Economic modernization loan
  Report No: ; Type: Report/Evaluation Memorandum ; Country: Guatemala; Region: Latin America And Caribbean; Sector: Macro/Non-Trade; Major
                                                Sector: Economic Policy; ProjectID: P007210


The Guatemala Economic Modernization project, supported by Loan 3533-GU for US$120 million
equivalent, was approved in FY93. It was fully disbursed in three tranches and was closed in FY96. The
loan was amended after the release of the first tranche. Cofinancing for the financial sector reform
component was provided by the Inter American Development Bank in the amount of US$132 million.
The Implementation Completion Report (ICR) was prepared by the Latin America and the Caribbean
Regional Office. The borrower’s report is included as an annex.

     The Economic Modernization Loan (EML) was the first adjustment operation of its kind in
Guatemala. It supported reforms on a broad front. Reforms in public finance called for the
implementation of a comprehensive tax package, including improvements in tax and customs
administration. The public enterprise reforms included measures to restructure the agricultural marketing
agency and the electricity company and to improve the regulatory framework in the electricity sector.
Trade liberalization focused on reducing average tariff rates and their wide dispersion; elimination of non-
tariff barriers; and liberalization of the hydrocarbons market. Financial sector reforms aimed at
restructuring the state banking sector and strengthening prudential banking regulations. Reforms in the
social sector covered the improvement of expenditures in public health and education affecting the poor.

     The EML achieved many of its objectives. However, the broad design of the loan, institutional
difficulties, and sudden political changes contributed to implementation problems which led to delays.
About five months after loan effectiveness and release of the first tranche, Guatemala experienced a
political crisis when the President suspended parts of the Constitution. After a short period of intense
political turmoil leading to the ouster of the incumbent President, a new President was appointed by the
Congress. The new Government requested a restructuring of the loan and the Bank agreed. Under the
restructured loan, a number of critical conditions were moved from the second to the third tranche; some
conditions were revised or added; and the amounts of the loan tranches were changed. The loan
restructuring gave the Government more time to articulate its economic program and to put the reforms on
course.

     The macroeconomic framework improved during program implementation. Annual growth of GDP
improved from 3.3 percent to 4.4. Inflation fell from 28.8 percent (1986-89 average) to 8.4 percent in
1995. However, the external balance continued to show weakness. Public finance objectives were
partially achieved. Tax revenues fell short of targets. Trade reform objectives were substantially
achieved. In the financial sector, the strong resistance of the banking sector to new prudential regulations
was overcome through dialogue and negotiation between the Government and the banking community.
Three state banks in financial difficulties were either restructured, privatized, or their assets liquidated.
The EML tried to do too much. Its implementation tested to the limit the institutional capacity of the
Government as well as the supervision capacity of the Bank (a total of 17 missions were sent). Despite
political difficulties, however, the program was supported by the top leadership. Persistent court
challenges by opponents of the program limited or delayed the implementation of some reforms, such as
those dealing with the reduction of subsidies and the elimination of monopolies. A loan condition related
to the financial sector reforms had to be waived as the World Bank failed to properly coordinate with the
cofinancing institution (IDB). In addition, two conditions related to fiscal performance were waived to
allow the release of the third tranche.
    Major lessons from this operation include: (i) the importance of compactness and simplicity in the
design of adjustment operations; (ii) the need for a realistic assessment of the Borrower’s institutional
capacity for program implementation; and (iii) the significance of undertaking dialogues with key
stakeholders in the reform process.

     The ICR rates the project outcome as satisfactory, sustainability as likely, Bank performance as
satisfactory, and institutional development impact as partial. The Operations Evaluation Department
agrees with the outcome and institutional development ratings, but rates Bank performance as
unsatisfactory and sustainability as uncertain.

     The ICR is of satisfactory quality. An Aide Memoire from the completion mission was not included,
at the request of the Government, because it had prepared its own assessment of the operation. An audit is
planned, at which time these ratings will be reexamined.