainable irrigated agriculture practices by aligning its ‘More Water, More Income’ Program with its Irrigation Policy and its Water Resources Policy.

Completed

PA7: The GoRS has strengthened the institutional capacity of its Department of Water Resources (DRH) through the approval of an enhanced staff organogram and the launch of the corresponding recruitment process.

Completed

PA8: The GoRS adhered to the National Pact for Water Management, which establishes, inter alia, targets for improving the Borrower’s legal and institutional framework for water resources; planning, information and decision support tools; and operational instruments, including water availability, water use rights, water pricing and drought preparedness plans; and signed an agreement with the Guarantor’s Water Agency committing to comply with specific water resource management targets in exchange of financial support.

Completed

2.2 Major Factors Affecting Implementation

Pillar I. Strengthening Fiscal Management26. As noted above, the fiscal component of the project was prepared and

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implemented under difficult circumstances. The time available to prepare the loan and to implement the prior actions was limited due to the deadline imposed by the upcoming gubernatorial elections. The state’s ability to improve its own fiscal situation was also limited by federal legislation. This constrained the scope of the program.

Pillar II. Irrigation and Water Resources Management

27. The implementation of the irrigation and water management component was affected by institutional factors. As discussed in Section 3.2, the implementation of two of the reform areas was hampered by institutional and design factors.

28. The progress in strengthening the institutional capacity of the Department of Water Resources (DRH) was severely hampered, however, when the contracts of temporary technical employees expired in April 2015. This was largely a case of force majeure: Brazilian law did not permit the contracts to be renewed and the state was forced to find a work-around. Nevertheless, the larger aim of this reform area was also ultimately achieved. The process for issuance water rights has speeded up and seven river basin plans have been completed and approved.

29. The failure of the state to achieve the target for the installation of hydro-meteorological stations was partly impacted by a poor indicator of the results of this reform. According to the DRH, the state has achieved almost all of the other targets agreed with ANA and has received the corresponding funding from PROGESTÃO. The Bank’s selection of a poor indicator to measure the impact of the prior action is attributable to the speed with which the operation was prepared. Perhaps more time to prepare the operation would have resulted in a more appropriate indicator.

2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization30. The result indicators were identified at appraisal and, for the most part, had clear links to the prior actions. However, indicators had a less clear link to the overall PDO, which was too broad to be justified by the prior actions of the operation. The fiscal pillar of the program was monitored by the SEFAZ, while SEMA and SEAPI monitored the implementation of the reforms under the water pillar. The M&E implementation was satisfactory, focusing on the result indicators and with clear data and information sources to facilitate data collection and monitoring.

31. Supervision missions monitored the results closely while also looking at the state’s overall fiscal condition. While the first supervision mission (October 2014) focused strictly on monitoring progress on the implementation of the prior actions and results, the two subsequent missions also monitored the state’s fiscal situation. The ISRs from the second and third missions (in March and November of 2015, respectively) rated the macroeconomic risks to the project as ‘substantial’.

2.4 Expected Next Phase/Follow 32. No further operations in Rio Grande do Sul are currently planned. Nevertheless, reforms in Federal legislation governing subnational taxation and personnel policies may create

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opportunities for state-level fiscal reform loans either to Rio Grande do Sul or to other states in the future.

3. Assessment of Outcomes

3.1 Relevance of Objectives, Design and Implementation33. The PDO was relevant to the state’s economic challenges and closely aligned with the Multi-Year Plans (PPA) of the state’s government. Mitigating the economic volatility is even more relevant today, given the unsustainable path of public finances of the state and the volatility that comes from the agriculture sector due to water issues.

34. The design of the operation with the two pillars focusing on fiscal management and water management was sound, but the PDO was too broad and ambitious. In hindsight it is clear that the PDO was too broad and ambitious, and that it was not closely linked to the prior actions and the results indicators. In fact, although the state achieved almost all of the result targets set out in the program’s fiscal pillar, this had little bearing on the achievement of the overall PDO. The result targets on the water pillars were only partially met and also had a weak link to the overall PDO.

35. Implementation arrangements by the government were satisfactory. This is reflected by the near full achievement of the targets under the fiscal pillar. While the implementation under the water pillar did not proceed as expected, as explained below, for the most part this underperformance was not due to problems with implementation arrangements. The involvement of the Bank during the implementation period was satisfactory, as reflected in the ISRs of the regular supervision missions. 36. Overall, the Relevance of Objectives, Design and Implementation is rated as modest, since while the objectives were relevant, the design of the PDO was too broad and the prior actions were too modest side to make a meaningful contribution to achieving the PDO.

3.2 Achievement of Project Development ObjectivesRating: Modest37. Overall modest progress was made towards the PDO. Although progress against the results indicators was satisfactory—with 4 out of 5 PAs of the fiscal pillar fully achieved and the remaining PA mostly achieved, and with 1 out 3 PAs of the water pillar fully achieved and the remaining two PAs partially achieved—as explained above, the overall impact in terms of the PDO was limited because the prior actions and associated targets could not have been expected to contribute meaningfully to the overall PDO.

Pillar I. Strengthening Fiscal ManagementRating: Modest38. Pillar I had a modest impact in terms of improving fiscal condition of the state. The GoRS fully achieved four of the five targets set out in the program’s fiscal pillar, and mostly achieved the remaining one. While progress in the specific areas supported by the

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operation to some extent strengthened fiscal management tools, these measures were too modest to have had a significant impact on the state’s fiscal condition in the short run. If the assumptions underlying the project’s baseline projections had panned out, that is without the deep economic downturn suffered by the country, the state’s fiscal condition would have eventually recovered. However, the PDO precisely aimed to reduce the state’s vulnerability to economic volatility and the operation clearly fell short of that.

Prior Action #1: The Government of Rio Grande do Sul has improved its assessment procedures for new tax expenditures.

39. This reform was successful on its own terms. Tax incentives have been widely used to attract investment in Rio Grande do Sul. Most take the form of reductions in ICMS obligations. These, in turn, take various forms. Roughly one-third consist of outright exemptions. Another 30 percent take the form of presumed credits (créditos presumidos)4. The remainder consist of reductions in the calculation base (reduções na base de calculo) and tax reductions aimed specifically at small enterprises5. Most exemption and reduction in the calculation base apply to all firms in a given sector (a sector can be broadly defined, such as ‘manufacture of automobiles’ or narrowly defined, such as ‘goods for the marble, travertine and granite industries’ - mercadorias destinadas a indústria de mármores, travertinos e granitos). In general, the terms of these benefits are dictated by federal law or covenants with CONFAZ. Thus the state has little ability to reduce or eliminate them.

40. But the state also provides various benefits and exemptions to individual firms through its FUNDOPEM. These generally take the form of presumed credits and have been used to attract investment in RGS. In principle, the state is not permitted to grant such incentives to individual firms. However, in fact RGS (and all other states) do so. Moreover, before the operation, the authorities and legislators did not even know what was the fiscal impact of these tax expenditures or their performance over time. The identification mission believed that most tax incentives were not cost effective, but that it would be politically impossible to persuade the state to stop giving them out at once. The operation took a first step, and good international practice in the process of reforming this area, by prompting the state to recognize how much each incentive costed and mandating impact evaluation.

41. Issuance of a service order requiring the Subsecretariat of state revenue to analyze proposed tax incentives (Service Order 005/14) constituted compliance with the prior action. Progress in implementation was tracked by counting the number of presumed credits that had been evaluated. In quantitative terms, the indicator for this prior action was far surpassed. In 2015, 63 of the 146 presumed credits currently in effect were evaluated. In 2016 (to date) 67 of the 113 presumed credits have been evaluated. The 2015 figure amounts to 43 percent of the number of presumed credits conceded, thus vastly exceeding the target for this Prior Action: 25 percent.

42. The result set for the prior action in this area was achieved and further progress continues. However, despite recent progress (the value of ICMS concessions fell by nine 4 In the administration of the ICMS, a firm’s tax obligation is calculated as the tax rate multiplied by the gross value of the firm’s sales, less a credit for the amount of ICMS paid on inputs to the firm by its suppliers. A crédito presumido allows the firm to increase the value of the credit over the amount that was actually paid, thus reducing the firm’s tax obligation. 5 A reduction in the tax basis drops the assessed value of the firm’s sales.

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percent between 2014 and 2015 in real terms and the number of new sectoral concessions reduced), the current value of fiscal incentives is nine percent higher than it was in 2012 (in real terms). More recently, on June 3, 2015, the state governor sent the Assembly a bill (Draft Law no. 214/2015) to reduce presumed credits in all sectors by 30 percent but it has not been approved yet.

Prior Action #2: The Government of Rio Grande do Sul has established procedures to guide the recovery of tax arrears, reducing processing time and prioritizing cases with high values and high probability of recovery; and criteria to measure results of tax arrears recovery actions.

43. Overdue taxes amounted to R$ 30 billion in 2012, equivalent to 121 percent of annual tax revenues. Some of the causes of the high level of tax arrears were beyond the control of the state government, such as the protracted decisions of the judicial system. However, other reasons behind the poor performance of collection of tax arrears, such as inefficiencies in the procedure to enforce payments were susceptible to state intervention.

44. The indicator for this prior action focuses on results. It tracks the share of tax arrears recovered within 60 days of their generation. This was targeted to increase from 21 percent to 27 percent6. As of the first supervision mission, the state had increased the number of firms under the Special Regime of Inspection (Regime Especial de Fiscalização - REF) and was planning to list all firms owing more than R$ 500 in SERASA7. In addition, the state had set up an electronic communication system with notaries (tabelionatos) to facilitate issuance of ‘protestos de bens de devedores’ (a form of lien on title). The expanded role of notaries has been subsequently enshrined in Normative Instruction 026/ 2016, amending the regulations governing state tax collection (Normative Instruction 045/1998). The aide memoire of the second supervision mission also reported that a ‘pilot for stratification of debtors’ had been completed. The third supervision mission reported that a second pilot project, aimed at identifying targets using indicators, had been implemented successfully.

45. As a result of these efforts the target collection rate had been achieved by the third supervision mission: 28.6 percent of the arrears generated two months prior had been collected. More recent figures covering the period January-August 2016, show further improvement: the proportion of new arrears that have been recovered stands at 41 percent. The state is now working on recovering part of the stock of older tax arrears8.

Prior action #3: The GoRS has mandated the use of price information from the electronic fiscal invoice database as a reference price to inform its procurement processes of goods.

46. At the time DPL was under preparation, Rio Grande do Sul had already made advances in procurement practices with Bank support. In the 2008 DPL, the Bank

6 Note that this indicator was designed to measure the state’s success in controlling the growth of new arrears — rather than recovering past arrears. Thus, it measures the proportion of arrears generated in the last 60 days that have been collected, rather than the proportion of total arrears that have been collected.7 SERASA is a privately-operated website that allows merchants, banks, etc. to check whether an individual has outstanding arrears to the state tax authorities.8 Although R$ 40 billion in arrears is registered as Dívida Ativa, the state only considers R$ 12 billion of this to be collectible. To date, R$ 1.35 billion of the old stock has been collected. Dívida Ativa is indexed, so that the $40 billion figure represents its value in current R$, rather than its original values.

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supported the strengthening of the central procurement unit, which promoted the adoption of more modern procurement methods such as reverse price auctions and a price registry. According to the PD for 2014 DPL, the next step forward was to improve the way the state government obtained price information. At the time of loan preparation, the state had no structured price survey to inform its procurement process. Instead, the employee responsible for the procurement process had to conduct a phone survey with three suppliers, identifying himself and thus biasing the survey. As a result, it is expected that the procurement processes in general started with prices set at above-market prices. To resolve this problem, the state decided to draw on the electronic fiscal invoice database that registers the price of all transactions subjected to ICMS taxation. This information would be passed to procurement staff, who would use it to set initial prices and to negotiate further discounts in case these prices diverged significantly from the ones in the database.

47. At the time, the Government was already using this information on a pilot basis. In order to expand its usage, it was gradually including bar code information in its procurement catalog. This would enable it to match the bar codes it had in its procurement catalog with the bar code provided by the suppliers and make sure the correct price information was being used.

48. The Bank sought to reinforce these measures through a prior action. As in Prior Action 2, the indicator for this component focuses on results. The indicator was ‘increase in the share of goods procured using price information from the electronic fiscal invoice database, expressed as a percentage of the total value of goods procured.’ This was targeted to increase from zero percent to 25 percent.

49. As of the first supervision mission, this process was well underway in the health sector. Prices for 120 items had been obtained, resulting in a savings of R$ 31 million. 9 There was little progress on other types of goods in the state procurement catalogue, however. This finding was repeated in the aide memoires of the second and third supervision missions. Nevertheless, by the third supervision mission, the state had far exceeded the target indicator for this prior action: 51 percent of goods were being procured using NF(e) compared to a target of 25 percent. As shown in Table A2-4 in Annex 2, this was entirely due to the pricing of pharmaceuticals. While the proportion fell slightly in 2015 and 2016, this was due to growth of the denominator; i.e., non-pharmaceutical purchases. Overall, this Prior Action was highly successful in reducing procurement costs in the health sector, but had limited impact in other sectors10.

Prior Action #4: The GoRS has mandated all of its agencies that have implemented the Cost Policy and System for more than one year to prepare, as part of their annual report, a managerial cost report.

50. At the time DPL was prepared, the state government did not have accurate and

9 These savings on pharmaceuticals represent 5.3 percent of total state spending on pharmaceuticals in 2015 but only 0.1 percent of net current revenues in that year. Data on savings in subsequent years is not available. 10 It should be noted some issues in pharmaceutical pricing still remain. These involve IPERGS (the pension and health fund for employees). At present, the private hospitals serving IPE patients purchase drugs at market prices but charge IPERGS a much higher price. However, the problems will not be easily solved. State officials claim that IPERGS cannot simply lower the price it pays private hospitals for drugs, since the mark-ups on drugs compensate for the extremely low rates that IPERGS pays for diárias (daily charges for hospital stays).

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detailed information on the costs of each of its 20,000 lowest-level administrative units . As a result, it was difficult to measure the cost effectiveness of each unit. In conjunction with project preparation, the state government, through its internal control agency (CAGE) requested all 14 line secretariats to implement ‘a costing policy and system’ and to produce managerial reports using costing data. This was reflected in the fourth Prior Action by counting the number of managerial cost reports prepared by the secretariats.

51. As of the first supervision mission, CAGE had issued a circular requiring each secretariat to present a cost report. Only two (SEFAZ and SEPLAG) had sought the assistance of CAGE. CAGE had not actively pursued any of the others and believed that none of the others had taken any action on their own. Since then, there has been some progress. CAGE has prepared a list of 64 governmental organs11 that are now expected to produce reports. It has completed training exercises in 36 of them and is in the process of training another ten. Of those that have completed training, ten are awaiting the production of the detailed data for 2015, leaving 26 that have both completed training and have the 2015 data available. Of these, half (13) have submitted reports (See Table A2-4 in Annex 2). The mission was informed that 13 secretariats did not report any analysis using the data, such as the Secretariat of Education and the Secretariat of Public Works, although they are listed among the organs that have undergone the training.

52. Each of these reports is intended to show a breakdown of costs by spending unit, showing spending on personnel, goods, utilities, and rent. To varying degrees, the reports also describe actions that each organ has taken to improve expenditure efficiency. Some organs have been more ambitious than others. For example, the Secretariat of Labor and Social Development (STDS) reports that, in 2015, its principal accomplishment was to ask the director general to create a working group to prepare an official set of directives setting out the internal procedures (regimentos internos) to be used to enable the secretariat to force certain departments to provide the detailed breakdown of their costs. Other reports are more specific. The report for the department of prisons notes that during 2015, it revised the rental contracts for various facilities of the department with an eye to reducing rents and using buildings belonging to the public sector, whether they belong to the prison department itself or not.

53. Overall, the results expected were achieved: a system for reporting cost data by administrative units has been put in place and 13 management reports have been issued. This has the potential of improving expenditure efficiency if policy makers take on the recommendations of those reports. Some of the preliminary reports suggest substantial reductions (in percentage terms) in the spending of some individual spending units. The report of the state agency for the regulation of delegated public services (AGERGS), for example, cites a 36 percent drop in spending on printer cartridges, due to the introduction of an electronic filing system that renders printed documents unnecessary.

Prior action #5: The GoRS has created a policy to identify and estimate the fiscal risks created by contingent liabilities, and prevent and mitigate their fiscal impact.

54. The state government had R$ 68 billion in contingent liabilities in September of 2016, more than twice the level of net current revenues. The vast majority of these liabilities

11 The term organ (órgão) includes not only secretariats but also various decentralized units of administration.28

consist of judicial claims by public employees arising from disputes over wage increases.

55. At the time of project preparation, the Bank mission believed that the state lacked control over the managerial decisions that could give rise to future contingent liabilities. To address this problem, the state instituted a working group to propose a policy that would focus on control and prevention, identifying and monitoring contingent liabilities as well as estimating their impact. The state also planned to introduce accounting rules that would require such liabilities to be recorded in the balance sheet and might be part of the net consolidated debt capped by the Fiscal Responsibility Law (FRL). It was expected that the development and implementation of such a policy would result in a more comprehensive understanding of the state’s fiscal situation and a reduction in future contingent liabilities.

56. As of January 2014, the state assembly had issued a decree requiring all state organs to provide reports on contingent liabilities to the Subsecretariat of the Treasury12. SEFAZ had also created a special unit in the Subsecretariat of the Treasury that would work with the report and manage contingent liabilities more aggressively. By the second supervision mission, Treasury had completed its first report on contingent liabilities. It has now completed its second.

57. In the policy matrix, the result indicator tracked whether the policy instrument had been made effective. The system is now in place enabling a better control over contingent liabilities which are consolidated in a single report and with changes in flow reported by the new system on a regular basis.

Pillar II. Irrigation and Water Resources Management:

Rating: Modest

58. The performance of the Pillar II was modest. The pillar specified three prior actions, for which the results indicators were fully achieved for one and only partially achieved for the remaining two. Even though there was progress in some of the areas, as discussed below, it is not straightforward to identify how much impact this progress might have in terms of the fulfillment of the PDO.

Prior action #6: The GoRS has reinforced its commitment to sustainable irrigated agriculture practices by aligning its ‘More Water, More Income’ Program with its Irrigation Policy and its Water Resources Policy.

59. As noted earlier, irrigation holds considerable promise in Rio Grande do Sul. Nonetheless, less than seven percent of rural properties have irrigation facilities. At the time the DPL was prepared, the State Government had already taken some steps to promote irrigation. An Irrigation Policy Law had been adopted, setting out the principles, objectives and instruments of state intervention in the sector. The Law called for a statewide ‘Master Plan for Irrigation in the Context of Multiple Water Uses in Rio Grande do Sul’ (PIUMA) which was to include a diagnosis of the current condition of irrigated agriculture and its potential for sustainable growth, based on a set of parameters including projections of water availability and demands of other water users. PIUMA was also expected to yield guidelines and priorities for the granting of water use rights and environmental licensing for the irrigated agriculture sector. 12 Decree no. 51,153, of January 24th, 2014. ‘Institui o Sistema de Gestão de Passivos Contingentes do Estado do Rio Grande do Sul’.

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60. In May 2013, the state assembly approved legislation (Law 14.244/2013) aimed at encouraging small and medium scale farmers to construct small reservoirs (less than 10 ha) and small irrigation system (less than 100 ha). While the program, termed ‘More Water, More Income’ (Mais Água, Mais Renda) relies on federal lines of credit (e.g. the National Program for Strengthening Family Agriculture (PRONAF) to provide financing, More Water, More Income assists candidates in obtaining the environmental licenses and water rights required to apply for federal loans and then reimburses farmers for part of the costs of amortizing them. In the case of small scale farmers, the program pays 100 percent of the first and last payments.

61. Enactment of the legislation creating the More Water, More Income program was considered to constitute compliance with the prior action. Progress was to be measured in

terms of the number of medium and small farmers joining the program. From a base of 413 landholders, it was expected that 3,000 small/medium landholders would join by the end of 2015. As of December 2016, 3,096 landholders had joined the program (of which 56 percent were small landholders and 22 percent were medium landholders; while a further 618 applicants were awaiting approval)13. There is evidence that the administration of the program has improved substantially. The program is now conducted by a group of dedicated professionals, who follow clear procedures. Processing time has been drastically reduced, from years to some weeks, largely due to the introduction of a computer-based system for processing applications (Box 1). It is also noteworthy that the total land area under irrigation has increased by 72,000 ha (69 percent)14.

Prior action #7: The GoRS has strengthened the institutional capacity of its Department of Water Resources (DRH) through the approval of an enhanced staff organogram and the launch of the corresponding recruitment process.

62. The DRH plays a key role in the implementation of state water policy. It is responsible for issuing water use rights and providing technical assistance to the State Water Resources Council in the coordination, implementation, supervision and preparation of the

13 The authorities are revising the process of issuing environmental licenses (expected in April 2017) which should contribute to clear the backlog in landholders waiting for approval).14 Over time some of the criterias under the program have been revised. The initial goals were overestimated since there was no benchmark for comparisons. Farm irrigation was not common in Rio Grande do Sul, but in the last few years irrigation is becoming increasing common. In parallel the program adopted new monitoring parameters, in line with the limits imposed by the environmental agency. While farmer’s decision to invest in irrigation is largely outside the control of SEAPI, the irrigated area in the state doubled over the past four years with the program being directly responsible for 69 percent increase and possibly acting as a catalyzer for the rest of the expansion.

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Box 1: Computerizing the Water Rights Application Process

The digital water-user registry and water-use rights issuance system (cadastro de usuário de recursos hídricos e emissão de outorgas) was launched in December 2015, replacing the old manual process which was responsible for the long delays in the process. With the new system, applicants may be issued a right of use certificate immediately. (Complex applications still take up to six months.) The new system will also expedite the analysis of projects by SEAPI. The system is accessible through internet at www.siout.rs.gov.br.

http://www.siout.rs.gov.br/

State Water Resources Plan. It also prepares river basin plans or supervises and approves the work of consultants hired for that purpose. During DPL preparation, it became evident that the DRH lacked the managerial and technical capacity to perform these roles. This was largely due to staffing limitations imposed by the Fiscal Responsibility Law and the state’s own inability to offer competitive salaries.

63. Delays in obtaining water rights were discouraging farmers from undertaking irrigation projects under the More Water, More Income program, as water rights (along with environmental licenses), were required for each new project. The environmental license granted by SEMA is restrictive and hampers the expansion in irrigated areas. The SEAPI is currently discussing with the SEMA possible ways to make the license more flexible (SEMA Resolution no. 323/2016), and this process is expected to bring results after April 2017. The state eventually developed a work-around: DHR, the Secretariat of Environment, (SEMA) and the Secretariat of Agriculture, Livestock and Irrigation (SEAPI) agree to allow SEAPI to approve projects under simplified conditions fixed by SEMA and DRH. Nevertheless, staffing constraints remained, although 12 employees were given to DRH (6 from FEPAM and 6 from SEAPI).

64. Progress in preparing river basin plans was also slow. Along with agriculture, state waters are used to supply the demand for human and industrial consumption, power generation and navigation. River basin plans were needed in order to improve water allocation and minimize potential conflicts among these uses and to establish targets for water quality recovery to allow multiple water use as established by the Water Policy15.

65. The DPL addressed these problems in two ways. First, it prompted the state to revise its staffing plan for technical and scientific positions (Quadro dos Funcionários Técnico-Científicos do Estado) to include specialists in the relevant sectors. Enactment of the revision (Law 14.477/2015) was considered to constitute with the prior action. Second, it set a target for the completion of river basin plans and tracked it during project supervision.

66. While the state did enact the legislation, the situation did not immediately improve. Progress on the river basin plans nearly ground to complete halt in April 2015 when the contracts of the temporary personnel who formed the majority of DRH’s workforce expired and could not be renewed. By the third and final supervision mission (November 2015), however, the situation had improved significantly. After some months, the new SEMA and DRH administrations finally found a means to recruit and train personnel, as well as to implement a new digital system to process water applications (See Box 1, above.) Seven of the twelve proposed river basin plans had been finished and approved by river basin committees. Although the target had not fully been met at the completion of this ICR, the remaining plans were well under way.

Prior action #8: The GoRS adhered to the National Pact for Water Management, which establishes, inter alia, targets for improving the Borrower’s legal and institutional framework for water resources; planning, information and decision support tools; and operational instruments, including water availability, water use rights, water pricing and drought preparedness plans; and signed an agreement with the Guarantor’s Water Agency committing to comply with specific water resource management targets in exchange of financial support.

15 According to the Resolution CRH no. 211/2016, it is expected the procurement of 15 additional plans in 2017.31

67. The State has committed to enhancing its Water Resource System in a more comprehensive way by adhering to the National Pact for Water Management (PROGESTÃO). This is a results-based program designed and implemented by the National Agency of Water (ANA) that helps the States to define the current level of development of their Water Resources System, as measured against the objectives and instruments established by the Federal Water Resources Law, and define annual targets for a five-year period, which are discussed and approved by the State Water Resources Council. This agreement between the State and the Federal level requires the State to benchmark itself against other states and was expected to lead to substantial measurable improvements in the State’s legal and institutional framework for water resources; planning; information and decision support tools; and operational instruments (e.g. water use rights, water pricing, drought preparedness plans etc.). It came with some financial support from the Federal level to help achieve the targets, but it required primarily that the State coordinate the different interventions of the public sector related to water resources management.

68. The enactment of legislation formally entering the state into the federal program (Decree 50.741/2013) was considered to constitute compliance with the prior action. The prior action was to be monitored using one of the measurable annual targets set by the agreement with ANA: the installation of 80 hydro-meteorological stations in key river basins.

69. At the time, the DPL closed only 27 of the targeted 80 stations had been installed. The state claimed that it was still studying where the remaining stations should be located. DRH therefore decided to rely instead on existing data collected by public and private institutions The state intends to revise its agreement with ANA accordingly.

3.3 Justification of Overall Outcome Rating

Rating: Moderately unsatisfactory 70. The results in the first pillar were all fully achieved and those in the second pillar were only partially achieved. But given the rather weak link between prior actions, results and the overall PDO, the overall rating is set at moderately unsatisfactory.

3.4 Overarching Themes, Other Outcomes and Impacts71. Poverty Impacts, Gender Aspects, and Social Development. The project was expected to have a positive impact on the poor, both directly through actions supported by the water sector pillar and indirectly, through actions supported by the fiscal reform pillar.

72. While poverty rates are considerably lower in Rio Grande do Sul than in Brazil as a whole, relatively high poverty rates are found at the Northwest and West Central areas of the state, where small landholdings and family farmers predominate. These farmers are highly vulnerable to cyclical droughts as their earnings rely mostly on rain-fed or dry-land farming. Historically, they have lacked sufficient capital to invest in the water storage and irrigation works needed provide a more reliable water supply. The More Water, More Income program supported by the DPL was intended to address this problem by assisting small farmers in applying for federal credit under the PRONAF program, and then subsidizing their debt service. While the number of successful applicants was smaller than originally expected, there

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is evidence that the program is reaching its target population.

73. The poverty impact of the operation’s fiscal pillar is more difficult to measure. Improving the state’s fiscal situation would clearly have benefitted the poor as it is they who rely most on state public services. According to the Poverty and Social Impact Analysis undertaken for the operation, education is a major determinant of poverty in the state. The state government is responsible for slightly over half of primary and secondary education in Rio Grande do Sul, measured in terms of public school enrollment. Through its net contributions to FUNDEB, the state also supports the municipal schools that serve the other half.. If the fiscal pillar had been more successful in improving the state’s fiscal situation, levels of funding for education, as well as other services that the poor rely upon, could have been increased.

74. Institutional Change/Strengthening. Both project pillars have strengthened institutional capacity in Rio Grande do Sul. The fiscal pillar, for example, prompted the state to begin systematically gathering price data in the health sector, resulting in subnational savings in pharmaceutical procurement. Similarly, the water resources pillar strengthened the legal and institutional framework for water resources planning, information and decision support tools.

3.5 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops75. Not applicable.

4. Assessment of Risk to Development OutcomeRating: Significant

76. The specific management and administrative reforms supported by the loan fiscal pillar are likely to be sustained. Given the magnitude and intractability of the state’s fiscal crisis, Rio Grande do Sul is likely to have a continued interest in scrutinizing future tax concessions, cracking down on delinquent taxpayers, reducing procurement costs, improving the management of individual administrative units and tracking contingent liabilities.

77. Nevertheless, these actions may have only a modest impact on the state’s fiscal condition over the medium term. Whether the fiscal pillar’s development objectives will be sustained largely depend on factors that were not part of the scope of the operation and in some case out of the control of the state itself. These include federally imposed exemptions on the taxation of state exports and federally imposed pension benefits —particularly for workers that were hired before August 2016, period in which it was constituted the Complimentary Pension Fund (RS-Prev Fund) for the state’s servants that would be hired from that moment on, thereby limiting pensions payed by the state Treasury to the maximum benefit of the General Social Security Regime (RGPS – Regime Geral de Previdêncial Social); the continued existence of extensive tax incentives for broad sectors of the state’s economy and continuing low rates on certain major sectors of the ICMS base, as well as increases in staffing levels and in the level of individual salaries. As a result, the risks to the program’s fiscal objectives is rated as significant.

78. Given the importance of agriculture to the state’s economy, support the Water Resources Pillar is likely to be sustained. There are some risks to the long term prospects of the More Water, More Income, however. While the state has managed to overcome the

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administrative problems that faced the program at the outset, there is now some doubt that it will pay first block of subsidies due to farmers who joined the program in 2013 and those due in the coming years. A default may cause loss of credibility of the Program. As to the Water Resources Management component, the risk is considered to be low since the Water Resources Department (DRH) has the support of the Administration to continue the implementation of the Water Resources and Dam Safety Policies. Technical and administrative capacity is now implemented. The financial resources flow to DRH is guaranteed by law and seems to be sufficient to cover the present and future activities. By progressively coping with demands from water users and with the commitments required by law, this component of the DPL Program will offer no significant risk to development outcome.

5. Assessment of Bank and Borrower Performance5.1 Bank Performance

(a) Bank Performance in Ensuring Quality at Entry

Rating: Moderately Unsatisfactory

79. The Bank’s decision to go ahead with the operation within a timeframe dictated by the political calendar meant that opportunities for substantial reform might have been missed. The program could have pushed for an increase in ICMS rates or a reduction in fiscal incentives, or other expenditure containment and rationalization measures, which would have an immediate fiscal impact. With a more generous timetable, the state government might have had time to reach an accommodation among the relevant political actors and implement such reforms. The timetable was indeed rushed. The first identification mission visited Porto Alegre in early October, 2013. This was followed by a preparation mission in November, 2013 and an appraisal mission in February of the following year. Within this period, the team was required to identify, help prepare, and appraise the various components of the operation. In doing so, the team benefited from the Bank’s thorough familiarity with the state and its institutions, arising from the long relationship the Bank has had with Rio Grande do Sul. The team also benefited from analytical and prescriptive materials, as set out in the PD. Throughout the project preparation stage, the team maintained an intense technical dialogue with the state. The state’s own ability to act was in part constrained by federal legislation.

80. The same applies to the water management pillar. The team preparing this component had little time to analyze the various policy documents produced by the state. Although the team was well aware of the principles and mechanisms adopted by the National Water Agency under the PROGESTÃO program, it had little time to analyze the details of the state’s agreement under the program. It also did not have time to flag the staffing problems that arose early in project implementation and delayed applications to the “More Water, More Income” program as well as the production of river basin plans.

81. While the Bank’s team should be credited with making the best of a difficult situation, an overly ambitious PDO created the design shortcomings discussed in this ICR.

(b) Quality of Supervision

Rating: Satisfactory

82. The Bank conducted three supervision missions to the state: in October of 2014 34

and in March and November of 2015. These missions, quite rightly, focused on the implementation of the reforms supported by the prior actions and tracked through the performance indicators. The usefulness of the supervision missions is perhaps best illustrated by the steady progress toward those targets after the loan became effective. In addition, in the face of the economic crisis, the dialogue on fiscal policy issues strengthened considerably with the new government that was elected in late 2014.

(c) Justification of Rating for Overall Bank Performance


83. The Bank’s overall performance is rated moderately unsatisfactory. Within the constraints under which it was prepared, the project addressed several problems in the fiscal and water sectors in a manner that is likely to be sustained. But the program’s impact on the overall PDO and thus the state’s fiscal situation was modest. The operation did not address key underlying causes of the state’s fiscal problems. On the water side, while significant progress toward the results was made, the targets were not fully met. On the other hand, the work done under this ICR shows that progress on the results set for this operation will continue.

5.2 Borrower Performance

(a) Government Performance


84. The borrower was the Government of Rio Grande do Sul. Within the confines of the DPL’s limited ambitions, the GoRS did its part. The government complied with the prior actions, issuing all the required decrees between December 2013 and the end of March 2014. It issued the regulations and directives specified in the program’s prior actions with alacrity. And it also continued committed through the implementation and monitoring of results, providing all information needed for supervision in a timely and consistent manner. However, the administration that was in office at the time the loan was prepared can be faulted for its lack of ambition; specifically, its reluctance to undertake fundamental fiscal reforms. The state administration could have proposed the sort of fiscal reforms cited in the paragraphs above, but political considerations prevented it from pursuing more difficult measures. In addition, the government did not fully achieve the targets it had committed to under the water pillar.

(b) Implementing Agency or Agencies Performance

Rating: Moderately Satisfactory

85. The implementing agency was the Secretariat of Finance (SEFAZ). Other agencies involved included the Office of the Accountant and Auditor General (CAGE), the Secretariat of Agriculture, Livestock and Irrigation (SIAPI) the Secretariat of Environment and Sustainable Development (SEMA) and the Department of Water Resources (DRH).

86. SEFAZ played a key role in coordinating the fiscal components of the program. SEFAZ was directly responsible for setting the modest measures agreed under the fiscal pillar. Nevertheless, with respect to the fiscal pillar, SEFAZ and its subordinate agencies, along with CAGE, did a creditable job, as evidenced by their success in achieving the five targets in this component. For purposes of this ICR, it would have been useful to analyze their work in greater

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detail—particularly the analyses of proposed tax concessions (Prior Action 1) and the results of the managerial cost reports (Prior Action 4). Unfortunately, the analyses of proposed tax concessions could not be released to the ICR mission due to confidentiality concerns. The thirteen managerial cost reports that have been completed so far were released to the mission. Many of these contain specific proposals for cost savings in forthcoming years. The mission did not have time to discuss the reports with the individual agencies to determine whether these proposals are likely to be implemented.

87. In the water resource component, SEAPI and SEMA worked successfully together to establish procedures for implementing the new legislation, including the State Irrigation Policy. As noted earlier, they were particularly instrumental in solving the cumbersome and time-consuming process for obtaining environmental licenses and water-use rights by farmers who were interested in changing from the traditional rain-fed agricultural practices into more efficient irrigation practices. While DRH may bear some of the blame for its staffing difficulties—it should have foreseen the problem—culpability also lies with the state’s overall fiscal situation, which together prevented DRH from rapidly filling the positions vacated by the departure of temporary staff.

(c) Justification of Rating for Overall Borrower Performance Borrower/implementing agencies


88. The government did its part in issuing the regulations and directives specified in the program’s prior actions. The implementing agencies can be credited with achieving most of the targets in the fiscal pillar and making substantial progress on the targets in the water pillar. Nevertheless, the overall performance of the borrower is rated moderately unsatisfactory, due to the state’s lack of commitment to undertake more substantial fiscal reforms and the inability to achieve the targets under the water pillar.

(b) Cofinanciers89. Not applicable.

(c) Other partners and stakeholders90. Not applicable.

6. Lessons Learned91. The Bank should consider the high risks involved in making these operations available close to elections. In this specific case, if the operation had been delayed until after the election when the governor was enjoying a brief respite from the short term priorities of the campaign, more ambitious reforms might have been possible.

92. Budget support operations targeting medium-term fiscal improvements while providing short-term liquidity support should seek to leverage maximum impact from structural measures, particularly when structural spending pressures are evident.

93. Where national legislation prevents a state government from undertaking key reforms, every effort should be made to change the national legislation in conjunction with the operation. The analysis of the fiscal situation of RGS highlighted that there are some

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core issues that need to be addressed at the federal level, notably related to the wage bill and the pensions. It is unclear however from the program document whether these issues were raised at the federal level as a prerequisite for the operation to be feasible. Given that the STN was directly involved in the selection of this operation, this might have been a good opportunity to deepen the dialogue on fiscal policy at the federal level as well. It should be acknowledged, however, that there were no signs of appetite for such a dialogue at the time.

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Annex 1. Bank Lending and Implementation Support/Supervision Processes

(a) Task Team members

Names Title UnitLending (from the Program Document)

Rafael Chelles Barroso (TTL) Senior Economist GMF01Ernesto Sanchez-Triana Lead Environmental Specialist GENDRAlberto Coelho Gomes Costa Senior Social Development Specialist GSU04Paula Pedreira de Freitas de Oliveira

Senior Water Resources Spec. GWA04

Marcos T. Abicalil Senior Water & Sanitation Spec. GWA04Roland N. Clarke Program Leader LCC5CFrederico Rabello T. Costa Senior Procurement Specialist GGO04Angela Nieves Marques Porto Consultant GGO16Joseph Kizito Mubiru Lead Financial Management

SpecialistGGO22

Monica Moura Porcidonio Silva

Program Assistant LCC5C

Erwin De Nys Program Leader LCC1CSupervision (from the ISRs)

Antonio Nucifora (TTL) Lead Economist GMF04Paula Pedreira de Freitas de Oliveira

Senior Water Resources Spec. GWA04

Marcos T. Abicalil Senior Water & Sanitation Spec. GWA04Eduardo Franca de Souza Financial Management Specialist GGO22Frederico Rabello T. Costa Senior Procurement Specialist GGO04Fabio Sola Bittar Research Analyst LCC5CErwin De Nys Program Leader LCC1CGunars H. Platais Senior Environmental Economist GEN04

(b) Staff Time and Cost

StageStaff Time and Cost (Bank Budget Only)

No. of staff weeks USD Thousands (including travel and consultant costs)

Lending 41.28 166.40Supervision 21.08 139.71Total: 62.36 306.11

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Annex 2. Detailed Description of Implementation of each Prior Action

Prior Action #1: The Government of Rio Grande do Sul improved its assessment procedures for new Tax Expenditures.

1. Tax incentives have been widely used to attract investment in Rio Grande do Sul. Most take the form of reductions in ICMS obligations. These, in turn, take various forms. Roughly one-third consist of outright exemptions. (See Table below.) Another 30 percent take the form of presumed credits (créditos presumidos)16. The remainder consist of reductions in the calculation base (reduções na base de cálculo) and tax reductions aimed specifically at small enterprises. Most exemption and reductions in the calculation base apply to all firms in a given sector (a sector can be broadly defined, such as ‘manufacture of automobiles’ or narrowly defined, such as ‘goods for the marble, travertine and granite industries’ - mercadorias destinadas a industria de marmores, travertinos e granitos). In general, the terms of these benefits are dictated by federal law or covenants with CONFAZ. Thus, the state has little ability to reduce or eliminate them.

2. But the state also provides various benefits and exemptions to individual firms through its FUNDOPEM. These generally take the form of presumed credit and have been used to attract investment in RGS. In principle, the state is not permitted to grant such incentives to individual firms. But in fact RGS (and all other states) do so. The identification mission believed that most tax incentives were not cost effective, but that it would be politically impossible to persuade the state to stop giving them out. The Bank mission therefore adopted a more modest objective: to prompt the state to recognize how much each incentive cost and impact it was likely to have.

3. As shown in Table II-1, the value of these tax exemptions (desonerações fiscais) from the ICMS alone is immense, totaling R$ 8 billion in 2015. This was equal to 30 percent of gross ICMS revenues in that year, or 23 percent of the total ‘potential revenue’ from this tax. As shown in the Table A2-2, exemptions from other taxes bring the total value of tax exemptions up to nearly R$ 9 billion.

Table A2-1: Estimates for ICMS Tax Expenditures in Rio Grande do Sul - 20152015

R$ millions, nominal values % of total exemptionsExemptions 2,729.8 33.8%Presumed Credits 2,506.1 31.1%Microenterprises and EPPs 1,525.7 18.9%Calculation Base 1,303.0 16.2%

Total ICMS Tax Expenditures 8,064.6 100.0%Source: Receita Estadual/Secretaria da Fazenda do RS

16 In the administration of the ICMS, a firm’s tax obligation is calculated as the tax rate multiplied by the gross value of the firm’s sales, less a credit for the amount of ICMS paid on inputs to the firm by its suppliers . A crédito presumido allows the firm to increase the value of the credit over the amount that was actually paid, thus reducing the firm’s tax obligation. A redução na base de calculo reduces the assessed value of the firm’s sales.

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Table A2-2: Estimate of Revenue Losses Due to Tax Exemptions (R$ million)

Tax Collection Exemptions (a) Potential Tax

Collection (b) % loss

ITCD 2014 329.8 92.3 422.1 21.88%2015 632.1 129.3 761.4 16.98%

IPVA2014 2,239.0 732.5 2,971.5 24.65%2015 2,426.6 791.9 3,218.5 24.60%

ICMS2014 25,854.2 8,155.3 34,009.5 23.98%2015 27,125.9 8,064.6 35,190.5 22.92%

Total2014 28,423.0 8,980.2 37,403.2 24.01%2015 30,184.6 8,985.7 39,170.3 22.94%

Source: Receita Estadual/Secretaria da Fazenda do RS

4. Historically, the costs and benefits of tax incentives were not analyzed in any depth. At the time the loan was under preparation, tax expenditure pledges were received by the state secretariat of finance (SEFAZ) and then submitted, although not formally, to the Secretary and the Governor for a decision. The state intended to improve this process by issuing a regulation requiring ‘all tax expenditures pledges to be evaluated ex-ante, specifying (1) a clear objective and (ii) at least one effectiveness indicator. In addition, the GRGS committed to periodically reevaluating these tax expenditures and formally submitting the results of such evaluations to the Secretary. This policy was to be effective for new tax expenditures, but was expected to eventually encompass most of the tax expenditures since current tax expenditures had expiration dates and would have to go through the new process to be renewed.

5. The prior action was defined as: ‘the Government of Rio Grande do Sul has improved its assessment procedures for new tax expenditures’. The indicator was defined as: ‘percentage of tax expenditure measures under Government control evaluated according to the new procedures’. That percentage was to be calculated as the as value of tax incentives subjected to evaluation divided by the total value of tax incentives conceded during the period under review. (Note that the phrase ‘under Government control’ relieved the state of the burden of analyzing the various concessions imposed by federal law and CONFAZ. As such, the analysis has been largely limited to presumed credit.)

6. Prior to the first supervision mission, the state government had issued Service Order (SO) 005/14, of March 24, 2014, which was intended to provide the framework for the evaluation of fiscal incentives. Although the official summary of the SO states that it establishes ‘procedures for tax exemptions’ (procedimentos relativos às desonerações fiscais) it is, in fact, very general, stating merely that tax exemptions will be analyzed and setting general criteria for these analyses. No more detailed manual for evaluation has since been prepared. A working group to analyze tax expenditure policy was constituted informally in April 2015 but has not yet been formally constituted.

7. Nevertheless, some analyses of tax concessions have been performed. In 2015, 63 of the 146 presumed credit currently in effect were evaluated. In 2016 (to date) 67 of the 113 presumed credit have been evaluated. (The ICR mission did not have access to these evaluations, because they contain information on individual firms. As a result, the quality of the

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evaluations cannot be assessed). The 2015 figure amounts to 43 percent of the number of presumed credit conceded, thus vastly exceeding the target for this Prior Action: 25 percent.

8. There is some evidence that that the volume of tax concessions has at least stabilized since this DPL went into effect. As shown in Table II-3 below, the value of ICMS concessions shrank by nine percent between 2014 and 2015 (in real terms). At the same time, the number of new sectoral concessions has shrunk. Only one new sectoral incentive (for wine) has been conceded this year. And less than half the firms that are eligible for FUNDOPEM benefits are in fact taking advantage of them. Nevertheless, the current value of fiscal incentives is more than nine percent higher than it was in 2012 (in real terms) and the state assembly shows little inclination to cut fiscal incentives further. On June 3, 2015, the government sent the Assembly a bill that would reduce presumed credit in all sectors by 30 percent. Although more than a year has passed, the Assembly has yet to consider the proposal.

Table A2-3: Evolution of ICMS Tax Expenditures – Estimates (R$ million)Year Tax Collection Exemptions ICMS Potential % loss

2003 8,988.8 1,775.2 10,764.0 16.49%2004 9,637.9 2,242.7 11,880.7 18.88%2005 11,382.9 2,274.7 13,657.6 16.65%2006 11,813.3 2,633.6 14,446.9 18.23%2007 12,257.7 3,036.3 15,294.0 19.85%2008 14,825.2 3,789.0 18,614.2 20.36%2009 15,086.7 3,637.0 18,723.7 19.42%2010 17,893.3 4,724.4 22,617.7 20.89%2011 19,502.9 5,683.0 25,185.9 22.56%2012 21,378.2 5,992.1 27,370.3 21.89%2013 24,060.6 6,759.3 30,819.9 21.93%2014 25,854.2 8,155.3 34,009.5 23.98%2015 27,125.9 8,064.6 35,190.5 22.92%


9. As such, the Bank’s ultimate objective in incorporating this prior action into the loan -- to reduce the number of volume of tax concessions — has been partially achieved — in the sense that the volume of concessions under state control has at least stabilized. It is not clear that this impact is entirely due to the loan, however. It is likely that the state, in an increasingly desperate fiscal situation, has been compelled to cease granting tax concessions, simply because it needs every cent it can get. Similarly, the decline in the volume of concessions to individual firms (under FUNDOPEM) also reflects current economic conditions: with the recession, fewer firms are looking for new investment opportunities.

Prior action #2: The Government of Rio Grande do Sul has established procedures to guide the recovery of tax arrears, reducing processing time and prioritizing cases with high values and high probability of recovery; and criteria to measure results of tax arrears recovery actions.

10. Overdue taxes amounted to R$ 30 billion in 2012, equivalent to 121 percent of annual tax revenues. Some of the causes of the high level of tax arrears were beyond the control of the state government, such as the slowness of the judicial system. However, other

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reasons behind the poor performance of collection of tax arrears, such as inefficiencies in the procedure to enforce payments were susceptible to state intervention.

11. Prior to the second DPL, the state government had already taken several initiatives to expedite the collection of unpaid taxes. For example, tax agents were asked to accumulate small value claims against the same debtor before filing judicial claims. In addition, SEFAZ had adopted a policy of pouncing on arrears as soon as they were incurred, expediting internal work flows in order to reduce internal processing time and focusing efforts on the cases with highest recovery likelihood and highest values. (For example, efforts would no longer be wasted on companies that were no longer in business.) While these practices were already in common use, they were not formalized.

12. The Bank mission believed that they should be; that formally setting out tax enforcement procedures would further improve collection rates. The prior action for this component therefore reads: ‘the Government of Rio Grande do Sul has established procedures to guide the recovery of tax arrears, reducing processing time and prioritizing cases with high values and high probability of recovery; and criteria to measure results of tax arrears recovery actions.’ The indicator for this component focused not on process changes but on results. It tracks the share of tax arrears recovered within 60 days of their generation. This was targeted to increase from 21 percent to 27 percent. (Note that this indicator was intentionally designed to measure the state’s success in controlling the growth of new arrears—rather than recovering past arrears). Thus it measures the proportion of arrears generated in the last 60 days that have been collected, rather than the proportion of total arrears that have been collected.

13. The state issued the collection guide (manual de cobrança) envisioned by the prior action and has taken action to implement it. As of the first supervision mission, the state had increased the number of firms under Special Regime of Inspection (Regime Especial de Fiscalização - REF) and was planning to list all firms owing more than R$500 in SERASA (a privately-operated website that allows merchants, banks, etc. to check whether an individual has outstanding arrears to the state tax authorities). In addition, the state had set up an electronic communication system with notaries (tabelionatos) to facilitate issuance of ‘protestos de bens de devedores’17 (a form of lien on title). The expanded role of notaries has been subsequently enshrined in Normative Instruction 026/2016, amending the regulations governing state tax collection (Normative Instruction 045/1998). The aide memoire of the second supervision mission also reported that a ‘pilot for stratification of debtors’ had been completed. The third supervision mission reported that a second pilot project, aimed at identifying targets using indicators, had been implemented successfully.

14. As a result of these efforts the target collection rate had been achieved by the third supervision mission: 28.6 percent of the arrears generated two months prior had been collected. More recent figures covering the period January-August 2016, show further improvement: the proportion of new arrears that have been recovered now stands at 41 percent18. The state is now working on recovering part of the stock of older tax arrears. 17 With the issuance of the ‘protesto de bens’, the individual with tax arrears is prohibited from having access to bank loans or participating in public bids (licitações). This is intended to disincentive tax arrears18 The fiscal impact of this improvement cannot be determined with the data at hand. Information on the value of recently generated arrears is not available. At appraisal, the state government estimated that it would increase ICMS revenues by Rs 45 million. That amount is equal to about 0.2 percent of ICMS revenues.

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Although R$ 40 billion in arrears is registered as Dívida Ativa19, the state only considers R$ 12 billion of this to be collectible. (Dívida ativa is indexed, so that the $40 billion figure represents its value in current R$, rather than its original values.) To date, R$ 1.35 billion of the old stock has been collected.

15. Here again, the state government’s actions turned out to be more aggressive than the Bank conditionality required. Through the more aggressive pursuit of recent arrears (and some changes in the regulations governing the role of notaries) the rate of collections on arrears exceeded the target envisioned in the Prior Action. Of course, it is not clear that the increase in collection rates was entirely attributable to the Bank operation or whether if it reflects the state’s response to the ongoing fiscal crisis.

Prior action #3: The GoRS has mandated the use of price information from the electronic fiscal invoice database as a reference price to inform its procurement processes of goods.

16. At the time this DPL was under preparation, Rio Grande do Sul had already made advances in procurement practices with Bank support. In the previous DPL, the Bank supported the strengthening of the central procurement unit, which promoted the adoption of more modern procurement methods such as reverse price auctions and a price registry. Subsequently, the unit was elevated to the category of an under-secretariat and new permanent staff were recruited. In addition, this central unit had been carrying out analyses to substantiate decisions about the cost effectiveness of grouping and consolidating procurement processes, as well as policies to increase the participation of small and medium enterprises in government purchases.

17. According to the PD, the next step forward was to improve the way the state government obtained price information in procurement. At the time of loan preparation, the state had no structured price survey to inform its procurement process. Therefore, the employee responsible for the procurement process had to conduct a phone survey with three suppliers, identifying himself and thus biasing the survey. As a result, procurement processes in general started with prices set at a level higher than the average market price. In order to resolve this problem, the state government resolved to draw on the electronic fiscal invoice database that registers the price of all transactions subjected to ICMS taxation in the State. The state intended to pass this information to public employees in charge of procurement, who would use it to set initial prices and to negotiate further discounts in the final price in case these prices diverged significantly from the ones in the database. At the time, the Government was already using this information on a pilot basis. In order to expand its usage, it was gradually including bar code information in its procurement catalog. This would enable it to match the bar codes it had in its procurement catalog with the bar code provided by the suppliers and make sure the correct price information was being used.

18. The Bank mission sought to reinforce these measures by including a prior action specifying that ‘the GoRS has mandated the use of price information from the electronic fiscal invoice -- NF(e) -- database as a reference price to inform its procurement processes of goods.’ As in Prior Action 2, the indicator for this component focused not on process improvements but on results. The indicator was ‘increase in the share of goods procured using

19 The Dívida Ativa is composed of all the credits of a government, be they tax or non-tax, regularly registered by the Procuradoria Geral (General Attorney), after expiry of the deadline for payment, by law or judicial judgment.

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price information from the electronic fiscal invoice database, expressed as a percentage of the total value of goods procured.’

19. As of the first supervision mission, this process was well underway in the health sector. Prices for 120 items had been obtained, resulting in a savings of R$ 31 million. There was little progress on other types of goods in the state procurement catalogue, however. The second supervision mission reported that procurement using NF(e) was continuing in the health sector but was still facing obstacles in other sectors. This finding was repeated in the aide memoire of the third supervision mission (although it did report that savings in the health sector had reached R$ 67 million). According to the mission’s aide memoire, the failure to extend pricing beyond pharmaceuticals was due to the resistance of the state procurement agency (CELIC -- Centro de Licitações) to requiring suppliers to provide bar codes electronically. This was disputed on the ICR mission: at that time, CELIC argued that doing so was not worth the trouble, given the small quantities of individual items involved.

20. Nevertheless, by the third supervision mission, the state had far exceeded the target indicator for this prior action: 51 percent of goods were being procured using NF(e) compared to a target of 25 percent. As shown in table 4A below, this was entirely due to the pricing of pharmaceuticals. While the proportion fell slightly in 2015 (to 48 percent), this was due to growth of the denominator; i.e., non-pharmaceutical purchases. The proportion fell again in the first half of 2016, for the same reason.

Table A2-4: Goods procured through price information from NF(e)

2014 2015 2016

Baseline Procured NF(e) Baseline Procured

NF(e) Baseline Procured NF(e)

Pharmaceuticals 495 495 589 589 266 266Non-Pharmaceuticals 477 0 651 0 381 0Total 51% 48% 41%


21. Overall, this Prior Action was highly successful in reducing procurement costs in the health sector, but had limited impact in other sectors.20

Prior Action #4: The GoRS has mandated all of its agencies that have implemented the Cost Policy and System for more than one year to prepare, as part of their annual report, a managerial cost report

22. At the time this DPL was prepared, the state government did not have accurate, detailed information on the expenditures of each of its 20,000 lowest-level administrative units. As a result, it was difficult to measure the cost effectiveness of each unit. In conjunction with project preparation, the state government, through its internal control agency, the Office of the Accountant and Auditor General (CAGE), requested all 14 line secretariats to implement ‘a

20 It should be noted some issues in pharmaceutical pricing still remain. These involve IPERGS; the pension and health fund for employees. At present, the private hospitals serving IPE patients purchase drugs at market prices but charge IPERGS a much higher list price. But the problems will not be easily solved. State officials claim that IPERGS cannot simply lower the price it pays private hospitals for drugs, since the mark-ups on drugs compensate for the extremely low rates that IPERGS pays for diárias (daily charges for hospital stays).

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costing policy and system’ and to produce a managerial report using costing data to be included in the agencies’ annual report. This was reflected in the fourth Prior Action: ‘the GoRS has mandated all of its agencies to have implemented the Cost Policy and System for more than one year to prepare, as part of their annual report’. Progress was to be tracked by counting the number of managerial cost reports prepared by the secretariats.

23. As of the first supervision mission, CAGE had issued a circular requiring each secretariat to present a cost report. Only two (SEFAZ and SEPLAG) had sought the assistance of CAGE. CAGE had not actively pursued any of the others and believed that none of the others had taken any action on their own.

24. Since then, there has been some progress. CAGE has prepared a list of 64 government organs21 that are now expected to produce reports. It has completed training exercise in 36 of them and is in the process of training another ten. Of those that have completed training, ten are awaiting the production of the detailed data for 2015, leaving 26 that have both completed training and have the 2015 data available. Of these half (13) have submitted reports (Table A2-5).22

Table A2-5: Status of Cost Center ReportingTotal of agencies/organs that have submitted reports 64total in some stage of implementation 46

of which: in training 10trained but 2015 data not yet available 10trained with 2015 data available 26

of which: have submitted report 13have not submitted report 13

Source: CAGE/Secretaria da Fazenda do RS

25. Each of these reports is intended to show a breakdown of costs by spending unit, showing spending on personnel, goods, utilities, and rent. Information on daily travel allowances and contractual services is to be added later. To varying degrees, the reports also describe actions that each organ has taken to improve expenditure efficiency. Some organs have been more ambitious than others. For example, the Secretariat of Labor and Social Development (STDS) reports that, in 2015, its principal accomplishment was to ask the director general to create a working group to prepare an official set of directives setting out the procedures (regimentos internos) to be used to enable the secretariat to force certain departments to provide the detailed breakdown of their costs. Its major activity for 2016 is to make the ‘staff of the secretariat who are responsible for expenditures aware that costs must be controlled, that resources are finite, but also that in spite of the current financial difficulties, they should not lose sight of the secretariat’s objective, which is to provide services to its target populations’. Other reports are more specific. The report for the department of prisons (SUSEPE, within the Security Agency - Secretaria de Segurança) notes that during 2015, it revised the rental contracts for various facilities of the department with an eye to reducing rents

21 The term organ (órgão) includes not only secretariats but various decentralized units of administration.22 The costs report is attached to the annual statement of accounts of each órgão and sent to the State Court of Accounts (Tribunal de Contas do Estado – TCE). In case an órgão do not deliver its costs reports, the State Court of Accounts might decide to apply administrative penalties to the órgão’s authorities, such as fines.

46

and using buildings belonging to the public sector, whether they belong to the prison department itself or not.

26. Overall, this component seems to have been a success within its own terms, in the sense that a system for reporting expenditure data by administrative units has been put in place and 13 management reports have been issued. How much impact this will have on expenditure efficiency will of course depend on the quality of the reports and the willingness of the relevant parties to implement their recommendations. The mission was informed that 13 secretariats did not report any analysis using the data, such as the Secretariat of Education and the Secretariat of Public Works, although they are listed among the organs that have undergone the training.

Prior action #5: The GoRS has created a policy to identify and estimate the fiscal risks created by contingent liabilities, and prevent and mitigate their fiscal impact.

27. The state government currently has R$ 68 billion in contingent liabilities, more than twice the level of net current revenues. The vast majority of these liabilities consist of judicial claims by public employees arising from disputes over wage increases. Some of these claims date as far back as Governor Britto (governor from 1995-1999) who promised to give state employees raises according to a schedule that extended beyond his term. The raises were never given. Similar promises were made by recent Governor Tarso Genro. In addition, the state may be liable for wage increases (arguably) required by the Federal law on teachers’ salaries. (See Annex 8 on state finances.)

28. At the time of project preparation, the preparation mission believed that the state lacked control over the managerial decisions that could give rise to future contingent liabilities. To address this problem, the state had instituted a working group to propose a policy that would focus on control and prevention, identifying and monitoring contingent liabilities as well as estimating their impact. The state also planned to introduce accounting rules that would require such liabilities to be recorded in the balance sheet and might be part of the net consolidated debt capped by the FRL. It was expected that the development and implementation of such a policy would result in a more comprehensive understanding of the state’s fiscal situation and a reduction in future contingent liabilities.

29. In the policy matrix, the prior action specified that the state would ‘create a system to identify and estimate the fiscal risks created by contingent liabilities and to prevent and mitigate their fiscal impact’. The indicator tracked whether the policy instrument had been made effective on a yes/no basis.

30. As of January 2014, the state assembly had issued a decree requiring all state organs to provide reports on contingent liabilities to the Subsecretariat of the Treasury.23 SEFAZ had also created a special unit that would work with the report and manage contingent liabilities more aggressively.

31. By the second supervision mission, Treasury had completed its first report on contingent liabilities. It has now completed its second. Data is derived from two sources. The first is a report from the state’s attorney (Procurador Geral do Estado, PGE) which lists the

23 Decree 51/24 Janeiro/2014. ‘Institui o Sistema de Gestão de Passivos Contingentes do Estado do Rio Grande do Sul’.

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cases the state is currently defending in the courts. As shown in Table A2-6, this totaled is $65.6 billion at the end of 2015. The other consists of reports from other state organs. They report 389 such cases, totaling R$ 2,310 billion. The PGE provides an opinion on likelihood of adverse outcomes from current cases. Based on these opinions, the analysis unit in SEFAZ has calculated a summary estimate of the actual value of the state’s contingent liabilities (assigning a weight of 80 percent to cases with a likelihood of adverse outcomes, 50 percent to cases with a medium likelihood of adverse outcomes, etc.). This yielded an estimate of R$ 31.36 billion.

Table A2-6: Contingent Liabilities, 2015 (R$ millions)Value of pending lawsuits reported by General Attorney 65,625

Wage increases for active and retired servants 33,929Teachers minimum wage policy 13,100Civil class actions regarding health issues 8,583Dispute over value of shares in privatization of phone company 5,000others 5,013

Plus, contingent liabilities reported by organs 2,310Total 67,935


32. Overall, this Prior Action succeeded in the sense that there is now a system in place that allows contingent liabilities to be consolidated in one report and a regular system for reporting on changes in the stock. Whether this will restrain the growth of contingent liabilities in the future is not so clear. It is not obvious that such information will prevent governors from promising unaffordable wage increases to public employees in the future. Nor will it prevent the federal government from imposing unfunded mandates.

Prior action #6: The GoRS has reinforced its commitment to sustainable irrigated agriculture practices by aligning its ‘More Water, More Income’ Program with its Irrigation Policy and its Water Resources Policy.

33. As noted earlier, irrigation holds considerable promise in Rio Grande do Sul. Nonetheless, less than seven percent of rural properties have irrigation facilities. At the time the DPL was prepared, the State Government had already taken some steps to promote irrigation. An Irrigation Policy Law had been adopted, setting out the principles, objectives and instruments of state intervention in the sector. The Law called for a statewide ‘Master Plan for Irrigation in the Context of Multiple Water Uses in Rio Grande do Sul’ (PIUMA) which was to include a diagnosis of the current condition of irrigated agriculture and its potential for sustainable growth, based on a set of parameters including projections of water availability and demands of other water users. PIUMA was also expected to yield guidelines and priorities for the granting of water use rights and environmental licensing for the irrigated agriculture sector.

34. In May 2013, the state assembly approved legislation (Law 14.244/2013) aimed at encouraging small and medium scale farmers to construct small reservoirs (less than 10 ha) and small irrigation system (less than 100 ha). While the program, termed ‘More Water, More Income’ (Mais Água, Mais Renda) relies on federal lines of credit (e.g. the National Program for Strengthening Family Agriculture (PRONAF) to provide financing, More Water, More Income assists candidates in obtaining the environmental licenses and water rights

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required to apply for federal loans and then reimburses farmers for part of the costs of amortizing them. In the case of small scale farmers, the program pays 100 percent of the first and last payments.

35. Enactment of the legislation creating the More Water, More Income program was considered to constitute compliance with the prior action. Progress was to be measured in terms of the number of medium and small farmers joining the program. From a base of 413 landholders, it was expected that 3,000 small/medium landholders would join by the end of 2015. As of December 2016, 3,096 landholders had joined the program (of which 56 percent were small landholders and 22 percent were medium landholders; while a further 618 applicants were awaiting approval)24. There is evidence that the administration of the program has improved substantially. The program is now conducted by a group of dedicated professionals, who follow clear procedures. Processing time has been drastically reduced, from years to some weeks, largely due to the introduction of a computer-based system for processing applications (Box 1). It is also noteworthy that the total land area under irrigation has increased by 72,000 ha (69 percent)25.

Prior action #7: The GoRS has strengthened the institutional capacity of its Department of Water Resources (DRH) through the approval of an enhanced staff organogram and the launch of the corresponding recruitment process.

36. The DRH plays a key role in the implementation of state water policy. It is responsible for issuing water use rights and providing technical assistance to the State Water Resources Council in the coordination, implementation, supervision and preparation of the State Water Resources Plan. It also prepares river basin plans or supervises and approves the work of consultants hired for that purpose. During DPL preparation, it became evident that the DRH lacked the managerial and technical capacity to perform these roles. This was largely due to staffing limitations imposed by the Fiscal Responsibility Law and the state’s own inability to offer competitive salaries.

37. Delays in obtaining water rights were discouraging farmers from undertaking irrigation projects under the More Water, More Income program, as water rights (along with environmental licenses, were required for each new project. The environmental license granted by SEMA is restrictive and hampers the expansion in irrigated areas. The SEAPI is currently discussing with the SEMA possible ways to make the license more flexible (SEMA Resolution no. 323/2016), and this process is expected to bring results after April 2017. The state eventually developed a work-around: DHR, the Secretariat of Environment, (SEMA) and the Secretariat of Agriculture, Livestock and Irrigation (SEAPI) agree to allow SEAPI to approve projects under simplified conditions fixed by SEMA and DRH. Nevertheless, staffing constraints remained, although 12 employees were given to DRH (6 from FEPAM and 6 from

24 The authorities are revising the process of issuing environmental licenses (expected in April 2017) which should contribute to clear the backlog in landholders waiting for approval).25 Over time some of the criterias under the program have been revised. The initial goals were overestimated since there was no benchmark for comparisons. Farm irrigation was not common in Rio Grande do Sul, but in the last few years irrigation is becoming increasing common. In parallel the program adopted new monitoring parameters, in line with the limits imposed by the environmental agency. While farmer’s decision to invest in irrigation is largely outside the control of SEAPI, the irrigated area in the state doubled over the past four years with the program being directly responsible for 69 percent increase and possibly acting as a catalyzer for the rest of the expansion.

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SEAPI).

38. Progress in preparing river basin plans was also slow. Along with agriculture, state waters are used to supply the demand for human and industrial consumption, power generation and navigation. River basin plans were needed in order to improve water allocation and minimize potential conflicts among these uses and to establish targets for water quality recovery to allow multiple water use as established by the Water Policy26.

39. The DPL addressed these problems in two ways. First, it prompted the state to revise its staffing plan for technical and scientific positions (Quadro dos Funcionários Técnico-Científicos do Estado) to include specialists in the relevant sectors. Enactment of the revision (Law 14.477/2015) was considered to constitute with the prior action. Second, it set a target for the completion of river basin plans and tracked it during project supervision.

40. While the state did enact the legislation, the situation did not immediately improve. Progress on the river basin plans nearly ground to complete halt in April 2015 when the contracts of the temporary personnel who formed the majority of DRH’s workforce expired and could not be renewed. By the third and final supervision mission (November 2015), however, the situation had improved significantly. After some months, the new SEMA and DRH administrations finally found a means to recruit and train personnel, as well as to implement a new digital system to process water applications (see Box 1, in section 2.1). Seven of the twelve proposed river basin plans had been finished and approved by river basin committees. Although the target had not been met, the remaining plans were well under way.

Prior action #8: The GoRS adhered to the National Pact for Water Management, which establishes, inter alia, targets for improving the Borrower’s legal and institutional framework for water resources; planning, information and decision support tools; and operational instruments, including water availability, water use rights, water pricing and drought preparedness plans; and signed an agreement with the Guarantor’s Water Agency committing to comply with specific water resource management targets in exchange of financial support.

41. The State has committed to enhancing its Water Resource System in a more comprehensive way by adhering to the National Pact for Water Management (PROGESTÃO). This is a results-based program designed and implemented by the National Agency of Water (ANA) that helps the States to define the current level of development of their Water Resources System, as measured against the objectives and instruments established by the Federal Water Resources Law, and define annual targets for a five-year period, which are discussed and approved by the State Water Resources Council. This agreement between the State and the Federal level requires the State to benchmark itself against other states and was expected to lead to substantial measurable improvements in the State’s legal and institutional framework for water resources; planning; information and decision support tools; and operational instruments (e.g. water use rights, water pricing, drought preparedness plans etc.). It came with some financial support from the Federal level to help achieve the targets, but it required primarily that the State coordinate the different interventions of the public sector related to water resources management.

42. The enactment of legislation formally entering the state into the federal program

26 According to the Resolution CRH no. 211/2016, it is expected the procurement of 15 additional plans in 2017.50

(Decree 50.741/2013) was considered to constitute compliance with the prior action. The prior action was to be monitored using one of the measurable annual targets set by the agreement with ANA: the installation of 80 hydro-meteorological stations in key river basins.

43. At the time, the DPL closed only 27 of the targeted 80 stations had been installed. The state claimed that it was still studying where the remaining stations should be located. DRH therefore decided to rely instead on existing data collected by public and private institutions The state intends to revise its agreement with ANA accordingly.

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Annex 3. Beneficiary Survey ResultsNot applicable.

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Annex 4. Stakeholder Workshop Report and ResultsNot applicable.

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Annex 5. Summary of Borrower's ICR and/or Comments on Draft ICR

Avaliação do Estado e comentários

O Programa permitiu importantes avanços na gestão fiscal e na gestão de recursos hídricos, decorrentes das ações prévias implantadas, o que pode ser verificado na melhoria dos indicadores das referidas ações. Das oito ações prévias constantes do Programa, cinco estavam ligadas à gestão fiscal - Gastos Tributários, Cobrança de Impostos em atraso, Preços de referência em licitações, Relatório de Custos e Passivos Contingentes - e três ligadas à gestão de recursos hídricos - Mais Água, Mais Renda, Fortalecimento do Departamento de Recursos Hídricos da Secretaria do Meio Ambiente e Progestão – Pacto Nacional para Gestão das Águas. Relativamente à área fiscal, a maior parte das metas definidas para os indicadores foi atingida e superada, a exceção foi referente ao Sistema de Custos do Estado cuja meta era ter 14 relatórios gerenciais de custos elaborados pelos órgãos e o resultado obtido foi 13 relatórios, correspondendo, portanto, a cerca de 93% da meta. No que tange à área de recursos hídricos, o desempenho dos indicadores ficou abaixo do definido no Programa, entretanto, observam-se melhorias significativas em relação a linha de base das três ações prévias (ano 2012).

As ações prévias ligadas à área fiscal contribuíram para o incremento e melhoria da gestão de receitas, por meio da adoção de novos procedimentos para avaliação dos benefícios fiscais concedidos na modalidade de crédito presumido e aumento da recuperação de impostos em atraso, bem como para a diminuição e aprimoramento da gestão do gasto, por meio da utilização da Nota Fiscal Eletrônica como parâmetro de preço nas compras da área da saúde, implantação do Sistema de Custos e da Sistemática de acompanhamento dos Passivos Contingentes, entretanto, todas essas medidas não foram suficientes para enfrentar o desequilíbrio fiscal do Estado do Rio Grande do Sul, agravado fortemente pela crise econômica que acomete o país, cuja expectativa de queda do Produto Interno Bruto supera 7% no biênio 2015-201627.

Em relação à área das águas, mostrou-se acertada a inclusão de medidas voltadas ao fortalecimento da gestão de recursos hídricos para mitigar os efeitos da estiagem na agricultura, dada a importância do setor na economia e, consequentemente, na arrecadação tributária do Estado do Rio Grande do Sul. Nesse sentido, pode-se destacar a ampliação da área irrigada de 105 mil hectares para 177 mil hectares representado um aumento de 68,6%, por meio do Programa “Mais Água, Mais Renda”. Ademais, salientam-se diversas ações implantadas visando o aprimoramento da gestão da água, como por exemplo, aumento dos planos de bacia com supervisão do Departamento de Recursos Hídricos da Secretaria do Meio Ambiente (DRH/SEMA), adesão do Estado ao Pacto Nacional pela Gestão das Águas (PROGESTÃO), instalação de novas estações hidrometeorológicas e da sala de situação para monitorar os dados dos rios em tempo real, que só foram possíveis graças ao fortalecimento do DRH/SEMA apoiado pelo Banco e priorizado pela Secretaria do Meio Ambiente, no âmbito do PROCONFIS.

27 Em 2015 a redução do Produto Interno Bruto brasileiro foi de 3,8%. Para o ano de 2016, a expectativa do mercado é de diminuição de 3,49%, segundo Relatório Focus do Banco Central, de 30/12/2016, disponível em http://www.bcb.gov.br.

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http://www.bcb.gov.br/

Em que pese o Programa não ter previsto reformas estruturais, o Governo do Estado vem implantando, desde início da atual gestão, em 2015, importantes medidas de ajuste necessárias para o enfrentamento da crise econômica e fiscal, com impacto no curto e médio prazo, como também vem introduzindo reformas profundas referentes a responsabilidade fiscal, política de pessoal e estrutura administrativa, visando a sustentabilidade fiscal a longo prazo. Como exemplo das medidas de ajuste fiscal adotadas no biênio 2015-201628, pode-se citar: (i) pelo lado das despesas, a forte contenção de gastos com serviços terceirizados, consultoria, diárias, passagens e horas-extras e a limitação das despesas de custeio dos órgãos do Poder Executivo, autarquias e fundações; e (ii) pelo lado das receitas, a elevação das alíquotas do ICMS nos exercícios de 2016 a 2018, equalizando as alíquotas com outros estados, a criação do Fundo de Proteção e Amparo Social do Estado do Rio Grande do Sul (Ampara/RS), com receitas oriundas do adicional de alíquotas de 2% do ICMS, além de modificações na legislação do IPVA, antecipando prazo de pagamento do tributo e diminuindo percentuais de descontos, e alterações na legislação do ITCD, reestabelecendo as alíquotas progressivas. Relativamente às reformas já implantadas29, destacam-se: (i) a edição da Lei de Responsabilidade Fiscal Estadual; (ii) a instituição do Regime de Previdência Complementar; (iii) a majoração das alíquotas de contribuição dos servidores ativos, aposentados e pensionistas para 14% (quatorze por cento), a partir de abril de 2017; e (iv) a reestruturação e modernização do Estado, cujos Projetos de Lei já aprovados pelo Poder Legislativo consistem na extinção de 9 fundações, reduzindo de 19 para 10 fundações, na extinção de uma Companhia e em modificações em 2 autarquias (reestruturação com redução de custos em uma e extinção de outra), além da fusão de secretarias, diminuindo das atuais 20 secretarias para 17 (na gestão anterior eram 29 secretarias). Além dessas medidas já aprovadas, tramitam na Assembleia Legislativa, outras importantes ações30, como a retirada de exigência de plebiscito prevista na Constituição Estadual para futuramente privatizar ou federalizar 3 companhias, a revisão dos benefícios 28 Medidas de redução de despesas implementadas por meio dos Decretos Estaduais nº 52.230, 52.294 e 52.295, de 2015, e prorrogadas pelos Decretos Estaduais nº 52.862, 53.169 e 53.009, de 2016. Medidas de aumento de receitas implantadas pela edição das seguintes Leis Estaduais: Lei nº 14.743/2015 (ICMS), Lei 14.472/2015 (Fundo AMPARA/RS), Lei 14.740/2015 (IPVA) e Lei 14.741/2015 (ITCD).29 Lei de Responsabilidade Fiscal Estadual aprovada pela Lei Estadual nº 14.836/2016, Regime de Previdência Complementar instituído pela Lei Complementar Estadual nº 14.750/2015 e majoração das alíquotas previdenciárias por meio das Leis Complementares Estaduais nº 14.967 e 14.968, ambas de 2016. Em relação à reforma da estrutura do Estado, destacam-se os seguintes Projetos de Lei já aprovados pela Assembleia Legislativa em dezembro de 2016 e aguardando sanção do Governador: PLs nº 301/15, 240/16 e 246/16 – extinção de 3 fundações de direito público (Fundação Instituto Gaúcho de Tradição e Folclore, Fundação Estadual de Pesquisa Agropecuária e Fundação Estadual de Produção e Pesquisa em Saúde) e autorização para extinção de 6 fundações de direito privado (Fundação Zoobotânica, Fundação de Ciência e Tecnologia, Fundação de Economia e Estatística, Fundação Estadual de Planejamento Metropolitano e Regional, Fundação Piratini e Fundação para o Desenvolvimento de Recursos Humanos); PL 247/16 – redução das secretarias; PL 249/16 e 251/16 – reestruturação da autarquia Agência Gaúcha de Desenvolvimento e Promoção do Investimento para Escritório de Desenvolvimento de Projetos, com redução do quadro funcional e de custos, e extinção da autarquia Superintendência de Porto e Hidrovias de Porto Alegre, cujas atividades passam a integrar a autarquia Superintendência do Porto do Rio Grande; e PL 244/16 – extinção da Companhia Rio-grandense de Artes Gráficas.30 Projetos em tramitação na Assembleia Legislativa: PL 214/15 - redução dos créditos presumidos nos exercícios de 2016 a 2018; PEC 242/15 - extinção da licença-prêmio assiduidade do servidor estadual e criação da licença-capacitação; PEC 258/16 - extinção do direito aos adicionais por tempo de serviço aos servidores estaduais; PEC 259/16 – retirada da necessidade de consulta plebiscitária para os casos de alienação, transferência do controle acionário, cisão, incorporação, fusão ou extinção da Companhia Estadual de Energia Elétrica, da Companhia Rio-grandense de Mineração e da Companhia de Gás do Estado do Rio Grande do Sul.

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fiscais, o contingenciando os benefícios concedidos na forma de créditos fiscais presumidos de ICMS, até o exercício de 2018, de forma a permitir a apropriação de valor correspondente a 70%, em cada ano, do total dos créditos a apropriar, a extinção da licença-prêmio assiduidade do servidor estadual e criação da licença capacitação, a extinção dos adicionais de tempo de serviço público de 15 e 25 anos.

Ainda em relação às medidas de impacto nas finanças públicas estaduais, há de se destacar a renegociação das dívidas dos estados junto à União e o Plano de Auxílio aos Estados, cujos benefícios para o Estado do Rio Grande do Sul, considerando os efeitos das Leis Complementares nº 148/2014 e 156/2016, consistem em: (i) redução prevista do saldo devedor da dívida em 2028 em torno de R$ 22,1 bilhões, decorrente da alteração dos encargos incidentes sobre o saldo devedor, que passaram de juros de 6% ao ano e correção monetária pelo IGP-DI (Índice Geral de Preços – Disponibilidade Interna) para 4% ao ano e correção monetária pelo IPCA (Índice Nacional de Preços ao Consumidor Amplo), limitado à taxa SELIC (Sistema Especial de Liquidação e Custódia); (ii) em ganho financeiro estimado de R$ 4,6 bilhões até 2018; e (iii) prazo adicional para pagamento de 240 meses, isto é, até 2048, permitindo diminuir gradualmente o atual comprometimento de 13% da Receita Líquida Real.

Por fim, como detalhado ao longo do Relatório de Conclusão de Resultados, o Programa proporcionou significativos avanços na gestão fiscal e na gestão de recursos hídricos, entretanto, ainda há muito o que ser feito na consolidação do equilíbrio fiscal. Nesse sentido, o Governo do Estado reitera seu compromisso com a implantação de políticas públicas voltadas ao aprimoramento da gestão fiscal e de recursos hídricos, agradece todo o apoio técnico e financeiro que tem recebido do Banco Mundial ao longo dos últimos anos, não só no âmbito do PROCONFIS como também no Programa de Reestruturação da Dívida (2008) e no Programa de Apoio à Retomada do Desenvolvimento Econômico e Social - PROREDES (assinado em 2012 e ainda em execução), e conta com a continuidade da parceria com Banco nesta caminhada rumo ao equilíbrio fiscal para o desenvolvimento econômico e social do Estado do Rio Grande do Sul.

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Annex 6. Comments of Cofinanciers and Other Partners/StakeholdersNot applicable

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Annex 7. List of Supporting Documents

Program Document 87120-BR (May 5, 2014);

Aide Memoire of the 1st Supervision Mission (October 27 to 30, 2014);

ISR16376 (November 23, 2014);

Aide Memoire of the 2nd Supervision Mission (March 30 to April 1, 2015)

ISR19014 (May 29, 2015);

Aide Memoire of the 3 Supervision Mission (November 3 to 5, 2015);

ISR22308 (December 22, 2015).

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Annex 8. State Fiscal Situation

1. RGS’s fiscal situation has been steadily worsening for several years and has now arrived at a crisis.

Revenues

2. RGS derives the vast majority of its recurrent revenues from state- administered taxes. In 2015, nearly eighty percent of current revenues were derived from tax revenues (receitas tributárias).31 Of this, slightly over eighty percent was generated by the state-administered VAT (ICMS). The state has autonomy over the ICMS rate on transactions within the state but rates on interstate sales are determined by federal law. Federal law exempts exports to other countries entirely.

3. Until recently, RGS had one of the lowest VAT/GDP ratios in the country. This was partly due to the large proportion of state production (e.g., agricultural production) that is exported—to other states and to other countries. However, even rates on transactions within the state have historically been low by the standards of its neighboring rivals: the states of Santa Catarina, Minas Gerais, Sao Paulo, Rio de Janeiro, and Parana. In 2015, the state’s basic rate (17%) was lower than in four of those states. The rates on specific sectors that dominate ICMS revenues (and are more severely taxed) were also relatively low. As shown in Table A8-1, the rate on gasoline was lower than in three rivals. The rate on electrical energy was lower than in two. In addition, even the rate of telecommunications was lower than in one rival. Of the major sectors, only beer was taxed at a higher rate in RGS than in its neighbors. As discussed below, the state has subsequently raised these rates in response to the current crisis. The current rates are shown under ‘2016’ in Table A8-1.

Table A8-1: ICMS rates

Rates in RGS No of rival state w/ higher

rates in 20152015 2016

Basic rate 17 18 4Gas 25 30 3Electricity 25 30 *2Telecommunications 25 30 **1*plus RJ, SC for high volume consumers**plus RJ for high volume consumers


4. Roughly ten percent of revenues consist of current transfers. About one–third of current transfers are derived from the principal formula-based unconditional transfer from the federal government, the Fundo de Participação dos Estados (FPE). This is funded from a fixed share of federal revenues from the income and industrial products taxes and is distributed

31 Following the practice used in the original fiscal analysis for this operation, ICMS revenues are reported net of contributions to FUNDEB but gross of Constitutional transfers to municipalities. The revenue items ‘retorno FUNDEB’ and ‘dedução da receita corrente (to FUNDEB)’ are both excluded from the calculation of revenues. Net transfers to FUNDEB are instead treated as expenditures.

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among the states based on a formula. The remainder consists largely of payments by the federal health care system (SUS) and federal compensation for certain federally imposed tax exemptions (e.g., IPI-exportação) and mandated expenditures. See Table A8-2. The state government has no control over the yield from these sources.

Table A8-2: Revenues - Intergovernmental Transfers Breakdown, 2015 (R$ millions)Total* 4,084FPE 1439SUS 853IPI-exports 450Salário educação (from federal government) 360Lei Kandir 147other 835*Excludes R$ 3,866 million from FUNDEB


5. Another six percent of current revenues are derived from ‘contributions’ (contribuições). These largely consist of mandatory contributions by active and retired staff, based on a fixed percentage of their salaries and pensions (respectively) ostensibly toward the costs of their retirement. (See further discussion below.)

6. Overall, state recurrent revenues grew fairly robustly after 2007. According to the PD for DPL1, ‘shortly after taking office in January 2007, the newly-elected administration quickly introduced emergency measures to reduce the projected deficit for 2007. On the revenue side, Government actions were geared toward increasing tax collection through administrative improvements. To this end, it introduced new managerial tools to reduce tax evasion (a matrix management model) and embarked on a revision of the system of tax credit devolution to exporters, in order to restrict its abuses. Other measures to raise revenues included the implementation of the Growth Incentive Program, which was designed to stimulate those sectors of the economy with great revenue generating potential. It also mandated the use of electronic fiscal receipts, in order to discourage evasion in interstate trade.

7. The effort to increase revenues appears to have paid off, at least in the short run. 60

Box A8-1 Accounting for FUNDEB

In Brazil, both state and municipal governments operate primary and secondary schools. Under the Fundo de Manutenção e Desenvolvimento da Educação Básica e de Valorização dos Profissionais da Educação (FUNDEB) both levels must contribute 20 percent of their revenues from certain taxes (e.g., the ICMS) and intergovernmental transfers to a pool, which is then distributed among the state government and individual municipalities on the basis of enrollment. In RGS’ fiscal reports to the STN, the figure reported for ICMS revenues is net of contributions to FUNDEB. Revenues reported for ‘transferências intergovernamentais’ include the reverse flow; i.e., funds from FUNDEB. To more accurately convey the state’s fiscal situation, the analysis in this annex reports ICMS revenues net of deductions for FUNDEB but gross transferências constitucionais to municípios.) The state’s contributions to FUNDEB and its revenues from FUNDEB are netted out, so that only the state’s net transfers to FUNDEB are shown. These amounted to about R$ 1 billion in 2015.

As shown in Figure A8-1, ICMS revenues increased by 13 percent in real terms between 2007 and 2008, considerably faster than growth in GDP (5.1 percent). Although growth in ICMS revenues leveled off subsequently, it averaged 5.2 percent per year over the period 2007-2014. Revenues from other smaller taxes also grew rapidly. Revenues from the IRRF (the federal income tax on state employees, which the state is allowed to retained), grew by 6.7 percent per year between 2007 and 2014. Revenues from the motor vehicles tax (IPVA), grew by 6.3 percent. While other sources of revenues grew more slowly (current transfer - transferências correntes -, for example, actually declined at an average annual rate of 0.1 percent over this period), current revenues as a whole grew at an average annual rate of 4.9 percent.

Figure A8-1 Trends in Composition of Current and Capital Revenues

2007 2008 2009 2010 2011 2012 2013 2014 2015 -

10,000

20,000

30,000

40,000

50,000

other capital rev.new loansother current transferscurrent transferscontributionsother taxesICMSco

nsta

nt R

$ m

ns o

f 201

5


8. In 2015, however, ICMS revenues dropped sharply, falling 4.8 percent in real terms—considerably faster than the decline in state GDP (-3.4 percent). Current transfers dropped about the same rate, resulting in a drop of five percent in total current revenues.

Expenditures

9. The state’s expenditures are dominated by personnel costs. In 2015, expenditures on personnel (including current employees, retirees and pensioners) totaled 47 percent of total expenditures. In Brazil, levels of personnel spending are typically measured as a proportion of discretionary revenues to give a sense of the bite they are taking out of the revenues that the state has some control over. In 2015, personnel costs were 72 percent of net current revenue32.

10. The salaries of active staff account for only about 45 percent of personnel expenditures. Payments to retirees and pensioners comprise the remainder.

11. The state has managed to control growth in the number of active personnel. As shown in Figure A8-2, the number of current employees remained relatively stable over the period 2007-2014 and in fact declined with the onset of the recession in 2015. This was

32 For purposes of this calculation, net current revenues are defined as gross current revenues (before transfers to Fundeb) minus constitutional transfer to municipalities.

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accomplished partly through a slowdown in hiring, accompanied by the retirement of existing staff. (The current administration plans to hire another 2000 police, however, in order to combat public perceptions of a crime wave.)

Figure A8-2 Trends in Number of Active and Retired Staff

Figure A8-3 Trends in Average Cost per Staff

2007 2008 2009 2010 2011 2012 2013 2014 2015 150,000

160,000

170,000

180,000

190,000

200,000

210,000

active servants

retired and pensioners

2007 2008 2009 2010 2011 2012 2013 2014 201530.0

40.0

50.0

60.0

70.0

active servants retired and pensioners

Con

stan

t R$

ths

of 2

01

5


12. Average wages of active staff (measured as expenditures per occupied positions, termed as ‘vinculações’) have climbed steadily over this period, however. As shown in Figure X-3, the average wage of current employees in 2015 was roughly 40 percent higher than in 2007. This is due to periodic salary increases by a succession of governors: average real wages increased 24 percent during his four years in office (2011-2014). At the end of his term, he promised an even larger (60%) increase to the police force, to be phased in over the years 2014-2018. The full implementation of this increase could create an additional expenditure of R$ 4 billion in 2018. The current administration is seeking to freeze wages in nominal terms.

13. The administration is currently under pressure to increases the salaries of teachers, however. This pressure arises from a federally mandated minimum wage for teachers, which was fixed in national legislation in 2008. The legislation was intended to set a minimum level of compensation (piso) for teachers at the lowest rank of the magisterial career structure. In Rio Grande do Sul, however, few, if any, teachers are employed at this grade. Even entry-level teachers earn more than the piso because they are normally required to have university degrees. (The lowest grade in the magisterial career structure is reserved for teachers without these qualifications.) While the state contends that it therefore does not have to increase salaries to comply with the law, the teachers’ union says that it does. The union contends that the since the piso implies a percentage increase in the base salary, all higher-grade salaries should be increased by the same percentage. The state, so far, has not conceded the argument and the case remains in dispute, giving rise to one of contingent liabilities described in the discussion of prior action 5.

14. The majority of personnel costs consist of payment to retirees and their surviving dependents. In 2015, current and retired public servants represented 55 percent of personnel expenditures (and an equal percent of occupied positions - vinculações). The retirement benefits of nearly all state employees are paid by the state on a pay as you go basis. The rules of the pension system are largely determined by federal legislation. The 1988 Constitution entitled employees to retire while still relatively young (more so for women than men) and more so for

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teachers, police officers and firefighters than for employees in other occupations. Retirees were guaranteed a pension equal to their exit salaries (termed the ‘salário integral’) indexed to changes in the salary of the position they formerly occupied. Upon the death of the retiree, surviving unmarried dependents could continue to receive a partial pension. While this generous pension regime applied to all states, it has particularly adverse effects in RGS due in part to an expansion in basic education that occurred under the administration of Governor

Brizola (1959-1963). It is the retired teachers from this era, and their immediate successors, that swell the ranks of the state’s current retirees. Other states that were slower to expand basic education do not (so far) face so large a problem.

15. Since 1988, there have been some attempts at federal level to reduce the generosity of retirement benefits. In 1998, Constitutional Amendment no. 20 introduced a minimum age of retirement into the public employee retirement system (RPPS - Regime Próprio de Previdência Social). In order to qualify for retirement, for people hired after 1998, the employee is required to have 35 years of contributions (if male) or 30 years (if female)33. In addition, a man must be 60 and a woman must be 55. (A five-year reduction for rural workers of either sex and for teachers in elementary school and high school remained in place.) Perhaps most importantly, the Constitutional amendment removed the generous benefit formula from the Constitutional text. This opened the door to future reforms, because it meant that legislation governing pensions could be amended without amending the constitution itself.

33 Years of contribution to the pension system for private sector employees (RGPS – Regime Geral de Previdência Social) count against this total.

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16. This did not have immediate impact, however. During the late 1990s and early 2000s, sub-national governments continued to struggle with large and growing pension obligations. They were only able to prevent an even greater increase in pension costs by containing the growth of public sector wages in real terms. Because pensions are indexed to the wage in the position formerly occupied by the retiree, any increase in the wages of current employees would have spilled over to pensions.

17. A second round of reforms occurred in 2003, in the form of Constitutional Amendment No. 41. This made four significant changes. The first applies to all staff — current employees, retirees and pensioners — regardless of when they were hired. It permitted states to impose a mandatory pension contribution on current employees, retirees and pensioners of at least 11 percent.34 As noted earlier, these contributions are treated as revenues in the state’s fiscal accounts, but they in effect reduce the net wages and net pensions of current employees, retirees and pensioners respectively. In 2004, RGS introduced a rate of 13.25 percent. At the time of DPL1, there was plan to capitalize the pension fund using half of the proceeds from the initial public offering for the state bank (Banrisul). (This raised a total of about R$ 2.25 billion in July 2007.) The state assembly did not approve this proposal, however, and it never occurred.

18. Two other reforms applied only to staff hired after 2003. The first eliminated the salário integral. The initial pension of employees hired after 2003 is equal to 70 percent of the retiree’s average monthly wage over his/her entire working life.35 Second, the adjustment factor for subsequent pension increases is now tied to inflation (or more precisely, to the adjustment factor for RGPS) rather than the salary of the position formerly occupied by the retiree. In principle, this second measure frees states to increase the salaries of current employees without increasing the pension benefits of retirees and pensioners—at least for employees hired after 2003. Nevertheless, it also carries a downside risk. With pension benefits tied to inflation, states no longer have the ability to control the level of pensions by controlling the salary level of current employees. Since this provision only applies to people hired after 2003, it has had little impact to date. (Most of the people hired after 2003 are still working.)

19. A fourth reform occurred in 2011. Staff hired between 2011 and July 2016 now contribute to a separate fund (FUNDOPREV) which is legally separated from the state general fund and cannot be used to finance general expenditures.36

20. The most recent reform is more radical. Under Constitutional Amendment no. 41/2002, the federal government, states and municipalities are permitted to reduce the starting pensions of new employees to the RGPS level. However, governments wishing to adopt this reform are also required to reduce the new employees’ mandatory pension contributions to the RGPS level as well, thereby reducing their contributions to the general revenues of the government they work for. Those governments are also required to create an authentic

34 The mandatory contribution applies only to the difference between the wage/pension of the contributor and the RGPS ceiling, which was R$ 5,189 in 2016. Law no. 10.887/2004 set the level for federal employees at 11% and stipulated that the level adopted by states cannot be less than federal level.35 The lowest 20 percent of the retiree’s monthly salaries are excluded from this calculation.36 Article 7 of RGS Law no. 13.758/2011 states: ‘Todos os valores em espécie destinados ao FUNDOPREV serão depositados em conta específica e exclusiva do Banco do Estado do Rio Grande do Sul S.A – BANRISUL –, distinta da conta do Tesouro do Estado, vedada sua utilização pelo Sistema Integrado de Administração de Caixa no Estado do Rio Grande do Sul – SIAC’.

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complementary pension fund for the new employees, inaccessible to the state, to which the new employees would contribute. (Contributions into this fund would be made only on wage income above the RGPS threshold.) Thus, these new employees would have the same pension benefits (and contribution levels) as employees in the private sector, but would have the option of contributing to—and benefitting from—the complementary pension fund.

21. This option only applies to staff who are hired after the state has adopted the required legislation, including the establishment of the complementary fund. In RGS, this did not occur until August of this year (2016). Thus, it affects very few current employees. When this reform does start to affect significant numbers of staff (i.e., when the 2000 new police to be hired in 2016 come on board) it will, ironically, have an adverse short term effect on the state’s finances: the mandatory contributions of these staff will drop from 13.25 percent to the RGPS rate and any employee contributions in excess of the RGPS level will go into an account that the state cannot touch. While this reform will pay off in the long term, the long term is far away.

Figure A8-4: Trends and Composition of Current and Capital Expenditures

2007 2008 2009 2010 2011 2012 2013 2014 20150

10000

20000

30000

40000

50000

amortizationinterestinvestmentsnet transfer to FUNDEBother current exptransfers to munsretired and pensionersactive servantsCo

nst

ant

R$

mn

s of

20

15


22. For the time being, expenditures on retirees and pensioners continue to rise. As shown in Figure A8-2, the number of retirees and pensioners continues to climb steadily. Between 2007 and 2015, their ranks increased at an average annual rate of 1.8 percent.37 The average cost per retiree/pensioner grew at an average annual rate of 3.6 percent. As a result, spending on retirees and pensioners increased by over 50 percent (53 percent) in real terms over this period.

23. Certain other categories of expenditure grew during this period (2007-2015. Transfers to municipalities increased, not surprisingly, in line with ICMS revenues. (As noted earlier, states are required to transfer 25 percent of their ICMS revenues to their respective 37 For reasons that remain unclear, the number of pensioners declined over this period (at an average annual rate of 0.7 percent). The number of current employees increased at an average annual rate of 2.7 percent.

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municipalities). Spending on other forms of transfers also grew rapidly (7.2 percent per year between 2007 and 2015). The largest single category of such expenditures consists of ‘outros servicos de terceiros’, most of which consists of payments to health care facilities under the state/federal health insurance system (SUS). Expenditures in this category grew at an average annual rate of 28 percent between 2008 and 2015. (Data for 2007 is not available.) Spending on capital investment grew between 2007 and 2015 (at an average annual rate of 21 percent) but from such a low level, that it had little impact on the state’s overall fiscal situation. Most of the increase occurred between 2007 and 2008. Since then, the level of spending on capital investment has stabilized at 2 to 4 percent of total state expenditures.

24. Debt service (including both interest and amortization) makes a significant claim on the state budget. In 2015, it accounted for about eight percent of total state expenditure. Even this figure understates the size of the state’s future debt service obligations, as it is the product of series of debt rescheduling and World Bank loans accompanied by interest caps and grace periods, as discussed in the paragraphs below. As a result, it does not necessarily reflect the burden that debt service will pose once these concessions expire.

Debt

25. RGS has a large stock of debt. At time of the first DPL (2008), the state’s consolidated debt totaled R$ 40.53 billion, equal to 224 percent of its net current revenues38. RGS was one of only two states (out of 27) that had been unable to comply with the federal Fiscal Responsibility Law’s restriction on the stock of debt. At the time, the vast majority of contractual debt was owed to the Federal Government, much of that arising from the federal debt restructuring in the late 1990s. (Box A8-3). Court judgments accounted for five percent with ‘precatórios’ (a kind of debt originated of a judicial decision). Since then, the total stock of debt has grown to roughly R$ 68 billion, of which R$ 62 billion consists of contractual debt. As shown in Table A8-3, 87 percent of this is still owed to the federal government, with the remainder owed to the World Bank and the IDB. ‘Precatórios’ totaled R$ 5.87 billion in 2015.

38 Source: Relatório de Gestão Fiscal do Estado do Rio Grande do Sul. Figure includes R$ 2.27 billion in precatórios.

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Box A8-3: The Federal Bailout of 1997

On three different occasions (1989, 1993 and 1997) the Federal Government has assumed and rescheduled the debts of the states. The largest operation occurred in 1997, under Law 9496, when the Federal Government restructured R$200 billion (12 percent of national GDP) of the debts owed by the states.

In the 1997 refinancing operation, the debts were refinanced for 30 years. This refinanced debt (termed intra-limite debt, carried an interest rate of 6 percent and an inflation index, with principal indexed to inflation. One feature of the agreement was the capping of the debt service at 13 percent of states’ net current revenues. Any debt service above the 13 percent cap is recapitalized and added to the intra-limite debt stock. At the end of the contracts (in 2028), if there are residual debt balances, the state will have to pay off the remainder within 10 years.

The 1997 bailout was conditioned upon the state’s compliance with medium-term fiscal adjustment and structural reform programs. In exchange for the rescue package, the debt renegotiation contracts mandated the implementation of three-year rolling Programs of Fiscal Adjustment (PAFs) to be agreed upon by the STN and the 25 states that had their debt restructured by the STN during the period of the contract. The PAFs set annual targets on indebtedness, primary balances, personnel spending, tax revenue and public investment, in order to guarantee a gradual decline in indebtedness. In addition, the PAFs include structural reforms such as privatization or other public sector modernization initiatives.

In 2000, PAF targets were institutionalized and made uniform under the Fiscal Responsibility Law, which sets limits on set limits on personnel costs, credit operations, total debt, debt servicing, and guarantees. Complementary resolutions from the Senate limit sub national borrowing.

26. Under the debt restructuring agreement, the debt owed to the federal government was classified into two categories. The first, termed intra-limit debt, included all debt covered under the restructuring program as well as residual debt from the previous bail-out operations of 1997 (Law no. 9.496/1997). This totaled R$ 30.1 billion in 2007 and represented more than 80 percent of the total. The interest rate on this debt was set at 6 percent plus an inflation index. Principal was also indexed to inflation. Annual debt service, however, was capped at 13 percent of the state’s net revenues, with any residual automatically capitalized into the stock. In effect, this last provision limited the state’s debt service obligations in the short run but added to the stock of debt that would have to be serviced in the future. The other component—the extra-limit debt-- included all the remaining debts that had not been restructured with the STN and any new debts contracted after that time. It included external debt, a floating rate bond, debts incurred under the Program of State Bank Restructuring (PROES, and debts to the pension fund of Banrisul employees. It also included contingent liabilities, most of them coming from judicial decisions (precatórios). Much of this debt was coming due in 2008-2012.

Table A8-3: Debt Stock 2012-2015 (R$ millions) 2012 % 2013 % 2014 % 2015 %

Law 9.496/97 and PROES 42,619 90.3 45,231 89.7 47,181 86.1 51,617 83.5

Law 9.496/97 Principal 17,888 37.9 18,097 35.9 17,984 32.8 18,733 30.3

Law 9.496/97 Residual 19,285 40.9 21,625 42.9 23,723 43.3 27,182 44.0

PROES Intralimit 4,608 9.8 4,662 9.2 4,633 8.5 4,826 7.8

PROES Extralimit 837 1.8 847 1.7 842 1.5 877 1.4

Law 8727/93 581 1.2 341 0.7 239 0.4 183 0.3

DMLP 97 0.2 106 0.2 0 0.0 0 0.0

Caixa Econômica Federal 20 0.0 18 0.0 15 0.0 13 0.0

BNDES 563 1.2 788 1.6 1,001 1.8 919 1.5

Banco do Brasil 300 0.6 300 0.6 785 1.4 747 1.2

INSS - Débitos Parcelados 75 0.2 102 0.2 91 0.2 82 0.1

PASEP - Parcelamento 174 0.3

Debt owed to the Federal Government 44,254 93.8 46,886 92.9 49,312 90.0 53,736 87.0

Other domestic debt 20 0.0 20 0.0 20 0.0 20 0.0

Total Domestic Debt 44,274 93.8 46,906 93.0 49,332 90.0 53,756 87.0World Bank - IBRD 2,307 4.9 2,717 5.4 4,002 7.3 5,979 9.7

Inter. Dev. Bank - IADB 521 1.1 767 1.5 1,418 2.6 2,023 3.3

Japan Bank International Coop. 77 0.2 58 0.1 43 0.1 42 0.1

External Debt 2,906 6.2 3,541 7.0 5,463 10.0 8,043 13.0Total Debt 47,180 100.0 50,448 100.0 54,795 100.0 61,800 100

27. This debt was refinanced under the Bank’s DPL1 operation. According to the PD for DPL1, the first tranche of DPL1 (US$650 million) was to be disbursed upon loan effectiveness, with the second tranche (US$450 million) contingent upon the Government’s adherence to the conditions described in the loan agreement which were expected to be accomplished by the end of 2009. Resources from the first tranche were to be used, inter alia, to pay down the debts with the Banrisul employees’ pension fund and the floating debt. Resources

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from the second tranche would be used to pay down the debts incurred under PROES.

28. The result of this arrangement was a high level of expenditure on amortization payments in 2008-2011 (as the existing debts were paid off) which then fell abruptly in 2012. (See Figure A8-5). Expenditures on interest however, moved in the opposite direction. Spending on interest was surprisingly low in the period before 2012, averaging a rate of only 0.4 percent of the stock. It subsequently increased due to growing obligations on loans from the World Bank and BNDES, both of which were not subject to the intra-limit cap. While it averaged 2.7 percent from 2012 to 2015, it remains remarkably low—suggesting a further jump in interest payments when current grace periods and caps expire. It should be noted that the Federal government recently agreed to grant the states temporary debt service relief, allowing them to postpone debt service on loans from the federal government from July 1, 2016, to December 31, 2016. (Debt service due during this period will be capitalized into the stock.) States are required to begin to service this debt starting January 1, 2017, but at a reduced level. Full debt service will resume on July 1, 2018.

Figure A8-5 Trends on Debt Service

2007 2008 2009 2010 2011 2012 2013 2014 20150

1000

2000

3000

4000

5000

interests amortization

Cons

tant

R$

Mns

of 2

015


Overall Fiscal Performance

29. Since 2008, the state’s fiscal performance has steadily declined. It was expected that the first DPL loan, in connection with other reforms,39 would improve the state’s fiscal condition--slowly but consistently. As described in the fiscal sustainability annex (Annex V) of the PD for this DPL, the state’s operating deficit was expected to shrink to 0.8 percent of net current revenues in 2020. Net consolidated debt was expected to drop to 174 percent of net current revenues in 2015.

30. This did not happen. Growth in personnel spending has gradually overtaken growth

39 Including reforms in the civil service pension system, modest growth in employee compensation and reduced spending on goods and services. However, the projections did assume a doubling of expenditure on capital investment.

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in tax revenues, resulting in a sharp decline in the state’s operational balance after 2011. In 2015, the state did manage to slow the growth of expenditures. As noted earlier, spending on current employees grew by only two percent in real terms (while spending on retirees and pensioners grew by 4.4 percent.) Transfers to municipalities declined by 2.7 percent. Other transfers (e.g., for health care) declined by three percent. Investments in capital works fell nearly 60 percent. But this was not enough to turn the tide. The state’s operational deficit increased to 8.8 percent of net current revenues. (Figure A8-6). The state’s cash flow deficit40 grew to 13.7 percent of net current revenues.

31. The state appears to be financing its cash flow deficit in a number of ways. First, it is delaying payment of some obligations, including salaries. The expenditure figures shown in the preceding tables represent expenditure commitments; ‘despesas empenhadas’. They do not represent actual disbursements of cash (despesas liquidadas and pagas). The state is covering its ostensible cash flow deficit by postponing the latter. As of the February 2016, restos a pagar processados (i.e., accounts payable) totaled R$ 3.2 billion, an increase of R$2.36 billion over the figure only two months earlier (end of 2015). The state is also resorting to some questionable sources of borrowing. These include an arrangement whereby the state treasury ‘borrows’ judicial deposits arising from lawsuits between private parties. This practice, while widespread among the states, has been challenged on Constitutional grounds.41 The amount of third party judicial deposits ‘borrowed’ by RGS totals R$ 9.4 billion and constitutes an important contingent liability of the state. (Note that these contingent liabilities are not included in the total reported in the discussion of Prior Action 5.)

32. The state has not engaged in much further contractual borrowing, however. Proceeds from contractual borrowing in 2015 totaled only R$ 439 million. Amortization payments, on the other hand, totaled R$ 2,075 million. Nevertheless, the state remains above the current Federal ceiling on state debt. Senate Resolution 40/2001 sets the ceilings for states at 200 percent of net current revenues. As of end-2015, the stock of Rio Grande do Sul’s debt (including precatórios) stood at R$ 68 billion, 2.18 times the level of net current revenues.

33. The state’s actual fiscal performance has varied considerably from the baseline scenario described in the PD for this operation. The PD provided a detailed set of projections of the state’s fiscal prospects, running through the year 2020, with debt projections through 2030. It set out three scenarios: a baseline scenario, a scenario incorporating expected reductions in the interest rate on federal loans, and a ‘worst case’ scenario, which assumed zero growth in revenues in nominal terms in the years 2013 and 2014. Under the baseline scenario, the state’s GDP was expected to grow by six percent in 2013. The growth rate was then projected to slow to two percent in 2014, but then gradually increase to 2.4 percent in 2015 and 2.6 percent in all the following years of the projection. Growth in the major categories of revenue was expected to largely follow suit, at least in the outer years. Growth in the largest category of VAT revenues (‘other’) was expected to exceed growth in GDP by three percentage points in 2013 and 2014, but then grow at the same rate as state GDP in subsequent years. Expenditures, on the other hand, were projected to grow independently of GDP. The figure for

40 Defined as total receipts including borrowing, minus total expenditures including amortization.41 In 2015, the Federal Government adopted Complementary Law no. 151/2015, which allows the states to draw upon judicial deposits, only if the state is a party to the lawsuit. The law also restricts the proportion of the deposit that can be used.

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employee compensation in the education sector for 2013-2015, for instance, was based on the level of expenditure in 2012, plus three percent each year, plus the estimated cost of certain one-time increases in wages granted by previous administrations. Subsequent spending in this category was projected to increase by three percent annually, in real terms42. Other categories of expenditure, on the other hand, were projected to grow more slowly. Spending on goods (other than health-related) were projected to remain constant in 2013 and then decline by 1.7 percent per year over the rest of the projection period.

34. The result, according to the baseline projection, was to be a slight worsening of the state’s fiscal situation in the short term. The operational deficit43 was projected to increase to 2.7 percent of net current revenues by 2015. Due to extensive borrowing, the cash flow deficit was projected to decline to zero. The situation was expected to improve from 2016 onwards, as growth in revenues was projected to gradually outstrip growth in expenditures, resulting in an operational deficit of only 0.8 percent in 2020. Under the ‘worst case’ scenario, on the other hand, the operational deficit was projected to increase to 18 percent of NCR in 2015 and 22 percent of NCR in the following year. By 2020, Rio Grande do Sul was projected to be running an operational deficit of 25 percent of NCR and borrowing R$ 8 billion (in prices of 2012) to cover its cash flow.

Figure A8-6 Trends in Operating Balance and Cash Flow

2007 2008 2009 2010 2011 2012 2013 2014 2015-15%

-10%

-5%

0%

5%

10%

15%

op balance/ncr cash flow/ncr

Perc

ent o

f Net

Cur

rent

Rev

enue

s


35. In the event, actual performance in the 2013-15 period fell in between the ‘base case’ and ‘worst case’ scenarios. State GDP growth outstripped the projection in 2013, growing by 8.2 percent. But GDP then fell—by 0.4 percent in 2014 and 3.4 percent in 2015. As a result, actual revenues grew at a much more modest rate than anticipated in the base case

42 The projections were made in nominal terms and assumed an inflation rate of 5.8 percent in 2013 and 2014, declining to 5.3 percent in 2015 and five percent in all subsequent years. For purposes of clarity, growth rates in this text are expressed in real, rather than nominal, terms. 43 ‘Operational deficit’ is defined as total current revenues minus total expenditures excluding amortization.

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scenario. As shown in Table A8-4, current revenues increased only five percent, in real terms, between 2012 and 2015. Current expenditures also grew more slowly (13 percent compared to a projected 18 percent). Nevertheless, the gap between projected and actual revenues was wider than the gap between projected and actual expenditure. As a result, the operating deficit in 2015 was considerably larger than projected (8.8 percent as opposed to 2.7 percent). Amortization expenditures were also considerably higher than anticipated, resulting in the ostensible cash flow deficit equal to 13.7 percent of NCR.

Table A8-4: Comparison of Projected and Actual Changes in n Revenues and Expenditures, 2012-2015 (real terms)

Projected Base Case Actual

Current revenues 15% 5%

VAT 17% 3%

Current expenditures 18% 13%

personnel 16% 17%

interest 77% -9%

other current 14% 9%

Capital investment -34% -46%

Comparison of Projected and Actual Fiscal Indicators 2015 (% NCR)

Operating deficit -2.7 -8.8

Cash flow balance 0 -13.7Source: Receita Estadual/Secretaria da Fazenda do RS

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Annex 9. Background on World Bank Operations with Rio Grande do Sul1. The Bank’s efforts to improve RGS’ fiscal situation date back nearly twenty years. The first operation of this sort was the Rio Grande do Sul State Privatization and Reform Loan (US$ 125 million, approved in March of 1997, fully disbursed and closed on schedule in December 1998). This policy-based loan was one of several loans the Bank made to Brazilian states at the time to support structural reforms. The loan to RGS emphasized fiscal adjustment and privatization. The privatization components of the project were successful, with the privatization of the telecommunications and electricity companies and the concessions of ports and road maintenance services. However, the state’s fiscal condition did not improve. On the contrary, the state adopted an expansionary policy financed in part by the privatization proceeds, undermining its medium-term fiscal sustainability.

2. The second bank operation of this type was a two-tranche DPL in the amount of US$ 1.1 billion (approved in 2008): Rio Grande do Sul Fiscal Sustainability for Growth Program. At the time the loan was prepared, RS’s finances had continued to deteriorate. According to the Program Document (PD) for the operation, RGS was one of only two states (out of 27) that had been unable to comply with the federal Fiscal Responsibility Law (LRF). This reflected years of rising expenditures on personnel (both active and retired) and the extensive use of tax incentives. The operation was designed to assist the Government in attaining a more sustainable fiscal position and undertaking important public sector reforms.

3. On the revenue side, Government actions were geared toward increasing tax collection efficiency, given the limited scope the state had to raise rates on its principal revenues source, a state-administered VAT44. On the expenditure side, the Government undertook to (1) eliminate 20 percent of commissioned positions (about 750 positions); (2) restructure the Executive Branch (reducing the number of entities from 76 to 69; (3) issue a decree imposing expenditure ceilings for all the state secretariats and indirect administration entities; (4) mandate a cut of about 30 percent in the operating cost of all the state secretariats; and (5) implement a reduction in planned investment by more than 50 percent.

4. The loan also permitted the state to restructure its debt. As elaborated in Annex 8, the state was facing a steep increase in amortization and interest obligations. The Bank loan allowed the state to pay off a significant proportion of these obligations, replacing them with the Bank loan at longer maturities. The state also undertook some organizational reforms to its pension system (although as discussed in Annex 8, these had little long term impact). In fiscal terms, the operation was successful. The state’s operational surplus doubled (as a percent of net current revenues) between 2007 and 2008.

5. The 2008 DPL was followed by a SWAp in 2012, in the amount of US$ 480 million

44 As discussed in Annex 8, federal law exempts exports from the VAT and fixes the ceiling on interstate sales. The state does have some latitude to increase the rate on intrastate sales, but this option faced determined opposition in the state legislature.

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(P120830). According to the PD for the operation, ‘the Government was conscious that the (preceding) fiscal adjustment had been achieved largely through cuts in public investment and recognized that the state has slipped in national rankings of educational and infrastructural quality as a result. It therefore requested that the Bank support a set of selective well-targeted growth-oriented interventions in transport, education and private sector development supported by improvements in public sector management, environmental management and public service delivery.

6. The SWAp had two parts: (1) a cross-cutting public sector management part comprising of technical assistance of approximately US$ 55.3 million and (2) an eligible expenditure program (EEP) part of approximately US$ 423.5 million. Under the latter part, the project undertook to finance eligible expenditure programs encompassing investments in public sector management (inter alia, public asset management), transport (inter alia, highway rehabilitation and repair), education (inter alia, technological modernization, buildings repair), and private sector development for small and medium-sized enterprises (inter alia, cluster programs, industrial extension services and technology parks) identified by the Government as critical for restarting economic growth.

7. The loan became effective in August 2012. Its closing date is February 28, 2019. Up to now, the disbursements have amounted US$ 277.6 million (58 percent of the total). According to the ISR of June 2016, implementation is broadly on track. However, there have been concerns over the delays in the execution of eligible expenditure programs in the transport component, particularly in the preparation and execution of road rehabilitation contracts. The project was restructured in December 2015 to allow the completion of these contracts within its amended duration. Concerns have been alleviated for the time being with the borrower meeting the agreed June 30 2016 milestones. The Bank intends to continue to focus its attention on ensuring that the roads agency (DAER) meets its commitments and that its attempts at short crisis management can be converted into longer term gains in managerial efficiency.

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FISCAL AND WATER RESOURCES DPL (2014)

SWAP (2012)First DPL (2008)Privatizaton and Reform Loan (1997)

MAP OF RIO GRANDE DO SUL / BRAZIL