Report No. 14084-HO Honduras Reforming Public Investment and the Infrastructure Sectors A Joint World Bank and Inter-American Development Bank Study September 12, 1995 Latin America and the Caribbean Region Document of the World Bank GOVERNMENT FISCAL YEAR January I - December 31 CURRENCY EQUIVALENTS Currency Unit = Lempira US$1.00 = L8.4 (May 1994) ACRONYMS AND ABBREVIATIONS AGSAC Agricultural Adjustment Credit CABEI Central American Bank for Economic Integration CEM Country Economic Memorandum/Poverty Assesment. 1994. CNEE National Comission for Electric Energy CNSSP National Comission for the Supervision of Public Services DGAC Directorate General for Civil Aviation DGCCA Directorate General ot Roads and Airport Maintenance DGT Direcci6n General de Tributaci6n (General Directorate of Taxation) DGMCA Direcci6n General de Mantenimiento de Caminos y Aeropuertos ENP National Ports Enterprise (Empresa Nacional de Puertos) ESAC Energy Sector Adjustment Credit ENEE Empresa Nacional de Energia Electrica (National Electric Energy Enterprise) FHIS Fondo Hondurefho de Inversi6n Social (Honduran Social Investment Fund) FNH Ferrocarril Nacional de Honduras FOSOVI Fondo Social de Vivienda (Social Housing Fund) HDM Highways Design and Maintenance Model HONDUTEL Empresa Hondurenia de Telecomunicaciones (Honduran Telecommunications Enterprise) ICOR Incremental Capital Output Ratio IDA International Development Assiciation IDB InterAmerican Development Bank IMF International Monetary Fund ]MPREMA Pension Funds for Civil Servants and Teachers INFOP Instituto de Formaci6n Profesional (Institute for Professional Training) INJUPEMP Instituto Nacional de Jubilaciones y Pensiones de Empleados del Poder Ejecutivo (National Institute of Retirees of the Executive Power) MTEF Mediumn Term Expenditure Framework PE Public Enterprise PFP Policy Framework Paper Pi Public Investment PIP Public Ilvestmenit Program PIR Public Investment Review PRAF Programa de Asignaci6n Familiar (Family Income Support Program) SANAA Servicio Aut6nomo Nacional de Agua y' Alcantarillado (National Autonomous Water and Sewerage Service) SI)SP Ministry of Health Si'S San Pedro Sula SCHP Ministry of Finance SEC Ministry of Economy and Commerce SE.COPT Secretaria de Comunicaciones. Obras Publicas y Transporte (Ministry of Communications, Public Works, and Transport) SECPLAN Ministerio de Planificaci6n (Ministry of Planning) SlICP Secretaria de Hacienda y Credito Publico (Ministry of Finance and Public Credit) SISPU Sistemila de Inversiones del Sector Publico (Public Sector Investment System) UNAH Universidad Nacional Aut6noma de Honduras (National Autonomous University of Hlonduras) UNICEF United Nations Children's Fund IJNDP Programa para el Desarrollo de las Naciones Unidas (United Nations Development Program) UPNFM Universidad Pedag6gica Nacional Francisco Morazan WDR World Development Report Reforming Public Investment TABLE OF CONTENTS PREFACE jj; EXECUTIVE SUMMARY iv RESUMEN EJECUTIVO xi 1. INTRODUCTION: THE ECONOMIC IMPACT OF PUBLIC INVESTMENT 1 Public Investment and Public Finances I Public Investment and Macroeconomic Instability 2 Macroeconomic and Microeconomic Inefficiencies of Public Investment 4 Who Invests in the Public Sector? 4 The Sources of the Problem 5 2. INVESTMENT PROGRAMMING AND IMPLEMENTATION 7 Lack ofStrategy and Lack of Project Evaluation Criteria 7 The PIP and Investment Budgeting as Tools of Fiscal Management 9 Recommendations 12 3. INFRASTRUCTURE PROVISION: COMPETITION, PRIVATIZATION AND REGULATORY REFORM 13 Structure of Infrastructure Service Provision and Competition 13 Regulation of Infrastructure Service Provision 19 Structures for Monitoring and Controlling Sector Policy 20 Tarif Setting Procedures and User Charges for Infrastructure Services 22 Maintenance of Infrastructure Stocks 25 Financing of Maintenance and Investment in Roads 27 Recommendations 29 4. PUBLIC INVESTMENT AND POVERTY ALLEVIATION 33 Lack of a Strategy for Poverty Reduction 33 Public Financing of Education and Health 34 Fixed Investment in the Social Sectors and the Poor 37 Recommendations 40 BIBLIOGRAPHIC REFERENCES 42 This report is based on the findings of a joint World Bank/Inter-American Development Bank team. The team was integrated by Daniel Cotlear (WB, team leader and main author of this report), Frannie Humplick (WB, co-author of Chapter 3), Luis Cosenza (IDB, electricity), Joaquin Carabayo (IDB, roads), George Guess (WB, investment planning and budgeting), Francisco Ochoa (IDB, water and sewerage), Zvi Raanan (IDB, ports and airports), Alfredo Sarmiento (Ruta Social, social sectors) and Danilo Alvarado (IDB, statistical appendix). Mike Stevens (World Bank) was peer reviewer for Chapter 2. Edilberto Segura, Donna Dowsett-Coirolo and Ian Bannon are Country Director, Division Chief and Lead Economist respectively for the World Bank. Miguel Martinez and Jorge Sapoznikow are Regional Manager and Division Chief, respectively for the Inter-American Development Bank. ii A joint World BanklIDB Study TABLES Table 1-1: Public Finances in Latin America (9 Countries), 1993 2 Table 1-2: Finances of Public Enterprises in 1994 3 Table 1-3: Growth and Investment 4 Table 1-4: Structure of Public Investment 4 Table 2-1: Investment Program for 1995 11 Table 3-1: Market and Regulatory Structure in Infrastructure Services 14 Table 3-2: Performance of the Telecommunications Sector 15 Table 3-3: Performance of the Ports Sector 15 Table 3-4: Comparative Ship Charges in Honduras and Guatemala, 1992 15 Table 3-5: Performance of the Water Sector 18 Table 3-6: Distribution of Costs and Tariffs for Telecommunications 24 Table 3-7: Costs of Electricity Supply by Private and Public Enterprises 27 Table 3-8: Summary of Sectoral Recommendations 32 Table 4-1: Public Investment in Social Sector Infrastructure 33 Table 4-2: Total Expenditures in Social Programs (% of GDP) 34 Table 4-3: Expenditures and Enrollment in Education (%) 36 Table 4-4: Social Sector Coverage 37 Table 4-5: Investment Targeting by FHIS 38 DIAGRAMS Diagram I - 1: Public and Private Investment as a Percent of GDP I Diagram 1-2: Overall Deficit and Public Investment 3 Diagram 1-3: Disbursement of Extemal Debt and Public Investment 3 Diagram 3-1: Access to Telephone Services in the 1990s 15 Diagram 3-2: Households with Access to Electricity in the 1990s (percent of total) 16 Diagram 3-3: Quality of Electrical Services in the 1990s (system losses as % of output) 16 Diagram 3-4: Population With Access to Water Supply Services in the 1990s (percent of total) 18 Diagram 3-5: Index of Tariffs for Selected Public Services (in real terms, 1993 = 100) 23 Diagram 3-6: Roads in Good Conditions (%) 26 TEXT BOXES Box 2- 1: Three Polemic Projects 8 Box 2-2: A Medium Term Expenditure Framework (MTEF) 10 Box 3-1: Recent Regulatory Reforms in Electricity 16 Box 3-2: The High Cost of Maintenance Neglect 26 Box 3-3: The Case for and against a Road Fund in Honduras 29 Reforming Public Investment iii PREFACE This report is prepared by the World Bank and the IDB as a contribution to their ongoing policy dialogue with the Government of Honduras. The policy dialogue of the World Bank with the Administration of President Reina began in January 1994 with a presentation to the members of the transition team of the World Bank's Country Economic Memorandum/Poverty Assessment (CEM). The main macroeconomic message of that report was the need to restore the fiscal equilibrium lost during the presidential elections of 1993. The CEM was published in English in November 1994 and later, at the request of the Government, it was translated into Spanish to encourage dissemination of its results in Honduras. During early 1994, the economic dialogue continued based on discussions of the Govemnment's Policy Framework Paper (PFP), of the results of supervision missions of the Agricultural Sector Adjustment Credit (AGSAC) and the Energy Sector Adjustment Credit (ESAC). and of documents produced in preparation for a forthcoming Public Sector Modernization Credit. The policy dialogue of the Inter-American Development Bank with the Reina Administration was initiated at the beginning of the Administration through the supervision of sectoral reform projects in energy, agriculture and finance. This dialogue was continued through several missions leading to the Programming Mission and the presentation of IDB's Country Paper to the authorities in mid-1995. IDB has also been involved in policy dialogue with the Government through the preparation of the programs for the Reform of the Public Sector, the Reform of the Water and Sanitation Sector, the Refonn of the Judiciary, the Reform of the Legislative and the Refonm of the Tax Administration. In early 1994, it became clear that one of the main challenges to be faced by the new administration was improving the management of public investment and the provision of infrastructure services. The Government and the IMF requested that the World Bank and IDB undertake a study to make recommendations in this area. Preparations for the study were supported by the Economic Cabinet and particularly by SECPLAN which prepared a Public Investment Program document especially for use of the mission. The IMF supported the effort by making available some of its data on the evolution of public investnient. Task managers of sector projects financed by the World Bank and the IDB also contributed to the preparation of the mission, and later provided comments on early drafts of this report. The report is based on the findings of a visit to Honduras in December 1994 and its results were updated during subsequent visits. An initial draft of this report was prepared in the field in December 1994 and discussed with the Authorities at that time. An advanced draft was presented to the authorities in June 1995. Discussions of the draft report were held individually with each of the sector agencies and a general presentation was given to the Economic Cabinet. The conclusions reached during those discussions are reflected in this report. In addition to this report, team members prepared sector reports discussing in greater detail the issues for the following sectors: Roads; Ports and Airports: Telecommunications; Electricity; Water and Sanitation; Investment Planning and Budgeting: and Social Sectors. After incorporating comments from the task managers responsible for the respective sectors in both banks, the reports were sent to the Government in January 1995. Additional copies of these reports can be obtained fromn the World Bank or IDB. Reforming Public Investment v EXECUTIVE SUMMARY 1. High levels of public investment (PI), low levels of savings and an inefficient system of regulation for the provision of infrastructure services constitute a key obstacle to macroeconomic stability and growth in Honduras. The main source of macroeconomic instability is a structurally high fiscal deficit, which reached over 10 percent of GDP in 1993 and was reduced to 7.5 percent of GDP in 1994 with the implementation of courageous measures by the Administration inaugurated in January 1994. Public investment and debt service for debt contracted to finance past investment constitute over half of public expenditures. The new Administration found its hands tied with rigid investment contracts signed by the previous Administration and was forced to cut recurrent expenditures, postpone desired investments in the social sectors and increase taxes to begin to bring the fiscal deficit under control. An inefficient system of regulation adds to the fiscal burden created by this investment by further draining the public finances to compensate for incomplete cost recovery by the public enterprises in charge of providing the main infrastructure services. Over two thirds of public investment is implemented by five agencies: The Ministry of Communications, Public Works and Transportation (SECOPT) and the main four public enterprises (PEs). Public finances will not be brought under control until the sectors where the four PEs provide services are reformed and until the reform process initiated in SECOPT in 1991 is completed. 2. In addition to its impact on macroeconomic instability, there are important macroeconomic and microeconomic inefficiencies associated with PI which constitute an obstacle to economic growth. The macroeconomic inefficiencies consist of a crowding out of private investment and a growing ineffectiveness of investment in generating growth. Public investment has grown every decade since 1950 as a proportion of GDP and as a share of total investment. Until the 1970s, the growth of public investment accompanied growth in private investment. From 1980 on, the growth of public investment has occurred at the expense of private investment levels. The growing ineffectiveness of investment is reflected in the more than doubling of the ICOR from 1950-79 to 1980-94. 3. The provision of infrastructure services is characterized by lack of competition and inefficient regulations which have led to important microeconomic inefficiencies: (i) low coverage -- usually excluding the poor; (ii) poor quality of service and lack of enforcement of safety and environmental regulations; (iii) distortionary tariffs; (iv) lack of maintenance; and (v) the unsustainable use of foreign credits to finance the maintenance of the road network. 4. Public investment is high because the state has replaced private investment by monopolizing key economic areas and by regulating these areas in ways that restrict or prevent private participation and competition. The poor performance of the PEs in infrastructure provision can be attributed mainly to the overextended role of the state and the lack of competition in the provision of infrastructure services. The public sector is in control, to varying degrees, of all four of the major functions in infrastructure provision: ownership, operation, regulation, and sectoral policy setting, monitoring and control. There is little competition in the provision of infrastructure. Telecommunications are served by public monopolies. Electricity and railways are sectors where private providers have some participation, however the public enterprises dominate the supply with the private operators operating only at the fringe of the market. About half of the services in ports are provided directly by the traders, however important inefficiencies remain for other users of the port, partly related to an inefficient system of regulation. While some horizontal unbundling has taken place in the case of water and sanitation services by the decentralization of some of the services to some municipalities and the development of private and community providers, the sector has not developed a competitive structure. Transport services is a sector where divisibility could allow the development of a textbook case of competition. However, licensing of urban and intercity transport services has created an oligopolistic structure behind protected markets. 5. The role of the state is yet to be redefined in a way that allows the economy to rely more on the market for efficiency and on the private sector for financing. Numerous initiatives for privatization or other forms vi A joint World Bank/lIDB Study of participation in the provision of infrastructure services are being considered by the authorities and interest in these initiatives is developing in the private sector. There is a Presidential decision to privatize telecommunications, the new electricity law (despite some important flaws discussed in the main report) opens the way for the private sector in new generation and distribution, there is talk of concessioning/privatizing several services in ports, airports, roads, railways and water and sanitation. The private sector has also shown interest in some of these possibilities, although the terms in which this interest would materialize remain unknown. Two joint World Bank/IDB adjustment operations are under preparation, to support these initiatives. A Public Sector Modernization Credit will support the privatization of HONDUTEL and the corporatization and concessioning of airports. A Water and Sanitation Adjustment Credit will support the decentralization and reform of this service. A Transport Sector Rehabilitation Credit is providing technical assistance for the reform of ports and airports. 6. For 1995, the Government aimed at raising the share of the social sectors in the budget to 35 percent of public investment. This target was surpassed in the 1995 budget where the share of the social sectors in public fixed investment is 38 percent. Furthermore, for 1995 Congress has approved a budget that allocates 56 percent of total primary (i.e. non-interest) expenditures to the social sectors. Despite the large fiscal allocation to the social sectors, there remains a widespread perception, that includes Government officials, public opinion and donor agencies, that not enough is being done for the poor through the PIP and the economic policy framework. Two reasons explain this perception. First, the Government needs to develop a strategy explaining how poverty reduction is to be achieved. There is no statement that explains the Government's strategy for growth and poverty reduction, identifying the links between the two. Lacking such a strategy, Government officials place excessive emphasis on direct interventions, subsidized credit, price controls and control of the tariffs of public enterprises. The lack of an explicit strategy for poverty reduction is partly due to lack of information and analysis about who the poor are and how they can be reached through public policy and investment. Second, most of the investment in the social sectors is not reaching the poor because of its bias in favor of the middle classes and because of inefficiencies in the way public services are provided. In 1994, 73 percent of the investment in the social sectors was assigned to areas that have a very limited impact on the welfare of the poor: housing financed by the pension funds, water and sanitation investments by SANAA and higher education. Changing this bias will require drastic changes in the composition of new investment and in the operation of the social sectors. 7. Public expenditures in the social sectors, at almost 9 percent of GDP, are high relative to incorne by international standards. The main challenge at present is in the education sector, where despite a notable expansion of coverage at the primary level to its current level of 86 percent, Honduras continues to lag behind comparable countries in terms of educational achievement, even among the young who benefited from the recent expansion of coverage. Given the Government's fiscal constraints, improving the quality of social services will depend on achieving greater efficiency rather than on increasing expenditures. 8. A change of paradigm is needed in primary education, moving away from an emphasis on expansion to one of increased quality. The Ministry of Education, with support from an IDA credit is beginning implementation of the new paradigm of improving quality. Quality of education is strongly correlated with non-salary recurrent expenditures (e.g. textbooks and training). Although the budgetary allocation to education, at over 4 percent of GDP, is high by international standards, non-salary current expenditures are under 4 percent of the sector budget and have fallen by 20 percent since 1980. This decrease was due to the need to expand coverage, which required a larger allocation to the construction of new infrastructure and the hiring of additional teachers. It was also due to the rapid increase in the weight of transfers to higher education in the sector budget. Also, administrative costs per student have more than doubled since 1980. As the budgetary allocation to the sector is already high, increased quality requires savings and a reallocation of sector resources. Savings could be obtained by reducing administrative costs and by reducing the high rate of student repetition. The Government should also explore the (admittedly politically difficult) possibility of reallocating resources from higher education to primary education. Reforming Public Investment vii 9. Most of the investment in small scale infrastructure for water and sanitation (i.e. excluding SANAA and the municipality of San Pedro Sula), education and health is built by the social investment fund (FHIS). FHIS was created in 1990 to contract small-scale construction with private builders. Its agility and relatively low administrative costs has allowed the Government to increase substantially the construction of small-scale social infrastructure. The precision of the targeting of the investments by FHIS has been the subject of considerable debate. In favor of FHIS, it must be noted that in comparison with most other public agencies which usually exclude the poor, FHIS does reach the rural localities and shantytowns inhabited by the poor. However, official data show that there has not been efficient targeting in the sense that, in per capita terms, the poor benefit from FHIS investments only to the same extent as the rest of the population. 10. While the Government is planning to strengthen FHIS in preparation for an expansion of its activities in the near future, more than what is currently planned will be needed to overcome four weaknesses in its institutional setup. First, the line ministries for education and health and the water authorities do not participate effectively in the setting of priorities. In the social sectors, the real limitation to the expansion of services is not financing for bricks and mortar, it is rather the capacity of the line ministries to finance, train and equip more teachers and health workers and to develop effective maintenance procedures for the water systems. The expansion in infrastructure should be limited by the possibilities of financing its recurrent costs, and should be guided by clear priorities. Second, by procuring its projects through direct contracting procedures, FHIS has provided contractors an incentive to become promoters for new investments -- a contractor designs and lobbies for the approval of projects in the knowledge that he will receive the contract to execute it. While this has been advantageous in terms of agility, it has not helped in the development of priorities based in the needs of the beneficiaries. Third, FHIS has been increasingly open to political pressure: 46 percent of disbursements took place during the presidential campaign of 1993. Fourth, one of the objectives of FHIS has been the creation of employment. Occasionally, this has taken precedence over the need to ensure the quality of the investments. In mid-1995, the IDB and the World Bank approved credits for FHIS which introduce measures to address these issues. 11. A successful reform of PI and the provision of infrastructure needs to confront three key issues: * Public investment programming lacks a strategy and its implementation suffers from procedural weaknesses. The lack of a strategy makes it easier for interest groups to succesfully lobby for socially inefficient investments. The procedural weaknesses have opened the way to mistakes in the choice and preparation of investment projects, to costly implementation of these investments and to the development of underfinanced recurrent obligations. Large unplanned expenditures are added to the budget every year during implementation. * The regulatory framework for the provision of infrastructure services is inefficient, obsolete and combines excessive control over areas which require autonomy, with lack of regulation over areas of public interest that require oversight. This is reflected in: * Lack of competition and displacement of the private sector from the provision of infrastructure; * Lack of quality control; * Politicized tariff setting procedures that contribute to the financial deficits of PEs, limit the available financing for the expansion of services and generate distortions in resource allocation; * Absence of a maintenance policy (except for the road subsector); and + Absence of a fiscal framework to finance the maintenance of a road network; * An explicit strategy for poverty reduction needs to be developed to guide investment in infrastructure for the social sectors. viii A joint World Bank/lIDB Study Public Investment Programming and Budgeting 12. There are no sectoral strategies to guide public investment. In each sector it is necessary to ask fundamental questions about the role of the govemment -- the responsibilities of the state and how they should be discharged. In some cases what previously was deemed to be a function of government should now be devolved to the private sector. In other cases, the govemment may continue to budget for an activity, but sub-contract its delivery to the private sector. Overall, the government needs to develop a strategic vision of its role in each sector against which public investment proposals can be evaluated. For each sector, strategies should be developed and should include a discussion of the needs and problems and the objectives for the sector laying out program targets for the next few years. The role of the public and private sector in reaching those objectives should be clearly specified. 13. The investment approval process is highly bureaucratic and lacks analytical content. Inject analysis into the investment approval process by: * linking approval of proposed investments to sectoral strategies; * appraising sectoral investment in the form of an investment program rather than individual projects. The Govemment should develop sectoral envelopes to force the examination of trade-offs by sector agencies; • basing the investment approval process on the application of rigorous technical criteria; * ensuring that PEs apply appropriate cost recovery policies and raise their operational efficiency to intemational standards; and * strengthening technical capacity for project design and appraisal in the relevant agencies. 14. The public investment program (PIP) does not constitute an effective tool of fiscal management. To change this situation, the Govemment should: * Develop a rolling medium term expenditure framework as a limit on the PIP. The framework should consist of projections of expenditure, revenues and financing requirements for the next three years and a target fiscal deficit. These figures should be revised each year during budget formulation on a rolling basis; * tighten the planned/actual linkage in the budget by discouraging the introduction of new projects during the year or by requiring that these be linked to additional revenues or reductions in other expenditures; and * stop transfers to cover operating losses of PEs. Provision of Infrastructure 15. The report recommends a widespread reform encompassing key aspects of the provision of infrastructure services. Specific recommendations for each sector are provided in the main report, here we summarize the recommendations conceming ownership and competition, the regulatory and control processes, tariff-setting, maintenance and financing of the road network. 16. Change the structure of ownership within the infrastructure sectors and enhance the degree of competition in and for the provision of services, removing all artificial barriers to entry in service provision. Further participation of the private sector should be pursued as altematives for improving the efficiency of infrastructure services and for generating sources of finance. This increased participation should be sought through transfers of ownership and vertical and horizontal unbundling of service provision. 17. Reform the regulatory and control processes in the provision and management of public services. The role of the Govemment as regulator and controller needs to be more clearly specified. Further participation Reforming Public Investment ix of the private sector in service provision as well as the enhancement of competition should be pursued in order to improve the efficiency of regulation and perhaps even reduce the need for it. Regulatory bodies should be designed to be as free as possible from the pressures of regulatory capture by interest groups and should be properly funded to ensure that they can effectively carry out their functions in an independent manner. Regulators should be skilled in sectoral regulation issues, with long enough term limits to make them independent of any particular administration. 18. The current dispersion and duplication of functions in the existing structure of regulation and controls should be reduced. Controls should be designed in order to ensure that public enterprises have autonomy to manage service operations delegating to sectoral ministries the authority to ensure that the enterprises are accountable in meeting sectoral and macro-economic objectives. Sectoral planning and policy development functions within the line ministries and the Ministry of Planning need to be improved in order to ensure effective control of the behavior of public enterprises. 19. Tariff setting procedures should be based on a proper cost analysis as well as on the need to finance investments for expansion and improvement of services. Enterprises should be allowed to meet at least their operating costs for small residential consumers of electricity and water supply and local telephone services, and their long run marginal costs for all other services. Regulatory bodies in charge of setting tariffs should ensure that the cost of inefficiencies of companies is not transferred to the consumers. 20. Cross-subsidies within a sector, when used, should be properly designed to avoid penalizing a particular group that is important for economic growth (e.g., industries that use large volumes of electricity and that make international calls) or the extremely poor who generally do not have access to service and need to be connected. If the Government decides to subsidize low income families, these subsidies should be as direct as possible to avoid subsidizing the wrong group. In general, subsidies should be directed towards expansion of services and as little as possible towards subsidizing usage of services. This is especially relevant for the case of urban transport where the current system of subsidies goes to the operator and not to the passengers, except in an indirect sense. 21. There is a need for a clear strategy for maintenance in all the infrastructure subsectors which defines the levels of service that need to be maintained in order to minimize total costs of reconstructing deteriorated systems and the costs to users of non-functioning systems. 22. The annual financing requirement for road maintenance (excluding new construction) is about 2 percent of GDP. To become sustainable, the roads network needs to be increasingly maintained from domestic revenues, phasing out the existing system of financing based on external credit. To achieve this, additional sources of revenue need to be sought as the existing transport related revenues are currently needed to finance other fiscal expenditures. The scope for increasing revenues from tolls, or by raising fuel tax rates to levels similar to those under use in other Latin American countries and other sources should be studied. The Government is considering the implementation of a roads fund. A law was passed creating this fund in 1993, but it has not been implemented. Fiscal soundness would require that such a fund be based on incremental revenues and not by redirecting tax revenues (as required by the existing law). Investments in the Social Sectors 23. The Government needs to develop an explicit strategy for poverty reduction. While poverty reduction is emphasized by the Government, the absence of a clear statement of how it will be achieved lends itself to contradictory policies. The strategy should explain the effects on poverty reduction of the reinstatement of growth, of an expansion of social services and of the use of safety net mechanisms. The Social Cabinet, should be charged with the task of developing such a statement for approval by the Government. The strategy would then serve as a guide for the development of the PIP. In order to develop this task, the x A joint World BanklIDB Study Government will have to invest in better data on poverty and in the development of stronger skills to analyze the impact of economic and social policies on the poor. 24. An important risk to the implementation of the Government's education strategy of improving quality of basic education is posed by the inertia of the old paradigm that pushes for a continued expansion in construction of new schools and hiring of new buildings. This inertia may receive support and financing from FHIS. Given the budgetary ceiling, there is a trade-off between allocating resources to improve the quality of education on the one hand and allocating resources to expanding the system by building schools and classrooms and hiring teachers to staff them on the other. The plan to improve the quality of education has identified urgent needs for investment in infrastructure with an estimated total cost of about USS 3 million per year over the next four years. FHIS has a different plan, which would spend US$ 12 million only in 1995, mostly in the construction of classrooms. This could force the Government to hire possibly 1,000 new teachers per year, derailing the careful programming needed to allow the budgetary reallocation required to improve the quality of education. Under the new credits approved by the IDB and the World Bank, measures will be taken to address these issues. 25. New investments in FHIS need to emphasize the priorities for the location and type of its investments. Getting the priorities right will require preparation of investment programs (i.e. going beyond the approval of individual investments) for education, health and water and sanitation. These should be developed by the line ministries and regulatory agencies and these agencies need to develop the skills and data required for this task. Targeting to the poor should remain one of the main criteria to establish the priorities for FHIS investment. The achievements noted in targeting can be lost if FHIS becomes more open to political pressures or if contractors are allowed to drive the investments. The use of prioritized programs should allay both risks. 26. The Government's involvement in housing needs to undergo a deep reform. Public investment financed by the pension funds in housing should be stopped. These investments are inefficient and weaken the financial viability of the pension funds. A study is needed to understand what are the needs of the poor in regards to housing, and what role, if any, the state should play in its provision. The study should reflect on the possibility that the housing needs of the poor would be best served by increasing their access to services currently provided mainly to the middle class: water, sewerage, garbage disposal, transport, electricity, telecommunications. Reforming Public Investment xi RESUMEN EJECUTIVO 1. Elevados niveles de inversi6n publica y un ineficiente sistema de regulaci6n para la provisi6n de servicios de infraestructura constituyen un obstaculo importante para la estabilidad macroecon6mica y el crecimiento econ6mico en Honduras. La principal fuente de inestabilidad macroecon6mica es un deficit fiscal estructuralmente alto, que ascendi6 al 10% del PIB en 1993 y se redujo al 7,5% del PIB en 1994 gracias a la implementaci6n de dificiles medidas adoptadas por el Gobierno que tom6 posesi6n en enero de 1994. La inversi6n puiblica y el servicio de la deuda contraida para financiar inversiones en el pasado constituyen mas de la mitad del gasto publico. En 1994, el nuevo gobierno se encontr6 con las manos atadas por los rigidos contratos de inversi6n suscritos por el gobierno anterior, y se vio forzado a recortar el gasto corriente, a retrasar inversiones necesarias en los sectores sociales y a elevar impuestos para empezar a controlar el deficit fiscal. El ineficiente marco regulatorio de las empresas publicas hace aun mas pesada la carga fiscal proveniente de la inversi6n al obligar a recurrir al financiamiento publico para compensar la incompleta recuperaci6n de los costos de las empresas piublicas encargadas de prestar los principales servicios de infraestructura. Mas de las dos terceras partes de la inversi6n pubblica son realizadas por cinco organismos: La Secretaria de Comunicaciones, Obras Publicas y Transportes (SECOPT) y las cuatro principales empresas publicas. Mientras no se reformen los sectores en los que estas empresas prestan sus servicios, ni se l]eve a termino el proceso de reforma iniciado en la SECOPT en 1991, no sera posible controlar las finanzas piiblicas. 2. Ademas de las repercusiones sobre la inestabilidad macroecon6mica, la inversi6n publica padece de ineficiencias importantes, tanto macro como microeconomicas, que constituyen un obstaculo para el crecimiento econ6mico. La ineficiencia macroecon6mica se manifiesta en un desplazamiento de la inversi6n privada por la del sector publico, y en una creciente ineficacia de la inversi6n en generar crecimiento econ6mico. La inversi6n piublica ha venido registrando aumentos constantes como proporci6n del PIB y de la inversi6n total desde 1950. Hasta los aflos setenta, el crecimiento de la inversi6n publica fue complementario al de la inversi6n privada. Sin embargo, a partir de 1980, el aumento de la inversi6n publica se ha producido a expensas de la inversi6n privada. La ineficacia cada vez mayor de la inversi6n se refleja en la duplicaci6n de la relaci6n marginal capital-producto entre 1950-79 y 1980-94. 3. La prestaci6n de servicios de infraestructura se caracteriza por la falta de competencia y la existencia de una regulaci6n ineficiente que han dado lugar a importantes deficiencias microecon6micas: (i) escasa cobertura que en general excluye a los sectores pobres; (ii) baja calidad de los servicios y falta de rigor en el cumplimiento de las normas de seguridad y medio ambiente; (iii) distorsiones en las tarifas; (iv) insuficiente mantenimiento, y (v) recurso insostenible al credito externo para financiar el mantenimiento de la red vial. 4. La inversi6n publica es elevada porque el Estado ha desplazado al sector privado monopolizando areas clave de la economia y reglamentandolas de forma que limita o impide la participaci6n privada y la competencia. Los deficientes resultados de las empresas publicas con respecto a la prestaci6n de servicios de infraestructura pueden atribuirse sobre todo al omnipresente papel del Estado y a la falta de competencia en la provisi6n de dichos servicios. El sector publico controla en distinto grado las cuatro funciones principales en que se apoya la prestaci6n de servicios de infraestructura: propiedad, operaci6n, regulaci6n, y formulaci6n, seguimiento y control de la politica sectorial. La competencia en la provisi6n de infraestructura es escasa. Las telecomunicaciones estan en manos de un monopolio publico. Los puertos, los ferrocarriles y la electricidad son sectores en los que existe una pequeffa participaci6n de proveedores privados; no obstante, las empresas puiblicas dominan el abastecimiento, mientras que los proveedores privados operan casi al margen del mercado. Pese a que se ha logrado cierta descentralizaci6n horizontal en el caso de los servicios de abastecimiento de agua y alcantarillado con la delegaci6n de algunas funciones a las municipalidades y la participaci6n de proveedores del sector privado y las comunidades, no se ha desarrollado todavia una estructura competitiva. El transporte es un sector que podria facilmente ser xii A joint World Bank/lIDB Study altamente competitivo, sin embargo, la concesi6n de licencias y la imposici6n de barreras de entrada para el transporte urbano e interurbano ha creado una estructura oligopolistica amparada en mercados protegidos. 5. Todavia esta por redefinirse el rol del Estado en la economia de Honduras de tal manera que la economia pueda depender mas del mercado para lograr eficiencia, y mAs del sector privado para obtener mayor financiamiento. Las autoridades estan estudiando una serie de iniciativas para la privatizaci6n u otras formas de participaci6n privada en la prestaci6n de los servicios de infraestructura, iniciativas en las que el sector privado esta demostrando un creciente interes. Por decisi6n presidencial estA previsto privatizar las telecomunicaciones; la nueva ley del sector electrico (pese a algunas fallas importantes que se analizan en el informe principal) abre el camino al sector privado en las actividades de nueva producci6n y distribuci6n; se esta considerando la posibilidad de privatizar o delegar en regimen de concesi6n algunos servicios de los puertos, los aeropuertos, las carreteras, los ferrocarriles y el abastecimiento de algunos servicios relacionados al agua y alcantarillado. El sector privado tambien ha mostrado interes en estas posibilidades aunque todavia no es claro en que condiciones financieras se podria materializar dicho interes. Para respaldar estas iniciativas, el Banco Mundial y el BID estan preparando conjuntamente dos operaciones de ajuste. Con el apoyo de un Credito para la Modernizaci6n del Sector Publico se privatizarA HONDUTEL y los aeropuertos seran corporatizados y cedidos en regimen de concesi6n. Un Credito de Ajuste para el Abastecimiento de Agua y Alcantarillado permitira la descentralizaci6n y la reforma de este servicio. Finalmente, con el respaldo de un Credito para la Rehabilitaci6n del Sector de Transportes se prestarA asistencia tecnica para la reforma de los puertos y aeropuertos. 6. Para 1995, las autoridades tenian previsto aumentar la participaci6n de los sectores sociales hasta el 35% de la inversi6n publica. Este objetivo se sobrepas6 en el presupuesto de 1995, en el que la participaci6n de dichos sectores en la inversi6n publica en capital fijo ha sido prevista como 38% del total. Para 1995, el Congreso ha aprobado un presupuesto en el que se asigna el 56% del gasto primario total a los sectores sociales. Pese a la cuantiosa asignaci6n presupuestaria a estos sectores, sigue existiendo una impresi6n generalizada --incluso entre los funcionarios del gobierno, la opini6n puiblica y los organismos donantes-- de que no se esta haciendo suficiente por los pobres a traves del programna de inversiones publicas ni de la politica econ6mica en general. Ello obedece a dos motivos: en primer lugar, las autoridades necesitan hacer explicita su estrategia para la reducci6n de la pobreza. En particular, es necesario expresar la forma en que la reducci6n de la pobreza se liga al crecimiento econ6mico. Carentes de esa estrategia, las autoridades han hecho excesivo hincapie en las intervenciones directas, en la subvenci6n del credito, los controles de precios y el control de las tarifas de los servicios publicos. La falta de una estrategia para reducir la pobreza se debe en parte a la falta de informaci6n y de analisis para determinar quienes son los pobres y c6mo se puede llegar a ellos a traves de las medidas de politica y la inversi6n publica. Segundo, la mayor parte de la inversi6n no Ilega a los pobres debido a la existencia de un sesgo que favorece a las clases medias, y a la ineficiencia en la forma en que se prestan los servicios publicos. En 1994, el 73% de la inversi6n en los sectores sociales se asign6 a sectores que tienen un impacto muy limitado en el bienestar de los pobres: vivienda financiada por los fondos de pensiones, inversiones del Servicio Aut6nomo Nacional de Agua y Alcantarillado (SANAA) y educaci6n superior. Para eliminar este sesgo sera necesario modificar drasticamente la composici6n de las nuevas inversiones y el funcionamiento de los sectores sociales. 7. El gasto publico en los sectores sociales, cifrado en casi el 9% del PIB, es alto en relaci6n cop al ingreso del pais, en comparaci6n con los niveles internacionales. Actualmente, la tarea mas acuciante es satisfacer las necesidades del sector de educaci6n. Pese a la notable expansi6n de la cobertura educativa a nivel primario hasta la cifra actual del 86%, Honduras sigue yendo a la zaga de otros paises comparables en lo que respecta a logros escolares, incluso entre los j6venes que se beneficiaron con la reciente ampliaci6n de la cobertura. Habida cuenta de las restricciones fiscales con que operan las autoridades, para mejorar la calidad de los servicios sociales, mAs que aumentar el gasto, sera necesario lograr una mayor eficiencia. Reforming Public Investment xiii 8. Es preciso un cambio de paradigma con respecto a la educaci6n primaria, para lo que habra que hacer mas hincapie en la calidad que en la cobertura. El Ministerio de Educaci6n, con el respaldo de un credito de la AIF esta poniendo en marcha este nuevo enfoque basado en la mejora de la calidad. La calidad de la educacion guarda una fuerte correlaci6n con los gastos corrientes no salariales (por ejemplo libros de texto, capacitaci6n de docentes). Aunque la asignaci6n presupuestaria para el sector de educaci6n, cifrada en mAs del 4% del PIB, es alta en comparaci6n con los niveles internacionales, los gastos corrientes no salariales se situan por debajo del 4% del presupuesto del sector y se han reducido en un 20% desde 1980. Este descenso se debi6 a la necesidad de ampliar la cobertura, lo que oblig6 a asignar una mayor proporci6n del gasto a la construcci6n de nueva infraestructura y a la contrataci6n de maestros. Tambien se debi6 al rapido aumento de la importancia de las transferencias destinadas a educaci6n superior en el presupuesto del sector. Ademas, los gastos de administraci6n por estudiante se han duplicado con creces desde 1980. Como la asignaci6n presupuestaria para el sector ya es elevada, para aumentar la calidad sera necesario ahorrar y reasignar los recursos con que cuenta el sector. Se podria ahorrar, por ejemplo, recortando los gastos de administraci6n y reduciendo la elevada proporci6n que representan los estudiantes repetidores. Las autoridades deberian estudiar tambien la posibilidad (bastante diflcil desde el punto de vista politico) de reasignar recursos de la educaci6n superior a la educaci6n primaria. 9. La mayor parte de la inversi6n de pequeffa escala en los sectores de infraestructura de agua y alcantarillado (es decir, excluidos el SANAA y la municipalidad de San Pedro Sula), educaci6n y salud proviene del Fondo Hondureflo de lnversi6n Social (FHIS). El FHIS se cre6 en 1990 para contratar obras de pequefla escala con constructores privados. Su agilidad y el nivel relativamente bajo de sus gastos de administraci6n han permitido a las autoridades aumentar significativamente la construcci6n de infraestructura social de pequefia escala. La precisi6n con que el FHIS focaliza las inversiones ha sido objeto de amplio debate. Cabe seflalar a favor del FHIS que, en contraste con la mayoria de los demAs organismos publicos que no llegan a cubrir a los sectores de menores ingresos, las inversiones del FHIS llegan a las comunidades rurales y a las poblaciones marginales donde viven los pobres. Sin embargo, los datos oficiales indican que la focalizaci6n de los recursos no ha sido eficiente en el sentido de que, en cifras per capita, las inversiones del FHIS s6lo han beneficiado a los sectores pobres en la misma medida que al resto de la poblaci6n. 10. Pese a que las autoridades tienen previsto fortalecer el FHIS en preparaci6n de la expansi6n de sus actividades en un futuro pr6ximo, sera necesario desplegar mas esfuerzos para eliminar cuatro deficiencias de caracter institucional. En primer lugar, los ministerios sectoriales --educaci6n y salud-- y las autoridades competentes de los servicios de agua no participan de hecho en el establecimiento de prioridades. En los sectores sociales, lo que verdaderamente limita la expansi6n de los servicios no es el financiamiento de los ladrillos y el cemento, sino la capacidad de los ministerios competentes para financiar, capacitar y equipar a mas maestros y al personal de los servicios de salud. La expansi6n de la infraestructura deberia limitarse en funci6n de las posibilidades de financiamiento de los gastos corrientes, y guiarse conforme a prioridades claramente establecidas. Segundo, al asignar sus proyectos en base a procedimientos de contrataci6n directa, el FHIS ha brindado a los contratistas un incentivo para que se conviertan en promotores de nuevas inversiones: un contratista disefla y promociona la aprobaci6n de proyectos sabiendo que le otorgaran el contrato para ejecutarlos. Si bien esta politica ha resultado ventajosa por to que respecta a la agilidad, no ha contribuido a desarrollar las prioridades en funci6n de las necesidades de los beneficiarios. Tercero, el FHIS se ha visto cada vez mas sometido a presiones politicas: el 46% de los desembolsos se produjeron durante la campaffa presidencial de 1993. Cuarto, uno de los objetivos del FHIS ha sido la creaci6n de empleo. En ocasiones, este objetivo ha primado sobre la necesidad de velar por la calidad de las inversiones. A mediados de 1995, el BID y el Banco Mundial aprobaron sendos creditos para financiar las actividades del FHIS que contemplan medidas para afrontar estos problemas. 11. Para reforrnar con exito la inversi6n publica y la prestaci6n de los servicios de infraestructura, es necesario abordar tres problemas clave: xiv A joint World BankhlDB Study * La programaci6n de la inversion publica carece de una estrategia en que apoyarse, y en su ejecucion se observa una serie de deficiencias de procedimiento. La falta de dicha estrategia crea un vacio en la politica de inversiones que ha permitido ceder a presiones para la ejecuci6n de grandes proyectos antiecon6micos. Las deficiencias de procedimiento han abierto la via a otros errores en la selecci6n y la preparacion de los proyectos de inversi6n, han hecho que la ejecucion de esas inversiones sea costosa y han dado lugar a la acumulaci6n de obligaciones ordinarias no financiadas en su totalidad. Todos los afios, durante la fase de ejecuci6n,. se incorporan al presupuesto gastos cuantiosos que no se habian planificado. * El marco regulatorio en el que se inscribe la prestaci6n de los servicios de infraestructura es ineficiente, obsoleto y controla en exceso materias en las que es necesaria la autonomia, mientras que deja sin reglamentar otras areas de interes publico que requieren supervisi6n. Todo ello se refleja en: * La falta de competencia v en la falta de participacion del sector privado en la prestaci6n de los servicios de infraestructura: * La falta de control de calidad: * La politizaci6n de los procedimientos de fijacion de las tarifas, lo que contribuye al deficit de las empresas publicas. limita el financiamiento disponible para la expansi6n de los servicios y produce distorsiones en la asignaci6n de los recursos; - La falta de una politica de mantenimiento (salvo en lo que respecta al subsector de carreteras), y * La ausencia de un marco fiscal para financiar el mantenimiento de la red vial; * Es necesario desarrollar una explicita estrategia de reducci6n de la pobreza que oriente la inversi6n en infraestructura para los sectores sociales. Programaci6n de la Inversi6n Publica y Presupuestaci6n 12. No existen estrategias sectoriales para orientar la inversi6n publica. En cada sector es necesario plantear interrogantes fundamentales con respecto a la funci6n del Estado: 6cuaes son sus responsabilidades y como debe cumplirlas? En algunos casos, lo que antes se consideraba como funci6n del Estado debe ahora delegarse en el sector privado. En otros casos, el Estado puede seguir presupuestando una actividad determinada, pero debiera subcontratar la prestaci6n de los servicios al sector privado. En general, es necesario que las autoridades desarrollen una visi6n estrategica sobre las funciones que el Estado esta llamado a desempefiar en cada sector que sirva de referencia para evaluar las propuestas de inversi6n puiblica. Tambien es conveniente desarrollar estrategias para cada sector, en las que se incluya un analisis de las necesidades y los problemas, asi como los objetivos del sector estableciendo las metas. A este respecto, debe especificarse con toda claridad las funciones que han de desempefiar tanto el sector publico como el sector privado para alcanzar dichos objetivos. 13. El proceso de aprobaci6n de las inversiones esta excesivamente burocratizado y carece de contenido analitico. Para inyectar al proceso ese contenido, se recomiendan las siguientes medidas: * Vincular la aprobaci6n de las inversiones propuestas a las estrategias sectoriales; * Evaluar la inversi6n sectorial como un programa de inversiones en vez de hacerlo en forma de proyectos individuales. Las autoridades deben fijar techos sectoriales para obligar a los organismos del sector a anializar los pros y los contras de proyectos especificos; * Basar el proceso de aprobacion de las inversiones en la aplicacion de rigurosos criterios tecnicos de costo beneficio; * Velar porque las empresas publicas apliquen las pertinentes politicas de recuperaci6n de costos y aumenten su eficiencia operativa para equipararla a los niveles internacionales, y Reforming Public Investment xv * Reforzar la capacidad tecnica de los organismos competentes con respecto al disefio y la evaluaci6n de los proyectos. 14. El programa de inversi6n publica no constituye un instrumento eficaz de gesti6n fiscal. Para cambiar esta situaci6n, las autoridades deben adoptar las medidas siguientes: * Establecer un marco de gasto a mediano plazo como limite para el programa de inversi6n puiblica. A tal efecto, deberan incluirse proyecciones del gasto, de los ingresos y de las necesidades de financiamiento de los tres aflos siguientes, y fijar una meta con respecto al deficit fiscal. Estas cifras deberan revisarse todos los aflos, cada vez que se formule el presupuesto; * Vincular mas estrechamente en el presupuesto las cifras previstas con las cifras efectivas para desalentar la incorporaci6n de nuevos proyectos durante el affo, o exigir que dicha incorporaci6n se condicione a que aumenten los ingresos o disminuyan otros gastos, y * Suprimir las transferencias de recursos encaminadas a financiar las perdidas de operaci6n de las empresas puiblicas. Provisi6n de Infraestructura 15. En el informe se recomienda llevar a cabo una reforma de gran alcance que abarque a los aspectos clave de la prestaci6n de servicios de infraestructura. En el informe principal se formulan recomendaciones especificas para cada sector; en el presente resumen se sintetizan las recomendaciones relativas a la propiedad y la competencia, los procesos regulatorios y de control, la fijaci6n de las tarifas, el mantenimiento y la financiaci6n de la red de carreteras. 16. Es necesario modificar la estructura de propiedad dentro de los sectores de infraestructura y aumentar el grado de competencia en la prestaci6n de servicios, eliminando todas las barreras artificiales que impiden el acceso a dicha prestaci6n. Como alternativa para mejorar la eficiencia de los servicios de infraestructura y generar fuentes de financiamiento se recomienda fomentar una mayor participaci6n del sector privado. Esta mayor participaci6n podria lograrse, segun el caso, transfiriendo la propiedad y descentralizando tanto vertical como horizontalmente la prestaci6n de los servicios. 17. En cuanto a la reforma de los procesos regulatorios y de control en la prestaci6n y la gesti6n de los servicios puiblicos, deben especificarse con mas claridad las funciones de regulaci6n y control que ha de desempeffar el Estado. Tambien en este caso debe fomentarse una mayor participaci6n del sector privado en la prestaci6n de los servicios y un aumento de la competencia, para mejorar la eficiencia de la regulaci6n e incluso quizas hacerla menos necesaria. Los organismos reguladores deben gozar de la mayor libertad posible frente a la injerencia, en el desempeflo de sus funciones, de los grupos de presi6n, y deben contar con el suficiente financiamiento para desempei1ar dichas funciones eficazmente y con independencia. Por su parte, las autoridades competentes deberan tener los conocimientos apropiados de las cuestiones que afectan a la regulaci6n del sector, y su mandato debera ser suficientemente largo para que puedan actuar con independencia del gobierno. 18. Es necesario reducir la dispersi6n y la duplicaci6n de funciones que se observa en la estructura actual de regulaci6n y control. Es necesario incrementar la autonomia de las empresas publicas, delegando en los ministerios competentes exclusivamente la facultad de velar porque las empresas se responsabilicen de la consecuci6n de los objetivos sectoriales y macroecon6micos. Para lograr un control eficaz del comportamiento de las empresas puiblicas, tambien habrA que mejorar la planificaci6n sectorial y las funciones de desarrollo de politicas en el seno de los ministerios competentes y de la autoridad de Planificaci6n. 19. Los procedimientos de fijaci6n de tarifas deberan basarse en un adecuado analisis de costos, asi como en la necesidad de financiar inversiones para la expansi6n y mejora de los servicios. Se debe permitir a las empresas que cubran por lo menos los costos de operaci6n del consumo residencial de pequeffa escala de xvi A joint World Bank/IDB Study electricidad y agua corriente, y de los servicios telef6nicos locales, asi como los costos marginales a largo plazo de todos los demas servicios. Los organismos reguladores encargados de establecer las tarifas habran de velar porque el costo de la ineficiencia de las empresas no se traslade a los consumidores. 20. Siempre que se otorguen subvenciones cruzadas dentro de un sector, deberan diseflarse de tal manera que no penalicen a un grupo concreto, importante desde el punto de vista del crecimiento econ6mico (por ejemplo, las industrias que consumen un gran volumen de electricidad y hacen llamadas telef6nicas internacionales) o a los sectores mas pobres que generalmente no tienen acceso a los servicios y necesitan conectarse a los mismos. Si las autoridades deciden subvencionar a las familias de bajo ingreso, esta subvenci6n debe ser lo mas directa posible para evitar subsidiar al grupo equivocado. En general, las subvenciones deber orientarse a la expansi6n de los servicios y, lo menos posible, a subvencionar el uso de los mismos, sobre todo en el caso del transporte urbano, en el que, conforme al sistema actual, las subvenciones las recibe la empresa que explota el servicio y no el usuario, salvo por una via indirecta. 21. Es necesario adoptar una estrategia clara para el mantenimiento de todos los sectores de infraestructura, en la que se definan los niveles de servicio que hay que mantener para reducir al minimo los costos totales que conileva la reconstrucci6n de los sistemas deteriorados y los costos que entraflan para los usuarios los sistemas que no funcionan. 22. Las necesidades anuales de financiamiento para el mantenimiento de la red vial (excluida la construcci6n de nuevas carreteras) se situan en torno al 2% del PIB. Es necesario que el mantenimiento se haga recurriendo cada vez mas a los ingresos internos y eliminando progresivamente el actual sistema de financiamiento basado en creditos externos. Para alcanzar este objetivo, es preciso buscar nuevas fuentes de ingreso, dado que los ingresos actuales conexos con el transporte se necesitan para financiar otros gastos fiscales. Se recomienda estudiar que margen de maniobra existe para aumentar los ingresos provenientes del peaje, o para elevar los impuestos sobre los carburantes hasta niveles similares a los vigentes en otros paises de America Latina. Inversi6n en los sectores sociales 23. Es necesario que las autoridades desarrollen una estrategia explicita para la reducci6n de la pobreza. Si bien este es un objetivo en el que el gobierno esta haciendo hincapie, la falta de una declaraci6n clara con respecto a su consecuci6n se presta a la adopci6n de medidas contradictorias. En la estrategia en cuesti6n se deberfan explicar los efectos que tendrian sobre la reduccion de la pobreza la reactivaci6n del crecimiento econ6mico, una expansi6n de los servicios sociales y la adopci6n de mecanismos de protecci6n social. La estrategia serviria de orientaci6n para desarrollar el programa de inversiones publicas. Para ejecutar esta tarea, el Gobierno tendra que invertir en la preparaci6n de datos mAs fidedignos sobre la pobreza y en el fortalecimiento de las tecnicas necesarias para analizar el impacto de las politicas econ6micas y sociales sobre los sectores pobres. 24. Habida cuenta de las limitaciones presupuestarias, es necesario elegir entre dos opciones para el sector educativo: por una parte, la asignaci6n de recursos para mejorar la calidad de la educaci6n y, por otra, la asignaci6n de recursos para ampliar la cobertura del sistema construyendo mas escuelas y aulas, y contratando mas maestros para utilizar las nuevas aulas. Al elaborarse el plan de mejora de la calidad de la educaci6n se ha detectado la urgente necesidad de invertir en infraestructura, con un costo total estimado de alrededor de US$3 millones al aflo durante los pr6ximos cuatro aflos. El FHIS tiene un plan distinto, conforme al cual se invertirian US$12 millones s6lo en 1995; de esta cifra, la mayor parte se dedicaria a la construcci6n de aulas escolares. Ello podria obligar a las autoridades a contratar posiblemente a 1.000 nuevos maestros por aflo, lo que echaria por tierra la cuidadosa programaci6n necesaria para permitir la reasignaci6n presupuestaria que se precisa para mejorar la calidad de la educaci6n. Los creditos recientemente aprobados por el BID y el Banco Mundial incluyen medidas para afrontar estos problemas. Reforming Public Investment xvii 25. Es necesario que, en las nuevas inversiones del FHIS, se haga hincapie en las prioridades relativas a la ubicaci6n y el tipo de sus inversiones. Para asignar correctamente las prioridades es necesario elaborar programas de inversiones (es decir, trascender la mera aprobaci6n de inversiones individuales) para los sectores de educaci6n, salud y agua y alcantarillado. Los programas deberian prepararlos los ministerios competentes y los organismos reguladores, y estos a su vez, tendrian que desarrollar los conocimientos y los datos necesarios para llevar a cabo esa tarea. La focalizaci6n especifica de los servicios en los sectores pobres debe seguir siendo uno de los criterios principales a la hora de establecer las prioridades para las inversiones del FHIS. El terreno ganado en materia de focalizaci6n podria perderse si el FHIS se abre mas a las presiones politicas o si se permite que los contratistas impulsen las inversiones. Con la aplicaci6n de programas elaborados teniendo en cuenta las prioridades se podrian eliminar ambos riesgos. 26. Es necesario que se reforme en profundidad la participaci6n del Estado en el sector de la vivienda y que se interrumpa la inversi6n publica en vivienda financiada con cargo a los fondos de pensiones. Estas inversiones son ineficientes y debilitan la viabilidad financiera de los fondos de pensiones. Es preciso realizar un estudio para comprender cuales son las necesidades de los pobres en lo que respecta a la vivienda, y que funcion podria desempeflar el Estado para atender a dichas necesidades. En el estudio se deberia reflejar la posibilidad de que la mejor forma de satisfacer las necesidades de vivienda de los sectores pobres sea brindarles un mayor acceso a los servicios que se prestan en la actualidad principalmente a la clase media: agua, alcantarillado, recogida de basuras, transporte, electricidad y telecomunicaciones. Reforming Public Investment 1. INTRODUCTION: THE ECONOMIC IMPACT OF PUBLIC INVESTMENT 1.1 High levels of public investment (PI) and an inefficient system of regulation for the provision of infrastructure services constitute a key obstacle to macroeconomic stability and growth in Honduras. The main source of macroeconomic instability is a structurally high fiscal deficit, which reached over 10 percent of GDP in 1993 and 7.5 percent of GDP in 1994. Pi and debt service for debt contracted to finance past investment constitute over half of public expenditures. An inefficient system of regulation adds to the fiscal burden created by this investment by further draining the public finances to compensate for incomplete cost recovery by the public enterprises in charge of providing the main infrastructure services. In addition to its impact on macroeconomic instability, there are important inefficiencies associated with PI which constitute an obstacle to economic growth. This chapter describes the evolution of public investment in recent decades, the factors behind the countrv's high levels of P1 and its impact on macroeconomic instability and growth. The chapter then identifies the main agencies in charge of public investment and concludes by describing the rest of the report. Public Investment anid Public Finances 1.2 During the 1950s and 1960s, PI oscillated at around 2 percent of GDP, while private investment had a level about 4 times larger. In the 1970s and 1980s. the state increased its direct participation in the economy and public investment grew sharply, peaking at 12 percent of GDP in the early 1980s during the construction of the hydroelectric plant of El Caj6n. These high levels of investment generated large fiscal deficits which reached over 10 percent of GDP in the early 1980s. The mirror image of the fiscal deficits were large deficits in the current account of the balance of payments, which trebled Diagram I -: Public and Private Investment as a Percent ofGDP between the mid 1970s and the mid 1980s. Access to abundant grants and concessional 25.00 credit, provided generously while the Contra War was being fought il the 20.00 EzPr.ntr I-. A Honduras/Nicaragua border, allowed the oPubil In-. Government to stave off a major balance of 15.00 payments crisis. As a consequence, external I debt almost tripled during this period 0 X0 reaching 110 percent of GDP by 1990 and |.00 making Honduras the 5th most indebted country in Latin America. When political 0.00 circumstances changed in the region in the late 1980s. external finance became scarce and the Government cut expenditures and resorted to external arrears to finance its continued deficit. P1 fell to around 7 percent of GDP. In 1989 Honduras wNent into arrears with the multilateral institutions and was isolated from the international financial community. 1.3 In 1990, the Callejas Administration was inaugurated and initiated a program of stabilization and adjustment that lasted the first three years of its 4-year period. The financial community supported this program initially by providing a large bridge loan to allow Honduras to pay its accumulated arrears, and later by financing new investments. In contrast to the experience of other Latin American countries, Pi was restored during the stabilization period. In the run off to the presidential elections of 1993, the outgoing Administration reversed the course of economic policy. Most of the increase in the 1993 fiscal deficit above its programmed level was created by a sharp increase in P1 which reached a staggering 14.5 percent of GDP. Most of the increase in expenditures was in the form of capital expenditures. Revenues also fell, partly due to a reduction in the real value of tariffs charged by key public enterprises. Over US$100 million in international reserves were lost that year. 2 A join! World BanklIDB Study 1.4 The Reina Administration, inaugurated in January 1994 inherited a difficult economic situation marked by a high projected fiscal deficit for 1994 equivalent to 12 percent of GDP, accelerating inflation, rapid depreciation of the currency and low levels of international reserves. A major difficulty faced by the incoming Administration was the impossibility of cutting expenditures in the larger investment projects as the loans and contracts with suppliers and contractors for these projects had already been signed by the previous Administration and could not be cut or delayed without incurring large penalties. The new Administration was also faced with electricity shortages due to a combination of lack of maintenance of key equipment, low tariffs, mismanagement of hydroelectric water reserves and insufficient rain. In consequence, the Reina Administration was faced with the need to implement unpopular austerity measures and to ration electricity and-raise electricity tariffs. The rigidities inherited in the investment program prevented the new Administration from taking action on its campaign promises of increasing expenditures in the social sectors. 1.5 During the second semester of 1994, some important measures were taken on the fiscal front reducing the fiscal deficit for 1994 as a whole to around 7.5 percent of GDP. The main corrective measures were approved by Congress in October 1994 and included measures to provide increased tax revenues (use of market exchange rate for custom valuation, creation of a gross assets tax, elimination of some income tax exemptions, and expansion of the sales tax base), and curtailment of public expenditures (reduction in transfers and subsidies and in the public wage bill). Economic activity was affected adversely by the measures taken to control the budget deficit and by the electricity shortages and real GDP contracted by about 1.5 percent. Improvements in the terms of trade, brought about by the increase in international coffee prices, helped avoid a 1994 external crisis and has allowed some accumulation of international reserves. 1.6 After implementing the austerity measures, the Government reached an agreement with the IMF on an economic program. The program contemplates a reduction in current expenditures and in the debt to GDP ratio. Part of the reduction in expenditures would be achieved by a reduction in public investment as a percentage of GDP. Pi is projected to decrease from 11.7 percent in 1994 to 10.5 percent in 1995, and Tible 1-1: Public Finances in Latin America (9 Countries), 1993 stabilizing at 8 percent in 1996 Country Total Public Overall Tax Interest Public onwards. A large proportion of the Expenditurel1 Fiscal Revenues Payments Investment debt contracted and the equipment Deficit purchased in 1993 was for a large (as a percent ofGDP) (as % of investment in telecommunications. primary In order to achieve the public Venezuela 41.1 3.3 7.8 2.4 25.2 investment and debt targets projected Nicaragua 38.0 -0.1 22.3 3.8 354 in the program, the Government has Costa Rica 38.0 -0.6 22.5 4.0 16.0 committed itself to privatizing the Honduras 37.3 10.5 16.5 6.6 39.3 telecommunications state enterprise Panama 35.9 -1.0 16.4 2.2 13.9 (HONDUTEL) in 1995. Dom. Republic 25.0 0.2 12.7 1.6 52.1 Mexico 24.9 -0.7 12.7 3.1 17.0 El Salvador 21.6 1.5 9.4 2.2 28.5 economic Instability Guatemala 14.8 1.5 8.1 1.8 25.4 Central America 29.7 0.3 15.7 2.8 23.8 exc. Honduras 1.7 In 1993, Honduras had one Of the Non-Financial Public Sector of the highest fiscal deficits in Latin 2 Primary Expenditure excludes interest payments. America. This deficit was created by Source: World Bank Individual Country Data Bases a combination of high expenditure and relatively low taxation levels. As shown in table 1-1, Honduras was the fourth largest spender in a selected group of Latin American countries. While slightly higher than the regional average, tax revenues, as a proportion of GDP, were Reforming Public Investment 3 substantially lower than in other high-spending countries. Below we discuss the role of PI in the high level of expenditures. The scope for increasing tax revenues is discussed in the 1994 Country Diagram 1-2: Overall Deficit and Public Investment Economic Memorandum of the World Bank. 1.8 Public investment is the main driving force 14-ubc Investr behind the high level of public expenditures. The 12 mOverall Defict distinguishing features of expenditures in Honduras o 10-_ as compared to other Latin American countries 6 81l (Table 1-1) are: (i) a high debt service (for debt r 64l contracted mainly to finance past public X 4 investment); interest payments as a share of GDP CL 2 are almost three times larger in Honduras than in 0 . 4 l 4 t _ t the other Central American countries; and (ii) a N o c¢o a high share of investment in the primary m 0 0 0 0 a) 0 0 expenditures of the public sector (this share is 50 percent higher than the average for the rest of Central America). 1.9 There is a tight association between the Diagram 1-3: Disbursement of External Debt and Public fiscal deficit and PI; the fiscal deficit has been high Investment in the years of high public investment, and lower in I r the years of lower PI (Diagram 1-2). This associa- 14 tion was temporarily interrupted at the height of the 12 [ IDsbursements 1991-92 stabilization program, when the Govern- | 10 L ment managed to delay wage increases for public | 8 |l employees during a period of high inflation. As 6 1 Il monetary illusion wore off and pressure for wage 8 4 increases mounted, the Government granted wage 0 X 2l increases which partially compensated for the | o tt[s+++llllut]+El| previous losses in real wages. In mid 1992, the o N ID CO 0 e association between public investrnent and the fiscal deficit was reestablished. The relationship between PI and debt accumulation is shown in Diagram 1-3. There is a tight association between the level of P1 and disbursements of new debt. This association was only broken in 1990, when Honduras was given a large bridge loan to allow it to pay its accumulated arrears to the multilateral organizations. 1.10 Public finances are also affected by inefficiencies in the regulatory framework of Table 1-2 Finances of Public Enterprises in 1994 infrastructure services. One aspect of this Enterprise Primary Surplus after Capital inefficiency is the political management of tariffs Surplus Debt Repayment Expend. which are generally set at a low level, affecting the as % GDP finances of the PEs (the level and structure of tariffs is analyzed in Chapter 3). Low revenues and ENEE 1.8 -1.2 1.6 operational inefficiencies have led the main PEs SANAA U0.1 -0 1 0.5 into a weak financial position that has the potential ENP 0.5 0.3 0.7 of becoming a large fiscal drain. The water Source: Central Bank of Honduras and 1MF enterprise (SANAA) does not generate enough revenues even to pay for its payroll. The electricity enterprise (ENEE) cannot pay its debt out of its own revenues. The telecommunications enterprise (HONDUTEL) and the ports enterprise (ENP) can only finance less than a fifth of their investment needs. An urban transport subsidy reached almost I percent of GDP in 1994. 1 Real wages of the public sector in 1994 remained 40 percent below their 1985 level. 4 A joint World Bank/lIDB Study Table 1-3: Growth and Investment Macroeconomic and Year GDP: Public Private. - . Microeconomic Inefficiencies GrowthD Pbicvsmn Prinat. Public ICOR of Public Investment Growth Investment IvesInvestment Investment percent as % GDP as % of total investment 1.11 Public investment has grown 1950-59 3.0 2.1 8.3 19.6 4.2 every decade since 1950 as a 1960-69 5.6 2.9 10.3 21.8 3.7 proportion of GDP and as a share of 1970-79 5.8 6.6 13.8 31.9 4.7 total investment (Table 1-3). This 1980-89 2.7 7.7 8.9 46.6 8.1 growth has been associated with 1990-94 2.2 8.9 10.7 42.7 9.6 macroeconomic and microeconomic Source: Central Bank of Honduras inefficiencies. The macroeconomic inefficiencies consist of a crowding out of private investment and a growing ineffectiveness of investment in generating growth: Until the 1970s, the growth of public investment accompanied growth in private investment. From 1980 on, the growth of public investment has occurred at the expense of private investment levels. Total investment has remained stagnant and has yet to recuperate on a sustained basis its average level of the 1970s when it peaked at 20 percent of GDP. 1.12 The growth in total investment during 1950-79 was accompanied by an acceleration in the rate of growth of GDP that reached an average of almost 6 percent per year during the 1970s. Since 1980, the growth of public investment as a share of total investment has been accompanied by falling rates of growth of GDP. The growing ineffectiveness of investment is reflected in the more than doubling of the ICOR from 1950-79 to 1980-94 (Table 1-3). 1.13 Infrastructure services are crucial for economic growth and for the delivery of key social services. The provision of these services is characterized by lack of competition and inefficient regulations which have led to important microeconomic inefficiencies: (i) low coverage; (ii) poor quality of service; (iii) distortionary tariffs; and (iv) lack of maintenance. These issues are discussed in detail in Chapter 3. Table 1-4: Structure of Public Investment Who Invests in the Public Sector? Year t993 1994 1995 (actual) (sctual) (budget) percent 1.14 Most public investment is implemented PublivInvestment 100.0 100.0 100.0 by five agencies: The Ministry of Communi- Central Government 49.2 22.0 35.7 cations, Public Works and Transportation of which SECOPT 40;1 17.4 22.0 (SECOPT) and the main public enterprises Public Enterprises 25.9 52.2 37.9 (ENEE, HONDUTEL, SANAA and ENP). ENEE 15.0 14.0 8.9 SECOPT was responsible for 40 percent of public ENP 2.7 1.7 1.6 investment in 1993. In 1994, the Government cut HONDUTEL 4.7 30.1 16.9 substantially investments by SECOPT to made SANAA 3.5 6.4 10.5 fiscal space for investments by the four main PEs Rest of General Government 24.9 25.8 26.4 which were responsible for over half of public FHIS 7.2 42 6.2 investment in 1994. The events of 1993 and 1994 Local Governments 9.0 6.6 5.5 described above suggest that public finances will PensionFunds 64 12.4 10.6 not come under control until the sectors where the Other 2.3 2.6 4.1 four PEs provide services are reformed and until __ _ _ _ _ _ _ _ _ - _ _ the reform process initiated in SECOPT is Source: SHCP completed.2 These five agencies and their sectors are discussed in detail in Chapter 3. 2 SECOPT was reorganized in 1990-92. Employment was reduced by about 3,000 positions and contracting-out of works for construction and maintenance was successfully introduced in large scale. These, and other reforms Reforming Public Investment 5 1.15 The Government aims to increase investments in the social sectors, including water and sanitation, education, health and housing. The main agencies in charge of investments in these sectors are SANAA and DIMA (the water agency for San Pedro Sula) for water and sanitation, FHIS (Fondo Hondureflo de Inversi6n Social) for education and health and INJUPEMP and IMPREMA (the pension funds for civil servants and teachers respectively) for housing. Investments in the social sectors are discussed in Chapter 3. The Sources of thie Problem 1.16 Public investment is high because the state has replaced private investment by monopolizing key economic areas and by regulating these areas in ways that restrict or prevent private participation and competition. Tackling Honduras's high and inefficient levels of PI at one level is a matter of applying better project screening and programming techniques. More fundamentally, it means changing the paradigm of interventionist (Government that has characterized economic policy in recent decades and driven PI. The role of the state is yet to be redefined in a way that allows the economy to rely more on the market for efficiency and on the private sector for financing. This redefinition also implies changing the governance of the PEs that historically have been responsible for so much investment, either by privatizing them or by other reforms to make them more cost-effective and accountable for results. 1.17 Numerous initiatives for privatization or other forms of participation in the provision of infrastructure services are being considered by the Government and interest in these initiatives is developing in the private sector. There is a Presidential decision to privatize HONDUTEL, the new electricity law (despite some important flaws discussed below) opens the way for the private sector in new generation and distribution, and the concessioning/privatization of several services in ports, airports, roads, railways and water and sanitation is being discussed. The private sector has also shown interest in many of these possibilities. There have been inquiries about HONDUTEL, private energy generation has began (although with difficulties), there is talk of a build-operate-transfer operation for an aqueduct in the Sula Valley and there have been offers from private groups to take in concession the San Pedro Sula Airport, some of the ports and some stretches of roads. Two Joint World Bank/lDB adjustment operations are under preparation, to support these initiatives. A Public Sector Modernization Credit will support the privatization of HONDUTEL and the corporatization and concessioning of airports. A Water and Sanitation Adjustment Credit will support the decentralization and reform of this service. 1.18 To make the reforms successful at facing the problems discussed in this chapter, three additional issues need to be confronted. * Public investment programming lacks a strategy and its implementation suffers from procedural weaknesses. The lack of a strategy makes it easier for interest groups to succesfully lobby for socially inefficient investments and has led to the implementation of large uneconomic projects. The procedural weaknesses have opened the way to mistakes in the choice and preparation of investment projects and to costly implementation of these investments. * The regulatory framework for the provision of infrastructure services is inefficient, obsolete and combines excessive control over areas which require autonomy, with lack of regulation over areas of public interest that require oversight. This is reflected in: * Lack of competition and displacement of the private sector from the provision of infrastructure; * Lack of quality control; under way in the transport sector receive support from transport sector loans financed independently by the World Bank and the IDB. 6 A joint World Bank/IDB Study * Politicized tariff setting procedures that contribute to the financial deficits of PEs, limit the available financing for the expansion of services and generate distortions in resource allocation; * Absence of a maintenance policy (except for the road subsector); and * Absence of a fiscal framework to finance the maintenance of a road network. An explicit strategy for poverty reduction needs to be developed to guide investments in the social sectors. 1.19 The rest of this report discusses these problems. Chapter 2 describes the weaknesses in investment programming and implementation. Chapter 3 provides an analysis of the regulatory framework and discusses the prospects for reform and privatization of the main sectors providing infrastructure services. Chapter 4 discusses the impact of investment in social sector infrastructure on poverty reduction. Reforming Public Investment 7 2. INVESTMENT PROGRAMMING AND IMPLEMENTATION 2.1 Part of the problems noted above concerning the public investment program (PIP) derive from weaknesses in the process of investment programming, budgeting and execution. These weaknesses have led to the inability to stop very large uneconomic projects, to the undertaking of investments with low social and economic returns, to investments in areas of lower priority which crowd out investments in higher priority areas, and to a high and often unforeseen fiscal impact of public investment. It has also inhibited the participation of the private sector in areas where services could be expanded based on private investment. Honduras has not produced an official PIP document for several years. While SECPLAN attempted to produce such a document for 1995-97 and to base the Government's 1995 budget on this document, the attempt was not successful. The budget document itself consists of a volume of text describing Government expenditures and a large volume containing only numbers. Only the latter receives attention and the text is not developed as a justification or explanation for the proposed expenditures. The volume on numbers suffers of basic classification problems, such as the use of the same code number for capital expenditures, rehabilitation and sometimes maintenance. 2.2 A PIP should: define strategies, objectives and criteria for prioritizing projects within those strategies and should serve as a tool of fiscal management. Within the strategy there needs to be a clear division of labor between the private and the public sector. The existing system in Honduras provides neither of these conditions. This chapter analyzes the problems involved and provides recommendations to overcome them. Lack of Strategy and Lack of Project Evaluation Criteria 2.3 While there have been general policy statements given by the Callejas and the Reina Administration in recent years concerning the overall direction of economic policy, these statements have not been sufficiently specific either in the sectoral strategies to be followed or in the targets to be achieved.3 Also, there has been ambiguity in the roles the private and public sector should play in the provision of specific services -- a blatant example of this was the initiation of an enormous public investment program in telecommunications in 1993 while the Government was simultaneously announcing the privatization of telecommunications. This situation is replicated at the sectoral level. Ministries do not provide functional plans analyzing needs and problems, laying out program targets for the next few years or making a link between proposed investments and economic growth or poverty reduction. The expected benefits and contributions of projects proposed are rarely spelled out. This strategy vacuum has made it impossible for SECPLAN to develop a PIP based on specified objectives and established policies. 2.4 Modernizing the state in Honduras means determining the part public agencies should play in achieving the fundamental objectives of the government. This means developing a strategic view of the respective roles of the government and the private sector in each area, defining the objectives and policies without which consistent decisions on programs and projects cannot be made. 2.5 The vacuum created by the lack of strategies is made worse by the simultaneous lack of rigorous criteria for project evaluation. The main criteria for contracting projects has been the availability of external financing for their execution. Formally, SECPLAN and SHCP apply additional criteria during the project evaluation process (dictamen): whether it has a "high social content", whether it will involve rehabilitation rather than new construction, whether property rights over land are clear and whether the 3 Partial exceptions are the roads and the education sectors, for which specific strategies where prepared during the Callejas Administration. While the new Administration has given indications that it generally intends to continue with these strategies, it has not made explicit where they may diverge, and in practice some important elements of these strategies are not being pursued. 8 A joint World Bank/lIDB Study administrative detail for the execution of the project is complete. However, these criteria receive less weight than the availability and terms of external financing. Some of the largest investments initiated in 1992 and 1993 were approved against the advice of SECPLAN officials, because external financing was available and there was substantial lobbying from the executing agencies and from foreign contractors Box 2-1: Three Polemic Projects Several large public investments were initiated during the 1990-93 Administration. Three of the more polemic were the new airport terminals, a cooling plant in Puerto Cortes and the expansion of the telecommunications network. The first two were financed under a bilateral umbrella agreement that includes several other investments. The World Bank .in 1993 recommended against these investments, judging them to be uneconomical. Two new airport terminals, with a cost of US$57 million, are under construction. One in the Island of Roatan, to replace the rustic makeshift facility serving the eco-tourists to the Bay Islands and another in San Pedro Sula (SPS), the agro-industrial metropolis in the plain, to replace its aging facility. The terminal of SPS is regarded by transport specialists as overdimensioned. The feasibility study, the design and the construction (using prefabricated parts) were made by contractors of the country providing the financing. The loan was supposed to cover 100 percent of the uinvestment required to make the project operational. Only after signing the contract, the parties became aware that, to make the SPS terminal operational, it would need an additional investment of US$18 million to build a new access road, a parking lot and ramps for the planes to park outside the terminals. Local interests are said to have lobbied for the SPS terminal. The Government is now looking for private investors to finance the remaining costs and operate the SPS terminal. The same financing umbrella supplied funds for a cooling plant for agricultural produce at Puerto Cortes. According to its management, ENP was initially opposed to this investment, believing the plant to be overdimentioned (25,000 cubic meters capacity) and finding the investment of almost US$ 12 million, beyond its capacity to service. ENP was forced. by the Government to assume the servicing of the debt. There is still some argument as to whether a refrigeration plant is necessary in the port, as most refrigerated produce is cooled close to the growing areas and shipped out in refrigerated containers. The idea of the port plant was that it should serve the small growers and producers, who would consolidate their cargo for shipping by refrigerated vessels. If there is such a demand by small growers and cultivators, it is felt the private sector could easily have responded to such demand, in a modular fashion, growing as demand increased over time. Local interests also favored this investment. HONDUTEL is expanding its capacity by 220,000 lines financed under a loan of about US$150 million. The project was originally approved by the Government for 110,000 lines. The initial adjudication of the contract was contested by one of the companies that presented a bid and the Government avoided a complex adjudication issue by doubling the size of the expansion giving each company a contract for 110,000 lines. This solution was favored by HOND1JTE.L. Because of these problems and because of shortcomings in project design, the project suffers deficiencies that could render it practically inoperative. Under current design, only 30,000 lines will be operational by the time theTproject is completed (1996), two exchanges have been installed in areas where no new lines are planned (Principal and Miraflores) and new lines are installed where there are no new exchanges. HONDUTEL is pursuing an ,additional investment of about US$65 million to correct these problems. (Box 2- 1). 2.6 The dictamen, is a complex procedure of review and clearance of projects which functions as a heavily bureaucratic vehicle for aggregating opinions and signatures for legal compliance which do not add up to an analytic project evaluation system. The dictamen process can take many months and involves several agencies (usually, SECPLAN, SHCP, the Central Bank and agencies in charge of the regulation of the sector). The conclusions on projects do not follow from an economic cost benefit analysis, an assessment of the institutional capacity to implement an investment or the consistency of the proposed investments with sectoral program objectives or the capacity of a Government agency to finance the incremental recurrent costs after the project is completed. For example, the dictamen on the SANAA 1995 budget noted serious debt, pricing, operations and maintenance shortcomings and numerous administrative inefficiencies. Despite these observations, without further explanation, and without making any recommendations on mechanisms to correct the problems noted, it approved a 64 percent increase over the 1994 approved level (13.2 percent less than requested). The origin of these precise figures is not explained Reforming Public Investment 9 and they bear no relation to the analysis. Some of the advocates of the process claim that it is useful because it ensures that the projects approved are consistent with the Honduran legislation. However, as noted above, the more controversial of the large public investments approved during the last two years of the Callejas Administration were approved despite having had negative dictamenes from the technicians of SECPLAN and hence, were probably not consistent with the legislation. 2.7 The new Administration has taken some steps to prevent a new uncontrolled upsurge of investments by strengthening controls for the approval of new debt and by establishing priorities based on short run criteria which restrict the approval of new projects to those with assured external financing. While these new criteria are useful to take decisions over the short run, they are not sufficient to establish a medium term PIP and can reinforce the pattern of favoring projects simply because soft financing is available. To counter this tendency, SECPLAN is attempting to strengthen the Government's capacity to develop a medium term PIP. First, it is developing policy statements for the main sectors of public investment. Unfortunately, with the exception of the Ministry of Natural Resources (which has published a strategy document) and the roads maintenance plan, none of the agencies has endorsed, published or acted on the basis of these or any other policy statements. Second, SECPLAN, with technical assistance from a UN technical agency and financing from UNDP and IDB, is working on the introduction of a new system of public investment (SISPU--Sistema de Inversiones del Sector Puiblico). SISPU is being designed to include: (i) regulations setting new institutional procedures which would base project approval on technical criteria; (ii) more rigorous methodologies for project appraisal, monitoring and evaluation; and (iii) training programs to improve the management of all stages of the project cycle. As part of SISPU, consideration is being given to development of a computer network for project monitoring. This network would link SECPLAN with project executing agencies and would provide instant, on-line information on physical and financial aspects of project implementation. The decision to go ahead with the computer network should be taken with great care and, if implemented, it should be a complement and not a substitute for the more fundamental reforms required. 2.8 An additional source of support to the Government is a proposed technical assistance credit for public sector modernization which will provide support for inter alia: (a) development and implementation of an integrated financial management system linked with a personnel database management system; (b) establishment of specific investment criteria and mechanisms to set priorities and guide public expenditure programming; (c) strengthening of budget programming and evaluation functions, and improved coordination of the budget process; (d) attuning of basic financial management functions, including budgeting, accounting, treasury and public debt; and (e) strengthening of budget programming and evaluation, and control. The PIP and Investment Budgeting as Tools of Fiscal Management 2.9 The PIP is not designed as an instrument of fiscal management. It does not allow an analysis of the medium term implications of proposed investments. The investment budget is also weak for short term expenditure management as it is usually a poor predictor of the actual investments to be undertaken during the year, and the budget document is prepared in a way that does not make it amenable to the analysis of options or to cutting back on proposed investments if cuts become necessary. 2.10 Project planning and linkage to the budget process is limited to one year ahead. The PIP document does not include an analysis of the aggregate recurrent budget implications of proposed investments, including future year counterpart fund requirements and debt service. For investments where cost recovery will not cover operations and maintenance, these expenditures also need to be taken into account. Neither SECPLAN nor SHCP develop sectoral recurrent budget envelopes for the medium term. Hence, the Government approves the PIP without an understanding of the sustainability of the investments to be undertaken. A medium term expenditure framework is described in Box 2-2. 10 A joint World Bank/lIDB Study Box 2-2. A Medium Term Expenditure Framework (MTEF) A Medium-Term Expenditure Framework (MTEF) is an instrument of public expenditure planning parti- cularly relevant to countries which need to restructure public expenditures, to restore balance between different spending categories and to concentrate resources on priority programs that can be sustained. It also has the potential to improve perfonrance by changing the incentives of the annual budget. Projections of government revenue, expenditures, deficit and financing over a three or five year period, are typically expressed as shares of GDP and in constant prices. This provides the macroeconomic framework for an MTEF - the government's best estimates of aggregate revenues and expenditures, together with a target for the budget deficit. An MTEF takes this further by breaking aggregate expenditures into sector resource envelopes, after deducting statutory expenditures such as debt servicing and pensions. Consistent with the government's perception of where programs need to be strengthened or scaled-back, the departmental sector envelopes are likely to increase or decrease. Expressed in constant prices, the MTEF would be rolled over annually, ahead of the budget preparation cycle. Setting sector envelopes is both a technical and a political process, and blends bottom-up information on the cost of programs with top-down strategic judgments on whether the government wants to see spending increase and decrease in a particular sector. The MTEF is the basis for the annual budget ceilings. It provides a framework for departments to explore alternative running cost configurations (for example, changing the balance between personal emoluments and non- wage operations and maintenance to estimate the full costs of funding existing policies and programs and relate them to prospective resources, and to make tradeoffs between programs. Preparing a MTEF involves both spending departments and the central ministries of finance, planning, and personnel to ensure overall coherence. An MTEF thus becomes a valuable tool for strategic expenditure management. Conservatively defining medium-term resource envelopes for departments should help change the psychology of budgeting from a "needs" to an "availability" mentality. In this way, the annual budget preparation cycle becomes less of a zero-sum game of extracting non- existent resources from the finance ministry, and more of a opportunity to improve the efficiency of resource use within a firm and predictable resource envelope. Further, by making the future prospective budgets of departments more predictable, incentives for rnanagers to improve program efficiency should increase. 2.11 The formal budget, approved by Congress in December, is a poor predictor of actual expenditures to be undertaken, as the budget undergoes numerous modifications throughout the year. In practice, the actual budget is made during execution without the benefit of prior analytic inputs. Actual investment expenditures exceeded planned investments by an average of 28 percent in 1989, 1990 and 1993.4 Planned expenditures exceeded actual outlays during the 1991-92 stabilization period. It should be noted that the gaps between planned and actual expenditures are even wider for specific sectors as the aggregate gap is an average. 2.12 There is a considerable risk that actual investments in 1995 will be higher than the amounts indicated in the PIP and approved by Congress in the budget. Table 2-1, based on information collected in December 1994, shows that line agencies plan substantially higher expenditures than what is recomended by SECPLAN. The main problems could arise in HONDUTEL and ENEE. Also, as explained below problems could appear related to SECOPT's maintenance and rehabilitation program. * ENEE's investment plan is two and a half times larger than SECPLAN's recommendation. According to ENEE, its investment plan is necesary to eliminate the risk of electricity rationing, to undertake needed deferred rehabilitation of the transmission network and to continue with its expansion plan. While it is unlikely that ENEE will have the capacity to fully undertake its proposed investments, there is an important risk that its expenditures will be higher than what is planned in the Government's fiscal projections. If events follow the same pattern as in 1994, ENEE could finance the investments from its 4 This gap reached 53 percent in 1993, whereas inflation that year was only I I percent. Reforming Public Investment II own resources and then force the Government to "lend" the funds needed to cover ENEE's large external debt service. * HONDUTEL's investment plan is not clearly known. In 1994, its actual investments fell 25 percent short of what it had planned, possibly because of capacity constraints. Funding could be available for high levels of investment: Under the terms of the loan to finance the expansion of the 220,000 lines, an escrow account with US$150 million was opened in the name of HONDUTEL in December 1993, only US$60 million had been spent by December 1994. The Ministry of Finance or SECPLAN have no control over that account. * There is agreement between SECOPT and SECPLAN on the total amount to be invested in roads, but there is a disagreement on the total amount to be invested in airports and on the composition of the investment for both roads and airports. SECPLAN assigns part of the total road allocation to the construction of a beltway for Tegucigalpa, leaving less for maintenance than what SECOPT's maintenance and rehabilitation plans require. In airports, it is unclear if the totals include the full amount needed for emergency rehabilitation of the runways. 2.13 In the past, gaps between planned and actual expe..ditures have been due to the addition to the budget of new projects and partly to lack of integration of the procedures of the different agencies involved in budget planning and implementation. New projects are added by Congress or the Executive branch. New projects added by Congress rarely come with an additional source of revenues and often force SHCP to raise the total expenditure ceilings. SHCP can, Table 2-1 . Investment Program for 1995 and does authorize expenditures in non-budgeted (in million of Lempiras) projects with officially approved external -- :.... -- .-- xl> . . . es>g. 595 595 - see table 1.2. Worse yet, these transfers are 201 250 often unforeseen by the treasury as PEs produce their budgets late in the year of their execution (ENEE had not submitted its 1994 budget by November of that year) and transfers needs tend to be underestimated at the time of budget preparation. This is partly due to the poor quality of the budget forecast techniques used by the PEs. It also reflects the strategic behavior of the managers of PEs, who determine it is better to present late "emergency" requests for transfers instead of planning ahead. If these requests are foreseen, SHCP may force them to reduce other expenditures. If they are late and necessary to attend to an emergency (e.g. the urgent rehabilitation of equipment to attend rationing in a key utility, or payments of external debt given unforeseen revenue shortfalls), the transfer will usually be granted. 2.14 There is no integration in the financial management system that feeds into decisions on budget planning. There is a lack of timely and accurate accounting, expenditures and project progress information from PEs, some donors and line ministries. For this reason, the 1995 budget is prepared by projecting the approved budget for 1994 rather than the actual (and as explained above the actual tends to be substantially larger). Information from the PEs is delayed over a year, despite legal requirements of quarterly reporting. All information is exchanged manually and there are no data connections between the different agencies involved in budget preparation. As a result, budgets are typically made in an incremental way, without the benefit of up to date information on actual expenditure by departments, program costs and what has been spent on projects. Managers do not have the financial information they need to manage their departments and agencies effectively. In many other Latin American countries public sector modernization has entailed a fresh look at all aspects of the government's financial management system: budgeting, debt management, cash management, financial reporting, accounting, internal and external auditing. This has led to the development of integrated financial management systems based on generally accepted accounting principles applied in a consistent way across government. 12 A joint World BanklIDB Study Recommendations 2.15 Develop sectoral strategies to guide public investment. These should include a discussion of the needs and problems and the objectives for the sector laying out program targets for the next few years. The role of the public and private sector in reaching those objectives should be clearly specified. Investment projects add to public sector capacity, enabling governmient agencies to implement policies and programs more effectively. Projects cannot be considered in the abstract, independent of the objectives, policies and programs the sector agencies are charged with putting into effect. 2.16 Inject analysis into the investment approval process by: * linking approval of proposed investments to sectoral strategies; * appraising sectoral investment in the form of an investment program. rather than individual projects. The Government should develop sectoral envelopes to force the examinationi of trade-offs by sector agencies, * debureaucratizing the dictamen process and basing it on the application of rigorous technical criteria. The process should become a means to assess if the project goals will be achieved through the project. The contents of dictcimenes should be specified to include at a minimum: cost-benefit analysis, consistency with sectoral program strategy and expenditure targets, absorption capacity and future year recurrent budget implications. The basis for dictamen decisions on projects should explicitly be these criteria. Similarly, dictamnen decisions on annual budgets should arrive at numbers explicitly from the analytical content of the analysis; e linking new investment to operating and financial management performance; and * strengthening technical capacity for project design and appraisal in the relevant agencies. 2.17 Make the PIP a tool of fiscal management and improve expenditure planning: * develop a rolling medium term expenditure framework as a limit on the PIP. The framework should consist of projections of expenditure, revenues and financing requirements for the next three years and a target fiscal deficit. These figures should be revised each year during budget formulation on a rolling basis; * tighten the planned/actual linkage in the budget by discouraging the introduction of new projects during the year or by requiring that these be linked to additional revenues or reductions in other expenditures; * strengthen the integration of the financial management system: * provide a clear classification of investment, rehabilitation and maintenance expenditures; * make a more user friendly budget document; the program narratives should indicate goals, attained performance and constraints encountered other than lack of funds. The act of narrative writing forces institutional examination of means-ends and highlights data weaknesses, particularly for performance measurement. Thus, narratives can generate incentives to shift from monitoring financial inputs into the budget to linking expenditures to performance measured in terms of profitability, project progress, client service and management efficiency. Reforming Public Investment 13 3. INFRASTRUCTURE PROVISION: COMPETITION, PRIVATIZATION AND REGULATORY REFORM 3.1 The poor performance of the PEs in infrastructure provision can be attributed mainly to the overextended role of the state and the lack of competition in the provision of infrastructure services. The public sector is in control, to varying degrees, of all four of the major functions in infrastructure provision: ownership, operation, regulation, and sectoral policy setting, monitoring and control. Table 3-1 summarizes these four functions within each sector. The infrastructure sectors analyzed in this chapter are: telecommunications, electricity, water supply, ports, rail and roads. The infrastructure component of aviation is also used to illustrate some of the main issues in the provision of services. The chapter focuses on selected issues, a more detailed discussion of each sector is provided in the five infrastructure papers prepared by the team and named in the Bibliographical References. Unless noted otherwise, all international comparisons in this chapter are taken from the World Development Report 1994. 3.2 As shown in Table 3-1, there is little competition in the provision of infrastructure. Telecommunications is served by a public monopoly. Electricity, ports and railways are sectors were private providers have some participation, but public enterprises dominate with private providers operating only at the fringe of the market. While some horizontal unbundling has taken place in the case of water and sanitation services by the decentralization of some of the services to some municipalities and the development of private and community providers, the sector has not developed a competitive structure. Transport services is a sector were divisibility could allow the development of a textbook case of competition. However, licensing of urban and intercity transport services has created an oligopolistic structure behind protected markets. 3.3 The inefficiency associated with this ownership structure and lack of competition is described in section A below. A rigid and obsolete structure of regulation is partly behind the lack of competition and the inefficiencies in the provision of services; this is analyzed in section B. The PEs suffer simultaneously from a lack of clear objectives and suffocating micromanagement from the central Government. This is due to deficiencies in the state's roles in policy setting, monitoring and control. These deficiencies are described in section C. The aspect of infrastructure provision that takes most of the public attention in Honduras is tariffs. Section D describes the financial problems, missallocations and inequities created by politicization of tariff setting procedures. Section E analyzes the reasons and impact of the lack of maintenance typical in most sectors. Section F discusses problems of financing of road maintenance. Section G outlines recommendations for the reform of infrastructure provision by developing competition, allowing private provision and regulatory reform. Structure of Infrastructure Service Provision and Competition Telecommunications 3.4 Telecommunications services are in the hands of a public enterprise, HONDUTEL, which has the monopoly over provision of all services including telephony, telex, telegraphy, and radio communication. Despite the high investments in the telecommunications sector noted in Chapter 1, HONDUTEL has failed in its obligations as the sole provider of services. The costs of service provision are very high, efficiency of operations is low, and quality of service is low by international standards (Table 3-2). Coverage in terms of mainlines per inhabitant was similar to that of neighboring Central American countries (see Diagram 3-1) before the large investments initiated in 1993. These investments are hard to justify as there was no need to undertake such a rapid expansion and instead of reducing the inefficiencies of operations, it is likely to have increased them substantially: as noted in Chapter 2, problems of design make much of the 14 A joint World Bank/lDB Study Table 3-1: Market and Regulatory Structure in Infrastructure Services Sector Ownership Competition Regulatory Policy Monitoring and Structure Control Telecoms Autonomous Public monopoly in the HONDUTEL SECOPT public enterprise hands of HONDUTEL CNSSP Board of Directors of HONDUTEL Hondutel SECPLAN SCHP Contraloria Ports I Autonomous Public monopoly in the ENP Board of Directors of ENP public enterprise hands of ENP, exports of CNSSP SEC (ENP) fruit and imports of oil are SECOPT managed directly by the Navy, Chamber of traders Commerce Organized labor National ship owners SECPLAN SCHP Contraloria Electricity Public enterprise Vertically integrated ENEE SECOPT, Gabinete (ENEE) as main public enterprise ENEE & CNSSP Energetico actor with fringe two private generators CNEE ENEE's Board of Directors of private (serving 2% of market) SECPLAN operators SCHP Contraloria Rail Ownership of Mixed operation with SECOPT SECOPT 1:660 km by public 25% operated by public FNH Board of Directors of FNH enterprise (FNH) enterprise (FNH), 34% SECPLAN rernaining 336 operated by concession SCHP concessioned to (TRR), and the rest not in Chamber of Commerce private company service Railway Workers Union (TRR) Contraloria Water Supply National Entity National Enterprise, SANAA SdSP * 0 (SANAA) & SANAA and horizontally SdSP Board of Directors of Decentralized unbundled enterprises CNSSP SANAA Municipal SECPLAN Entities, fringe of SCHP private operators Ministry of Environment Municipal Entities Contraloria Roads Directorates of Most roads managed by SECOPT SECOPT Roads, Road and central directorates Contraloria Airport Maintenance by private Maintenance, and contracting (87%) and Public Works force-account (13%) Regional and Municipal Entities. Airports Central Managed by central SECOPT Central Government Government directorate, maintenance International DGAC DOAC by force account Aviation Authority DGCCA _____i______ DGMCA DGOP Source: Constructed:from sectoral descriptions found under separate cover. Reforming Public Investment 15 Diagram 3-1: Access to Telephone Services in the 1990s Table 3-2: Performance of the Telecommunications Sector Panmna Category HONDUTEL Benchmark C.s. RI Cost of service provision 435 200 in $ per Line El S.lvador Staff productivity in 36 4 __em-^ l CTelephane number per 1,000 lines in - mainlines service ll,dsrin (persons) Mainlines per o00 persons 2.4 7 Call completion rate 45% 65% Nik-rag,. Source: Constructed from HONDURAS: Mision de Evaluacion de la Inversion Publica: Informe del Sector II 211 .Pl 4,4 844 14444 Telecomunicaciones. January 1995. The benchmark values investment effectively useless from the point of view of connections to service. Under the present design, only 30,000 of the 220,000 lines being installed will be operational by 1996. Ports 3.5 ENP, an autonomous public enterprise, owns and manages all six ports in Honduras. Staff productivity and service efficiency are low (Table 3-3). About half of the ships are handled by fruit exporters or oil importers. The discharge of bulk grain is undertaken by private contractors and is highly inefficient. The port authorities claim that the private contractors are reluctant to making needed investments in this and other areas. A reform of the regulations for concessioning is required to introduce efficiency criteria and competition into the concessioning of port services. As the geographic position of Honduran ports and its connections with comparatively high quality roads attract substantial traffic, ENP has no incentives to improve service levels as long as it is making large profits--the operating ratio for ENP in 1994 was 45 percent.' Ship operators complain that the tariffs of Honduran ports (specifically Puerto Cortes) are excessive and that there is a constant problem with lack of properly maintained equipment. Evidence for high tariffs can be obtained by comparing ship charges in Honduras (Puerto Cort6s) and Guatemala (Sto. Tomas de Castilla) as shown in Table 3-4. There is a lack of correlation between costs and tariffs. For example, charges for cargo-handling and wharfage have not been changed since 1982, whereas costs have risen in the last ten years. The large profits of ENP are mainly extracted from monopoly rents gained from ship charges, which have been "dollarized" since November 1990 and represent a high source of revenue for ENP. Ship services generated more than 50 percent of the total revenues for ENP in 1991. Table 3-4: Comparative Ship Charges in Honduras Table 3-3: Performance of the Ports Sector and Cuatemala, 1992' Category ENP Benchmark Category Puerto Cortes Sto. Tomas de Total Staff (1993) 1018 600 Castilla Rate of discharging containers 14-25 25-30 (million US Dollars) in number per ship-hour Mooring 100 57 Rate of discharging bulk grain 1500 3000-5000 Berthage 10,403 4,100 in tons per ship-day Dock Cleaning 100 42 Source: Constructed from HONDURAS: Public port Dues 7,656 263 Investment Review Mission: Ports. Aviation and Railway Surcharge 426 128 Subsectors, January 1995. Benchmarks based on Source: Constructed from HONDURAS Transport intemational best practices and what the private sector Sector Rehabilitation Projec . Staff Appraisal Report through interest letters have suggested that they could No. 10680-HO, The World Bank, January, 1993 accomplish. 5 Operating Ratio = Total Operating Expenses (including depreciation) divided by Operating Revenues. 16 A joint World BanklIDB Study Diagram 3-2: Households with Access to Electricity in Diagram 3-3: Quality of Electrical Services in the 1990s the 1990s (percent of total) (system losses as % of output) Pan-Am P |u Com Rica Colso Rica El S.lcador El Sd-d-r Gua.malaF Guatem-l Hondur.M Honduras Ni-argua Nik-ragu| II 21) 411 61 8H11 111 I 5 11) 15 211 25 11 Electricity 3.6 Electricity generation is for the most part in the hands of the public enterprise ENEE, serving 98 percent of users. A private generator, RECO, serves the island of Roatan. Beginning in 1994, private generation is allowed in the mainland. While the Government has made some attempts to attract private investors, new power generation from independent power producers has been slow to develop. New investments have only been made by ELCOSA with an installed capacity of 24 MW (to be expanded to 80 MW in 1995) and San Lorenzo (40 MW), compared to 620 MW of ENEE. Therefore, there is no significant competition between the existing generators. Transmission and distribution is mainly in the hands of ENEE, with the exception of 6 MW generated by ELCOSA which are sold directly to a group of small clients. 3.7 Private sector funds have not yet been effectively mobilized for expanding access to service through increased generation and distribution capacity. Furthermore, low tariffs have made it impossible for ENEE to meet its debt payments or its investment costs (see "tariff setting procedures" in this chapter). As a result, there has been very little expansion of service making Honduras one of the countries with the lowest access to electricity in Central America (Diagram 3-2). The efficiency of service provision is also low, as can be evidenced by the system losses which, at 27 percent are higher in Honduras than in any other Central American country (Diagram 3-3). By comparison, an efficient enterprise has losses of around 10 percent. Since 1991, the Government has made some attempts to reform the electricity subsector and improve the performnance of ENEE to increase its operational efficiency and reduce its Box 3-1: Recent Regulatory Reforms in Electricity In 1994 the Government attempted to reform the regulatory framework for electricity provision with the passage of a new Legal Framework for the Electricity Subsector (D158-94). This new law enables privatization of new generation and of the existing distribution network to take place, sets the conditions for competition in the provision of services, and lays out the main regulatory framework for the sector. It establishes the National Commission for Electric Energy (CNEE) as a technical advisory body to CNSSP for the application of the law. The law also creates the Energy Cabinet as the entity responsible for policy formulation and overall strategy for the electricity subsector. As approved, the Law suffers important shortcomings. (i) credibility of the new tariff setting process is low given that regulatory control under this law, is weakened by the definition of CNEE as a technical body with the actual regulation of the electricity subsector remaining in the hands of CNSSP (see section on regulation); (ii) competition in the sector will be weakened by limitations imposed on price competition between generating plants selling to large consumers and also by allowing ENEE to retain a major position in generation and simultaneously in distribution; and (iii) introduces disincentives to private investment by imposing a 15 percent income tax on electricity firms over thosepaid by businesses in other sectors and by not providing instruments to force payment of debt by public agencies and by distribution enterprises. The Government is attempting to correct these shortcomings through an amendment to the law or possibly, through the issuance of regulations. 6 ENP officials claim that the higher charges in Puerto Cortes reflect Government subsidies for Santo Tomas. Reforming Public Investment 17 financial losses. These attempts have been supported by sector adjustment loans from the World Bank and IDB. A key instrument for the reform of the sector was the design of a new Electricity Law, which would allow the development of competition in the sector by leveling the playing field and depoliticizing regulation of electricity. In late 1994, Congress approved a modified version of the Law submitted by the Executive branch. As approved, the Law may attract new investors to Honduras, although some aspects of the law remain problematic (Box 3-1). 3.8 During 1994, the macroeconomic policy of the new Administration was unclear, putting off most potential investors to the sector. While this source of uncertainty has been lessened with the fiscal measures taken in late 1994 and the agreement on an economic program reached with the IMF, Honduras continues to be perceived by potential investors as a risky country. This is due to a continued uncertainty of the future availability of foreign currency, the weak financial position of ENEE, the manner in which tariffs are set (see below), and the numerous policy reversals of the past. Railway Services. 3.9 The autonomous public enterprise in charge of railway operations (FNH) owns 66 percent of the railway network, but operates only 25 percent of the network, the rest having been abandoned (41 percent) or concessioned out (34 percent) to a subsidiary of a banana producer. The inefficiencies of FNH have led to a financial crisis, whereby it posted expenditures in 1993 of US$1.53 million while its revenues were $0.89 million. As with many other public enterprises in financial crises, a total neglect of maintenance of both railway track and equipment has been the major outcome, leading to accidents and derailments, thus losing further traffic and consequent revenues. With recent improvements in road conditions, FNH finds itself in intense competition with roads. The concessionaire is operating in much better conditions and serves as the main revenue source for FNH (in the order of US$ 0.84 million per year). The Government is considering options for the future of the railway, including a permanent sale of the assets to the concessionaire and closure. Water Supply and Sanitation 3.10 In water supply and sanitation there has been some unbundling of services. Responsibilities are split between: (i) a national enterprise SANAA serving about 34 percent of the national population (most of which live in the capital Tegucigalpa); (ii) municipal enterprises which have responsibility for water supply and sewerage as well as storm drainage (the exception is the Municipality of Tegucigalpa which only has storm drainage responsibilities, the rest being in the hands of SANAA); and (iii) small-scale private providers and small-scale provision by communities in rural areas and in the shanty-towns of Tegucigalpa. These community based organizations own and operate their own systems of water provision- -some are connected to the SANAA network (such as the marginal areas in Tegucigalpa) while others are independent systems of wells, pumps, and storage tanks. The small scale investments were funded by several agencies including the Social Investment Fund (FHIS) and NGOs. 3.11 The structure of service provision in the water sector, shown in Table 3-1, has not succeeded in improving the quality of life of Hondurans. Honduras has invested heavily to expand coverage of water supply and sanitation. In 1990 Honduras was performing better than Nicaragua, Guatemala and El Salvador in terms of the proportion of population with access to water connections (Diagram 3-4). However, the expansion in infrastructure has not been accompanied by a significant improvement in quality of life (Table 3-5). The existence of a reliable service of good quality is almost unheard of. Service interruptions are frequent forcing many families to undertake costly investments in storage tanks and pumps, or to make short-term cash commitments by purchasing water from vendors. Among the 59 percent with access to service, only 17 percent are now receiving treated water. In addition, Honduras has among the highest costs of providing service and the lowest tariffs. Coupled with the fact that water losses are in the order of 50 percent, this makes the public enterprise SANAA one of the most inefficient in 18 A joint World BanklIDB Study Central America. The impact of these deficiencies Diagram 3-4: Population With Access to Water Supply can be seen in the high incidence of water-borne Services in the 1990s (percent of total) diseases compared to other countries and in the recent appearance of cholera outbreaks in Honduras. pan&l Costs Ri,. F 3.12 Barriers to reform prevent effective k competition for service provision and ElS.lv.d.r decentralization to the municipalities. A recent Municipal Law (Ley de Municipalidades Decreto de cult -l__ Creacion 134-90) and reforms to this law (Decretos Hidurt Reformados 48-91 and Acuerdo 018-93) give _ responsibility for provision of public services to cru t . municipalities. However, there is an article in the ___ creation law of SANAA which prevents the transfer 0 20 40 60 80 100 of SANAA assets to third parties. At present, SANAA can only delegate service operation and maintenance responsibilities, but it cannot transfer ownership to municipalities, limiting the autonomy of municipal enterprises. Table 3-5: Performance of the Wgter Sector Category Honduras Nicaragua Guatemala El Salvador Costa Rica Panama Production Cost in 0.20 0.14 - - 0.17 0.07 SIM3 Construction cost in 257 116 147 - 80 110 US$ per capita thouse connections) Tariff in S/mr3 0.24 0.44 - - 1.50 0.29 Access (%) 64 55 62 47 92 84 Waterborne diseases 6,630 6,190 - 3,600 - 2,788 in cases per 100,000 Water Losses (%) 50 20 - Source: Humplick F. and A. Estache, "Does Decentralization Improve Infrastructure Performance?", Background paper prepared for World Development Report 1994: Infrastructure and Development, and Mission data. Transport 3.13 Oligopolies with protected markets characterize the provision of urban and intercity passenger services as well as specialized freight transport. There are artificial barriers to entry in the provision of transport services as a result of licensing procedures as well as route and product regulation. In addition, existing operators receive generous subsidies which reached the equivalent of almost 1 percent of GDP in 1994. Operating licenses for urban public transport are given for a period of 10 years (article 27 of the Land Transport Law) and preferential rights are granted to service providers who already exist in the market (article 28 of the Land Transport Law). This process prevents entry and hence competition in the market for transport service provision. Furthermore, there are barriers to entry in the provision of freight services as own-account services (transport by non-transport firms) are prohibited and for-hire services require specific route and product licenses. Such barriers and lack of competition impact the poor severely. Urban transport providers have no incentives to expand services to poor areas, as they have protected markets and a generous system of subsidies which does not give them the incentives to expand markets. Existing evidence suggests that the poorest people in Tegucigalpa rely for a large part of their transport needs on small non-subsidized vehicles such as group taxis, paying about three times more than other transport users, while subsidies are allocated to large private urban transport providers serving the rest of Tegucigalpa (World Bank: Transport Sector Rehabilitation Project, Report No. 10680-HO). Reforming Public Investmenf 19 Regulation of Infrastructure Service Provision 3.14 Regulation is the setting of rules and ensuring compliance with such rules that: define procedures for price setting; induce firms to reduce costs of production and improve service quality; encourage the introduction of new services; manage externalities such as health and environmental effects; and set norms and standards for service provision. The role of the Government as regulator of public service provision in Honduras is limited by a number of factors: (i) insufficient separation of the functions and responsibilities of regulation from the functions of policy setting and from those of monitoring and controlling the achievement of policy objectives; (ii) regulatory bodies which lack independence and resources to perform; and (iii) unequal application of regulations to all parties concerned. 3.15 Insufficient separation of functions and responsibilities reduces the incentives to regulate and encourages the pursuit of personal and political interests. From Table 3-1 we observe that the same entities are involved in regulation as well as policy setting, monitoring and control functions. Public enterprises not only own the infrastructure stocks and manage all service operations, but also self-regulate and set sector policy. In addition, PEs are subject to reporting requirements to multiple entities at the central government level as well as to interference in their day to day management. 3.16 Regulatory bodies lack independence and resources to perform their functions. This seriously reduces the effectiveness and credibility of regulatory bodies, subjecting regulation to pressures by political interests. The National Commission for the Supervision of Public Services (CNSSP) is in theory in charge of the regulation of services such as water supply and sewerage, electricity, telecommunications and ports. The CNSSP, created in 1991 in an attempt to withdraw regulatory powers from Congress, is not an independent body. The membership of this commission is political rather than technical in nature. It has two members representing Congress, two representing the labor unions, two representing the private sector, one from the patronatos communales (community associations), three representing different secretariats of the executive branch and four professionals from the field. The Executive branch and Congress remain in practice in charge of regulation, especially for the setting of tariffs. There is a struggle between these two powers to influence the PEs for the benefit of political constituencies by providing subsidized services and employment. As part of this struggle, Congress has not assigned representatives to the CNSSP and engages openly in discussions pertaining to the management of the PEs. 3.17 Among the major reasons for the lack of independence of the CNSSP is the lack of technical skill and knowledge to carry out its regulatory functions as well as the meager budget allocated to it. CNSSP receives a transfer of US$71,000 (L. 600,000) annually from SECOPT with which it is supposed to supervise the four largest public enterprises. This budget barely covers administrative costs and cannot be used to hire technical consultants to review proposals for regulatory change such as tariff proposals from the enterprises and other government bodies. 3.18 There is no effective regulation of quality, efficiency and externalities. Such regulations when they do exist are rarely or unequally applied. Despite its broad agenda, CNSSP has so far only functioned as a tariff-control institution. According to its law of creation, CNSSP has the following responsibilities: (i) ensure compliance with administrative, operational, and financial efficiency norms; (ii) assess and approve tariffs for public services; (iii) be informed about the privatization initiatives of the Government; and (iv) ensure quality and efficiency of service provision. IIs legal smiU s alYows it to set standards of performance to be achieved by these enterprises, and modify wheni necessary the sectoral plans produced by the autonomous enterprises. However, it has not carried out any of these responsibilities so far. 3.19 Among the major reasons is that responsibilities for the above activities are fragmented among multiple entities: (i) SECPLAN, SCHP and line-ministries also have responsibilities for ensuring compliance with administrative, operational and financial norms; (ii) there is a separate body which deals 20 A joint World BanklIDB Study with privatization issues (the Commission of Privatization created in 1994) which rarely coordinates its activities with the CNSSP; and (iii) responsibilities for quality of services are sometimes in the hands of other bodies such as the Ministries of Environment and Health. 3.20 There is no effective regulation of the fringe private sector providers and other decentralized public enterprises. Other public and private sector enterprises such as municipal entities providing water and sanitation and private water vendors in the marginal areas are not regulated by CNSSP. Similarly for the case of electricity supply by the fringe private sector operators. These enterprises set their own tariffs which are usually higher than those charged by the regulated enterprises, and there is no body designated to regulate the quality of their services. DIMA is an exception, as it is regulated by an independent office of the municipality of San Pedro Sula. Structuresfor Monitoring and Controlling Sector Policy 3.21 Control is the action of auditing, ensuring compliance with, and directing influence over the behavior of enterprises (usually public) producing public services in such a way as to achieve sectoral and macroeconomic objectives. This involves control over planning the timing, incidence, and level of investments, expenditure control processes, as well as setting goals and objectives of the enterprises and sectoral policies to be followed. Misguided controls exist when bodies responsible for directing the behavior of PEs interfere in day to day management, assume some of the responsibilities of regulatory agencies such as setting norms for service provision, or exert influence over the achievement of commercial objectives. 3.22 Managers of public enterprises feel asphyxiated by an excess of control over their activities, while the agencies charged with the control of public enterprises feel that they lack tools to effectively control the behavior of these enterprises. Both are right. The existing system combines an excess of controls over day-to-day management decisions with a lack of control over the efficiency, equity, and safety of the operations of PEs. The existing structure results from the lack of sectoral strategy discussed in Chapter 2, and is compounded by the dispersion of control functions among several entities, leading to unclear lines of authority. The result of this dispersion is a restriction over the accountability and autonomy of the PEs. The imposition of dispersed and disorganized controls leaves the PEs without clear objectives and the corresponding set of incentives. Dispersion of Control 3.23 Dispersion of control functions among a number of entities leads to unclear lines of authority and lack of PE autonomy, and accountability. There are a number of bodies who, in addition to the CNSSP, control the behavior of public enterprises through a set of statutes and legal sanctions. PEs are subject to the control of the line-ministries under which they fall, of the ministries of Finance (SCHP), Planning (SECPLAN) and Economy and Commerce (SEC) and of Congress. These bodies have the responsibility for regulating investment levels as well as ensuring that investments are aligned with sectoral policy through the Law of Public Administration (article 36). Because of weaknesses in the budget approval process as well as in the setting of sectoral policy and the managing of expenditures of the PEs (see Chapter 2), these controls are rarely applied. 3.24 A severe example of dispersed controls is the case of the Civil Aviation Sector. There are three entities responsible for operations in this sector: (i) the Directorate General for Civil Aviation (DGAC) charged with responsibility for managing airport operations and maintaining electrical installations and terminals; (ii) the Directorate General of Roads and Airport Maintenance (DGCCA) charged with maintenance of the paved sections such as runways and taxiways; and (iii) the Directorate of Public Works within SECOPT which has responsibility for construction works. DGAC has no control over tariff levels or revenues as these are in the hands of the Ministry of Finance. Civil aviation depends on three separate Reforming Public Investment 21 budgetary processes, one from each of the above entities. This sector should be handled by an autonomous enterprise which has full control of its operating and investment budget. Regulation and control should be limited to safety and security concerns.7 3.25 Another example of dispersion of controls is the water and sanitation sector: (i) CNSSP controls principally the water tariffs for Tegucigalpa; (ii) the Ministry of Health (SdSP) is charged with setting sectoral policy and defining and supervising quality standards for drinking water; (iii) the Secretariat of the Environment establishes norms for water management and pollution prevention; (iv) the Board of Directors of SANAA sets technical norms for the construction of drinking water infrastructure; (v) the Honduran Social Fund (FHIS) is responsible for a large part of the provision of water and sanitation infrastructure to dispersed rural and marginal urban communities through social development programs; (vi) municipal bodies such as that for San Pedro Sula (DIMA) have varying degrees of influence over the manner in which services are provided in their jurisdiction, including the setting of tariffs for their locality; and (vii) a number of NGOs control service provision in some rural areas and urban shanty-towns through their role in the management and financing of local infrastructure. Lack of Autonomy 3.26 When controls are exerted, they often take the form of micromanagement. SCHP as well as the respective line ministries, and sometimes SECPLAN, control day to day management decisions of the PEs. These types of control prevent the enterprises from achieving commercial objectives, further exacerbating their weak financial condition. These controls include interference with decisions such as the approval of purchases in excess of US$3,600, including spare parts for maintenance, the hiring and firing of technical personnel as well as the nomination of managerial and supervisory staff within the enterprises. Managers up to the department level are appointed on political rather than professional grounds and there is a high tumover in management with frequent changes in high level decision-making staff. These controls present serious constraints to the performance of activities such as periodic and routine maintenance, and are one of the causes of the maintenance crisis currently facing all the infrastructure sectors (see section E below). 3.27 Lack of autonomy is especially severe in water supply and sanitation. Even though SANAA was created as an autonomous entity, in practice it has neither financial nor managerial autonomy. Since 1973, the Government has prevented SANAA to take on debt to avoid having to reflect it in its tariffs. Severe control over its tariffs and the fact that it cannot contract debt make SANAA totally dependent on transfers to meet its financial obligations (see section D below). Furthermore, its managerial autonomy is seriously affected by political interference and the defacto co-administration by the Labor Union. The commercial activities of SANAA -including metering, invoicing and collection- are undertaken by union leaders with no supervision from the management of the enterprise. There is no cadaster of users and all accounts are done manually. 3.28 Lack of control over the use of revenues is also a critical outcome of existing structures of monitoring and control. ENEE has no control over the use of its revenues, as the enterprise--until the application of the new law becomes effective -- is required to keep its funds at the Central Bank with no independent authority to use these funds, open accounts, or acquire foreign currency. [NEE, HONDUTEL and ENP are required from time to time to transfer funds to the Central Government and Congress upon request. HONDUTEL has in the recent past also made transfers to the Armed Forces. The level of uncertainty created by this system further reduces the ability of the enterprises to manage their finances. On the other hand, the PEs are not required to pay income taxes according to normal commercial law, and with few exceptions, taxes and transfers to the Government have been minimal. The single exception was HONDUTEL in 1992 and 1993, when it paid transfers equivalent to about 0.7 percent of GDP to the Central Government. 7 Technical assistance to draft a new law creating the autonomous enterprise is being provided by the Transport Sector Rehabilitation Project and UNDP. The reform of the sector will be supported by the Public Sector Modernization Credit currently under preparation. 22 A joint World Bank/lIDB Study 3.29 There is no effective control of the efficiency and effectiveness of investments made by the PEs. Budgets approved and implemented have very little to do with a strategic vision of the sector and mainly address short-term issues. The approach being followed in the investment planning and control process at present is one of crisis management, with emphasis on satisfying short-term macro-economic objectives. The budget approval process is a line-item approval. There is a one-way flow of informnation, from the enterprises to the secretariats. As explained in Chapter 2, revised budgets are often returned to the enterprises without justification of why particular items were deleted from the budget. SHCP and SECPLAN provide no feedback to the PEs and there is no attempt to monitor the achievement of sectoral, investment, or performance objectives. While SECPLAN and SHCP justify this process by the need to keep control over expenditures, this process is not effective as an expenditure control process as there are many avenues for extra-budgetary spending. The main reason is the weakness in the accounting processes within the enterprises as well as weaknesses in SECPLAN and SCHP, whereby delays in the budget approval process result in overcommitment of funds and large deficits. Tariff Setting Procedures and User Charges for Infrastructure Services 3.30 Tariff setting is an intensely political exercise. As a result, the current level and structure of tariffs are inappropriate as they: (i) prevent enterprises from meeting costs and increase the fiscal burden of the PEs; (ii) unfairly penalize the poor in some sectors; and (iii) induce misallocation of resources. In this section we describe the procedures for tariff-setting and, based on examples from specific sectors, analyze the effect of the tariffs on the finances of Pl_s, the welfare of the poor and the allocation of resources. 3.31 Tariffs for the public enterprises . re proposed by the Boards of directors, while those for private operators, such as in transport, are propos J ,), hese operators. The types of charges that are recovered by the tariffs differ by sector, as does the structure f the tariffs. In the case of telecommunications and water supply there is a fixed fee for connecting to '-, .ervice. Then usage is charged by type of user and for the case of telecommunications also by timi. cf -..,_e. Electricity charges are also on a per unit basis (Kwh) and differ by type of user (residential, ir dustrial. commercial, low tension, medium tension, high tension). Transport charges are usually on a per ui " of r;argo basis or per passenger basis. Infrastructure charges in the case of roads are mainly indirect and ta\ the form of fuel taxes, operating licenses and fines for traffic and safety infractions. ENP in the provision of port services, HONDUTEL for international calls, and SECOPT for some airport services use dollar-denominated tariffs. Services provided by municipalities and private operators such as water supply have tariffs that are, on a per unit basis, substantially higher than those charged by public enterprises. 3.32 Tariff setting procedures are often affected by politics. When there is a need to change the structure or level of tariffs, the enterprises prepare a study justifying a request for tariff change. This request is sent to the Board of Directors who revise it and forward it to CNSSP for public enterprises. Private operators of transport services send their request to the Directorate General of Transport (DGT) for approval. For municipal services, such as water supply and sanitation, tariffs are set by the municipalities, who according to the 1992 law have full discretion to set and charge tariffs without regulation. 3.33 CNSSP was created in 1991 in an attempt to depolitizice the tariff setting process. This objective has not been achieved. The formal tariff setting procedure described above is frequently interrupted by political interests. The Boards of Directors hold consultations with the Cabinet and Congress before proposing a particular structure and level of tariffs. These consultations are widely publicized by the press for weeks or even months and politicians see this as an opportunity for establishing their presence. As a result of this process, there have been major differences between the tariffs requested and those approved in the case of electricity, water supply, and urban transport. Political factors prevent the use of strong measures to increase collection of debt owed to the PEs. In the past, this has been used to prevent disconnection of electric service or even the installation of meters. In recent years, the introduction of electricity meters produced a substantial increase in revenues. Reforming Public Investment 23 3.34 Tariffs for telephone, urban transportation in Tegucigalpa and water supply services have systematically declined between 1990 and 1994, in real terms (Diagram 3-5). Tariffs for electricity and airport services have followed the same trend since 1992. Tariff reviews in the utility services are infrequently carried out. In the case of water supply, the last review was in 1990 for services provided by SANAA. This can be contrasted with municipal services (such as those provided by DIMA in San Pedro Sula) which have been reviewed annually. Domestic telecommunications tariffs were last raised in 1990 and fixed until 1995. In electricity, tariffs were reviewed monthly between 1990 and 1993. There was no tariff adjustment in 1993 and the first half of 1994. Tariffs for transport services are reviewed at the request of the operators, with the last review in 1994. The decision to maintain dollarized tariffs for international calls in telecommunications, ship charges in ports, and landing fees in airports has depoliticized tariffs and resulted in real increases in tariffs for these services. 3.35 Current tariff and collection levels do not cover operating costs in some sectors and are insufficient to meet debt amortization in others. In the case of water supply, tariffs charged by SANAA do not even meet SANAA's payroll, when it includes the approximately 500 employees hired under the various executing units for SANAA's investment projects. Important hidden subsidies to SANAA include the service of its debt by the Government and non-payment of its large electricity bill. Municipal provision of water supply and sanitation services in the case of DIMA in San Pedro Sula, has covered full operating costs in the past. However, DIMA projects that from 1995 onwards it will have problems meeting debt amortization payments. Until 1994, tariff revenues in electricity and telecommunications covered operating costs including debt payments but this is no longer the case. Tariffs in urban transport covered about one third of the total costs of operation in 1994, the rest was handed over to the companies as subsidies from the Central Government.9 3.36 While politicians usually justify low tariffs as beneficial to the poor, their effects tend to be the exact opposite. The current tariff and regulatory structures protect the "small consumer" who is connected to service or has access to the service. This "small consumer" is generally not a poor consumer. Many of the poor do not have telephones or electricity, are not connected to the water supply network, and have no access to the buses that are subsidized (as these buses cannot operate in the marginal areas which typically have narrow roads in very bad conditions). Meanwhile, the level of tariffs does not allow the companies to make investments that will increase coverage and they defer maintenance on existing networks. Small users who have access to the services suffer from non-functioning systems as they cannot afford to meet Diagram 3-5: Index of Tariffs for Selected Public Services 8 the basic tariff as well as pay for an (in real terms, 1993= 100) alternative supply (e.g., an electricity generator or a small satellite for 1.60 _ telecommunications) while the poor who are L ~o199O .1991 n j not connected to service continue to pay 1.40 t _ El1992 .1993 high charges for alternative services. 1.20 1.00 oo II L_ ., L |v 3.37 The problem is dramatically illustrated by the case of water supply 0.30 | - 1 - 11 1 - |services. SANAA provides drinking water, 0.60 at highly subsidized rates, covering only a 04a fraction of the population of Tegucigalpa. Most of the poor are not reached by SANAA. These families obtain water o.ooLAr T+ y U- W services from direct purchases from street Transort ror vendors, extraction from wells and 8 Tariffs refer to the following: Airports: landing fees for 727-200 at Toncontin International Airport; Telephones: fixed fee for residential telephone lines; Electricity: average revenue per kWh; urban Transport: passenger service in Tegucigalpa; Water: charge for a cubic meter of water provided by SANAA in Tegucigalpa. Transport tariffs in Tegucigalpa were raised from LO.25 to LO.60 in January 1995. 24 A joint World BanklIDB Study collection from storage tanks which are filled by privately operated water tankers. The tariffs paid by such families in 1991 were about US$3.15 per cubic meter (L17 per cubic meter): 77 times higher than those paid by customers connected to the SANAA system. Expenditures for water represented about 12 percent of the monthly family income for about 80 percent of these poor families.'° This suggests that the poor would benefit from an increase in tariffs used to finance service expansion. The largest subsidy is provided by SANAA. DIMA in San Pedro Sula charges almost 3 times more than SANAA, and as stated above, has adjusted its tariff levels every year since 1990. In some community based operations, such as the UNICEF-funded project for shanty towns of Tegucigalpa, tariffs meet total costs, including the amortization of investments. In water purchased from private vendors, the full cost of transportation and distribution is usually charged. 3.38 The classification of "small consumers" is increasingly being expanded to cover the middle classes. In water the ceiling for the definition of small consumers was raised from 20 to 35 cubic meters per month. Contrast this with consumption of poor families in the shanty towns of Tegucigalpa which averages 3 cubic meters per month. In electricity, initially, the customers to be cross-subsidized were those consuming less than 100 Kwh. Eventually, these cross-subsidies were extended to customers consuming 300 Kwh or less. In the tariff adjustment of July 1994, the only category that did not face a tariff increase was for less than 300 Kwh. As a result, there was a need for a substantial increase in tariffs for the other users, making them pay up to 140 percent of the long run marginal costs. 3.39 In some sectors, poorly developed schemes of cross-subsidies affect the international competitiveness of exporters and can lead to misallocation of resources. The distribution of tariffs across users is such that for the case of electricity, there are cross-subsidies between large and small users, and residential and commercial users. Industrialists complain that they pay high tariffs for electricity, which affect their competitiveness. Cross-subsidies in telecommunications create important distortions. The international calls are charged at a very high rate to subsidize local calls (see Table 3-6). The only category of service that meets the marginal costs is the international calls. The current tariff structure results in a high rate of charges for international calls. As a comparison, it costs on average about US$0.90 pulse/minute to call Honduras from the US, during business hours, but calling the US from Honduras costs US$2.00 pulse/minute. As a result of the current tariff structures, HONDUTEL is losing some international calling customers as they typically use call-back systems to make their calls. These are computerized systems that automatically call-back the customer and establish a connection at rates substantially lower than those charged by HONDUTEL. Collect calls have also increased substantially. The team estimates that because of this competition, revenues from international calls will fall by about 20 percent per year over the next two years. Meanwhile, local calls are very difficult to make due to high levels of congestion; an indication that there is room to increase the rates to reduce the demand for local service and hence the level of congestion. Table 3-6: Distribution of Costs and Tariffs for 3.40 Subsidies in urban transport also create Telecommunications distortions and are not targeted to the poor. The Category Unit Actual Tariff Marginal Cost Government provides a subsidy to the transport U.S. Dollars operators, on a lump sum basis. The subsidy is Local pulse .022+.003 0.31 estimated from a monthly volume of passengers long-distance minute 0.03 to 0.12 0.15 carried by the operator. This lump sum subsidy is not Intemational minute 2.07 0.225 directed at the passengers that really need the subsidy Source: Mission Calculations. Note that the rate for local calls and it encourages inefficient operation by the includes a rental fee of which allows i50 free pulses estimated at 0.022$/pulse/minute. Extra calls are charged at 0.003 transporters as they have no incentive to improve S/pulse/minute for every call above the free 150 pulses. This coverage or quality of service (it is said that some of makes the subsidy to the local calls even higher. them just keep an old bus without operating it as they receive subsidies for every registered vehicle supposed to provide urban bus transport). 0 UNICEF, "El Gasto Familiar por la Compra de Agua en los Barrios Marginales de Tegucigalpa", 1991. Reforming Public Investment 25 Maintenance of Infrastructure Stocks 3.41 In Honduras, maintenance is rarely performed in the infrastructure sectors. The exception is main roads, where since 1991, maintenance based on the use of private contractors has become a central part of the Government's strategy. A new approach to maintenance based on the private sector is also beginning to develop in electricity. Lack of maintenance of SANAA's network is one of the factors leading to water losses of about 50 percent. In telecommunications, the number of faults per subscriber per year is about 0.5, compared to about 0.2 in other countries with well-maintained systems. In electricity, the distribution system of ENEE has losses of about 28 percent due to poor maintenance compared to 10 percent in well- functioning systems. The severe rationing of electricity that took place during most of 1994 was also the result of the lack of maintenance of thermal and hydroelectric generation plants and of the distribution system." The cost to the economy of such rationing in terms of foregone production, damage to goods, and the cost of self-provision through private generators is enormous, not to mention the environmental costs of fuel emissions from all the small generators in place. Poor condition of roads in marginal areas prevent large buses from having access leaving alternative forms of transport to operate services at high rates and low frequencies. The poor suffer more under poor maintenance policies as they can rarely afford alternative services. 3.42 Preventive maintenance strategies are not used, leading to the need of high-cost emergency repairs and to reliance on periodic investment on rehabilitation of deteriorated infrastructure. There is a high cost to maintenance neglect as demonstrated by the example in Box 3-2. In the case of telecommunications which is the responsibility of HONDUTEL, no preventive maintenance is done. Instead faults are fixed when they appear and expensive replacement of cables are undertaken when they fail catastrophically. Preventive maintenance for such a system could be testing and fixing insulation resistance of cables before water seepage damages the cable. Similarly in the case of water and sewerage systems under the responsibility of SANAA, no maintenance is performed. Instead corrective repairs and major rehabilitation are done in the case of catastrophic failure such as the breaking of water pipes. 3.43 The lack of maintenance is due to a combination of factors including: (i) dispersion of responsibilities for maintenance among multiple entities; (ii) lack of proper supervision of contracted maintenance; (iii) budgetary pressures, lack of sectoral policy and interference in day-to-day management decisions of PEs; and (iv) lack of a sense of ownership of infrastructure stocks which reduces the incentives to carry out maintenance. 3.44 Dispersion of responsibilities for maintenance among multiple entities leads to maintenance neglect. This is illustrated by the aviation sector where lack of maintenance of airfield pavements has occurred to the extent that many of the airports are considered to be in dangerous condition by most pilots. One of the reasons for this neglect is the dispersion of responsibility for airport maintenance among two different agencies: (i) the Civil Aviation Directorate (DGAC) with responsibility for maintaining the equipment and terminal facilities; and (ii) the DGCCA with the responsibility for the airfield pavements. The DGAC has direct relationship to the users of airports and has the most information about maintenance needs, yet it does not have the budgeting nor execution responsibility for carrying out maintenance. This asymmetry in information and functional responsibility leads to the maintenance neglect apparent in the system. 3.45 Maintenance by contract, when carried out, is sometimes not properly supervised, undermining any efficiencies that could be gained from involving the private sector in maintenance. Another reason for poor maintenance in HONDUTEL is due to the fact that contracted out maintenance is not properly The Government was forced to introduce rationing because of a combination of insufficient supply and excess demand. Insufficient supply was due to lack of maintenance, ENEE's 1993 decision to allow water levels to fall in El Caj6n to avoid rationaing during the presidential election, poor rain and deforestation of the water shed of El Caj6n. Excess demand was caused by low tariffs and consumer's awareness that lack of payment would not be punished. 26 A joint World BankIlIDB Study Box 3-2: The High Cost of Maintenance Neglect The cost of routine maintenance on a one km stretch of road carrying 1000 vehicles a day in Honduras is $1,300/km. This includes performing activities such as patching potholes, crack-filling, vegetation clearance, ditch and culvert cleaning and routine maintenance of bridges. Periodic maintenance in the form of overlays is about US$28,000 /km and is performed every five years. The cost of pavement rehabilitation in the event of total failure is US$112,000 /km. Within a ten year period, the choices are: (i) routine and periodic maintenance over the 10 year period thus avoiding the cost of reconstruction. or (ii) deferring most maintenance and needing a reconstruction at the end of 10 years. The net present value of the first strategy at a 12 percent discount rate is about US$3 1,000 while that of the second strategy is 25 percent more. An agency perforning the first schedule could receive substantial savings. When we include user costs in the calculation, we see the additional cost of deferred maintenance which the users face in terms of vehicle operating costs (fuel, tires, spare parts, replacing vehicles etc.). The average user costs when roads are in "bad" condition is about 40 cents/vehicle/km (calculated by HDM for Honduras for 1000 vehicles per day and 40 percent trucks). When the roads are in "good" condition these costs are about 25 cents/vehicle/km. The additional cost to users for using the second schedule (that is not performing maintenance) has a net present value of about US$124,000. checked for quality. When components that have been repaired fail, HONDUTEL blames the contractors and they in turn blame HONDUTEL. This is mainly due to the weakness in supervision of contracted out works and the lack of a proper enforcement system for ensuring compliance with contracts. Exceptions include the contracting out experiences in the electricity and road sectors. 3.46 Budgetary pressures, lack of sectoral policy and interference in day-to-day management Diagram 3-6: Roads in Good Conditions (%) decisions leads to further deferral of maintenance. 50 Electricity generation and supply is a good 4 example in this regard. ENEE does not have sufficient allocations in its budget and hence 40 defers maintenance. Furthermore, there is no 50 3 interest among enterprise managers to carry out maintenance, partly because of lack of motivation f 25 but also as a result of the cumbersome procedures = 20 for getting approval to purchase spare parts. X I5 Limitations in the Ley de Contratacion del Eslado l0 make it difficult to make purchases that are more 5 than L30,000. Most components for the proper 0 L _ i ll maintenance of electricity generation, HIondara Guatemala Costa Ric. PaAm transmission and distribution, as well as telecommunications would typically cost more than this. HONDUTEL overcomes this constraint by making large purchases of stocks of spare parts to cover maintenance demands for up to three years in the initial purchase of equipment. While this procedure allows the enterprise to get around the cumbersome procurement procedures dictated by law, it produces high costs of stocking and storage which further reduce the effectiveness of maintenance expenditures. 3.47 Maintenance is not performed due to a lack of a sense of ownership of infrastructure stocks by the users. In the case of small education and health facilities, only those that are in the hands of community organizations are properly maintained. This is an indication of the impact of the sense of ownership on the maintenance behavior followed. Ownership rights usually lead to desires to preserve stocks and hence the performance of proper maintenance actions. 3.48 Savings and maintenance benefits can be seen in the case of contracting road maintenance by SECOPT which has developed and is implementing a roads masterplan. The road network in Honduras has been divided up into 53 sections, 46 of which are maintained by private enterprises through contracts financed by the World Bank and the Government of Kuwait, and the remaining 7 are maintained by force- account units within SECOPT. The contracts are awarded following a competitive bidding process and the works are supervised by private consulting firms as well as by national auditing bodies and external financiers. The unit costs of maintenance in Honduras are lower than those of neighboring countries. This Reforming Public Investment 27 policy has resulted in impressive improvement in the conditions of the road network; 20 percent of the total road network is in good condition, 26 percent in fair condition, 14 percent is currently under repair, and the remaining 40 percent is in bad condition. These levels of condition are much higher than those of neighboring countries as shown in Diagram 3-6 Table 3-7: Costs of Electricity Supply by Private and Public Enterprises Category ROM ELCOSA (emergency) ELCOSA (long term) ENEE Type of Contract operation and installation, operation and installation, operation and installation, operation mnaintenance maintenance maintenance and maintenance Costs of Supply (S/KWh) 0.06 0.11 0.09 0.10 3.49 Recently ENEE has signed two contracts with the private sector for the supply, operation and maintenance of electricity services and has called for bids for other contracts. The first contract signed is for the operation and maintenance of the existing 90 MW diesel plants with a private company, leaving the responsibility for the investment in the rehabilitation of the plants to the private contractors. The second contract was signed with ELCOSA and consists of the provision of services in two stages. The first stage was designed as an emergency response to the rationing that took place in 1994 and consisted on the rapid installation of power generating units for 24 MW. To allow the rapid installation of these units, ELCOSA and ENEE agreed on the installation of small and low efficiency equipment which required high tariffs during the duration of the emergency. The second stage will begin with the installation of 8 higher efficiency generating units of 10 MW each and should be fully operational by June 1995. Once these units are in operation, the smaller units will be retired and the purchasing price of energy will be reduced. The costs from these contracts are lower than an alternative suggested by ENEE whereby it would install a gas turbine of 75 MW with an operating cost of $0.08 per KWh. Adding to this the cost of maintenance of $0.02 per KWh we obtain a figure of $0.10 per KWh, higher than most of the private sector alternatives (except for provision from ELCOSA during the emergency period)12. Table 3-7 shows the cost efficiency gains obtained by using the private sector. The advantage of such contracting out is two-fold: (i) reduction in the costs of electricity production and hence tariffs; and (ii) better performance of maintenance activities. 3.50 The Government has unsuccessfully attempted to attract more private investors to the sector by inviting several public bids. Private investors were reluctant to enter the sector in 1994 because they felt uncertain about the future economic and sectoral policies of the new Government. Those investors that even considered entering the sector would have required extremely high tariffs to offset the perceived risk. The perceived risk by potential investors is that the recent sectoral reforms can be reversed or that the new electricity law may not be fully implemented. The risk is also concerned with the general management of the economy as most of these negotiations took place while it was unclear if Honduras would agree a program with the IMF. In addition, a specific concern of potential investors arose from the switch in mid- 1994 to an auction system for foreign exchange that strengthens the role of the Central Bank in the foreign exchange market. Financing of Maintenance and Investment in Roads 3.51 While financing of maintenance by PEs should be obtained by charging fees to users, financing of road maintenance, where the link between use and payment of fees is weaker, poses special problems. In this section we describe the investment program of the road sector and the sustainability of its financing. 12 The unit costs of operation resulting from this bidding process are higher than those obtained from similar processes in other Central American countries. The main reason for this discrepancy is the perception of risk by investors. Additionally, in some of the other Central American countries private producers are excempt from taxes and import duties which they must pay in Honduras. 28 A joint World BanklIDB Study 3.52 While there has been significant progress in the rehabilitation of roads since 1990, two thirds of the roads remain in need of rehabilitation. The rehabilitation program, which is being supported by among others, IDA, IDB, CABEI and the Government of Kuwait, requires an investment of about US$40 million per year over the next 5 years. Routine and periodic maintenance needs are estimated in the US$35-40 million range per year. Hence, the sector requires about US$70 million per year in the near future, not including needs for an expansion or upgrading of the main road network nor for an expansion of the secondary road system. These are very large numbers for Honduras, equivalent to over 2 percent of GDP. 3.53 Investment in roads grew steeply from 1990 to 1992 and leapfrogged to US$131 million in 1993. All investments by SECOPT, and especially investments for roads were cut drastically in 1994 by SHCP to make fiscal room for the expenditures committed by PEs and the new airport terminals. In 1994 investments in roads were less than US$50 million. In addition to affecting the rehabilitation and maintenance program of SECOPT, this reduction created underutilized capacity among private contractors and led to cancellation of new purchases of equipment by these contractors, which could affect their future ability to provide services at competitive rates. 3.54 The status of the 1995 budget for SECOPT remains confused. About US$60 million have been budgeted for roads, but over a third of this is earmarked for new construction (including a beltway around Tegucigalpa). This implies that the rehabilitation and maintenance program would become substantially underfunded for the second year in a row and could affect the sustainability of the gains obtained in road quality. Over US$20 million are budgeted for airports, but there are important disagreements over the use of these funds. There has been almost no maintenance of runways in recent years, and civil aviation technicians consider that some rehabilitation is urgent to avoid accidents. Other Government officials want to direct the budgeted funds to the investments required to make operational the new airport terminal of San Pedro Sula. 3.55 The financing of road maintenance constitutes one of the major fiscal challenges for the medium term. Revenues from fuel taxes, vehicle registration and other fees related to road transport were over US$36 million in 1994. This figure is similar to the financial requirements for road maintenance (excluding rehabilitation). However, these revenues are needed to finance the general budget. Financing of road investment and maintenance is based on the use of external credit and avoids the use of domestic financing from the treasury. In 1994, 80 percent of maintenance and almost all investment in rehabilitation was financed from external loans. Clearly this system is not sustainable. In view of the financial difficulties of 1994, IDA eliminated the requirement of counterpart funds for that year. This liberated funds which were then applied as counterpart for a loan from the Government of Kuwait. This loan was then used as counterpart for a loan from IDB. 3.56 The problem of financing of road maintenance has two dimensions. The first is the scope to increase fees or taxes related to transport to cover the financial needs of the sector and the fiscal needs of the Government. While a careful review of the revenue system is needed before any firm recommendations are made, there seems to be scope for increasing these fees and taxes. No tolls are charged for the use of the recently rehabilitated main roads. Honduras's central location in Central America and the relatively good quality of its roads has made it an important transit area for transport from other country's exports -- however no revenues are obtained from this service. Perhaps most promising, only 7 percent of total tax revenues are collected from fuels, while this source of revenues provides 15-20 percent of total revenues in most other Latin American countries. The second dimension of the problem is institutional. A road fund was approved by Congress in 1993 but this law has not been implemented. Should a road fund be implemented in Honduras to earmark revenues from fuel to road rehabilitation? This question is discussed in Box 3-3. While there are arguments in favor and against the implementation of a fund, if the Government decides to go ahead in the implementation of the road fund, it should introduce a crucial change to the existing law: the Fund should become a mechanism to increase revenues and not to redirect existing revenues as is stated in the existing law. Reforming Public Investment 29 Box 3-3: The Case for and against a Road Fund in Honduras Road Funds are a form of earmarking whereby revenues raised from gasoline taxes, motor vehicle fees, tolls and other road user specific charges are allocated to specific activities related to roads such as maintenance, There have been many arguments for and against the use of road funds some of which are summarized below. [The Case for Road Funds | The Case Against Road Funds l (1) Suitable for raising new sources of revenues for (I) Taxes levied on road users (e.g., fuel and vehicle taxes) road maintenance as users know what funds will be are an important source of general revenue and it is difficult used for and will hence be more willing to pay. to dissociate user charges from general taxes. Hence the (2) Protect road maintenance activities against major benefit of earmarking which is to link benefits to politicized and unreliable allocations from the central taxation is not realized. government, thus avoiding periodic haggling over (2) Does not allow period by period economic allocation of levels of funding, avoiding the deferral of needed resources leading to allocative inefficiencies with too much maintenance. being given to road maintenance and not enough to others (3) Channel additional funds and regularize the flow of under budgetary pressures. funds for road maintenance to an agency that has (3) Hampers the effectiveness of budgetary control maintenance as its primary responsibility. especially when the provisions for the road fund are (4) Greater stability and continuity of funding for embedded in statutes that cannot be easily overridden. maintenance may lead to lower costs of long-term (4) Infringes on the powers of the legislative and executive maintenance. branches of government. (5) Increases the chances for cost recovery in the road (5) Impart inflexibility in the budgetary process in that sector when the types of charges used to finance the changes only come with a lag and original levels of the road road fund are directly linked to the level of usage, fund may continue after their usefulness has been served. damage, and hence maintenance. This is especially a problem as maintenance needs tend to be (6) Eases the task of functional and locational cyclical depending on the cycle of usage and damage. decentralization as revenue raising activities are closer (6) Removes expenditures from close public scrutiny as to the immediate beneficiaries (the road users in a activities financed through the road fund may not be subject particular state or district). to the same rigorous evaluation as other budgetary (7) Improves the efficiency of revenue collection and expenditures. This may lead to waste, squahder, needless sharing schemes between central and local overheads or suboptimal allocation. governments for road maintenance activities. Recommendations 3.57 This section recommends reforms to the structure of ownership and competition, the regulatory and control processes, the procedures for tariff setting and the system of r-aintenance. Table 3-8 presents a summary of recommendations for each of the main infrastructure sectors. 3.58 Structure of Ownership and Competition. There is a need to change the structure of ownership within the infrastructure sectors and enhance the degree of competition in and for the provision of services, removing artificial barriers to entry in service provision. Further participation of the private sector should be pursued as alternatives for improving the efficiency of infrastructure services and for generating sources of finance. This increased participation should be sought through transfers of ownership and vertical and horizontal unbundling of service provision. 3.59 In sectors where direct private participation is less likely to be achieved, such as water supply and sanitation, reforms should focus on transferring (or delegating) service provision to entities that have more chance of being faced with accountability constraints (such as municipalities and community groups). The recent Law of Municipalities is a step in the right direction but requires modification to enhance possibilities for public/private partnerships and more competition. 30 A joint World Bank/lIDB Study 3.60 Regulatory and Control Processes. There is a need for a major reform of the regulatory and control processes in the provision and management of public services. More specifically, the role of the Government as regulator and controller needs to be more clearly specified. Further participation of the private sector in service provision as well as the enhancement of competition should be pursued in order to improve the efficiency of regulation and perhaps even reduce the need for it. Regulation may be unnecessary when there is sufficient competition and there are no externalities. 3.61 Regulatory bodies should be designed to be as free as possible from the pressures of regulatory capture by interest groups. Regulators should be skilled in sectoral regulation issues, with long enough terms to make them independent of any particular administration. Regulatory bodies should be properly funded to ensure that they can effectively carry out their functions in an independent manner. In order to ensure fairness to consumers who are served by alternative providers (such as private water vendors), regulations should be applied equally to all providers. Further analysis is needed to evaluate the costs and benefits of revamping CNSSP or creating new individual regulatory agencies for each sector as was done for electricity through the passage of the Electricity Law. 3.62 The current dispersion and duplication of functions in the structure of regulation and controls should be reduced. Controls should be designed in order to ensure that public enterprises have autonomy to manage service operations delegating to sectoral ministries the authority to ensure that the enterprises are accountable in meeting sectoral and macro-economic objectives. 3.63 Sectoral planning and policy development functions within the line ministries and SECPLAN need to be improved in order to ensure effective control of the behavior of public enterprises. Improving the flow of information between the enterprises, line ministries, SECPLAN, SCHP, and the regulatory bodies is an important step to increase the effectiveness of regulation and control. 3.64 Tariff Setting. Tariff setting procedures should be based on a proper cost analysis which includes all categories of users and what it actually costs the company to operate the services as well as finance investments for expansion and improvement of services. A common misconception is that a proper tariff setting process requires a lot of information which is not available and enterprises require complex tariff studies in order to properly set tariffs. Enterprises should be required to meet at least operating costs, while waiting for the information to design more complex tariff structures. Water supply is a service with operating costs that users are willing to pay for. The high tariffs currently paid by the poor to get water services is an indication of willingness to pay. The other income categories that receive subsidized rates should be required to pay more for these services and SANAA should behave as a commercial enterprise with efficiency and cost recovery objectives. 3.65 Enterprises should be allowed to meet at least their operating costs (for small residential consumers of electricity and water supply and local telephone services) and their long run marginal costs for all other services. Regulatory bodies in charge of setting tariffs should ensure that the cost of enterprise inefficiencies is not transferred to the consumers. For example, SANAA now operates with 50 percent water losses and ENEE has about 28 percent losses in electricity supply. The costs of such inefficiencies should not be passed on to the users as a higher tariff to meet operating costs. Tariffs should be based on the production costs of an "efficient" enterprise. 3.66 Cross-subsidies within a sector, when used, should be properly designed to avoid penalizing a particular group that is important for economic growth (e.g., industries that use large volumes of electricity and that make international calls) or the extremely poor who generally do not have access to service and need to be connected. Revenues from such cross-subsidies should be used to expand services to the poor when possible, instead of using them to subsidize the middle class. If the Government decides to subsidize low income families, these subsidies should be effectively targeted to avoid subsidizing the wrong group. In general, subsidies should be directed towards expansion of services and as little as possible toward subsidizing usage of services. This is especially relevant for the case of urban transport where the current Reforming Public Investment 31 system of subsidies goes to the operator and not to the passengers, except in an indirect sense. A coupon system such as that used by PRAF could be envisaged, where the operator gets reimbursed for the actual number of poor he has carried rather than some theoretical number which assumes that every one using the service needs the subsidy. 3.67 Maintenance. There is a need for a clear strategy for maintenance in all the infrastructure subsectors which defines the levels of service that need to be maintained in order to minimize total costs of reconstructing deteriorated systems and the costs to users of non-functioning systems. Specifically, the following reforms are needed. * Using longer term perspectives in planning with proper incentive schemes for sectoral decision-makers to include maintenance in their sectoral plans would solve the problem of maintenance neglect. * Long-term sources of finance for maintenance that will allow a sustainable performance of maintenance activities, including a proper system of tariffs and charges, need to be identified. * Information systems to develop sound maintenance strategies, such as condition inspection systems and methodologies to measure the effect of maintenance deferral need to be improved. * Strengthen units within public enterprises and line ministries responsible for maintenance. * Private sector alternatives for performing maintenance such as contracting out (efforts done by SECOPT to contract out maintenance should be encouraged and followed by other sectors), and leasing to the private sector (as the example of ENEE where the operation, rehabilitation, and maintenance of three diesel power stations was leased to the private sector) should be encouraged. * Other means of improving maintenance outcomes should be explored such as exploiting equipment suppliers services as much as possible to get maintenance schedules for new equipment as well as training in the purchase contracts for equipment. * develop norms for maintenance processes at the level of enterprises and line ministries, to be reviewed by SECPLAN and enforced by SHCP. 3.68 Financing of Maintenance of Roads. To become sustainable, the roads network needs to be increasingly maintained from domestic revenues, phasing out the existing system of financing based on external credit. To achieve this additional sources of revenue need to be sought as the existing transport related revenues are needed to finance other fiscal expenditures. The scope for increasing revenues from tolls, or by raising fuel tax rates to levels similar to those under use in other Latin American countries and other sources should be studied. If a road fund is established, fiscal stability will require that it should be financed by incremental revenues, and not as stated in the 1993 law, by redirecting existing revenues. 32 A joint World Bank/lIDB Study Table 3-8: Summary of Sectoral Recommendations Sector f Ownership Structure I Competition Regulation Control Telecom T Privatize, Liberalize entry to Design regulatory Create a technical - HONDUTEL provide private networks framework that body to oversee the and cellular telephony promotes competition restructuring of the I Liberalize value added in service provision sector and service provision privatization of i___ f______________ f__ ____________ ______ HONDUTEL Electricity Contract to the Remove barriers to entry Revise the Electricity Increase autonomy ponriate setor the in elevse liC l private sector the in electricity law Law to promote of ENEE by operation and Revise articles dealing competition and restructuring the maintenance of with permission to use efficiency objectives Board of Directors, thermal plants transmission network Strengthen the removing Privatize all capacity of CNEE and restrictions on the distribution activities Promote competition for i transfer regulatory use of revenues, and I the supply of electricity functions from all reforming the Ley de !_________ I:_________________ 'other bodies to CNEE Contratacion Water Transfer of the assets Create opportunities for Create a regulatory Clarify institutional Supply of SANAA to the competition in the body with technical responsibilities municipalities provision of non-piped capacity and Reduce bureacratic Concession the services independence tendencies in the operation of large Contract out commercial Revise the Law of management of the piped water systems activities of service SANAA to remove sector Increase opportunities providers barriers to transfer its Make municipal fe for community i , assets to third parties water enterprises fi i : pfarticipation I 'I Fix tariffs using commercially viable economic costs as Coordinate donor basis activity in rural areas | Subsidize only increased coverage to V | V~ ~~~~~~~~~~ the poor La Ports. Pre-par-e managemnent Pro,mote competition in lthe poor sud Reduceth h~ it tariff study } edc the nuibr contract for container the provision of port f and develop necessary o of bodies controlling termiinal at Puerto services I regulation topromote decision-making in| Cortes . : competitition in the ! port activities Lease bulk terminal . : : provision of services in Puerto Cortes Concession or I transfer ownership of I Puerto Castilla, La Ceiba and San Lorenzo : . . _____ Rail. Concession, sell, or i Promote internodal Ensure regulation of lease FNH assets competition by removing safety is enforced all price controls fot road l __________ _____________________ transport I_ _l Airports Concession out Promote intermodal Revise the Law of Create autonomous airport services such. competition by removing Civil Aviation to body to manage as baggage handling, all price controls for road ! promote autonomy of airports in a parking, and transport the airport authority . commercial manner ! Roads :: . passenger amenities Rag Increase participation I Liberalize. entr-y to f evise the Lanid -----1- - of private sector in transport service Transport Law bto road investments and provision address issues of i continue contracting safety, environment, out maintenance and artificial barriers l _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __to en try j . Reforming Public Investment 33 4. PUBLIC INVESTMENT AND POVERTY ALLEVIATION 4.1 The need to strengthen public support for the poor is one of the key objectives in the Government's development strategy. To reflect this emphasis on poverty reduction, SECPLAN attempted to translate this objective into a target for the preparation of the PIP. For 1995, it aimed at raising the share of the social sectors to 35 percent of public investment. This target was reached in the Table 4-1: Public Investment in Social Sector Infrastructure g 1995 budget. The share of the social sectors 193 1994 1995 in public fixed investment was 23 percent in (percent) 1993, increased to 27 percent during the first Social Investment 100.00 100.00 100.00 year of the Reina Administration and is Public Education 0.73 0.28 4.73 budgeted to reach 38 percent of public Public Health and Social Assistance 5.30 0.72 15.93 investment in 1995. Given the weight of SANAA 15.48 23.80 27.40 teachers and health workers in education and FHIS 31.24 15.60 16.19 health, the total weight of the social sectors in the budget, including recurrent costs is Local Governments (40 91 of total) 15.71 9.83 5.74 even higher. In the budget approved by Congress for 1995, about 56 percent of INFOP 1.22 0.78 0.64 primary (i.e. non-interest) expenditures are INJUPEMP 21.29 33.97 21.28 assigned to education, health and sanitation. INPREMA 6.59 12.06 6.54 UNAH 2.15 2.27 1.22 4.2 Despite the significant fiscal effort Investment in Social Sector assigned to the social sectors, there remains a a nfrastructure as: widespread perception, that includes a percent of GDP 3.11 3.14 4.04 Government officials, public opinion and a percent of total public investment 22.91 26.83 38.24 donor agencies, that not enough is being index of real Lempiras (1993= 100) 100.00 99.43 133.63 done for the poor through the PIP and the Source: MHCP economic policy framework. Two reasons explain this perception. First, the Government lacks an explicit strategy explaining how poverty reduction is to be achieved, and there exist conflicting views and conflicting political interests on this issue. Second, most of the investment in the social sectors is not reaching the poor because most of it is not directed to the poor and because of inefficiencies in the way public services are provided. These issues are discussed below. Section A comments on the lack of an explicit strategy for poverty reduction. Section B analyzes public financing, coverage and efficiency in education and health; in that section emphasis is given to the discussion of recurrent costs (as opposed to fixed investment which is the main theme of the rest of this report). Section C describes fixed investment in the social sectors and its benefits to the poor. Lack of a Strategy for Poverty Reduction 4.3 There is no statement that explains the Government's strategy for growth and poverty reduction, identifying the links between the two. Lacking such a strategy, Government officials place excessive emphasis on direct interventions, subsidized credit, price controls and control on the tariffs of public enterprises. Investment programming is based in an implicit perception that identifies investments in the social sectors with poverty reduction and "economic" investment with growth -- missing the crucial link between growth and poverty reduction. This duality is reflected in the areas of action of two groups of Cabinet Ministers. The Economic Cabinet deals with growth and macroeconomic stability issues and the Social Cabinet deals with social and poverty issues. Both cabinets rarely work together. Little emphasis is given to poverty issues outside of the social sectors and economic analysis is often lacking in the implementation of policies in the social sectors. One of the consequences of this duality is that investments outside the social sectors are not appraised for their impact on the poor. The second is that the simplistic 34 A joint World BanlI/IDB study assumption that all investment in the social sectors benefits the poor leads to neglecting the important inefficiencies present in the sectors. 4.4 The lack of an explicit strategy for poverty reduction is partly due to lack of information and analysis about who the poor are and how they can be reached through public policy and investment. The available poverty data lack the quality necessary to sort out the various views about the impact of economic policy. The data is based on surveys using a weak methodology and designed for purposes other than what is needed for poverty analysis. The methodology applied to these data is also weak and poverty estimates are formed based on an outdated consumption basket (from a 1978 consumption survey).'3 These problems are compounded by lack of definition on which institution should analyze and monitor poverty. Public Financing of Education and Health 4.5 Public expenditures in the social sectors, at almost 9 percent of GDP, are high relative to income by international standards. Comparisons of Honduras with 52 countries were performed controlling for income levels and produced strikingly different conclusions concerning the performance of the health and the education sectors. The proportion of GDP used for public spending in health in Honduras is close to the international average and its results in terms of life expectancy are better than average. In education, by contrast, the proportion of GDP spent is higher than the international average, while the literacy rate is below that average. The evolution of other social indicators Table 4-2. Total also suggests that the main challenge at present is in the Expenditures in Social Programs education sector. Infant mortality and general mortality rates (% of GDP) today are less than a third what they were in the l950s. In 1990-92 education, despite a notable expansion of coverage at the Education 4.2 e E .primary level to its current level of 86 percent, Honduras continues to lag behind comparable countries in terms of Health and Sanittation 2.9 HealthandSuanitation 2.9 literacy. Educational achievement, even among the young who Health Insurance 0.8 Others" .0.6 benefited from the recent expansion of coverage, continues to be Total 8.6 at low levels. This section analyzes the efficiency and equity of 1/ InCludes Ministerial. xpenditu r public expenditures in education and health, it underlines the labor, social assistance, and housing sectors need to improve efficiency in social service delivery, and transfers to the pension finds and from particularly in education, where efficiency is particularly low. FOSOVI. Source: CtM, table, 6. 2 Given the Government's fiscal constraints, improving the quality of social services will depend on achieving greater efficiency rather than increasing expenditures. Main issues in Education 4.6 An important achievement of the education sector has been the tripling of the number of students attending primary education since 1970. Access to primary school is now nearly universal (Table 4-4). The main problem confronting the sector is its low quality. Primary education suffers of low educational achievement, high repetition rates, high drop out rates and low completion rates. These poor results have their roots in poor teaching quality, an inappropriate curriculum and shortages of books and other teaching materials. Poor teaching quality is the result of insufficient classroom time, teacher absenteeism, inadequate supervision from the school system and the community, lack of external evaluation and 3 Data and methodological weaknesses are described in the 1994 Honduras: Country Economic Memorandum/Poverty Assessment. That report also analyzes the links between growth and poverty alleviation during 1989-92. The international comparisons were performed by means of regression analysis. A sample of 52 countries with per capita income between 340 and 2520 dollars was used. The results are reported in the CEM (1994), Annex D-6. Reforming Public Investment 35 insufficient training. External factors related to family poverty and lack of parental involvement in school issues compound the problem. These factors are analyzed in detail in the background section of the World Bank Basic Education Project Staff Appraisal Report approved in March, 1995. In this section we focus on the issues of public finance relevant to the sector. Two issues are highlighted: the scope for intrasectoral budgetary reallocations favoring primary education and the trade-off between a continued expansion of educational infrastructure and the need to improve the quality of education. 4.7 Educators find that quality of education is strongly correlated with non-salary recurrent expenditures. Although the budgetary allocation to education, at over 4 percent of GDP, is high by international standards, non-salary expenditures are under 4 percent of the sector budget, and have fallen by 20 percent since 1980. This decrease was due to two factors. First, to the expansion in student coverage, which required a larger allocation to new infrastructure and the hiring of teachers. Second, to an inefficient reallocation of the sector budget, the salary bill has grown faster than the total sector budget and so have transfers to higher education. Also, administrative costs per student have more than doubled since 1980 reaching 36 percent of per student costs in 1992. During the last decade, the number of teachers has grown by over 50 percent while non-teacher employees in public education have grown by 137 percent. These two groups constitute almost 60 percent of the total increase in public employment in Central Government over the last decade. 4.8 The Government, with support from an IDA Basic Education credit, is putting in place a plan to increase the quality of education. The plan, which builds on the results of a pilot project financed by IJSAID, involves: (i) a reforrn of the sector's administration including restructuring and decentralizing the Ministry of Education, upgrading and expanding the management information systems and providing currently inexistent managerial training for staff; (ii) a reform in the incentives for teachers including improvements in teacher training, introduction of a nationwide evaluation system, implementation of measures to increase effective classroom time by 64 percent, modernization of the supervision system, and the granting of pecuniary incentives to improve teacher attendance and performance; (iii) an increase in the provision of teaching materials and training on their use including: the printing and distribution of textbooks, and financing of small classroom libraries and other classroom material. Implementation of this plan will have to overcome capacity bottlenecks and possible political opposition. The World Bank and IDB propose to support these reforms as part of the Public Sector Modernization Adjustment credit currently under preparation. 4.9 As the budgetary allocation to the sector is already high, the Government is committed to maintain the budgetary share at around 4.5 percent of GDP, implying that the sector budget would grow at approximately the same rate of growth of GDP, or at about 1.5 percent per student enrolled per year. The reform of the sector is expected to produce important savings, as the total cost associated with grade repetition could be as high as 25 percent of the education sector budget, but these savings will be obtained very slowly. Hence, the improvement in quality will require a reallocation of resources within the sector towards primary education and towards non-salary recurrent costs. Teacher salaries were increased by 40 percent in 1994 and will have to be contained at their new level. Administrative costs will need to be reduced. 4.10 In theory, there is scope for an important reallocation of resources from higher education to primary education, however this would have to overcome a constitutional amendment introduced to the constitution in 1982 granting 6 percent of government revenues to the national university. While in practice on average 4 percent of revenues are trasnferred to the university, this leads to large inequities. Primary education, with 80 percent of the student population receives less than half of the education budget, while higher education, with 3 percent of the student population receives 18 percent of the education budget (Table 4-1). The heavy subsidy to university students is inappropriate: First, it cannot be justified for equity reasons as four out of five UNAH students come from middle and higher middle income class families. All of them are exempt from tuition fees except for small nominal payments. Second, research is almost nonexistent at UNAH, so there are no research externalities to be publicly financed. Third, there are serious inefficiencies at UNAH. Despite a significant increase in transfers to the university during the 36 A joint World BanklIDB study TUb*e 43.~ ExpeItures and Enrotlment in Educationi 1980s, coverage has remained stagnant at 6.5 percent E () of the 18 to 24 age group. Graduation rates are also 75 Expenditure Enrollment very low; only 15 percent of the 1981 cohort Primary 49 80 graduated in the 10 years after entrance. Secondary 17 17 Highcr 18 3 4.11 An important risk to the implementation of Administration 17 - Total 100 100 the Government's education strategy of improving Source: CEM, table 6.4. Data for 199o-92' quality of basic education is posed by the lack of a strategy governing FHIS. Given the budgetary ceiling, there is a trade-off between allocating resources to improve the quality of education on the one hand and allocating resources to expanding the system by building schools and classrooms and hiring teachers to staff them on the other. The plan to improve the quality of education has identified urgent needs for investment in infrastructure with an estimated total cost of about US$ 3 million per year over the next four years.'5 This plan would provide water and sanitation to the schools that currently lack this service, rehabilitate all schools currently in need of repair and build the 660 classrooms needed to overcome overcrowding and match the growth in student population. FHIS has a different plan, which would spend US$ 12 million in 1995, mostly in the construction of classrooms.16 This could force the Government to hire over 1,000 new teachers per year, derailing the careful programming needed to allow the budgetary reallocation required to improve the quality of education. A detailed discussion of FHIS is provided below. Table 4-4. Social Sector Coverage Main Issues in Health Coverage. % Pfublic Target i :o f 5 : m efe Sector Population =: D :: _ _~n O Education- -- v 1 4.12 The Ministry of Health is Prima rly 86.0 95 ages 7-13 responsible for national health policy, and Secondary 33.0 60 ages .x124- for planning, financing, and providing Higher 6.5 95 ages 18-24 0? :S ::ff: f: S; Ci f 0 f S ;ff (SS :Ce: (|tS f ;;; d tED LSS: fEd: faS C) SSSS: St) f; tS ' (fESS !i: E t; s ; fiA0t; t?;tSij0D SS0000000$S tt0000f0 it f;;; f tVf;4000 ffi;00;;,- dt 0;f tf f000j:40t:f E: f; t; f: :t0XE:: :: SES: fff :t; :; f: :d tESE SCS tlES SEF ff-2 dd l;80: S?. :; iS! f0; tt; S .SS .:00: .Si 204 fl? 00 CC, f:) a.St0-SSi: t; SS70 ff i.f f: t; S :E S \E : :: TE :: : ?: :): C: 0: t:: t: :0: ':EE, :'S\; :) :;0:.''0 '>1 E :S-:- $ it::d \: A:) :E? AS:: :E: ::: S 0 7 ff .: f; \TS : :; S.SE: 1;E iN'l t:: S:: \:kSS ?it ,: :f:::-SSS \ ): tE? ::tS S 'S :1.: :ffff:.;EdSSa. .': . 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