Report No. 23509-SAS Risk Management in South Asia A Poverty Focused Approach November 2001 Human Development South Asia Region Document of the World Bank ACRONYMS AND ABBREVIATIONS BAAC Bank for Agriculture and Agricultural Cooperatives BGMEA Bangladesh Manufacturers and Exporters Association BRAC Bangladesh Rural Advancement Committee BRDB Bangladesh Rural Development Board BRI-UD Bank Rakyat Indonesia-Unit Desa CBOs Community Based Organization CREDA The Centre of Rural Education and Development Action EGS Employment Guarantee Scheme FFW Food for Work GDP Gross Domestic Product GNP Gross National Product ICRISAT International Crops Research Institute for Semi-Arid Tropics ILO International Labour Organization IPEC International Program on the Elimination of Child Labor JRY Jawahar Rozgar Yojana MVF M. Venkatrangaiah Foundation NGO Non-Government Organization PERs Public Expenditure Reviews PPF Public Provident Fund PPP Purchasing Power Parity PRSP Poverty Reduction Strategy Paper RHP Rural Health Program SASHD South Asia Human Development Sector SCNSB Sri-Lanka National Savings Bank SEWA Self Employed Women's Association SPARC Society for Promotion of Area Resource Centers SUC Standard Unit Contract TR Test Relief UNICEF United Nations Children's Fund WDR World Development Report Vice President Mieko Nishimizu Sector Director Emmanuel Jimenez Task Leader Tara Vishwanath PREFACE This paper has been prepared for the South Asia region by Ambar Narayan, Tara Vishwanath and N. Roberto Zagha. We would like to thank the Social Protection Network for supporting this work. We would also like to thank Rie Hiraoka for inputs on the Child Labor section, Salman Zaidi for inputs pertaining to Bangladesh, and Robert Palacios for materials contributing to the section on pension reform. Finally, we are grateful to Alfred Friendly for editorial support, and peer reviewers Shanta Devarajan and Manny Jimenez for helpful comments. CONTENTS Executive Summary ..............................................................v I. Rationale For A Social Protection Strategy ............................................................1 Poverty and Vulnerability in South Asia .............................................................. 1 Social Protection and Poverty Reduction ............................................................. 4 How Vulnerability Affects the Poor ..............................................................5 Rationale for Intervention ............................................................8 Typology of Risk ............................................................ 10 II. Targeting the Vulnerable: Widows and Working Children ........................... 17 Addressing Vulnerability of Widows ............................................................ 17 Reducing the Incidence and Risks of Child Labor ........................................................ 18 III. Evaluating Existing Options for Risk Mitigation and Coping ........................ 24 Public Works Programs ............................................................ 24 Social Protection Through Targeted Transfers in Cash or Kind ................................... 28 The Role of Microfinance in Social Protection ............................................................ 31 IV. Expanding Options for Risk Mitigation and Coping: Saving, Insurance and Pension Reform ............................................................. 34 Mobilizing Savings of the Poor ............................................................. 34 Insuring the Poor against Risk ............................................................ 35 Reforming Pension Systems in South Asia ............................................................. 38 V. Guidelines For A Social Protection Strategy ........................................................ 41 Principles for Designing Comprehensive Strategies for Countries in the Region ........ 41 Elements of a Social Protection Strategy in South Asia ............................. .................. 43 Integrating Social Protection into the World Bank's Program in South Asia ............... 48 List of References ............................................................ 51 Annex: Indicative List of Activities in South Asia Region with Social Protection Component ............................................................ 57 Notes to the Text ............................................................ 61 iii BOXES, FIGURES AND TABLES IN THE TEXT Chapter I Figure 1 Head-Count Ratio with National Poverty Lines .................................... 2 Figure 2 Per Capita GNP at PPP - 1998 ....................................................... 2 Figure 3 Annual Growth of GNP (PPP Measure) ............................................. 3 Box 1.1 The Measurement of Vulnerability ................................................... 5 Box 1.2 Vulnerability of Women ....................................................... 12 Table 1.1 Sources and Types of Risk ....................................................... 14 Table 1.2 Policy Instruments for Risk Reduction .............................................. 15 Table 1.3 Instruments for Risk Mitigation and Coping: Public, Market-Based and 16 Informal .16........................................ Chapter II Box 2.1 Community-Based Efforts in Addressing the Vulnerability of Widows ...... 18 Figure 4 Workforce Participation Rates of Children in Selected South Asian Countries 19 Figure 5 Estimated Number of Child Workers in Selected South Asian Countries ....... 19 Box 2.2 Community-Based Anti-Child Labor Initiatives in India .......................... 21 Chapter III Box 3.1 Lessons Learnt from Maharashtra's Employment Guarantee Scheme ........... 27 Chapter IV Box 4.1 Safe Save in Bangladesh: Mobilizing Savings to Attain Financial 34 Sustainability........................................ Box 4.2 Insuring the Poor - the Programs of Grameen Kalyan and SEWA .37 Chapter V Box 5.1 The Recent Earthquake in Gujarat (India) and the Strategy for Reconstruction 48 iv Executive Sunmnary The World Development Report (2000) and the consultations preceding it have focused attention on particularly important aspects of poverty - risk and vulnerability. The poor, especially, are subject to a variety of risks that affect their short-term well-being and long-term ability to climb out of poverty. Because they lack the ability to insure against risks, the poor often shape their behavior and decision-making to minimize exposure to risks, even at the cost of economic efficiency and long-term interest. Poverty and vulnerability are thus mutually reinforcing, each likely to aggravate the other. As part of the Bank's recognition of this vulnerability and its consequences, this paper reviews what is known about the risk-coping and risk-mitigating behavior of the poor in South Asia, the support they receive from governments and NGOs and the Bank's contributions. It also presents suggestions for a strategy that integrates efforts to reduce poverty with efforts to overcome risk. Since poverty and vulnerability are mutually reinforcing, measures that mitigate risk can also bring meaningful reductions in poverty. Particularly for South Asia, where poverty is widespread and resistant to many traditional policies, the paper argues that effective poverty-reduction requires complementary risk-management measures that can cushion poor households against temporary setbacks, so that transitory events do not produce permanent destitution. In addition to the range of familiar safety-net programs such as targeted employment programs, credit and insurance, the paper finds promise in the microfinance movement spreading throughout South Asia and in informal, savings and insurance schemes. Such undertakings share one trait; they link participants with market institutions. For economic growth to yield strong, sustained returns in reducing poverty, markets must not only function efficiently but also enable the poor to gain strength from them. While standard poverty reduction measures have traditionally focused on ways to improve the mean utility of a poor household, the objective of Social Protection is best understood in terms of reducing the variance of household's utility over time. However, since poverty and vulnerability are closely linked, the policy responses to them overlap considerably, with important synergies. Having said that, a social protection strategy must extend beyond the traditional poverty reduction measures, to focus on creating opportunities for households to manage risk better, primarily through a variety of instruments that perform the role of safety nets. The focus of this paper will be on these elements of a social protection strategy. Social protection in developed countries have traditionally encompassed safety net measures like unemployment and health benefits and insurance, social security and food stamps. For countries in South Asia, where a vast majority of the poor are concentrated in the informal sector, the existing level of institutional development - with, for instance, the near-absence of insurance markets and institutions necessary to identify beneficiaries - strongly limnits the scope for social protection through formal mechanisms. Improving the institutional capacity would thus be imperative for social protection. However, given that such change is a lengthy process, the social protection strategy for the region in the immediate future has to look beyond the traditional formal mechanisms, and incorporate the potential role of existing programs like public works, as well as programs that involve the use of informal community-based institutions. Going beyond the specific programs under review, the current study's central message is a broad one: an effective social protection strategy must consciously integrate risk management and poverty reduction. They are two sides of the same coin. v Poverty and Vulnerability South Asia is home to the largest number of the world's poor. While the incidence of poverty as defined by head-count ratio has shown some decline in all South Asian countries over the years, a sizable proportion of the population in all the countries still live in poverty. Moreover, conventional measurements - head-count ratios of the population of various countries below their poverty lines - portray the static picture, but say little about the movement of households in and out of poverty in response to shocks. The limited evidence available reveals such movements to be quite common, and transitory poverty to be a dominant component of total poverty. Thus in order to understanding vulnerability better, more comprehensive studies that analyze the dynamics of income and poverty are imperative for South Asian countries. The link between poverty and vulnerability arises from the fact that the poor have higher exposure to a variety of risks, and also lack access to instruments to mitigate and cope with such risks. Risks range from the household-specific (or idiosyncratic) danger of a crippling illness or death, to the community-wide (covariant) risks posed by an economic downturn, a conflict or a natural disaster. For the poor in South Asia, normal living conditions carry a higher-than-normal risk to health, and labor markets in the informal sector where most of them are employed expose them to high risks of unemployment. Harvest risks, additionally, raise higher threats to poor farmers with restricted access to credit, pesticides, disease-resistant seeds and irrigation. Floods and plagues, while affecting all, do tend to leave longer-lasting effects among the poor. The literature documenting the consequences of risk for the poor includes a study of South Indian villages where just the higher risk represented by a shift in the onset of the monsoon could cut the farm profits of households in the lowest wealth quartile by 35%, compared to a 15% reduction for median households and no effect on the wealthiest. Hardest hit everywhere are those who must depend on others: children, the elderly, widows, the chronically ill and the disabled. Women are also especially vulnerable in South Asia, according to evidence from a number of countries. Compared to those who are better-off, the poor have relatively few opportunities to mitigate risks. Being overwhelmingly concentrated in the informal sector, which is isolated from markets and formal institutions, the poor have little access to formal risk-mitigating instruments. The market failures in insurance and credit markets that arise mainly from information gaps can be circumvented only through the use of collateral; the poor however seldom possess assets that can be used as collateral. Thus to cope with shocks, poor households are often obliged to adopt strategies with possible long-term adverse consequences, like withdrawing children from school to contribute their labor to the family, selling crucial assets or crop inventories, or borrowing from moneylenders at usurious rates of interest. Other than such coping measures, risk- mitigation, whether through diversification in livelihoods or informal kinship-based arrangements, can be potential strategies. Opportunities for diversification are however limited for poor households, due to factors like lack of skills and assets required to start a new activity. Thus their mechanisms for risk mitigation consist mostly of adopting low-risk, low-return technologies, at the cost of income and productivity, or informal arrangements based on migration and participation in kinship-based networks for mutual support. There is however evidence to suggest that such informal arrangements, while common, are inadequate in protecting the poor, and are also likely to prove inadequate in the case of wider community-level shocks. The Role of Social Protection Lack of access of the poor to formal instruments for risk-mitigation and coping, along with the inadequacy and the costly nature of informal instruments, together provide the rationale for public intervention in some form in the provision of safety nets, credit and insurance. Moreover, vi government participation can be justified on the grounds of the public good nature of these programs, where the externalities generated cannot be internalized by any private institution. An important justification for public intervention in safety net programs, such as public works and cash transfers, has traditionally been redistribution undertaken with the goal of promoting equity and improving welfare of the poor. This paper argues that in the presence of uncertainty, the design of such redistribution programs should explicitly take into account the importance of reducing volatility in the context of their immediate impact. This is however not to discount the importance of redistribution programs that operate independent of a safety net objective, like transferring or creating assets or providing free health and education services for the poor, that should be an integral part of a long-term strategy to reduce poverty and vulnerability. In the context of an overall strategy, it will be imperative for each country to take into account country- specific factors to decide on an optimal mix of such programs that provide benefits independent of shocks, and social protection measures that directly target volatility. Acknowledging the varieties of vulnerability and the differences in conditions across countries, it is nonetheless possible to suggest a social protection strategy that seeks to reduce risk, rnitigate its impact and enhance the ability of the poor to cope with shocks. Many of the elements of such a strategy derive from such long-standing programs as targeted public works and targeted transfers to vulnerable groups, which can potentially provide risk mitigation and coping benefits. In addition, innovative microfinance initiatives that are spreading in South Asia appear to offer considerable benefits by providing access to credit. The informal mechanisms that drive the success of such credit initiatives can also be harnessed for providing a range of financial services, like savings and insurance, which act as instruments for risk mitigation. Finally, while public safety nets like public works and targeted transfers can provide risk and welfare benefits in the absence of adequately functioning financial markets in the short run, the long-tenn solution would lie in correcting imperfections in credit and insurance markets, particularly since there is evidence to suggest that market imperfections hurt lower income groups disproportionately. Elimination of market constraints can be achieved through institutional reforms, including liberalization of the financial sector along with the creation of regulatory mechanisms that promote transparency. Such reforms should take precedence over a policy of direct subsidization of credit and insurance by the government, which has largely proved to be a failure in South Asia. This is mainly because the information problems that limit private participation also tend to make government programs unsustainable; also, the nature of government support often distorts the incentives of both private providers and clients. In the short run, public support in insurance and credit should largely involve nurturing and providing institutional support to innovative mechanisms like microfinance that seek to circumvent information problems by the use of informal networks on the one hand, and undertaking financial and regulatory reforms to facilitate market mechanisms on the other. In deciding which programs are most likely to prove effective, it will be necessary to lay some analytical groundwork. Beyond identifying the most vulnerable populations in each South Asian nation, such inquiries should seek to classify the risks that threaten different vulnerable groups or kinds of poor households according to their incidence and severity, an exercise attempted in Chapter I. A companion effort would produce detailed evaluations of both the risk-reducing impact of existing anti-poverty programs and the performance and potential of less traditional approaches such as microfinance, issues addressed by subsequent chapters. vii Targeting Vulnerable Groups: Widows and Children The fact that widows and working children are among the most vulnerable in most South Asian countries should shape the priorities of policy-makers. While there is evidence, albeit indirect or anecdotal given the paucity of data, of the special vulnerability of widows in most South Asian settings, it receives inadequate attention from current public policy. Even safety net programs that do exist, like the long-running state-government pension schemes for women in India, leave much to be desired in terms of coverage and impact. Responding to the weaknesses of official programs, grassroots organizations have developed imaginative measures for insurance, social assistance and legal support for widows. As a foundation for action to reduce the vulnerability of widows, there is a need for governments to evaluate both the adequacy and the accessibility of existing safety-net programs. In cooperation with innovative NGOs, moreover, public efforts should aim at enabling poor women - and poor widows in particular - to exercise guaranteed legal rights and employ effective savings and insurance instruments to reduce the risks they face. A social protection strategy that seeks to integrate efforts to reduce risk and poverty at the same time must also take into account the problem of child labor. Conservative estimates put the number of such working children in the region's five countries at 20-30 million, the largest concentration in the world. Although definitions of child labor vary and sweeping statements about the problem must be suspect, the need to supplement family incomes during times of stress is clearly an important reason behind children going to work rather than school. At the same time, the problem is attributable to the interaction of a complex range of factors that goes beyond economic factors, like the lack of access to quality education leading to perceived low returns to education vis-a-vis work, and social and cultural mores. A strategy to reduce child labor must therefore adopt a holistic approach that addresses the full range of complex issues involved. While some progress has been made in prohibiting hazardous working conditions for children, South Asian governments have mostly been unable to institute enforceable bans on child labor. What seems to be necessary is a combination of policies that include social protection and poverty reduction programs that reduce the household's need for the child's earnings on the one hand, and measures to increase demand-side incentives for schooling (such as targeted enrollment subsidies, and increasing the availability of quality schooling) on the other. The few isolated instances of success in addressing the problem of child labor in South Asian countries have mostly been a result of community-based efforts, or partnerships between NGOs, government and private initiatives, involving intensive efforts to create awareness and on inducing gradual transition from work to school. Examples of such efforts are discussed in detail in Chapter II. Assessing Government Programs While it is true that strategies need to speak to specific country situations, some of the most important policy mechanisms have mitigating and coping impacts on a wide range of risks present in varying degrees throughout the region. Recognizing the wide-ranging impact of such policy mechanisms, Chapter III of the paper evaluates the role, impact and potential of the ones that are conmmonly used by governments in the region. Public Works: Workfare programs, traditional mechanisms in South Asia and elsewhere for boosting the income of the poor through short-term employment can be purposefully designed to address vulnerability in the aftermath of community-wide shocks and seasonal downturns. What has proved problematic is ensuring that the programs actually target the poor and the vulnerable. Only if such public works are properly sited and timed, and if jobs can be distributed to match demonstrated need, will the assistance reach the target clientele efficiently. The benefits of the viii program can also be directed towards the target population if the wages are kept low enough to ensure self-selection by the needy into the program. Bangladesh's 26-year-old Food for Work (FFW) and companion Test Relief (TR) programs achieve a measure of self-selection by distributing wheat, considered an inferior grain, as payment in kind at less-than-prevailing agricultural wages. The Employment Guarantee Scheme (EGS) introduced by the Maharashtra state government in India in 1972 began as drought relief but has expanded to entitle all able-bodied adults in rural areas to unskilled jobs. Apart from stabilizing incomes during periods of low employment, EGS helps in mitigating the risk of labor market shocks and harvest failures, primarily by credibly guaranteeing work during times of need. Another large public works program in the region, India's countrywide Jawahar Rozgar Yojana (JRY) scheme, is targeted by time (the off-season) as well as geography (districts measured for their socio-economic backwardness). Unlike the EGS however, JRY's success in reaching poor households is very much open to question. But while the average transfer benefits from the program are low, consumption smoothing benefits may be considerable because of the timing of the program. Evaluating these public works programs with the emphasis on their place in a social protection strategy, it seems clear that for risk mitigation, programs that are continuously available and capable of emergency expansion produce the highest benefits. Local market levels should play the decisive role in setting wages for unskilled labor with the understanding that higher payments may bring higher transfer benefits, but at the expense of precision in targeting the poor and desired labor intensity. Payments in kind that improve self-selection by the poor also carry higher costs that may outweigh the advantages. Also, as with most other existing programs, evidence on the impact of public works programs on vulnerability is inadequate, making further studies on the subject imperative for more detailed analysis. Finally, while public works are important mechanisms to reduce vulnerability, such programs do not reduce vulnerability from all sources, nor are they able to reach all vulnerable groups, like the old, the infirm and children. Other programs are thus needed to complement the role of public works, and targeted transfers in cash or kind is an important class of such programs. Transfers in Cash or Kind: As entrenched in government social policy as public works, various means-tested social assistance programs in South Asia seek to make direct transfers to the poor through old-age payments, child allowances, subsidies and waivers for basic services and targeted human development programs. Taken together, the transfers represent short-term palliatives for vulnerability and poverty. In many cases however, the programs' targeting efficiency and impact on poverty are in doubt. Whether they mitigate risk, moreover, is an open question that is yet to be addressed substantively in empirical evaluations. Pakistan's 20-year-old program of redistributing wealth through Zakat and Ushr taxes is yet to reach more than two million beneficiaries in any year in a country where many more live below the poverty line. Only about half of the direct payments being made, moreover, go to the poorest of the poor, those in the lowest expenditure quintile. Targeting problems are also apparent from available evaluations of Sri Lanka's Samurdhi program, a large proportion of which consists of direct transfers in the form of food stamp grants. Under the circumstances, while existing government public works and cash transfer programs can be seen as important mechanisms of social protection, laying the foundations for a comprehensive social protection strategy that addresses poverty and vulnerability together would require a broader range of initiatives and reform of many of the existing ones. Facilitating innovative microfinance schemes that use group-based and other form of informal mechanisms to provide credit services would be a crucial element of such a strategy. ix Microfinance: The spread of microfinance in recent years in South Asia offers important lessons. As of 1997, microfinance institutions in the region had $900 million in 2.8 rnillion outstanding loans. Group-lending schemes, used by 93 percent of microfinance institutions in South Asia, are often able to circumvent the common sources of market failures, namely adverse selection and moral hazard, associated with conventional lending. By relying on peer pressure and the social information that the poor have about each other to monitor and enforce contracts, group-based lending provides incentives for borrowers to repay and improves selection of borrowers. The evidence on the poverty-reducing impact of microfinance is however inconclusive - targeting has not been universally successful, and studies have documented barriers to participation in programs for the very poor. Moreover, a large proportion of microcredit loans seem to be going towards consumption smoothing - particularly for extreme poor households - instead of productive investment. In the absence of alternate forms of insurance, use of microcredit for consumption smoothing helps to reduce short run vulnerability, and is especially crucial for the extreme poor. However, credit used for non-investment purpose does not generate income, suggesting that for the poorest microfinance borrowers, consumption smoothing often occurs at the expense of long run improvements in economic status. Finally, the cushion that microcredit provides may prove highly inadequate if disaster strikes a whole community or, as in the 1998 Bangladesh floods, almost an entire nation. The vulnerability of the smaller microfinance institutions themselves to such calamities suggests the advisability of creating a separate disaster fund to tide the lenders through such widespread adversity. The tradeoff between the long-term objectives of microfinance and its short-term use for consumption-smoothing suggest that providing alternative means of risk mitigation to the poor, for example in the form of access to insurance and saving schemes, can help microfinance achieve its long-term poverty reduction objectives. Such programs can be based on principles similar to those microcredit rely on, namely the use of informal social networks and local knowledge to circumvent information problems and mobilize support and awareness. Also, the fact that insurance provided by microfinance is inadequate against covariant shocks also underscores the importance of devising alternate insurance mechanisms specially designed for such risks. Chapter IV explores some of these relatively new directions in social protection. Innovative Programs for Saving and Insurance Services Savings can be a valuable instrument for risk mitigation and coping among the poor. While early microfinance programs were not effective in mobilizing savings, since it was thought that the poor are too poor to save, recent experience has shown that even poor households are eager to save if provided with safe, flexible and accessible accounts and attractive interest rates. Institutions like Safe Save in Bangladesh have been able to rely on the savings they mobilize for a majority of their credit activities, thus moving close to self-sustainability. Key to the success of these institutions in mobilizing savings from the poor is their ability to organize communities at the grassroot level, while decentralizing key elements of decision-making to groups within communities, which has led to ownership and commitment. Another equally important instrument for mitigating and coping with risk, namely insurance, has been largely absent or ineffective for the poor. In rural areas, insurance programs have mostly been limited to crop insurance schemes to address harvest risk. Commercial crop insurance have had little impact - the rural poor comprise largely of either the landless or farmers who do not grow the crops that are usually insured, and most commercial banks focus on large commercial farms rather than on smaller holdings or riskier clients. A strong rationale for large-scale public intervention in crop insurance is that such schemes can pool risks at a national or regional level, and therefore also be able to insure riskier clients like poor farmers. However, public crop x insurance in most countries in the region has proved to be not only unsustainable due to high costs, but also largely ineffective, due to a number of factors: lack of institutional capability, information problems that lead to moral hazard and adverse selection among clients, and distorted incentives for insurers due to availability of public funds to fall back on. While some public subsidies will no doubt be necessary for successful crop insurance, in order to be sustainable such schemes must operate on a commercial basis - focusing on insurable risks and calculating premiums based on actuarial data - and deny insurers automatic access to funds to cover losses. In the near-absence of formal insurance against idiosyncratic risks faced by the poor, innovative attempts by community-based initiatives - often associated with microfinance institutions - have developed to provide coverage in the areas of health, life and asset insurance. Too recent to be definitively evaluated, insurance programs like Grameen Kalyan in Bangladesh and the program run by the Self-Employed Women's Association in India have indicated the potential role and sustainability of such initiatives. While the insurance products provided by these schemes are formal in nature, the delivery of products is carried out through organization at the community level, facilitated by the trust created by the existing relationship between the institutions and their clients. The full potential of community-based innovations can be realized if they are incorporated in the overall social protection strategy, which would help in replicating so far isolated efforts on a larger scale. The government's role in such a strategy would be to play the role of facilitator, through creating the right institutional framework, facilitating linking of microfinance institutions to markets, and contributing in initial financing if necessary. The problems with traditional publicly funded crop insurance programs demand innovative solutions; one could be area-based index insurance contracts, where contracts are written against specific perils or events, like loss in average yield in the area, drought or flood, that are defined and recorded at a regional level. Insurance is sold as standard contract for each unit purchased where buyers are free to purchase as many units as they want to. Some of the attractive features of such schemes are low cost of administering, ease of marketing, affordability for the poor, and low moral hazard problems. Above all, it can be a sustainable way of insuring the rural population against covariant risks. However insuring against covariant risks also exposes the insurer to the risk of having to pay out huge indemnities at some instant; international financial markets can play an important role in hedging against such risk through mechanisms like reinsurance. Although private provision of such insurance should be the goal, public intervention may be needed in South Asia to provide the initial impetus, possibly in areas of credibly monitoring natural events, financing and creating regulatory framework. If the systemic correlated risk faced by an individual is eliminated through index based contract, the only remaining risk the individual faces is of the idiosyncratic kind, which can be more easily insured through conventional insurance or credit markets, as well as through community-based mechanisms described above. Thus all the different mechanisms described above fit into an overall strategy of insuring the risks of the poor. Pension Reforms The elderly among the poor are an especially vulnerable group, and any social protection strategy should address their risks explicitly. On the face of it, formal pension schemes in South Asia are unlikely to have great impact in reducing the vulnerability of the elderly poor. Such measures (based on evidence from India) are estimated to cover less than 10% of the region's workforce, largely excluding the informal sector, where the overwhelming majority of the poor earn their livings. Even where pensions are available to working contributors, poor households are more likely to seek to shield themselves against the immediate perils of health, harvest and unemployment risks. xi As discussed in Chapter IV, with significant reforms, that picture could change. A recent study of India's system underscores the need to develop a multi-pillar structure that would provide publicly funded benefits to those in need of social assistance, and participant-funded plans that define contributions for distribution after retirement. Where financial markets are experiencing on-going deregulation, as in India, opportunities are opening up for the creation of a competitive pension sector. At the lower end of the income scale, the work of informal savings, credit and insurance institutions also creates new possibilities for social assistance to serve the elderly poor. Towards a Comprehensive Strategy for Social Protection This report underscores the interdependence of poverty and vulnerability, and argues the need for a comprehensive social protection strategy that can address both. Although it is not possible to give a detailed blueprint for such a strategy, the broad building blocks that would underlie it are identifiable, as detailed in Chapter V of the paper. Designing a strategy should involve analytical assessment of specific kinds of risks and institutional arrangements relevant to each country, before an optimal mix of country-specific policies can be decided on. The country-specific strategies must have a poverty focus, given the close and mutually reinforcing relationship between poverty and vulnerability in the region. Moreover, the strategies should be informed by evaluations of existing forms of public and private (informal and formal) risk-mitigating and coping mechanisms in each country, that can generate suggestions for strengthening existing programs and expanding promising initiatives. Briefly, the design of an optimal strategy for each country would involve (a) identifying the priorities in terms of vulnerable groups and specific risks, (b) deciding on the combination of instruments to be used, (c) setting goals for the programs, and (d) developing an implementation structure, identifying strategic partners on the ground. The review conducted in this paper also suggests some essential elements of a social protection strategy that are broadly applicable to the region as a whole. These elements, outlined below, must then be modified and adapted for specific country needs, as well as the institutional capability of individual countries. Strengthening Risk-Mitigating Options: Institutional reforms that promote and expand market opportunities, backed by a regulatory environment that induce competitive behavior, are intrinsic elements of a long-term social protection strategy for all countries in the region. However, such institutional changes will take time to have their desired effect. Meanwhile, given the prevalence of risk and vulnerability in the region, it will be imperative for governments to incorporate measures that provide risk management options in the immediate future. As suggested by this paper, the options range from expanding and strengthening existing options in public safety net programs, including public works and targeted transfers, to building on recent successful experiences with community-based instruments like microfinance. The review of existing government, private or community based options in this paper provides some guidelines to improve the functioning of such programs as safety nets, and also helps identify the possible role that public policy can play in facilitating the expansion of informal, community-based initiatives. The medium and long-term strategy for social protection in each country must include broad- based institutional reforms that create market opportunities to promote growth and facilitate formal mechanisms for risk management. Such reforms will also allow informal initiatives like microfinance institutions to make use of market opportunities - crucial for their expansion and sustainability. Specific priority areas would be in designing comprehensive pension reform to mitigate the risks of old age, and creating the right regulatory environment to help reduce information problems in financial markets. Equally important will be to design insurance to address covariant or community-wide risks. In the light of the failure of subsidized crop insurance schemes in the past, index-based insurance, which by design reduces transactions cost xii and moral hazard problems, may help mitigate some of these covariant risks. Finally, poverty- reducing interventions, even when they do not address risk management directly, are important long-term measures for reducing risk. One example of such intervention would be initiatives to improve income diversification opportunities for the poor, by expanding access to credit, training, and extension services. Strengthening Risk-Coping Options: Since a large number of risks cannot be wholly eliminated, a social protection strategy must also focus on providing risk-coping options. This is especially true in the case of such covariant shocks as natural disasters, where most insurance mechanisms, formal and informnal, tend to fail. A proper disaster-management strategy, planned in advance and implemented promptly, would help in coping with such shocks. The strategy must develop mechanisms for immediate and widespread relief efforts in the event of the disaster, as well as for addressing the more long-term needs of the affected people, in the form of assistance to rebuild their homes and livelihood. Public works programs can play an important role in providing livelihood, while helping in the process of rebuilding communities and infrastructure. Integrating Social Protection into the World Bank's Program in South Asia The principles outlined so far should guide the Bank's involvement, along with partners in respective governments, in designing social protection strategies for individual countries in South Asia. There is also a need to integrate social protection objectives in analytical work conducted by the Bank to underpin the development strategy for individual countries, as well as in specific programs undertaken by the Bank in various sectors. As a first step it will be important to assess the role of existing Bank supported projects, encompassing diverse areas including rural and social development, environment and infrastructure, in creating opportunities for social protection. Furthermore, given the mutually reinforcing relationship between poverty and vulnerability, there is a need to address issues of risk, vulnerability and social protection more exhaustively in country Poverty Reduction Strategy Paper (PRSP) initiatives than they have been so far. For this, country social risk assessments should be made an integral part of the background work for PRSP, possibly by having analytical initiatives like Public Expenditure Reviews (PERs) and Poverty Assessments explicitly address risk and vulnerability issues. Integration of social protection in operational work of the Bank on the ground can be achieved through a number of avenues. For example, Bank supported anti-poverty programs (e.g. Poverty Alleviation Funds) could be expanded to include financial instruments that can better deal with risk. The Bank can also have a role in providing financial and technical assistance for pilot initiatives of innovative programs highlighted in this report, like savings and insurance schemes using local, community-based institutions. Such endeavors should have a special focus on monitoring and evaluation, to help learn the best practices on the ground, in order to inform scaling-up of current efforts and future design. xiii I. Rationale For A Social Protection Strategy As articulated in the 1990 World Development Report, the World Bank's cornerstone for poverty- reduction policy rests on three critical elements: promoting growth to foster and expand opportunity, supporting investments in health and education to encourage human development and creating safety nets. Safety nets, however, are envisioned primarily as protection for the poor in times of macroeconomic downturns. Although implicitly recognizing some of the vulnerability that afflicts the poor in developing countries, the poverty-reduction strategy has not explicitly recognized a broad range of risks as a factor in poverty and in measures to combat it. Incorporating risk explicitly in a poverty-reduction strategy, however, is important -- evidence has shown that the poor suffer disproportionately from the consequences of various kinds of risk. Often left destitute by the consequences of a shock, the poor, moreover, lack access to formal instruments for mitigating risks and are thus compelled to conduct their affairs in ways that weaken their ability to break out of poverty. The problem is especially relevant to South Asia, where the majority of the poor are concentrated in the informal sector, mostly in rural areas, where formal credit and insurance markets do not penetrate. In such circumstances, traditional poverty reduction strategies that accord risk little more than indirect attention may not produce the desired results. In recognition of this reality, the recent World Development Report (World Bank, 2000) has defined the three pillars of a poverty reduction strategy as opportunity, empowerment and security. This strategy paper for South Asia focuses on security concerns, going beyond the traditional approach toward reducing poverty to develop a social protection strategy dedicated to the objective of mitigating and coping with risk. In doing this, the paper draws from the discussion in the Social Protection Sector Strategy paper (World Bank, 2001), applying the insights and framework developed there to the specific context of South Asia. Poverty and Vulnerability in South Asia South Asia is home to the largest number of the world's poor. While the incidence of poverty as defined by head-count ratio has shown some decline in all South Asian countries over the years, a sizable proportion of the population in all the countries still live in poverty (Figure 1). In spite of growing relatively well over the recent decade, per capita GNP (with Purchasing Power Parity or PPP) of all countries and for the region as a whole remains low and is but a small fraction of that for middle-income countries (Figure 2). For a majority of countries in the region, average annual growth of GNP (at PPP) over the period 1989-99 has been higher than that in 1979-89, and has surpassed average rates for low- income and middle-income countries (Figure 3). In spite of the general improvement in growth, according to some evidence that is by no means conclusive, the pace of poverty reduction has slowed down in most countries in the region in recent years. Poverty estimates like head-count ratio can however represent only the static status of poverty, and not its dynamic aspects, namely the fluctuations in income, consumption and general well-being of the poor, as well as the cause and impact of these fluctuations. Recent research using longitudinal household survey data has shown that poverty is often a temporary phenomenon, with a large number of households moving frequently into and out of poverty due to transitory shocks such as illness or loss of employment. A 9-year panel survey of households in south Indian villages found that movements into and out of poverty were the norm for most households - only 20 percent were poor throughout the period, while only 12 percent were never poor. Figure 1: Head Count Ratios with National Poverty Lines (for latest available years) 45 40 35- 30- ~25- 820- 15 10 5 0 Q)U~~~~~~~) ~~~Co C X~~~~~~~~~~~~~Y c 1L. 0) CD ~ ~ ~ ~ ~ ~ ~ ~~) coC m0 7 co ~ ~ ~ ~ ~ 'Co Q . CD a)~~~~~~( co Figure 2: Per Capita GNP at Purchasing Power Parity in 1999 5000- 4000 - O 3000- a. 2000 - 1000 s - . aE m cn , i) v ca) O) a) Z~~~c ZmC)4- .. 0)